By RYAN TAYLOR

New homes sales reached record lows in January as transactions fell 10.2% from a month ago to seasonally adjusted annual rate of 309,000. This annual rate is the lowest in the history of the reading which the government started in 1963. The median sales price for new homes also fell by 9.9% to $201,000.

The sobering reality is that jobless claims are now the biggest driver of the falling homes sales. When this downturn in housing began in 2005, creative financing had allowed people with jobs to buy houses they could not afford. But even if incomes and employment were still at those 2005 levels, that same buyer pool would not be around to buy up houses at today’s “cheap” levels. Buyers at those prices no longer exist for  three basic reasons:

1) They are still trying to stay in their current home by acquiring a modification for their loan.
2) They have been foreclosed on and their credit score is below 700.
3) They no longer have a job so they cannot afford to buy a home even if they wanted to.

These facts are especially bad for new homes sales as most new developments are located far away from job centers. Since foreclosures are now prevalent throughout the country, most people are deciding to buy homes closer to their places of employment so they can avoid the long commute. Furthermore, most of the areas that are in close proximity to job centers are more established and are generally viewed as a better investment.

Those buyers looking to purchase homes in areas with new homes for sale have quite a few properties on the market to choose from. REO properties are becoming more popular purchases because they are frequently cheaper. As modifications become more prevalent, buying an REO in a neighborhood with few “For Sale” signs will be seen as less of a gamble because most struggling homeowners will find it easier to receive some mortgage relief from their servicer. Additionally, these buyers are avoiding new developments because there are not enough other buyers to suggest that the development will acquire the prosperous feel that is often advertised by the homebuilders.

Those who do have jobs can afford to be selective and, as a result, will most likely choose a home in an established neighborhood that is close to job centers. This home will rarely be a new home.

Until a publicly traded homebuilder is forced to liquidate their portfolio of homes, new home sales will remain at historically low levels.

By AUSTIN NELSON

There is considerable controversy as to the wisdom of the new measures introduced by the Obama Administration to stabilize the housing market: Will they work? What does it even mean for something like this to work?

While there are strong arguments on both sides, let’s look specifically at who Obama’s plan will definitely help and how that could in turn help the economy.

According to the White House’s official release on the Homeowner Affordability and Stability Plan (HASP), upwards of 9 million homeowners will be helped in their struggle to stay afloat. Even assuming that the administration is inflating these numbers a little, that’s still a lot of families. Each of these families could potentially be given a lifeline, a way to stave off the foreclosure of their homes.

In a plan estimated to cost $275 billion, HASP aims to achieve the lofty goal of slowing foreclosures by:

1.Reducing and subsidizing monthly payments for troubled borrowers
2.Incentivizing servicers and banks to modify loans
3.Instituting clear and consistent guidelines for loan modifications

The argument has been made that the plan rewards those who made poor financial decisions at the expense of those who did not. In some ways, this is true, but there could be effects of these measures beyond the families who are directly helped.

Most importantly, slowing foreclosures can prevent the downward spiral of home values that results when a number of homes get foreclosed within a single neighborhood. In fact, the White House claims that “the average homeowner could see his or her home value stabilized against declines in price by as much as $6,000 dollars.” While the exact modeling used to figure out such a specific number is unclear, the fact remains that preventing foreclosures will stabilize prices, particularly in neighborhoods with high rates of foreclosure.

Notice that I said that staving off foreclosures will STABILIZE prices, not that it would put an end to price declines. The underlying forces involved in the current home price correction go well beyond foreclosure activity. Prices will correct—indeed they must correct before the economy improves–and no foreclosure prevention plan can stop those fundamentals. The key is to make sure that the market doesn’t over-correct and cause unnecessary damage to the economy as a whole.

In a pattern we here at Cirios have seen many times over, a flood of foreclosures can cripple a neighborhood in a matter of weeks. The greatly increased supply caused by newly foreclosed properties coming onto the market results in price declines in the entire neighborhood. Additionally, foreclosed homes often sit on the market for months, largely because they are improperly priced and the bureaucracy involved in their sale is staggering. While on the market, these homes gradually fall into disrepair, decreasing the value of every home on the block simply by their ugly presence. The resulting decrease in home values leads to more homeowners going underwater and in turn even more foreclosures. And the spiral continues, feeding back on itself. By slowing the flow of foreclosures, it is theoretically possible to stabilize this cycle and remove the feedback mechanism.

