by Calculated Risk on 3/10/2007 02:12:00 PM

From Annette Haddad and E. Scott Reckard at the LA Times: Loan turmoil closes doors for buyers

Many would-be home buyers, and homeowners who want to refinance, are finding that virtually overnight their status has changed: They no longer are eligible for the kind of easy-credit loans that helped millions of people join the ranks of property owners during the housing boom.

This is an excellent summary article of the events of the last few weeks. It does seem like an "overnight change"!

A key concern: whether the problems of sub-prime lenders and borrowers could drag the economy into recession by causing a broader credit crunch.

Many economists, as well as Fed officials, say they don't believe that sub-prime borrowers account for a big enough share of the housing market to have a dramatic effect on the economy.

First, the problems in the sub-prime segment alone could be large enough to significantly impact the economy. As the LA Times article noted, 21.5% of all mortgages in 2006 were sub-prime. Some estimates are that about one fourth of all sub-prime borrowers will be locked out the market in 2007. That would represent 300K or more potential home buyers.

And the problem is much worse because of the dynamics of the housing market. Each first time home buyer (and many sub-prime borrowers are first time buyers) is the start of a mini-chain reaction in the housing market. As an example, when a first time buyer buys a home, the seller buys a move-up home, then that seller buys a larger home, and that seller buys a Toll Brothers' McMansion. The loss of one sub-prime borrower may result in the loss of several sales. The loss of 300K buyers will be in, the words of Bear Stearns' Dale Westhoff, "non-trivial".

And second, the problem is already spreading to Alt-A and will probably impact many prime borrowers - especially the borrowers that used non-traditional mortgages, like option ARMs, as "affordability products".