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The mortgage crisis was clearly one of the dominating catalysts of the recent economic fiasco. While many other factors contributed, this was one of the most visible and visceral to most people. Thus many people, particularly homeowners, are now wondering whether they can breathe a sigh of relief.

How Did We Get Here

By now we’re largely aware of the underpinnings of this crisis. Demand for securitized debt led to tremendous demand for mortgages. This demand led to lowered lending standards, which led to tremendous demand for housing. The demand for housing led to soaring housing prices. When those with the least capacity to pay their loans, who incidentally had the most onerous terms to their loans, couldn’t make their house payments, the whole house of cards came down. Foreclosures led to dropping housing prices, which led to more defaults, which continued the cycle.

The Subprime Crisis

During all of this we were told the mortgage crisis and the subprime crisis was one and the same. Many people equate the end of the subprime problems with the end of our troubles in general. This leads us to wonder if the subprime crisis is truly over. Signs suggest that this is the case. After huge surges, the default rates on these loans have come down sharply, leading many to suggest that the crisis is over. Of course, that depends on which crisis you’re discussing.

The Real Crisis

Subprime loans may very well be dropping in their defaults, however that statistic neither creates an increase in demand nor says anything about the impending wave of defaults in other types of mortgages. Falling home prices put everyone underwater increasing the chance of defaults across the board. Although many people who bought houses during the boom bought them with subprime loans, many more did not.

Defaults lead to a vicious cycle. The owner of the mortgage immediately wants to sell the property, which increases supply, which lowers prices, which leads to more defaults. Given that the subprime section of the crisis seems to be subsiding, the question becomes: What makes us think this process is not about to repeat itself?

Option-ARM mortgages are currently getting a lot of media attention. These are loans that have a low introductory payment, however over time that rate can be adjusted. While Option-ARM mortgage holders may not be as likely to default during their introductory period, when their rates go up and they’re already underwater default rates are sure to climb. While many stories are currently in circulation about this segment of the market, it small compared to Alt-A and Prime mortgages.

While the Option-ARMs may further the cycle this cycle seems sure to repeat in Alt-A and Prime mortgages as well. Even though these loans were made to fairly safe lenders, due to the crash, they frequently owe more than their house is worth, are possibly out of a job and very likely facing a weak housing market. If we look at Alt-As by vintage, we see soaring rates for those made in later years. Prime mortgages with similar vintages see a similar curve, just starting later. With all of this evidence and the relative size of the markets, it seems highly premature to suggest the worst is over.