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From PIMCO bond manager Bill Gross' latest monthly essay:

Long ago and far away there used to be an old “20% down” reality that morphed somehow into a subprime/Alt A cyberspace free-for-all (literally “free for all”). Talk about a second life! U.S. homeownership has expanded from 65% to 69% of households since the turn of the century, in part because it became so easy, and so cheap to finance a home. No avatars in that bunch – they were living, breathing U.S. citizens who yes, might knowingly or unknowingly have taken advantage of “low doc” or “no doc” applications, who might have taken out a “liar loan” in the face of “full disclosure” documentation required of their mortgage lenders, or who simply might just have jumped on board the 1% Fed Funds financing train of 2003. No matter. They bought a house, began living the American dream by making money with someone else’s money, and expected to live happily ever after. Well, not so fast, at least for some of them, it seems. Home prices, as measured by the National Association of Realtors, have gone down by 2% nationally over the past 15 months and there’s fear in the air that it could get worse. It most assuredly will.

The problem with housing, however, is not the frequently heralded increase in subprime delinquencies or defaults. Of course write-offs, CDO price drops, and even corporate bankruptcies of subprime originators and servicers will not help an already faltering U.S. economy. But foreclosure losses as a percentage of existing loans will be small and the majority of homeowners have substantial amounts of equity in their homes. Because this is the reality of our U.S. housing market, analysts and pundits now claim we’re out of the woods: the subprime crisis is or has been isolated and identified for what it is – a small part of the U.S. economy.

It will not be loan losses that threaten future economic growth, however, but the tightening of credit conditions that are in part a result of those losses. To a certain extent this reluctance to extend credit is a typical response to end-of-cycle exuberance run amok. And if one had to measure this cycle’s exuberance on a scale of 1-10, double-digits would be the overwhelming vote. Anyone could get a loan because shabby credits were ultimately being camouflaged within CDOs that in turn were being sold to unsophisticated foreign lenders in need of yield as opposed to ¼% bank deposits (read Japan/Yen carry trade). But there is something else in play now that resembles in part the Carter Administration’s Depository Institutions and Monetary Control Act of 1980. Lender fears of potential new regulations can do nothing but begin to restrict additional lending at the margin, as will headlines heralding alleged predatory lending practices in recent years. After doubling over 18 months between 2005 and the first half of 2006, non-traditional loan growth has recently turned negative, and lenders’ attitudes are turning decidedly conservative...

Source: Bill Gross on the Housing Market and Subprime Lending