by Patrick Henningsen

Created on: November 07, 2008   Last Updated: May 28, 2012

The housing bubble and the collapse of some major banks institutions are pointing towards the worst economic crisis since the Great Depression. The success of government rescue efforts remains to be seen. Every story needs a villain and we have three protagonists in this great drama: the borrowers, the lenders, and the government.

The Wall Street Journal published predictions as far back as 2006 that one in eight subprime loans will be foreclosed upon. Experts warned that the subprimes were "toxic" instruments.

An alarming number of media pundits and banking apologists have sought to lay blame squarely on the shoulders of the lower classes, apparently reaching too far' and beyond their financial means for a slice of the American Dream. The truth is that foreclosures are occurring across all income levels, not just the poor.

Industry experts in mixed income state Florida might differ, claiming that mortgage defaults do not fall solely on low income or "poor" homeowners. "A common misconception among Florida homeowners and consumers is that foreclosures disproportionately affect the lower income brackets and most often occur in poorer neighbourhoods when in reality, foreclosures are occurring in every price range and in every market across the state," explained Charles J. Kovaleski, President of Attorneys' Title Insurance Fund.

Borrowers can take partial blame, and then, only for playing the market. A large number of speculators were buying homes with almost no money down and many of those were intending to "flip" their property- for a profit. There is also the Southern California practice known as "double dipping", where one buyer closes escrow on two different properties... on the same day (but proving financial means' for only one property). Buyers who ran into trouble here often had to dump one house to save the other.

If the problem is that defaulting subprime mortgages are reducing the income flows through to the holders of the mortgage backed securities, why can't bailout money be used to rescue defaulting foreclosed mortgages? Instead we are pouring cash into banks and buying their toxic assets.

According to the U.S. Treasury, 90-93 percent of the mortgages are on safe ground. How then does a 7 to 10 percent default rate on U.S. mortgages translate into a systemic worldwide financial meltdown? The answer is much deeper. Monetary policy itself, could easily play the biggest role in this economic meltdown.

In 2007, the U.S. trade deficit with the rest of the world was approximately $617 billion. With such extreme financial exposure, any number of factors could push the U.S. into further crisis. Even a relatively small country could theoretically pop the U.S. housing bubble, simply by dumping their U.S. dollar reserves.

And the bailout? What has it accomplished to date? The jury is still out. Investors and taxpayers are still wondering whether it will be $1 Trillion well spent. If only we could be sure. The bailout cash will have to come from somewhere- borrowed abroad, or printed at home.

If other foreign Central Banks need those dollar reserves for their own troubled banks, then the U.S. Treasury may not be able to play the debt market like it has in the past. To have the Federal Reserve print it out of thin air invites the specter of hyper-inflation. Running a Fiat money system or continuing to borrow, either way, we are looking at a rough road ahead.

As the recession looms, further lost jobs and rising interest rates on troubled mortgages will certainly mean more defaults and more foreclosures.

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