This post first appeared on Minyanville.

It’s the government, stupid.

As Washington expands its role in managing the day-to-day operations of American business, companies are increasingly turning their strategic focus to tapping federal cash and lending programs. And despite the strings often attached to government money, many are finding that Uncle Sam is the only game in town during these troubled economic times.

This morning’s Wall Street Journal highlights just how essential lawmakers and regulators have become in America’s new breed of government-directed capitalism. Hunting retailers, farm-equipment manufacturers, and, of course, banks (Bank of America (BAC), Citigroup (C), Wells Fargo (WFC)) and insurance companies are all sidling up to the government trough.

And even as public opinion slowly turns against bureaucrats’ massive intervention into the private economy, Washington insiders are raking in piles of cash. According to the Journal, spending on lobbyists in 2009 could reach $3.3 billion, equal to the total during the 2008 election year. And for good reason: Without representation in Washington, companies just can’t compete.

After the financing arm of Deere & Co. (DE) tapped the FDIC to guarantee $2 billion in debt last December, the Equipment Leasing and Finance Association, a trade group, leapt into action to protect other members. Deere rivals, including Caterpillar (CAT) and a host of smaller firms, weren’t eligible for government-supported debt issuances, so the group’s president asked the Federal Reserve to expand the Troubled Asset Lending Facility to include sales of farm equipment and other machinery.

The Fed acquiesced; the agricultural industry must also be too big to fail.

But not every company has the ear of the Washington power brokers, leaving those forced to go it alone at a distinct disadvantage. Credit is already precious for small businesses, and what little they do have is far more expensive than that of their larger, better-connected rivals. This doesn’t bode well for an economy struggling to drag itself out of recession, since small businesses account for the lion’s share of job growth on the other side of a downturn.

The eventual recovery, which a growing number of optimists predict is just around the corner, could yield a bitter pill for corners of the economy still heavily dependent on government handouts. Although lawmakers vow to support systemically vital companies and industries for as long as needed, at some point Washington must try to take back what it has so generously given.

Witness the market for home loans, where government purchases of mortgage-backed securities have helped keep rates abnormally low. Even without the Fed dumping its Fannie Mae (FNM) and Freddie Mac (FRE) bond portfolio onto the market, rates have risen sharply in the past month, threatening to forestall the nascent “recovery” in the housing market.

Were the Fed to pull back its support of the housing market, rates would skyrocket. This would be politically — not to mention economically — unacceptable.

And while the ideological debate rages over whether Washington bureaucrats are becoming too entrenched in the American economy, businessmen and -women still must get up each morning, head to work, and try to stay above water. And — insofar as lobbying for government money outstrips developing new technologies or innovating, producing and otherwise generating economic output — the economy suffers.

And green shoots or no, this economy already has enough cards stacked against it.

This post first appeared on Minyanville.

It’s starting to make economic sense to go green.

Last summer, with gas prices topping $4 per gallon and commodities of all kinds becoming more expensive, renewable energy advocates thought their day in sun — so to speak — had finally arrived.

Investors flocked to industry leaders like First Solar (FSLR) and SunPower (SPWRA), whose stocks leapt to new highs. On July 8, 2008, renowned investor T. Boone Pickens announced an ambitious plan to wean America off its dependence on foreign oil. Later that week, crude touched an all-time high of $147.02 per barrel.

Since then, oil — along the rest of the commodity complex — has plunged, dashing hopes that renewable energy would soon be as cheap, if not cheaper, than traditional, dirty fossil fuels. But now, with the economy in free fall and Washington scrambling to boost productivity, renewable energy has been taken off life support.

Part of the recently passed $797 billion economic stimulus package gives incentives to homeowners to adopt energy-saving appliances, solar panels and other eco-friendly add-ons. Increased tax credits for qualifying expenditures can reduce tax bills by thousands of dollars a year. The catch (and there’s always a catch when the government is involved): Benefits only arrive if you shell out big bucks for pricey green gear.

Tax credits are applicable on new expenditures, and since solar-panel systems run in the tens of thousands of dollars, the 30% tax credit isn’t exactly like socking money away in the bank. Still, green construction firms and solar panel installation outfits like Akeena Solar (AKNS) are eager snatch up new business.

