1) foreclosures are skyrocketing in CA- up 800% in the past year
2) institutional investors who hold mortgage backed securities are obviously not happy about this. They want to get paid, and they increasingly are not.
3) because of the ever increasing risk of not getting paid from foreclosed homeowners, the institutional investors grow weary of MBSs. They begin to demand higher returns since their investment is riskier now than when prices were rising
4) Mortgage originators, e.g. Countrywide, IndyMac, etc. have trouble selling their bundles of mortgages on the secondary market to institutional investors for reasons described in #3
5) In order to be able to sell their mortgages on the secondary market, the originators have to charge borrowers higher interest rates. The higher rates will attract institutional investors who backed off due to the increasing risk in the market.
Basically it boils down to risk/reward. With risk increased (more foreclosures), investors will demand greater reward, and the market must comply.
Now it becomes a vicious cycle- the higher mortgage rates push home prices even lower, causing more foreclosures, which adds more risk to big investors who now demand even higher interest rates for the additional risk, which push prices lower…..
I’m pretty new to RE so I was hoping some resident Piggs could examine this thought train and point out if/where I’m missing anything.
In a strictly supply/demand driven world credit contraction would have a corresponding effect on interest rates, they should go up. This isn’t a supply and demand driven world though. Quite often the reasons for liquidity are more political than economic and therefor not amenable to that type of analysis, at least by itself.
The Chinese aren’t loaning us money, nor were the Japanese before them, becuase they like us. They are doing it to keep their exports stable. When they judge this no longer profitable they will stop, but that’s not an economic calculus, its political.
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