Apr052017

HELOC Abuse and Pascal’s Wager

Recent reports show an uptick in mortgage equity withdrawal. Is this history repeating itself, or did people learn the wrong lessons from the housing bust?

Money won’t buy happiness, but it can provide the finest forms of misery. Everyone wants money. If given the chance to do nothing and obtain money, most people would take it. Such was the lure of the housing bubble.

People only had to do two things to obtain copious amounts of cash. First, they needed to buy a house. Then they needed to find a lender who would give them money for signing some paperwork.

That’s it. No work, no skills, no risk, no sacrifice, nothing.

Buy a house, sign some papers, and anyone could obtain hundreds of thousands of dollars. It shouldn’t be surprising that kool aid intoxication is so strong. Who wants to give up on that deal?

Unfortunately, as with most things in life that are too good to be true, the housing boom was not real or sustainable. Equity is an illusion, but debt is very real. The debt hangover plagued the country for nearly a decade. Our banks were imperiled by the toxic debts polluting their balance sheets, and borrowers were burdened by debt service payments to the ailing banks.

That debt service was money that could have circulated in the economy as demand for goods and services. Instead, the money that should have created aggregate demand was sucked into the black hole of banking losses and dragged down the entire economy.

HELOC Abuse and Pascal’s Wager

HELOC_abuse_3During the housing bubble, I can remember having conversations with kool aid intoxicated fools concerning house prices and mortgage debt. They would tell me house prices only go up, so it doesn’t matter how much you borrow because the house will always pay for it. When the debt became expensive, you could serial refinance into one teaser rate Option ARM after another.

When I suggested that lenders may not always offer these teaser rates and that cheaper and cheaper credit might not always be made available, most scoffed at me as a fool who didn’t understand California real estate finance. When i asked people to tell me what would happen if house prices did not go up, or if interest rates went up, or if credit became tight, they would look at me with a blank stare or tell me I worried about stuff that would never happen.

Whenever I had these conversations, I was always reminded of Pascal’s Wager. Pascal’s Wager is an idea from philosophy first postulated by Blaise Pascal. He believed a rational person should wager as though God exists, because living life accordingly has everything to gain, and nothing to lose. So it is with HELOC debt.

I was always under the belief system that one should not wager the family home on the necessity for prices to always increase and cheap debt to always be made available. Many California loan owners wagered their family homes for a little spending money… well, actually a lot of spending money. But no matter what benefit people thought they would obtain from borrowing irresponsibly, they should never have wagered their family homes on it. They did make this wager, and they all lost. Given the stupidity of that mistake, it’s hard to feel too sorry for them.

But no matter what benefit people thought they would obtain from borrowing irresponsibly, they should never have wagered their family homes on it. They did make this wager, and they all lost. Given the stupidity of that mistake, it’s hard to feel too sorry for them.