The bubble that formed from 2001-2006 in the residential real estate market was unprecedented in its scope and magnitude. At the national level, median home prices climbed to more than 30% beyond historical trends. In many areas that number was twice that much.

As you can see in the graph below, a previous bubble (blue arrow) in the late 1980s (a time period where prices climbed above historic trends) was followed by a prolonged trough (red arrow) where prices fell below the trend. The same could be said for the late 1970s, but the bubble was much less severe.

In fact, the size of these “bubbles” and the length of following “troughs” have increased substantially. If the same pattern were to follow the currently deflating bubble, we should expect to see a trough that lasts on the order of fifteen years. With the current plummeting trajectory of home prices, that trough could be even deeper than the historical pattern would predict.

Source: Economagic, analysis by Cirios Real Estate

On the right side of the graph, I’ve placed a few projections of trajectories for housing prices. One represents a deep trough, which would result from a large “overshoot” in housing price declines. The other represents a “soft landing” for home prices which could result from breaking the foreclosure spiral. Note that the difference between the two projections is two-fold: depth and duration.

In other words, how bad will it get and for how long.

The variance between the trajectories is a 12% difference in low price and a five year lag in home prices’ return to historical trends. In the interest of scientific rigor, I have to say that there is no factual basis for either one of these scenarios. I have not run any models or even evaluated any data in a quantifiable way. But what I am trying to show is that the difference between a scenario where the foreclosure fueled home price spiral continues and one where it is attenuated could have drastic consequences for real estate markets and the economy as a whole.

Our fictional 12% difference in home price means well over $1 Trillion dollars in lost home equity. A five year lag in housing recovery means five more years of expensive and destructive foreclosures. The drag that both of these factors would place on the economy would certainly slow any eventual economic recovery we could hope for.

Only time will tell if HASP will have the desired effect on the housing market. As I’ve said, it certainly won’t be a magic bullet to “solve” the economic problems that currently face us. At best it only addresses a symptom and not the disease. But spiraling home prices are a symptom that we cannot afford to ignore. That HASP simultaneously provides a positive solution to a lingering problem while directly helping millions of families most strongly affected by the economic downturn is reason for praise.

That it helps a select few more directly than others is unarguable, but the overall effect on the housing market and the economy should be positive. Whether it is the best possible plan or merely the result of political expedience is a matter for debate, as are the moral implications that such a socialistic policy represents. But now is the time for action, and this plan strikes a powerful blow.

By RYAN TAYLOR

The National Association of Home Builders, or NAHB, released its confidence numbers for February this morning and the reading unexpectedly rose to 9, up from 8 in January. 8 is the lowest level the index has ever reached.

This surprise increase is not exactly a reason to start popping champagne and celebrating the bottom of the market for new homes: Sentiment is not deemed positive until it climbs over 50, so we have a long way to go before it is time to be optimistic.

“The market for new single-family homes remains very weak at this time,” NAHB Chairman Joe Robson said.

While the NAHB is rarely as misleading as the National Association of Realtors, these comments are far from reassuring. The basic reasons for the increase in the sentiment were increases buyers traffic and the blind hope that the $789 billion stimulus package would help turn the economy around.

“Looking forward, we are certainly hopeful that the newly passed economic stimulus bill, which includes some favorable elements for first-time home buyers and small businesses, will have a positive impact that will help get housing and the economy back on track,” said Robson.

In a more muted recessionary environment, we believe the $8,000 tax credit offered to first-time home buyers would have a significantly positive affect on demand. However, the economy remains quite weak and we believe most first-time home buyers are going to have a hard time buying homes since so many either A) no longer have a job or B) have seen their wages curtailed.