Before the credit crunch and the ensuing financial meltdown, Akeena had actually partnered with Comerica Bank (CMA) to offer low interest loans for buyers of new solar-energy systems, a portion of which could be backed by the value of the home. Since monthly loan payments were easier to stomach than plunking down cash to buy a new system, these new lending programs could have made solar available to the masses.

But now that home values have plummeted and lenders are reticent to part with their precious dollars, such borrowing programs are nearly impossible to find. Still, for those homeowners intrepid enough to take the plunge, tax credits offer an attractive reason to get off the green fence.

While solar power isn’t as economically efficient as traditional electricity sources, the more money that’s pumped into new technologies — even if it’s through a combination of private and public investment — the sooner we’re likely to reach the parity solar advocates have been promising for decades.

And the sooner that happens, the better.

By ANDREW JEFFERY

This post first appeared on Minyanville.

Washington just doesn’t get it: We don’t want more debt.

While congressmen berating bank CEOs for their unwillingness to lend out their bailout money makes for a nice media clip, it reflects the growing disconnect between our elected officials and any semblance of reality. Not that the relationship was ever particularly close - but lawmakers are floundering for good press while the nation’s economic future slips further and further from their tenuous grasp.

Bloomberg reports American consumers are wary of taking on more debt, as expectations about eroding economic conditions are forcing people, to *gasp* make responsible decisions about their personal finances.

Bloomberg cites Midsouth Bancorp (MSL) president C.R “Rusty” Cloutier, who says that, despite aggressive marketing, town hall meetings, and $20 million in TARP money, Midsouth’s customers just aren’t taking out new loans.

This is the rejection of debt Professor Depew speaks of when discussing the structural deflation we’re currently experiencing.

Credit is based on trust. And while conventionally we view this relationship as one in which the lender must trust the borrower to repay his debt — at least to an extent that’s commensurate with the interest rate — it does go both ways.

As lenders like Citigroup (C), Bank of America (BAC) and Wells Fargo (WFC) are increasingly being painted as corporate marauders out to rape and pillage the American public, would-be borrowers are wary of putting their financial future in the hands of these men of questionable repute. And with credit-card companies rushing to alter terms, it’s no surprise consumers are reluctant to extend themselves further.

Still, lawmakers are pushing through an economic stimulus package that depends, in part, on a willingness on the part of consumers to keep spending. Their delusion is only outmatched by their hubris - the belief that a bunch of self-interested politicos can coerce the average American into making ruinous financial decisions for the betterment of the country.

Floundering industries — notably automakers and homebuilders — are counting on government subsidies to encourage Americans to keep borrowing to buy their products. But what General Motors (GM), Ford (F), Centex (CTX) and KB Homes (KBH) don’t understand is this: We just don’t want what they’re peddling. And we certainly don’t want to borrow against it.

The transition from a debt-dependent, credit-drunk consumerist society won’t be immediate: It’s taken 18 months of financial panic for evidence of the shifting social mood to make its way into the mainstream.

But as the economic outlook continues to darken, the country becomes more disenfranchised, and the government grows ever-more addicted to sound bites and empty promises, reality will set in.

For the past 20 years, we’ve been blithely driving along an economic road that ends in a cliff. And that cliff is now in our rear-view mirror. We’re tumbling, groping for any branch that can save us from the fall. But each one of these new government programs, bailouts and rescues simply tries to set us gently back on the road from which we only just plummeted.

We already know where that path ends, and it ain’t pretty. What say we try another road?

By ANDREW JEFFERY

This post first appeared on Minyanville.

Our elected officials appear convinced that Americans should buy stuff they don’t need with money they don’t have.

The Senate, in passing its version of the over $800 billion economic stimulus package yesterday, threw a great deal of cash at 2 industries whose products we have far too much of already. Despite the fact that we have too many cars on the road and far more homes than we do people to buy them, lawmakers are determined to prop up both the auto-making and home-building industries.

