The NYT ran a story that connects two dots—the housing bust and a slowing economy. Because housing has been a big employer, as new home construction comes a standstill, the effects will reverberate through the economy. Thus comes the answer to a question I’ve heard many times:  So long as I’m not strung out on some crazy mortgage, why should I care if the housing market implodes? Because it affects the whole economy.

Now let’s add a third dot to the picture—the impact of an effectively unregulated home mortgage market. Over the past five years, lenders have sold billions of dollars of mortgages that are designed to go into eventual default because the borrowers cannot possibly afford to pay them. These so-called “creative mortgage products” have two powerful effects: They fueled the boom, pouring more money into an overheated housing market. Now they will accelerate the bust, pushing more people out of their homes through distressed sales, thereby accelerating price collapses on the way down. In other words, a housing bust doesn’t just happen. Regulators who won’t regulate have an effect as well.

Note the irony: Much of the middle class takes the hit either way. When the housing market exploded, houses became unaffordable in many cities. Last week we talked about firefighters and teachers who cannot afford to live in many cities. (“Great news—get a second job,” said a federal reserve economist.) Families took on terrible risks to try to get a home before they were completely closed out. 

Now Vikas Babjas and David Leonhardt describe who will be hurt most by the housing implosion: people who work in the real estate industry. “On average, real-estate jobs pay somewhat less — about 7 percent less a year on average — than those in other parts of the economy. But real estate has also been one of the only industries creating good jobs for workers without college degrees in recent years, especially in construction and contracting work.” A big chunk of the middle class crumbles away.

Housing prices rise and fall for many reasons. The effects of interest rates are widely appreciated, but mortgage rules—or lack of rules—play an important part too. A boom and bust in housing may be hard to avert, but better regulation of home mortgage would have moderated the rise in housing prices as well as the subsequent contraction in the economy when housing cools off.

Regulation has become a dirty word, but many middle class people will pay a steep price for poor oversight of mortgage lending.

The New York Times ran a front page story yesterday about re-refinancing. Families now facing the end of the teaser rates on their adjustable-rate mortgages can’t make the payments when the rates re-adjust, so they are taking out another adjustable rate mortgage—with another teaser rate. They stay alive for another two years. And what happens when that one comes due? Evidently they are following the Scarlet O’Hara plan to worry about that tomorrow.

The obvious problem is that if housing prices level out, these families will have no options at all. No more teaser rates because the value of the home won’t back up the mortgage.  They will have rented homes for two years or four years that they could not afford, and they will lose everything they invested and more. If the amount owed on the home is more than the outstanding loan balance when the music stops, the homeowner will face bad credit ratings and bankruptcy.

The Times article does not emphasize how expensive this re-refinancing is. Closing costs and fees all get lumped back in to increase the outstanding balance. Keep in mind that these buyers couldn’t make market-based payments on the old, lower balance. The odds of making those payments on the new, higher balance are worse than those in any Las Vegas gambling parlor.

In the industry, these mortgages are called 2/28s. The numbers refer to the teaser period (the 2) and the real payout period with the higher-than-market interest rates (the 28). How can the “2” be profitable for the lender, if the debtor re-fi’s the loan without paying the high 28 period? Many of these loans carry a pre-payment penalty, along with up-front fees and closing costs that make them instantly profitable. Even if the debtor refi’s immediately, the amount paid off includes all these costs, making the effective interest rate for the “2” ten or twenty times higher than the stated interest rate.  In the 2/28 game, the lender nearly always wins.

Could re-refinancing be the knife that will cleave what is left of the middle class?  There will be those who have fixed-rate mortgages, who pay off their homes, and who have something for retirement or savings if a catastrophe hits.  And then there will be those who live in houses, paying high rent, always vulnerable to rate hikes, flat real estate markets, job layoffs, etc.  That last group will nominally be called "homeowners" just like the first, but they won’t really be.  They will play the 2/28 game until they go bust.