Finally, new home sales will continue to be hurt by the ever growing prevalence of REOs on the market. Given the fact that numerous banks are keeping many of their REO properties off the market, we do not foresee competition from REO properties being eliminated in the foreseeable future.

Buying a new home remains a risky proposition.

This post first appeared on Minyanville.

Finally, housing is starting to act like a market searching for a bottom.

Well, sort of.

In former boom states like California, Arizona and Florida, distressed sales are driving the local real-estate markets. After a near-complete evaporation of buying activity last year, buyers have been brought off the sidelines by continued price declines, a glut of homes for sale, and low interest rates. Comparisons with last year are easy: Some areas are seeing activity up more than 300% year-over-year.

Many contend this is a healthy development, as prices return to more affordable levels and latent demand sops up overhanging supply. The bottom, they argue, is nigh.

However, even in areas seeing strong buying activity, median home prices continue to tumble. Banks and private sellers alike are finding the only way to guarantee a sale is to list the house below the market. This constant undercutting is pushing prices down, sometimes well below affordability levels derived from median income data.

This trend is not indicative of the capitulation most market watchers believe must happen before prices can truly bottom.

Capitulation is a concept more often reserved for equity-market analysis than for housing. Since real estate is vastly more fragmented and localized than stocks, housing trends take months, even years to develop, while equities can reverse course in a manner of days, if not hours.

Still, drilling down into individual transactions, evidence of capitulation in certain markets is becoming evident. Sellers, after 4 years of price declines, are finally throwing in the towel.

Homebuilders are becoming desperate: Toll Brothers (TOL) is trying to lure in buyers with 3.99% interest rates through a partnership with Wells Fargo (WFC). Centex (CTX) did them one better by offering rates as low as 3.25% (that rise to 4.50% after 2 years) and Pulte Homes (PHM) also offers a 3.99% fixed rate option for qualified buyers.

Banks like JPMorgan (JPM), Bank of America (BAC) and Citigroup (C), desperate to shed their growing inventory of foreclosed homes, are beginning to accept bids 10, 15 or even 20% below their asking prices.

And its not just banks. Just in the past few weeks, private sellers have started to jump at low-ball offers. Better to take less cash now than be constantly priced out of the market, chasing it all the way down.

Although this type of sale is still very much the exception rather than the rule, it’s an indication that sellers are becoming despondent, willing to accept any reasonable price to rid themselves of what could be months of headaches, upkeep expenses and deteriorating market conditions.

To be clear: This analysis is by no means a call that housing has bottomed, or is even remotely close to a bottom. It’s merely evidence that certain areas are closer to stabilization that others, and these signs — which may look like capitulation — should be viewed as a positive development in a market deeply in need of hope.

By RYAN TAYLOR

In this two part series, Cirios’ Valuation Guru Ryan Taylor offers an insider’s look into the nuances of investing in foreclosed homes. Please click here for Part 1.

As potential buyers embark on their search for a new home or a prospective investment, they are very likely to see at least one REO property. These buyers need to educate themselves on what an REO property has in store for them because avoiding an REO is often times unwarranted.

One of the first things a prospective buyer needs when looking at a property is imagination. In the case of owner-occupied sales, most buyers can visualize themselves in the property because someone lives in the home. Homebuilders like Centex, Lennar, Toll Brothers and KB Home have made their fortunes by staging homes with swanky furniture so it’s easy to envision life in their new home.

On the opposite end of the spectrum, REO properties are often times neglected by the bank that owns them and they are not nearly as welcoming.

Do not let weeds and trash in the yard, the lack of furniture or a pink bedroom distract you from seeing the property as your potential home.

Another attractive aspect of purchasing an REO is the ability to negotiate with the bank. This fact has become, and will continue to be, a big part of any REO transaction. In the early part of 2008, most banks were unwilling to negotiate for a variety of reasons, but as losses have continued to mount, the fear of the housing market falling further have forced banks to the negotiating table.

Any prospective buyer should ask to be compensated for closing costs and request money for needed repairs. While banks may not give you everything you ask for, with a little negotiating and the recognition that you, the buyer, are in the position of power, buying an REO can save you thousands of dollars.