According to Bloomberg, Ford (F), General Motors (GM) and Chrysler, the latter 2 already suckling the government teat just to stay alive, will benefit from a provision that allows consumers to deduct car-loan interest payments and local sales taxes from their income tax.

Meanwhile, Centex (CTX), DR Horton (DHI) and other homebuilders are salivating at the prospect of a $15,000 tax credit for those brave enough to buy a new home. The new, more generous tax break replaces a $7,500 credit granted last year.

In what shouldn’t come as a surprise, Brian Catalde, the president of the National Association of Homebuilders (or NAHB) is pleased that his group’s intense lobbying efforts paid off.

“We’re pretty happy with the way the Senate bill is shaping up,” Catalde said. “We think it will entice a lot of those people sitting on the sidelines into the marketplace.

”NAHB members nervously await the disposition of the final bill as their balance sheets remain bloated with unsold homes priced well above prevailing market prices.

Lawmakers seem determined to dig our way out our debt problem with yet more debt. By encouraging Americans to borrow more to buy the cars and homes irresponsibly manufactured by these industries in the first place, Congress and the President alike reward the very poor financial decisions that brought our economy to its knees in the first place.

To borrow the analogy from Professor Succo’s piece yesterday, Economy: Code Blue, this is akin to handing an obese person a donut, telling them to munch away as long as they stay away from pizza. It just doesn’t make any sense.

Among the Senate bill’s numerous differences from the House’s version passed last week — most notably the handouts earmarked for homebuilders and automakers — it also excises more than $20 billion in funding for new public-school construction.

Once again, lawmakers display their unparalleled financial acumen: Only more McMansions will counteract the vast oversupply of schools this country is struggling to get out from under.

By ANDREW JEFFERY

This post first appeared on Minyanville.

The private sector is actively engaging the mortgage crisis with the first broad-based, systemic attempt to prevent foreclosure. Both Bank of America (BAC) and JPMorgan (JPM) are attempting to help hundreds of thousands of troubled homeowners with massive loan modification efforts.

Regulators and bank executives are operating under the assumption that reducing foreclosures will slow record drops in home prices. In turn, this will help stabilize the financial system - and, by extension, the economy as a whole.

This logic isn’t necessarily flawed - but it’s reactive, rather than proactive, which is what’s most needed now.

Most foreclosures are concentrated in regions where homebuilders like Centex (CTX), KB Homes (KBH) and Lennar (LEN) built huge developments, using cheap financing to help fuel speculation and massive over-valuation. These areas, especially those where homes were purchased by lower income buyers, are being decimated by delinquencies and repossessions.

This, however, is widely known. What’s less well-understood is the storm that’s brewing on the horizon: Trouble in the prime mortgage market – where borrowers with good credit are starting to miss payments with alarming frequency — is looming on the horizon.

Recent delinquency data indicates that while defaults on subprime loans are occurring at a less frenetic pace than in recent months, prime borrowers are starting to feel the pinch. In early September – before the financial crisis accelerated in October — the Mortgage Bankers Association released its quarterly delinquency data, concluding,

“The increase in prime ARMs foreclosure starts was greater than the combined increase in fixed-rate and ARM subprime loans. Thus the foreclosure start numbers will likely be increasingly dominated by prime ARM loans.”

There is still a vast misconception that only “subprime” people maxed out credit cards, took out loans they couldn’t afford, and were generally reckless with their personal finances.

This couldn’t be further from the truth.

As the economic slowdown swirls outward into the broader economy, cracks are starting to form in established neighborhoods that have thus far experienced minimal home price depreciation. Many of these areas experienced stratospheric appreciation – just as their subprime neighbors did – but the strong job and stock markets insulated middle- and upper-middle income homeowners from rising interest payments and the slowing economy.

As mortgage underwriting requirements have tightened in recent months, home buying has slowed in these more well-to-do areas. This trend is being masked by spikes in the distressed sales driving broad housing market indicators.

As layoffs continue, homeowners in these areas will be forced to sell for the first time in years. The illiquidity in these markets means it will take just a few such sales to readjust prices dramatically downward. Homeowners that don’t sell by choice, particularly if they’ve accumulated equity in their homes, are apt to be less picky about their price.

