Why The Housing Market Isn't Going to Collapse

There's been a lot of talk on this site and across the Web about how the drop in housing prices is going to sink the economy. The common theory is that rising rates on variable rates loans are putting pressure on many homeowners who can no longer unload their homes because prices have fallen. As a result, many are going into default, causing the value of the securitized sub-prime loans to fall. This has wiped out several hedge funds and cast a pall over the sub-prime market in general.

Many believe the damage will spread out of the sub-prime market as housing prices continue to drop and interest rates rise. I see several problems with this theory:

1. The economy is strong and the unemployment rate is low. Most people who are employed do not default on their homes. They will give up everything else before they lose their house. As a result, while defaults are high compared to recent history, don't expect them to rise much higher unless the unemployment picture changes.
2. Interest rates are relatively stable and if anything may drop. Certainly if the economy weakens and unemployment rises, rates will drop. This will help to boost real-estate and allow many variable rate mortgage holders to refinance.
3. The drop in prices only impacts a small percentage of people who purchased their home in the last two years. The reality is that most homeowners are still way ahead on the value of their homes. Someone who bought 5-10 years ago still has plenty of equity, as long as they didn't take it all out with home equity loans.
4. The drop in prices isn't equal nationally. In many places of the country housing prices have hardly dropped at all. As a result, the damage is limited.

While real-estate may be a drag on the economy, it is hard to imagine that its impact will be consequential enough to drag a relatively robust economy into recession.