Probably the most beneficial aspect of purchasing an REO is that the buyer has an opportunity to buy a home that they can turn into their perfect home. Adding your personal touch will not only add personal value to the property, but also monetary value.

In a market where there are very few willing and qualified buyers, most homes that are purchased are turnkey or move-in ready. The majority of buyers are not interested and/or do not have the time to work on a “project”. While these people are getting a very nice home, they could have saved money by seriously looking at an REO property. The money they saved on the purchase price could have helped them upgrade the home to their own taste. Let’s face it – everyone has their own taste and would like nothing more than to have a home that has their own personal touches.

One of the biggest deterrents from an REO purchase is the potential work that needs to be done on the property. You name it and it could be broken, destroyed or missing. REOs come in all levels of disrepair, which makes having a trusted inspector (and a contractor in most cases) go through the home with you crucial to knowing that you are getting what you paid for. There is nothing like saving a few thousand dollars at the closing table and then having to turn around and pay for a new roof and new plumbing system. It can almost always be assumed that the property has been neglected by the bank so be sure all aspects of property repair have been thoroughly reviewed and included in any offer.

The other big risk is the supply of REOs in the property’s immediate neighborhood. The general rule is the more REOs, the worse the potential value declines could be in the near (if not long) term. As unsold homes sit on the market, buyers demand lower prices and neighborhoods become less desirable.

Just because you have found an REO that is in good shape and priced at or around your budget doesn’t mean it is a good buy right now. As you have read numerous times on this site, the real estate market is in for more pain. One of the main reasons for this is that banks are facing increased pressure to liquidate these properties and raise cash, so they are listing their REOs for less than anything else on the market.

This practice is one of the biggest drivers of the declines infecting most of the country, and the primary reason foreclosure prevention efforts are such a high priority in Washington.

Buying a home in a declining market can be a very risky financial decision and everyone needs to be aware that property values could decline by another 25%, if not more, depending on the area. At the very least, prospective buyers have to see themselves living in the home for 5 years. Even though living in the same house for a long time sounds like a great idea now, if you have a 5 year old and a 7 year old and are considering a one bathroom house, do you really to want to share a bathroom with them when they are 10 and 12? And maybe more importantly, are they really going to want to share that bathroom with you?

The final piece of advice I will offer regarding an REO purchase is you should always have an understanding of the true value the home. This is of course, no easy task to figure out.

If there are quite a few REOs on the market listed at $100,000 above their real value, even receiving a discount of $30,000 on the list price means you could still be overpaying by $70,000. List prices are simply what a seller wants, and often bears little resemblance to the actual market price.

On the flip-side of that coin, many banks will drop the list price of their REOs dramatically after they have been on the market for 30 or more days. If you see a home listed for $500,000 and your property valuation provider tells you it is worth $450,000, you should not be afraid to offer $450,000 for the property. If you wait for the list price to come closer to $450,000, you may miss out on the opportunity. When sellers drop their list price, the home immediately jumps on the radar screens of Realtors and investors — this can often create a bidding war that may drive the price up above your target. In addition, it’s hard to argue for closing cost incentives if you’re willing to pay more than the list price.

The supply of REOs is only increasing so do your homework and do not be afraid to make an offer on one of these homes. You never know when you could get a great deal.

By RYAN TAYLOR

In this two part series, Cirios’ Valuation Guru Ryan Taylor offers an insider’s look into the nuances of investing in foreclosed homes. Please click here for Part 2.

From Beverly Hills to Detroit, the term REO is quickly becoming part of our country’s vocabulary.

REO, or Real Estate Owned, refers to a property that has already been through the foreclosure process, was unable to be sold at a public auction and has reverted back to the bank. For most of us, the previous sentence is a gross over-simplification and requires more explanation.

Similar to many aspects of life, we are skeptical of things we don’t understand. Since most potential home buyers are unsure of what an REO is, they tend to shy away from even considering REO properties that are for sale. More often than not, this “fear” is unjustified because an REO property does have value, and can prove to be a great investment for those willing to do their research.