Furthermore, it’s likely the recent onslaught of modification programs, tomorrow’s election, and pundits’ continued obsession to call a bottom in housing will encourage buyers to step back into the market. Increased sales transactions – even if they continue to be concentrated in distressed areas – will fuel the perception that the housing market is stabilizing.

This is likely to encourage a fresh round of selling, as anxious homeowners leap to take advantage of “improving” market conditions. This new supply won’t necessarily offset inventory that’s kept off the market by preventing foreclosures on a unit-to-unit basis; instead, the supply will simply crop up in different neighborhoods.

The subprime mortgage crisis may indeed be waning; its final battles are now being aggressively fought in Washington and bank boardrooms across the country. The prime wave, however, is just beginning to crest.

This post first appeared on Minyanville.

The mortgage bailout parade marches on.

Just days after rival Bank of America (BAC) announced plans to modify hundreds of thousands of mortgages, JPMorgan (JPM) released details of a homeowner rescue plan of its own on Friday afternoon.

Following its takeover of both Bear Stearns and Washington Mutual, JPMorgan’s inventory of distressed mortgages has risen dramatically in the last 8 months. The bank’s modification efforts, which mirror Bank of America’s plan, are focused largely on subprime loans and option ARMs. The acquisition of WaMu saddled CEO Jamie Dimon’s firms with billions of these loans - $16 and $54 billion, respectively, according to the Wall Street Journal.

JPMorgan plans to identify borrowers with both the willingness and ability to pay, lower interest rates and, in some cases, forgive loan principal. For Option ARMs, borrowers may have the opportunity to replace their negatively amortizing mortgage with a safer, fixed rate 30-year loan.

Look out for more of these plans coming from the remaining big American banks, particularly Wells Fargo (WFC): Its recent acquisition of Wachovia (WB) included the Charlotte-based bank’s massive option ARM portfolio.

The plan is certainly a step in the right direction. It’s nice to see that some of the recent $25 billion injection from the government will be funneled toward the taxpayers that ponied up the money in the first place.

Both JPMorgan and Bank of America’s new programs, are, however, evidence of the government’s – and banks’ — inclination to deal with problems that already exist, rather than ones that are on the horizon.

This post first appeared on Minyanville.

Yesterday, I criticized Washington’s $700 billion financial bailout plan for missing the point. It fails to address the root of the problems facing the housing market and, by extension, the rest of the economy: Negative equity or a homeowner owing more on his house than it’s worth.

On The Exchange, several sharp-minded Minyans pressed for details on how the government could execute a program to “absorb negative equity” in a fair, equitable, efficient manner - and without bankrupting the entire country.

To be clear, I’m fundamentally opposed to government intervention into the free market beyond a requisite regulatory capacity. I’m also deeply skeptical that government can manage any program, large or small, with even the slightest degree of aptitude.

Unfortunately, the usefulness of ideological debate is growing fainter by the day. Practical solutions must be put forth and implemented immediately, lest we slip further toward a second Great Depression. Historians are welcome to argue semantics while we get down to fixing the problem. Only a mixture of public and private enterprise can repair the damage.

Negative equity creates a number of serious problems for the housing market, such as:

Foreclosures

Negative equity turns defaults into foreclosures. Delinquent borrowers can sell their way out of the problem if they can find a buyer at a level higher than their outstanding mortgage (plus closing costs and real estate agent commissions). But being underwater makes this impossible without coming up with the difference between the loan amount and the sale price.This is cash most struggling homeowners simply don’t have.

Oversupply

Negative equity exacerbates existing oversupply issues, pushing home prices down further. Sellers who haven’t yet missed a payment must list their house at least as high as their outstanding mortgage. But if a homeowner is upsidedown, the property gets listed too high and stays there. Borrowers must then choose to continue pouring money into a losing bet, while hoping someone buys their house at well above its market value. The alternative is to default and end up in foreclosure.

Bank losses

Once a mortgage becomes delinquent, banks must write down the asset and take a loss. Not only is the loan impaired because of the delinquency, but negative equity enhances the bank’s losses. As property values fall, balance sheets become even more impaired, mortgage-backed securities continue to lose value and the entire financial system becomes even more desperate for capital.

