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The problems extend well beyond subprime. I think it was Bill Gross who used a plankton analogy for subprime. Once the plankton dies, the entire ecosystem is affected. The subprime lenders are already dead. The Alt-A lenders are near death. Even the GSE's are hurting. They need to raise capital to meet their capital requirements, and that new capital is expensive in this environment.
But those are all first- and second-order effects. As brewer points out, an extended credit crunch would choke the economy. And combine that with depressed consumer demand, and you have a potentially lethal combo.
If a large number of ARMs were allowed to reset, there would be an increased default rate. Most of the current focus is on the new wave of bank write-offs that would lead to.
But that would also dump a bunch of REO inventory on an already saturated market. That would drive down prices for everybody, and we could start to see lots of "prime" mortgages upsidedown. This thing goes all the way up the food chain.
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