As more and more homeowners default, most look to a loan modification, a short sale, and finally, experience a foreclosure when the mortgage companies take possession of the property. Mortgage companies do not want to own (REO) properties, so their objective is to sell them to other willing buyers. But willing buyers have to qualify for a mortgage, and the parameters for qualifying today are much stricter than they were two years, and now even two months ago.

That's what is known as a liquidity crunch. In the real estate and mortgage business, its referred to as a housing affordability crisis.

For the U.S. real estate sector to work its way out of this situation, three things must happen: 1) home prices must decline, which usually means to a level below the outstanding mortgage on the property, 2) the cost of borrowing must come down and 3) the buyers' income level must rise.  So far, we have seen only a decline in housing prices. But as mortgage companies try to recover the full value of their mortgage commitments, the declines have not been significant enough to make houses affordable to new buyers. Ultimately, most experts expect U.S. housing prices to decline even further.

As for the cost of borrowing, the U.S. Federal Reserve has been adamant that any decision on interest rates will be tied to inflationary expectations. Of course, lower housing prices should help reduce inflation, but again, housing is only one sector in a very large U.S. economy.

Other sectors, notably raw materials and energy, have been pushing up inflation. And make no mistake, that 5% unemployment rate by all accounts still translates into a very tight labor market. In that environment, workers can push for higher wages -- which, if productivity does not keep pace, is inflationary.  Clearly there is more than enough bad news to go around. The question is how bad is bad? Or specifically, will the shock and awe of the sub-prime market spread to the rest of the U.S. economy? 

My solutions to housing affordability?  1. Greedy sellers with tons of equity hold the "key" to housing affordability.  It's time they cash in their 'lottery ticket' by pricing their home significantly below other homes in their area, cutting prices by 15-20%.  The sooner that housing values drop and local markets stabilize to "normal levels" of affordability, the sooner we will solve the housing crisis.  Unfortunately, lowering interest rates will only put a "bandage" on the highly severed affordability wound.  2. The greedy mortgage lenders need to proactively create for themselves a solution to the mess they got homeowners into over the past several years -- with teaser-rate neg-am products.  If they should, instead, decide to ignore the problem, they will end up closing their doors with non-performing loans going into default and foreclosure. 

I welcome your suggestions...