Banks are bleeding cash: JP Morgan (JPM), Wells Fargo (WFC), Citigroup (C) and Bank of America (BAC) all recently announced reduced earnings and were forced to take equity injections from the Treasury. Lenders are reticent to accept short sales (allowing borrowers to accept a sale price lower than the loan amount without making up the difference) because they can’t handle the losses.

Now, for the solution(s).

There’s no magic bullet, no one solution that can, in one fell swoop, wipe the slate clean. As I’ve described it, “sopping up negative equity” is an immensely complicated task. The mortgage industry is massive, inefficient, disjointed, riddled with redundancy, buried in paperwork and plagued by bad regulation and misplaced incentives. In short, it’s a mess. Cleaning it up will take a very, very long time.

Still, I’d argue spending money on the programs below — without any hope of it being returned — is a better use of taxpayer funds than watching hundreds of billions of dollars simply disappear into the opaque balance sheets of what remains of the financial system.

There may be additional solutions, but this laser focus on earning taxpayers a return on their investment dilutes the effectiveness of many important initiatives.

Principal Forgiveness

Fannie Mae (FNM) and Freddie Mac (FRE) are already experimenting with a pilot program to give borrowers the amount of their negative equity as an unsecured loan. Based on the most recent appraisal (appraisals are, for all their faults, currently the most accurate way to value individual homes), Fannie and Freddie could pay down the negative equity — plus some cushion for future depreciation — and refinance the existing loan at, say, an 80% loan to value.

Even if the government-sponsored enterprises started with just their own portfolio, that would be a huge step in the right direction. For loans owned by banks and in securities, Fannie and Freddie could pay off the mortgage at the outstanding balance, forgive the necessary principal and write a new loan.

At this point, the homeowner is free to sell the house at the new, lower market price (price discovery) or go on making the now much-more-manageable mortgage payments.

Shared Equity

Banks could “sell” negative equity to Treasury, sharing any future upside based on each party’s pro rata share of the home’s current value (again, we’re forced to use appraisals because there just is not a better option - yet). When the home sells, the bank and Treasury would participate in any future appreciation. If the home’s value continues to slide, the bank is less exposed to the losses.

Bank’s could effectively choose the amount they write off: The more they receive from Treasury, the less upside exposure they retain. On the flip side, stronger banks would be able to write off just enough to stay afloat without losing future earnings potential.

The U.K. is already trying a version of this program.

Homeowners, out from underneath the negative equity and armed with lower mortgage payments could stay in their homes or sell at the current market price. Again, forced price discovery while keeping people in their homes.

Community Redevelopment

I believe the best way out of this mess is to set up a federal land bank system, where funds are distributed by the Treasury to local community development organizations and vetted real estate developers. I recognize the potential for bureaucratic abuses, but unfortunately the government is the only organization with the scope to handle the problem on a national scale.

Just as we now have a Bailout Czar, we need a Housing Bailout Czar to oversee such a program. I’m sure Goldman Sachs (GS) could send up another of its finest for the betterment of the country.

Groups like Habitat For Humanity, which have existing ties in the community and teams of professional and volunteer contractors, could dramatically help rebuild struggling communities with requisite resources from the federal government. These groups could either buy foreclosed properties, refurbish them and rent them out, write low cost mortgages through the land bank or offer up funds to enable banks to accept short sales.

If there’s a better use for taxpayer money than rebuilding communities after a tragedy, helping families put their lives back together - I’m not sure what it is.

Will some speculators be helped in the process? Probably. But the good news is the widespread economic implications of this crisis, which are now inevitable, will take care of much of the moral hazard we so fervently argue against.

Not every stock speculator was taught his lesson after the stock market crash of 1929, but the Great Depression did affect an entire generation, encouraging thrift and aversion to risk for decades. Now isn’t the time to take the moral high ground, only to watch our cities washed away by the rising flood of poverty.

This isn’t socialism, it’s being American.

This post first appeared on Minyanville and our sister site Dawn Patrol.

The bailout is done! Time to breathe a sigh of relief.

Or is it?

