There seems to be an increasing consensus that the housing market was riding on a bubble and that the bubble is deflating. Many have been predicting a bubble for decades, some have come around recently, and others still dispute that there is a bubble at all. This entire debate has been of great interest to me because, until recently I was employed by the mortgage industry and my job involved, among other things, pouring over mortgage contracts from all over the country.

I think that there is something to be said for all three positions on the existence or non-existence of a bubble, but from a lot of what I read a lot of people don't understand the dynamics at play, what would cause a crash, and what a crash would look like.

Most comparisons are to the bubble most recent in our memory, the tech bubble. The two, however, are not really comparable at all.

The first problem with the tech stocks is that many of them had no intrinsic value. They were completely a product of hype. You cannot sleep, sit back and watch television, or have dinner in a tech stock. Tech stocks appear nowhere on anybody's hierarchy of needs.

This speaks somewhat optomistically of what a housing bubble burst would feel like. It could be less of a burst and more of a correction. People that own houses would have to wait to sell them if they wanted top dollar. The price of housing would likely stall and fall slightly, but eventually the economic reality that land value goes up with development would bring it right back to and then above its current value. Since most of the overvalued lands are in places of natural scarcity (expansion is blocked by water, mountains, or other development), it probably wouldn't even take that long.

So if that is what the bubble consists of, I believe that we would be very lucky indeed. Unfortunately, my recent professional experience has suggested that something much, much worse could well become of it all.

Day in and day out I looked at contracts. Though I did not have access to specific information about the loans, I knew what kinds of loans the banks were working on and frankly each one of them was more depressing than the last. I could not figure out for the life of me why people would be signing these atrocious documents. There are balloon mortgages (where you make insufficient payments throughout the loan and then pay a lump sum at the end of it), interest-only loans (ten years in and you haven't touched the principal), one-way adjustable rate mortgages (where the interest rate can go up but not back down), and worst of all negative amortization (where each payment you make leaves you further in debt than you were the previous month). By the time I left banks were combining these into an unholy mess of of a loan program where at ten years you own more than you did when you started. And the length of the loans were moving futher and further out, at 50-years by the time I left.

I received several answers to my questions, some of which were benign and others less so. Construction home buyers, for instance, would be interested in making minimal payments because they can't live in it or plan on selling it in short order. A bit more disturbing are the home-flippers, who buy a home with the intent to sell it before the principal is sue. Most disturbing are the increasing number of people that sign these documents because these are the only ones that will let them buy a house. We are all taught that it is better to buy and rent, and they can afford the $800/mo interest-only, but cannot afford much else. By the time the payment comes due they hope to be making the money they need, refinance it again, or be able to sell it and use that money on a down payment on another house.

The problem is, however, that the payment will eventually come due. The real question is not what happens when the market corrects as much as it is what happens when these interest-only and neg-am introductory periods expire? What happens when the interest rate goes up, pushing the ARMs out of reach? What happens when thousands of people are left holding the hot potato, with a buyer's market that won't buy for the money that they need and banks that have been burned too many times to refinance someone into what becomes a lifetime mortgage.

Which brings us to the second main difference between a housing bubble and a tech bubble: the housing bubble depends almost entirely on bank loans, where I don't believe that was the case. As such, a significant portion of the market is dependent not only on future buyers, but also the future willingness of the the banking industry and the government's continued willingness to allow it to operate under increasingly questionable practices.

I'm not sure at what time the introductory periods of the introductory loans (the term I will use for interest-only loans, fixed-period ARM loans, negative amortization loans, balloon loans, and any other loans they may have concocted wherein the first 5-10 years are with payments that are lower than will be expected later) will end, but it is quite possible that it will start a domino effect.

A slight slowdown in sales will cause some people to sell short. Some will succeed and they would drive the housing prices down. Others won't, which if frequent enough will create a secondary foreclosure market. Both cases would lead to at least a temporary surplus of houses on the market, making banks much more reluctant to issue loans for investment properties, which will in turn produce less buyers and increase the surplus of available homes.

The other possible cause for a domino effect is when the government finally puts its foot down on questionable loan practices before we end up in a situation like that in many foreign countries where loans are multi-generational. If the housing market is presently being propped up by an ever-increasing number of buyers that are propped up with ever-creative mortgage loans, once the creativity ends so will the supply of buyers and that, too, would leave a number of people with the hot potato when the buzzer goes off.

Unlike with the tech stock, the threat is not that they are significantly overvalued now -- I don't believe that they are -- it's that they will be undervalued tomorrow. This wouldn't be a problem if the housing market were dominated by people that were buying houses that they could afford to "ride out" when the market inevitably rebounds by correcting upward, but every indication that I have seen suggests that in many markets this is not the case.

The good news is that even in a worst-case scenario, a number of markets will remain relatively untouched. Houston, for instance, is probably pretty safe since few need to take out particularly questionable loans in order to afford a house. Even the pricier Austin is likely to be just fine. However, there are a lot of hotspots that are presently being propped up by speculators with no intention of paying the tab and I would strongly advise against real estate investments in those areas (California coast, Las Vegas, Phoenix, Denver, the northeast) or taking out a loan that you cannot afford to assume yourself to term, if need-be.

And it's quite possible that it will simply be a matter of various bubbles deflating than any popping or any dominoes being knocked over. I would say the chances are 50/50 that it will be a relatively smooth correction. I certainly hope that it is.

I shouldn't have to say this, but I will anyway: the opinions expressed in this post are mine and mine alone. They should not reflect on my former employer or any of the coworkers and friends that I had there.