Foreclosures, while an unpleasant part of the real estate and mortgage business, have jumped to the forefront of the country’s current economic predicament.

After a bank determines they can no longer depend on a borrower to make their mortgage payments, it begins the legal proceedings necessary to repossess the house. In California and other states where trust deeds are the preferred instrument for securing home loans, the foreclosure process usually culminates with a Trustee sale, where a lender-appointed representative puts the home up for public auction. These sales take place at the local court house, which is why you sometimes hear foreclosure sales described as occurring “on the courthouse steps.”

The lender will typically provide the trustee a minimum bid amount, and if no buyer shows up with the requisite cash, the home reverts to the bank and becomes REO.

Tight credit markets and falling stock prices over the past 15 months have created an environment where the vast majority of properties that enter the foreclosure process eventually end up REO. Even savvy investors, burned by the steep home price declines of recent years, are reticent to bid aggressively for distressed properties. As a result, banks are inundated with these homes, most of which are in extreme levels of disrepair. Banks have never had to deal with so many REO properties at one time and are ill equipped to manage their growing inventory of homes.

The supply of REO properties greatly outweighs the demand, and banks often can only sell them at fire sale prices. Their reluctance to realize further losses leaves these homes neglected, clogging up the real estate market with unsold and unattractive inventory. As long as economic conditions continue to deteriorate for banks, the number of REOs will remain high.

For prospective buyers — and indeed anyone who owns a home — it is essential to become educated on how to understand the current and potential value of an REO property.

The fact of the matter is that recessions create opportunities for those willing to do the work and research. Purchasing an REO property as either a home or income producing property can be a great investment. However, there are numerous pitfalls and market timing continues to be important as home prices continue their slide.

In the second article in this two part series, we will examine the risks involved in purchasing an REO property either an owner or investor.

By ANDREW JEFFERY

This post first appeared on Minyanville.

It’s wishful thinking that artificially low interest rates alone are enough to rehabilitate the housing market.

The mortgage industry has undergone a swift and ruthless downsizing over the past 18 months. While a necessary part of the corrective process, the market is ill-equipped to handle the onslaught of new loans that regulators are hoping to incite.

Last week, the Wall Street Journal reported the Treasury Department is considering pushing down mortgage rates to levels not seen since the heyday of the housing bubble. Through the recently nationalized mortgage giants, Fannie Mae (FNM) and Freddie Mac (FRE), loans would be offered to qualified homebuyers with rates as low as 4.5%.

The story sparked a wave of refinancing as rates on all types of mortgages tumbled. Coupled with the Federal Reserve’s plans to buy agency debt and freshly originated mortgage-backed securities, the stage is set for renewed buying activity.

Although Treasury Secretary Hank Paulson has since denied that he’s planning such a move, he did say that he’s “always looking at new ideas” and that “the key thing to get us through this period is getting housing prices down.”

Whether there’s an official program of 4.5% mortgages is immaterial, as Washington is doing everything in its power to push rates as low as possible.

It’s hard to argue cheaper mortgages won’t encourage buyers to leave the sidelines and jump into the market. However, as Bloomberg noted this morning, layoffs at mortgage companies and banks like Citigroup (C), JPMorgan (JPM) and Bank of America (BAC) have greatly diminshed origination capacity. Lenders, having already tightened underwriting standards, have limited resources to process new applications.

Many are hoping low rates will encourage refinancing and help clear out the toxic subprime and Alt-A securities still plaguing the financial system. Unfortunately, the loans originated for securities in 2005, 2006 and 2007 – the ones causing all the trouble — were done with minimal down-payment requirements. Falling home prices mean most of these borrowers are underwater - and thus unable to refinance.

Furthermore, any renewed buying is likely to be met with a flood of new supply. There’s a concept in real estate known as “phantom inventory,” which refers to homeowners who want to sell, but keep their homes off the market while they hope for conditions to improve. Some experts believe actual inventory levels, when these would-be sellers are taken into account, is as much as 25% higher than official data show.