As details emerge about the financial bailout package that was jammed through Congress over 10 days of political theater at its most nauseating, there’s still a striking omission from the plan to right American’s economic ship.

The failure of bureaucrats and regulators to propose a realistic solution for the foreclosure problem is emblematic of their inability to treat the root cause of an issue, focusing instead on simply applying band-aids to the visible symptoms.

The bailouts of Bear Stearns, Fannie Mae (FNM) and Freddie Mac (FRE), and AIG (AIG) all claimed to remove the cancer - but all they did was hasten the patient’s demise.

Treasury’s plan will deliver money into the banking system to sop up toxic assets sitting on the balance sheets of our financial institutions. This is a necessary — albeit unfortunate — step, but it still doesn’t address the root of the rot: Milions of homes are worth less than the outstanding balance of the owner’s mortgage.

Billions of dollars in negative equity are destroying Main Street’s balance sheet even as it devours Wall Street, eroding the value of the very securities Taxpayers are about to start buying.

As long as Washington tries to fight foreclosures with ineffective loan modification programs that simply prolong the problems, foreclosures will continue to set records. Modifying a mortgage for someone who is barely scraping by is sort of like rescuing him from the side of a cliff, only to leave him on the edge, dangling by one arm.

Foreclosures are often blamed for spiraling home prices and the resulting collapse in value of securities tied to the mortgages used to buy those houses. According to Bloomberg, the government’s aid package is designed to support “financial companies reeling from the record number of home foreclosures.”

Foreclosures don’t cause houses to lose their value. Foreclosures happen when a home loses value such that it’s worth less than the mortgage used to buy it, and the homeowner can’t sell or refinance if his interest payments become overwhelming.

Defaults become delinquencies, which become foreclosures, which become evictions, which become repossessions, which flood the market, depressing prices as supply outstrips demand.

Back in what seems like ancient history, when home prices only went up, banks weren’t too concerned with defaults, since homeowners could almost always sell themselves out of a problem. Foreclosures stayed low because the liquid, appreciating housing market bailed out troubled homeowners on its own. That’s part of the reason the industry is so ill-equipped to handle the scope of the current problem: it never had to before.

But now, with so many borrowers underwater — owing more on their house than it’s worth — defaults result in not only eventual liquidation of the property, but profound distress in the homeowner’s life and real losses for investors. Furthermore, delinquent borrowers are less inclined to pay for upkeep or security, and many foreclosed homes are seriously damaged by the time a bank is able to take possession of it.

Being underwater is debilitating. To sell, not only does a homeowner have to pay a Realtor 6% whether he gets a raw deal or not, but he has to pay the bank the difference between where his home sells and the outstanding balance of his loan.

For many who have seen the value of their homes fall hundreds of thousands of dollars, this is an impossibility. Most homeowners, once they’re upside down, just want to stay in their homes.

A more effective plan to curb foreclosures would require an independent reviewer to evaluate each delinquent mortgage, determine the borrower’s ability to pay going forward and the amount, if any, of negative equity that needs to be destroyed to bring the loan amount back under the home’s value.

Since the notion that buying Wall Street’s toxic assets will result in windfall profits is a willfully distributed fallacy aimed at getting the public on board for the bailout, Taxpayers would be well-served dumping money into a blender that’s at least in their own backyard.

British Prime Minister Gordon Brown recently proposed a similar plan, where the government will buy delinquent mortgages from banks for the outstanding balance of the loan. The home is then rented to the existing tenant or a new one and managed by a local housing association.

The government would absorb the difference between the loan amount and the resale value, which would hasten increase sales activity, clearing out the glut of homes listed too high for the simple reason that the owner can’t afford to sell at a lower price.

This type of personalized bailout, unfortunately, reeks of moral hazard. Many individuals who made bad financial decisions will get to keep their homes, albeit without actual ownership. But the current socialization of our free markets is simply moral hazard be design, so if Congress is so hell-bent on bailing out Wall Street, why not share the spoils with Main Street.

If Congress wants this bailout to help the American people and keep the financial system in tact, a sizable portion of the funds should be directed at fixing the asset that’s at the center of this turmoil: the residential property.

