continued Financial institutions will feel the squeeze, says Starr. The people who got the interest-only and negative amortization loans may not have put much money down. Sinking values will hurt. "This will result in distress sales," he says. "We will see some pockets of debt deflation. In downtown condos, we have seen price declines that are enough for highly leveraged borrowers to see their equity wiped out. The lender may be left holding the bag. Borrowers will hand over the keys and say they are sorry it didn't work out."
There's another scenario that could be even scarier. Gin notes that historically, people have done "whatever they could do to hold on to their homes." They will cut down on consumption, perhaps take second jobs. Or, worse, "they could take out 50-year interest-only loans -- go to even riskier mortgages."
That's like dope addiction -- the kind of approach the city's government has been taking.
Some demographic and economic factors are hard to predict. In 2008, baby boomers begin to retire. Some economists predict they will sell their homes to finance their golden years; that would put downward pressure on home values. On the other hand, if housing slumps severely in once-overheated markets like San Diego, the Federal Reserve could lower interest rates to fill the bubble again.
Another factor suggests the sting could be mild. Starr points out that San Diegans for decades have lived with high housing prices, excessive and risky debt, a cost-income squeeze, low savings, and real estate boom-bust cycles. We've lived on the edge before and maybe can do it again.