How We Got Here: It's Housing, Stupid

Long time readers know that I have been talking about the collapse of the U. S. housing market for many months and had predicted that the ripple effect and larger impact on the U. S. economy would be huge. Time and events have proved me right. Unfortunately, as yet there seems to be no consensus as to how to stop the market deterioration from further worsening. Meanwhile, John "Twelve Homes" McSenile still has not grasp the depth of the problem as he claims the "fundamentals of the economy are sound." CNN Money has a story that looks at the way the housing collapse has fueled so much of the current economic free fall. Here are some highlights"

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NEW YORK (CNNMoney.com) -- The nation's financial system is in the midst of a massive shakeup and many on Wall Street and in Washington are pointing fingers and looking for someone to blame. But in the end, it all comes back to one issue - housing.

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Earlier this decade, it was much easier to get a mortgage. Home prices soared about 85% from 1996 through 2006 in inflation-adjusted dollars, creating a bubble. Then the bubble popped. And the fallout isn't over yet, experts say. In the past two weeks, the government took over Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500), Lehman Brothers (LEH, Fortune 500) filed for bankruptcy and Merrill Lynch (MER, Fortune 500) sold itself to Bank of America (BAC, Fortune 500).

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None of this would have happened if the housing market had not imploded, leaving all these firms with staggering losses from their investments tied to mortgages. "These institutions, which weathered all kinds of calamities before, including depressions, are being knocked out," said Lakshman Achuthan, the managing director of the Economic Cycle Research Institute. "It's a testament to the significance of the problem we have here."

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But because of the depth of the housing problems, it may take a long time before real estate prices head higher again. Here's why. Home prices, while sharply off from the 2006 peaks, are still high in comparison to long-term gains in income, rents or overall prices, suggesting that they still have a way to fall, according to experts.

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The reason housing is wreaking havoc even on insurers like AIG and big investment banks, who do not make mortgage loans, is that during the boom, trillions of dollars of mortgages were packaged together into securities that promised to pay investors with the proceeds of those loan payments.

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This credit crunch in of itself slowed the economy, leading to job losses and more defaults, feeding a downward spiral that has been difficult to stop. "A really bad situation -- a home price bubble bursting -- was made significantly worse when the recession began," said Achuthan. "Now we have to let this thing play out."

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So even with perhaps hundreds of billions of tax dollars going to AIG, Fannie and Freddie, one expert said the only real solution to the housing problem is for the correction in housing to finish running its course. "We want home prices to return to normal," said Barry Ritholtz, CEO of Fusion IQ and author of the upcoming book "Bailout Nation."