Home prices need to come down further. They will come down further. It’s only a matter of time. We can either let home prices bleed down, slowly eroding the value of the securities they support and violently uprooting families, or the government can plug the hole.

Washington Mutual (WM) is already off the field, as JP Morgan (JPM) continues to play widowmaker for the financial system. Wachovia (WB) isn’t likely to remain independent for long. The sooner the rebuilding process begins, the better.

This crisis, and the resulting ebb and flow of what remains of the free market has already tipped the scales, started us sliding down a path of deflation in everything from stock prices, to cereal boxes, soda bottles, not to mention homes.

This is a good development. The hardest lesson Americans will learn from this crisis, should learn from this crisis, is that sometimes it’s necessary to live within our means. There is virtue in simplicity. More is not always better. Bigger is not always better. Sometimes, amazingly enough, less is often better.

This progress is the only true way we’ll make it out of this mess.

This post first appeared on Minyanville.

Washington is currently trying to sell the American public that its $700 billion bailout plan will help put a floor under falling home prices. And while the debate will rage over whether this is a good or bad thing, its not even true.

The most beaten down real estate markets (California, Arizona, Nevada, Florida) have thus far accounted for the lion’s share home price depreciation, specifically in the areas denoted as “subprime.” Those areas are now experiencing a final whoosh down, which will likely last months, as huge overhead supply and weak demand crush prices beyond normal levels of affordability. These markets will take years (if not decades) to recover. Entire streets are becoming vacant and will eventually become ghost towns. This is not something easily absorbed by already struggling communities.

This, however, is well known.

What’s less widely known is what’s happening to property values in middle and upper middle class neighborhoods. Cracks are beginning to form, sales volume is drying up, prices are starting to fall. Distressed sales in the “subprime” areas are masking this shift, which should show up in the data over the course of the next 6-12 months.

When the final whoosh of the hardest hit areas runs its course, as it eventually will, parts of town on the other side of the tracks will pick up where they left off. Homeowners who haven’t faced job losses and tighter budgets in years will start to become forced sellers, depressing prices. Years of artificially inflated values will come home to roost, as they have over the past two years for lower income neighborhoods.

The government bailout — in whatever form it takes — is aimed at the problem that’s already out of control. Right behind it, as evidenced by recent spikes in Prime and Alt-A mortgage delinquencies, are the loans that are yet to go down, borrowers who are still hanging on. Home prices started to plummet last summer after the credit markets seized up. This time around, since the government is focusing on what’s already happened rather than what’s about to (again), there is no reason to believe it will be any different.

The real estate and mortgage industries are busy battening down the hatches for the inevitable tidal wave of regulatory reform. Meanwhile, Housingwire.com reports government officials are already hard at work trying to outdo each other as the protector of the “everyday common household victim” of our “national crisis.”

Two illustrative examples of regulatory restructuring have been rolled out in last two months. In New York State, legislators passed a series of measures essentially placing a one-year moratorium on foreclosures. Under the program, borrowers already in default will pay a nominal monthly sum and be eligible for state funds to supplement existing mortgage obligations.

In California, lawmakers passed legislation that would require more extensive notification for delinquent borrowers before the foreclosure process can begin. Homeowners would be entitled to meetings with servicers to learn their restructuring options, placing a greater onus of responsibility on servicers to reach out to borrowers prior to beginning foreclosure proceedings.

Both measures are designed to ease pressures on distressed borrowers, but the New York plans go well beyond those in California. The California laws are designed to ensure increased communication between borrower and lender. The New York law is designed to put a halt to the process of foreclosure, presumably to await more extensive reforms or bailout plans still to come.

In both states, these measures mark the tip of the iceberg in the process of reforming regulatory frameworks for mortgage lending. In this election year, public support is swelling for pieces of legislation like these and even larger moves are likely on their way.

The challenge for regulators — and the lobbyists so generously pleading their case — is to enact rules and enforcement schemes that prevent fraud and predatory lending, without being too constrictive to legitimate business. Many such rules already exist; it remains to be seen if the fallout from the collapse of the mortgage industry can convince regulators to enforce their own rules.