Da Downturn
There's been an absolutely profound breakdown in the mortgage lending process. I would contend that the "subprime crisis" is misnamed, as it's really the "no-doc crisis" that's been the root of the problem. No-doc loans are predicated on the idea that credit scores are sufficient to establish credit worthiness, and we have significant data establishing historical default rates for various credit categories. For example, 56% of loan recipients with <600 FICO scores defaulting on their auto loans within two years (data as of 2005, Standard & Poors), you have to wonder why lenders would finance anyone in that category, let alone at only an 11% interest rate.
This article presents a very interesting alternative view: http://www.basis.wisc.edu/live/amabrief07-09.pdf. Loans to all borrowers have the potential to help them. However, banks need to realistically price that assistance. If 56% default within two years, then a 28% coupon will just break even (not including inflation & assuming all loans are the same size). In fact, banks might actually start high and DROP the interest rates over time as borrowers prove they can keep up with the payments, which might provide better incentives to continue payments and reduce the "moral hazard" problems of borrowers who do not actually intend to pay the loans.
The show 60 Minutes presents another side of the story: http://www.cbsnews.com/stories/2008/01/25/60minutes/main3752515.shtml. The fact that people don't want to pay simply because the "price or the value [of their house] is going down" is reprehensible. Boston's tax assessor's database lets me pull annual historical housing values for the last 20 years on any property in the city. A quick look at properties in my neighborhood shows that from 1991-2000 house prices were "underwater": http://www.cityofboston.gov/assessing/search/default.asp?mode=value&pid=2203905000 (I have no affiliation with this property, I just used it as an example because it's currently on the market - for above the assessed price!). That's happening again now in parts of the country, especially in historically weak markets like Stockton and Phoenix (the Dorchester neighborhood of Boston, too). In fact, in 2007 the number of foreclosures in just Stockton, CA (~2,400) was higher than all of the foreclosures in the Commonwealth of Massachusetts (~2,100).
The worst is yet to come and despite the federal stimulus package and other reforms, we will not see the bottom for 3-4 years. That's based on a rough look at historical housing prices from the Boston assessor's database. I'll also note that house prices moved independent of the dot-com boom in the late '90s, which might have caused values in some places (SF Bay Area, for one) to turn up, but certainly wasn't a rising tide. It was only after the dot-com bubble that things really started to get going in housing.
My advice: stay short anything to do with housing. Yes, Blackstone is starting to get long mortgage lenders. They have the luxury of a long time horizon, deal & management fees, and aggressive recap methods to which individual investors do not have access. Think twice about buying a home unless you're planning to hang onto it for more than 10 years. The Boston bottom didn't occur until 1994-1995, and at it's bottom prices were 28-33% below the peak. The $50,000-$100,000 in lost value is far more than 2-years' rent, so you'd do well to wait out this plunge.
Finally, ride the commodities tide. I believe that commodities are the next asset class to be inflated (after stocks, then housing). We started to see the rise, mostly in oil, beginning in 2005 and 2006, and I think it will continue as housing loses its luster. Gold will definitely hit $1,000 this year - probably in the first half - and other commodities will continue to rise as well. It helps that more people throughout the world can afford them, but it's chiefly because people pile into markets one after another. When your taxi driver or favorite celebrity says to invest in commodities, it'll be time to sell.