Precisely because housing has very slow time scales some people (the fed?) can assert there is no evidence of contagion. If it is going to spread (which it very possibly will), it’s gonna take months to a year or so at least.

Also, a couple of minor points: in Phase 2, “Wall Street is worried.” In the initial phases, at least some people on Wall Street weren’t worried. Merrill, Morgan Stanley, and Lehman were interested in buying failed mortgage brokers as late as mid-February, seeing the decline as a buying opportunity (http://www.nakedcapitalism.com/2007/02/free-fall-in-subprime-loan-market.html).

Also, on Phase 6, although it seems obvious to me that declining housing prices will have a negative wealth effect and lead to lower consumer spending (even the Economist has commented that housing market declines have a bigger economic impact than stock market declines), some economists dispute that notion.

SUBPRIME FALLOUT TIMELINE

Prelude: securitization of mortgages spurs lenders to issue as many loans as possible because investors keep buying RMBS. Lenders make more and more loans and pay less and less attention to creditworthiness and ability to pay off borrowers, resulting in a mortgage and home price bubble. Eventually the bubble implodes in gradual phases:

Phase 1
Events: ARMs reset, and home prices stagnate because of oversupply and prices so high that buyers are priced out of the market.
Effects: Subprime borrowers start defaulting on loans at a higher than anticipated rate. Prime borrowers start defaulting on investment property that they are now unable to sell as expected.

Phase 2
Events: RMBS investors realize what is happening and start to pull out of the market or at least stop pouring more money into it.
Effects: Wall Street is a little worried, but not much because of hopes the problems are contained to the subprime market.

Phase 3
Events: Lending becomes more restricted in reaction to the defaults.
Effects: Consumers cannot refinance their home or take cash out of their home as easily as before, and cannot as easily take out a second mortgage to buy investment property for speculation.

Phase 4
Events: Home prices start dropping because less mortgages means less buyers, and the oversupply is still there.
Effects: The collateral to the RMBS loses value, which means the RMBS loses value not just because of defaults but also because of vaporized collateral value.

Phase 5
Events: Housing speculation comes to a complete halt because of dropping prices. Churning of housing stops.
Effects: Less new loans to feed the pipeline of RMBS. Existing RMBS lose value consistently because of defaults and dropping value of collateral. Wall Street starts to really get worried about not just the whole RMBS sector, but debt securities in general because financial institutions and rating agencies got the RMBS situation so wrong.

Phase 6
Events: Consumers start spending less both because their homes are worth less and because it is harder to get a mortgage.
Effects: Consumers start defaulting on credit cards, and start spending less on retail, cars, luxury items, etc. Home prices drop further. Wall Street now has to deal with a drag on the whole economy.

Phase 7
Events: Wall Street processes the losses, demands better quality RMBS and more realistic credit ratings in general, and borrowers, lenders, and rating agencies become more responsible.
Effects: The economy and home prices stabilize.