Taken from the comments of a Housing Bubble blog:

Even most readers of this fine blog are NOT prepared for what's coming.

So, in the interest of "continuing education" please allow me to offer a scenario of what might happen and how those who frequent here might protect themselves (as futile as they will discover such an endeavor to be).

First of all, as more and more homedebtors (my estimate: millions of these suckers are out there, trapped in ARMs and other ѕυιcιdє loans) stop making payments, the banks, MBS holders and other debt-enablers are gonna be looking to the private mortgage insurance companies (MGIC, Radian and others) to make good on their promises to pay up.

Of course, the mortgage insurers have sold WAY more insurance than they can possibly provide, so look for them to immediately default.

Next of course, is Fannie and Freddie themselves. They GUARANTEE about $2 trillion in MBS payments, but they only hold about fifty billion or so in cash and other instruments. So, look for Fannie and Freddie to default as well. (And let us not forget that Fan/Fred hold about $1.5 trillion in mortgages DIRECTLY in their portfolios as well, so they are even MORE exposed to deadbeat homedebtors.)

At this point, the banks, the MBS holders, Fannie, Freddie will be in deep trouble as the cash flow/income stream they have been dependent upon will come to a screeching halt.

In addition, all the holders MBS (about $6 trillion in total holdings, held by mutual funds, pension funds, foreign central banks, hedge funds), will also be decimated as they will have to mark down the "market value" of the MBS to reflect the reality that these promises to pay are now basically worthless.

As this collapse ripples through the financial system, look for derivatives meltdowns all over the place (about $300 trillion in interest-rate derivatives alone!) as the counterparties who promised to make good when interest rates spike up (as they inevitably will when everybody panics about lending "good money after bad" to create more worthless MBS to feed the housing debt monster!) also are wiped out.

Now, none of this will happen in a vacuum, although the entire process could play out in weeks (or hours as William Poole President of the Federal Reserve Bank of St. Louis stated in a speech regarding the systemic risk of Fannie and Freddie in a speech in 2003!). Indeed, look for the Federal Reserve to begin buying MBS outright and attempt to drop interest rates to ZERO (but these moves will be useless as the market will go on a "buyers strike" against MBS).

Of course, Congress will be sticking THEIR nose into the mess and will create an RTC II--The Sequel to TRY to create an orderly liquidation of the TEN MILLION or so houses that will be dumped back on the market. But who will buy? Look for the feds to get stuck with about $2 trillion in real estate, and all the other homedebtors with ANY KIND of mortgage to be "upside down" on their loans.

Now, with the banks (who sit on $3 trillion in mortgages directly AND $1 trillion in MBS), Fannie, Freddie, FHLB (about $4 trillion), private MBS issuers (another $1 trillion) , PMI providers (hundreds of billions), mutual funds, hedge funds, money market funds, pension funds (about $3 trillion ALL crippled, even the MOST clueless of sheeple will realize something is wrong and will TRY to get what few dollars they have out of the banks and money market funds.

However, the sheeps are gonna discover that the feds have been VERY busy preparing for just such an event and--through "Patriot Act, FinCen, Anti-Drug Laundering" and other sheeple-pen legislation--will prevent the sheeps from making a run on the corrupt fiat-fractional reserve lending-central banking scheme.

Therefore, the majority of the sheeps will be caught VERY flat-footed, buried in debt, but unable to have access to any liquid funds.

At this point the feds will either choose to inflate their way out of this mess by monetizing the $6 trillion or so owed to the MBS crowd or will choose to let the suckers die in a deflationary collapse--I'm not sure which they will choose, but I AM sure either scenario will be catastrophic.

Okay, now that we know what may happen, how do we prepare for the inevitable.

Well, one of the MOST important moves would be to have some cash, some physical gold, physical silver, food and guns/ammo out of the system.

The next important issue is to have a well-running car, full of gas.

Next up on the list is to live in a location where civil unrest is least likely (smaller towns, away from large concentrations of urban dwellers).

However, even THOSE precautions will mostly be for naught as the tens of millions of jealous, disgruntled, former "grasshoppers" will be screaming for the heads of the "ants" who had the foresight to try to prepare for the inevitable worst.

The best bet for the "ants" would be for them to form "ant colonies" sooner rather than later to combine their resources and protection.

Yet, even at that, the greatest threat will come from an increasingly-desperate government/police state which will not tolerate ANY competition to their monetary and military monopolies.

In summary: We are screwed. The least prepared will be wiped out first. Followed by the better prepared. However, EVERYONE suffers.

Part 2

To Keith: Yes, it could be that bad and worse. In fact, it is ALREADY way beyond control. The best evidence can be found in the derivatives dungeon, where all sorts of chicanery has been going on (and accelerating at a much greater pace over the last five years) as the banks, hedge funds, Fannie, Freddie, corporations, governmnets, NGOs', off-shore entities and other shysters have been shuffling debt, attempting to offload risk, hide losses, obfuscate money flows and other shenanigans.

However, the numbers are so huge at this juncture, even the slightest "butterfly wing-flap" can cause a financial Cat-5 hurricaine.

In addition, virtually the ENTIRE worldwide economic system is tied into the ABS/MBS/Securitization scheme which has to be one of the most ingenious and destructive inventions of humankind.

To the anon poster who inquired just what the gov't might do as they grow incresingly desperate, I offer a few nuggets:

1. "Capital controls" which can mean anything to freezing checking and savings accounts to prohibiting capital flight out of the country in ANY form.

2. Nationalization of Fannie/Freddie/FHLB and even as far a Coutrywide Financial (Which was recently added to the "old buys club" of federal securities dealers, allowing the Fed to directly buy Countrywide MBS. This was NO coincidence!)

3. Confiscation of all cash, gold, silver, guns, ammo, or other private property.

3. Confiscation or punitave tax on 401(k)/IRA accounts.

4. "Conversion" of CDs at banks to ten-year treasuries.

5. Restrictions on travel, gathering in groups, and freedom of speech.

I'll stop there for now. No need to ruin your Sunday afternoon...