Inflating Bubbles until they Burst

Paul Krugman suggested that the Tech bubble of the 90's was replaced by the housing bubble. He further suggested that when the housing bubble bursts there are no bubbles to replace it.

Today in the Washington Post they tell us about a new kind of loan, the interest only loan, that is inflating the bubble even further and amounts to Russian Roulette for the consumer and the economy.

More than a third of the mortgages written in the Washington area this year are a risky new kind of loan that lets borrowers pay back only the interest, delaying for years repayment of any loan principal. Economists warn that the new loans are essentially a gamble that home prices will continue to rise at a brisk pace, allowing the borrower to either sell the home at a profit or refinance before the principal payments come due.

The loans are attractive because their initial monthly payments are tantalizingly low -- about $1,367 a month for a $320,000 mortgage, compared with about $1,842 a month for a traditional 30-year, fixed-rate loan. If home prices fall, though, borrowers could lose big.

"It's a game of musical chairs," said Allen J. Fishbein, director of housing and credit policy at the Consumer Federation of America. "Somebody is going to have the chair pulled out from under them when they find prices have leveled out and they try to sell, only to find they can't sell for what they paid for it."

I thought the little or no money down adjustable rate mortgages were a ticket to disaster but the interest only loans are much worse.