Anecdotally, this makes sense. For each buyer waiting for lower prices to step in, there’s a seller waiting for a better market. So any pop in buying activity will offer sellers an opportunity to list their homes in a seemingly stronger market. As foreclosures continue to spread into previously unaffected areas, inventory levels are likely to remain high throughout much of the country.

And while attractively-priced, well-maintained homes in desirable neighborhoods will continue to sell, more of the same will be available in each successive month. Patience remains the best ally for the prospective buyer.

By AUSTIN NELSON

Housing starts in the U.S. fell to their lowest levels since the government started keeping statistics on the subject in 1959. The drop is staggering — almost 20% since October — and is another stark indication of the current state of the U.S. housing industry, not to mention the economy as whole.

As noted ad nauseum on this site, supply far outstrips demand in most of the country’s real estate markets. Homebuilders are being kept busy simply trying to sell the homes they’ve already built, tens of thousands of which sit empty where they stand, surrounded by bank owned properties and uncompleted projects. There is simply not enough demand to support continued building.

Housing starts will likely continue their decline as large nationwide homebuilders contract their operations and some even close their doors. The homebuilding industry will struggle to improve until unemployment eases, lending standards loosen up and the flood of foreclosed properties recedes. It will be years until we see these events unfold.

In the meantime, savvy investors and prospective buyers will stay far away from the remote suburban housing developments that litter the outskirts of our major metropolitan areas. While these houses are often huge and full of top quality amenities, they’re simply too far away for any but the retired and semi-retired to reasonably consider making their home.

Services are already spotty in these areas, and as the nation as a whole becomes more eco-conscious and fuel costs emerge from their current swoon, demand for McMansions in the exurbs will remain low, perhaps indefinitely.

By ANDREW JEFFERY

This post first appeared on Minyanville.

Speculators have been flocking to California for centuries. Gold, computers, absurd dot.com start-ups, real estate - if it’s an asset, it’s probably boomed and busted in the Golden State.

The bursting of the latest bubble — real estate — is still in progress, as foreclosures push up inventory and drag down prices. Nevertheless, for every speculator that got burned on the way down, reinforcements are flooding the state with new money, hoping they’ll be lucky enough to pick the bottom.

In a trend that’s just beginning to emerge from the smoldering ashes of California’s housing market, the next wave of buyers could be armed with armloads of cash that’s red, rather than green. The Chinese are coming.

The Los Angeles Times paints a colorful picture of “Caravans of cash-rich Chinese in Hummers and Lincoln Navigators weaving through American neighborhoods in recent months, looking for foreclosures and other bargain properties to buy.”

What used to consist of small-scale, individual trips by wealthy Chinese buyers to scout for properties have turned into massive, safari-like operations. According to the Financial Times, SouFun.com, the biggest real estate website in China, received over 300 inquiries within days of announcing a home-prospecting trip to California.

For now, the groups are focusing on areas with existing Chinese populations, making San Francisco and Los Angeles prime targets. Almost 20% of San Franciscans hail from China; parts of LA, specifically the UC Riverside area and the San Gabriel Valley, boast large Chinese American communities.

And while not every potential Chinese investor is itching for a foreclosed tract house, a penchant for paying cash makes them desirable buyers in troubled markets. Big lenders like JPMorgan (JPM), Bank of America (BAC) (thanks, in part, to Countrywide) and Citigroup (C) have massive portfolios of foreclosed homes they’re trying to unload. Countrywide has over 6200 in California alone, up from 3900 just a year ago.

With mortgages increasingly tough to come by, banks are typically willing to knock 10% or so off the asking price for a cash bid. Countless sales have been falling through because the buyer can’t line up a loan, and cash is now king in the world of distressed home sales. This is no secret, and investors trying to snap up foreclosed properties at the courthouse steps tell stories of buyers showing up with millions of dollars in cashier’s checks at the ready.

Experts in China, however, are urging caution. Home prices in California are down 40% by some measures, but few expect the declines to taper off any time soon.

One tour operator told the LA Times he aims to give visitors a better sense of what life is like in America before they take the plunge: “What we sell is the culture, American culture.”

And what better souvenir to take home from a trip to the US than a shiny new…house.

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.