Downside of a Bubble.

Everyone knows that if there is a "bubble" in home prices, and if that bubble bursts, it will likely cause a few headaches for mortgage servicers. Default rates will likely rise, loss mitigation options will diminish and selling REO will become more difficult.

But the prospect of a bubble raises some challenges for the larger economy as well. To understand what a widespread drop in home values would do to the economy, it's important to remember just how important the housing sector has been to the economy in recent years.

As economic columnist Anna Bernasek of The New York Times pointed out recently, a bursting of the purported real estate bubble would likely have more profound consequences than the bursting of the stock market bubble did a few years ago.

Ms. Bernasek said an economic rule of thumb is that every $1 change in household wealth translates into about a five-cent change in consumer spending. As home prices have risen - and continue to rise - consumers feel wealthier and spend more of their disposable income. Or they even borrow more, often against the equity in their home, to fuel more spending. But the opposite is just as true. If consumers see the value of their homes start to ...