by Calculated Risk on 3/12/2007 01:29:00 AM

From the WSJ: Subprime Fallout May Not Infect Broader Market

As more financially stretched homeowners renege on their debts ... economists are surprisingly sanguine about the broader economy's ability to weather the storm. ...

... the market for "subprime" mortgages -- home loans made to people with poor or sketchy credit histories -- has unraveled with impressive speed and intensity. ...

So far, though, many economists -- including Federal Reserve Chairman Ben Bernanke -- haven't changed their forecasts as a result of the subprime troubles. ...

"No doubt some of the worst practices of the housing boom are going to yield some payback," says Steve Wieting, senior U.S. economist at Citigroup in New York. "But it's not large enough to derail an otherwise healthy economy."

It's amusing that the article quotes Citigroup, the poster child for overly optimistic housing forecasts.

... The main reason for economists' equanimity: Those who took out subprime loans tend to be less-affluent consumers who make up a relatively small share of consumer spending, the most important driver of the U.S. economy. ...

This seems reasonable if you make two assumptions: 1) the problems will stay in subprime, and 2) there will be little impact on the housing market from the subprime implosion. The first is possible, the second is not.

Then the WSJ article notes that housing supply will increase and demand will fall:

... the pullback in credit for subprime-mortgage borrowers could have a meaningful effect on its own. As some potential home buyers find it harder to get money and more bad loans beget more foreclosures, the decreased demand and increased supply of homes could depress prices, deepening the housing slump.

And what will be the impact on the economy of the deeper housing slump? The article doesn't take the next step, so I will: there will be significant housing related job losses, and slower growth in consumer spending since homeowners cannot borrow against their homes (less Mortgage Equity Withdrawal or MEW). It's probably a coin-flip if these problems will take the economy into a recession in 2007.

I'm definitely less sanguine than most Wall Street economists.