A highflying housing market has been one of the primary drivers of the U.S. economy for the last several years. It has supplied one third of all the jobs created since 2001—including jobs for builders, bankers, realtors, building suppliers, and many other dependant industries. In addition, skyrocketing home prices have enabled homeowners to extract equity from their homes just like using an atm machine, also boosting consumer spending and the economy.

Therefore, it is chilling to note that housing prices look like they are about to fall off a cliff.

As we mentioned yesterday, record numbers of homes for sale are putting downward pressure on home valuations. Making the excess supply issue worse is the fact that demand has been dropping as well.

There are several reasons behind the recent lack of demand for homes, but most of them can be summarized by reduced affordability. Affordability continues to worsen and is being squeezed by house prices and interest rates, says pimco’s Scott Simon. “That is a bad combination.”

Due to the “unprecedented run-up in housing prices over the past decade,” housing has become so expensive in many areas that people have been simply forced out of the market. Since 1999, the total amount of residential housing wealth in the United States has doubled from approximately $10.4 trillion to $20.4 trillion (Counterpunch, August 30). Stated another way, the $10.4 trillion which was the total value of all property developed from the founding of the nation to 1999, doubled in value in just the last seven years!

Mortgage rates have also spiked over the last year and a half. According to pimco, as typical long-term mortgage rates have moved from the 5 percent range to the 6.5 percent range, it means that on a 30-year mortgage, you end up paying 30 percent more for the same house. If you are a new buyer, and the house you want to purchase has appreciated 20 percent over the last year, if you factor in today’s 6.5 percent rates, you will be paying about 50 percent more for the house than the person who bought the house one year ago at the 5 percent interest rate.

Meanwhile, as house prices and interest rates have risen, consumer wages have actually fallen further behind. In fact, inflation-adjusted wages are lower today than they were 30 years ago. Bureau of Labor and Statistics data show that “average hourly wages were $15.72, adjusted for inflation, in 1973, but down to $14.15 in 2000,” according to Retail Traffic, and “[s]ince then wages have stagnated.”

Reduced affordability due to rising mortgage rates and to flat or falling wages has started to take a negative toll on homeowners. The clearest manifestation of this is the upsurge in foreclosures and mortgage defaults. In August alone, 115,292 properties entered into foreclosure. That was 24 percent above the July level and 53 percent more than a year ago, according to RealtyTrac, an online marketplace for foreclosure sales.

Foreclosure rates in Florida, California and Nevada are among the worst. In Florida, foreclosures in August were 62 percent higher than the previous year, while in California and Nevada, foreclosures were up a whopping 160 and 255 percent respectively over one year ago (ibid.).

Rick Sharga, RealtyTrac’s vice president of marketing, blames the rising wave of foreclosures largely on rising monthly payments for adjustable-rate mortgages (arms). Typically, arms have low introductory interest rates that, if interest rates rise, can head higher after an initial period.

By some estimates, $2.7 trillion of arm loans are set to adjust to higher rates throughout 2006 and 2007 (Comstock Partners, September 14). “[W]e’ve never had a situation like this,” with so many adjustable-rate mortgages coming due, says Sharga. A typical $300,000 arm taken out in 2003 at 4.6 percent would this year reset to approximately 6.6 percent. Financially, that translates into a payment jump of $327 per month, including the possibility of future increases each year of up to 2 percent—that is, even bigger jumps in the monthly payment (New York Times,September 24).

Approximately 25 percent of all existing loans are adjustable, but some say the number of adjustable-rate mortgages in pricier areas is much higher. Steven Schnall, the president of the New York Mortgage Company, for example, says that in New York, arms represented 57 percent of total loans (ibid.).

With all the arms coming due over the next couple of years, there is obviously the heightened possibility that increasing numbers of people will no longer be able to afford their mortgage payments.

Compounding the affordability problem is the fact that over the past few years, mortgage brokers have reduced lending standards. While this has allowed people who normally could not afford to purchase homes to be able to, it has also increased the risk of more mortgage defaults and bankruptcies.

In one example of reduced lending standards, many lenders no longer require that the income statement of the loan applicant be verified. When housing prices rise, it is not important to the loan provider whether or not the owner can afford his mortgage, because if the owner defaults, the house can always be sold to cover the loan. For similar reasons, people have also been allowed to purchase homes without even having a down payment. Forty-three percent of first-time home buyers in 2005 put no money down.

All this means trouble if house prices fall, and/or payment rates rise. Clearly, a person struggling to make mortgage payments, and who also has no down payment invested in his house, is far likelier to just walk away from his mortgage—especially if house prices fall and he ends up owing more for the house than it is worth. Already, 15.2 percent of 2005 home buyers owe at least 10 percent more than their home is worth.

The plethora of data now available concerning slowing home sales, increased home inventories, decreased affordability due to rising interest rates and falling real wages, ballooning mortgage default and foreclosure rates, and rapidly slowing or negative price appreciation, certainly suggests that the U.S. housing market may be at a breaking point. But what does that mean for the national economy?

The Guardian Observer says, “Fears are mounting that the ‘orderly’ housing slowdown predicted by the Federal Reserve will become a full-blown crash.”

If home prices stop rising so quickly or actually fall, home equity withdrawals will slow too. Consequently, consumer spending could drastically drop.

During the first quarter of 2006, lending agency Freddie Mac showed that 88 percent of refinancing was for equity take-out—the highest it has ever been. But here is the key: In 50 percent of the cases, the homeowner refinanced into a higher rate to take out equity. People were willing to commit themselves to higher interest-rate payments just to get out chunks of cash. In other words, people are literally using “their houses as an atm machine,” says Scott Simon.

“They’ve been using their houses as pocketbooks,” agrees Jack Plunkett, ceo of Plunkett Research, a market research firm in Houston. Some estimates suggest 33 percent of the billions of dollars consumers obtained from their homes through home-equity refinancing has gone to consumer spending. Not spent on home improvements that would increase the value of the property—just spent.

Reduced consumer spending due to falling home prices could have a significant effect on all Americans, especially since approximately two thirds of U.S. economic activity is wholly dependant on consumer spending.

If 30 percent of all jobs created since 2001 came as a result of a housing industry that now looks set to collapse, and two thirds of the U.S. economy is dependant on consumer spending—which is largely dependant on rising house prices, which are decelerating—perhaps you can see why the Trumpet has been warning readers to prepare to reduce their standard of living. If housing goes down, the rest of the economy could quickly follow.