Homes as ATMs made housing bubble and crash worse
Unrestricted mortgage equity withdrawal provides incentive for buyers to bid up house prices to create equity they can borrow and spend.
Bubble thinking is rampant, and the primary reason for its persistence is that people want the free spending money houses provide. The huge financial reward each bubble participant received as they went to the housing ATM gave a spender’s high like no other.
The real estate lottery
When you reflect on it, mortgage equity withdrawal is similar to state run lotteries that sell hope to the poor at a major cost. If you are a worker who doesn’t save money, you have no chance to acquire wealth. Lotteries give those who have no other opportunity for wealth a chance — slim though it may be.
If many people participate in the lottery, the payouts become enormous, and others become drawn to the action which further increases the payouts. This continues like a Ponzi Scheme until a big winner empties the lottery pool, and the game starts over.
Buying real estate is like buying a lottery ticket with important differences. When people participate in the real estate lottery, they are a guaranteed winner – for a while. Every participant gets to withdraw and spend their winnings as long as the pot grows. This makes the real estate lottery like no other, and it makes it much, much more desirable.
At some point, the real estate Ponzi Scheme collapses, the pool of equity “winnings” is emptied, and the game starts all over again. The big difference between the California lottery and the California real estate market is what happens to the losers. People who play the lottery are limited in their losses to the amount of money they invested. People who gamble in the real estate lottery have no limit to their losses; in fact, their losses may easily exceed their net worth resulting in bankruptcy. Most real estate losers also give up their homes.
The threat of foreclosure and bankruptcy doesn’t deter people from playing the game, particularly the poor who have nothing to lose anyway. Most people take the free money and don’t worry about the consequences because through either personal abdication of responsibility or a massive government bailout people will not face the consequences. Moral Hazard now rules the California real estate market.
Show me the money
The real culprit in a housing bubble was expanding home mortgage balances — people took on huge debts to bid up prices. The real question is, “why do people do it?”
Were people forced to borrow so much money because houses were expensive? No. Everyone had a choice, and rather than borrowing eight to ten times their yearly income with insane loan terms that they didn’t understand, people could have opted to rent instead.
So why would anyone borrow money they couldn’t reasonably expect to repay? First, most didn’t expect to repay the debt — at least not out of their own income. Nearly everyone assumed the house would continue to increase in value, and the house would pay off the debt when they sold.
Second, most simply didn’t care. For most people, they were acquiring an asset rapidly increasing in value, and they could borrow and spend this free money as they wished. Mortgage equity withdrawal is the doorway to appreciation; it makes houses very desirable and very valuable.
In Texas, no homeowner can be extended credit secured by a personal residence in excess of 80% loan-to-value. Since Texas residents couldn’t easily obtain and spend their home equity, and since property tax rates are nearly double in Texas what they are in California, Texans had no incentive to bid up prices, so they didn’t. It really is that simple. No access to home equity means no housing bubble. Can you imagine how Californians would react if you told them they couldn’t extract and spend their home equity?
HELOC abuse made the crash worse
The desire for home equity spending was the reason people were willing to pay insane prices to own real estate. But the spending itself is what made the crash so bad. If there were no mortgage equity withdrawal, the only people who would have been underwater and at risk of losing their homes would have been the late buyers. However, that isn’t what happened. As it turns out over 40% of those who lost their homes bought before 2004. Those buyers would never have sunk beneath their debts or struggled to make payments if they hadn’t gone to the home ATM machine.
Diana Olick, Monday, 5 Oct 2015
As home values rise, homeowners are gaining more equity on paper — and they’re taking it out in paper. Cash-out refinances jumped 68 percent in the second quarter from a year ago, according to Black Knight Financial Services. This is the highest volume of this type of refinance in five years.
“People realize that refinancing these funds is extremely inexpensive and that rates will eventually rise, so they’re capitalizing on the strength of home price appreciation,” said Ben Graboske, senior vice president at Black Knight Data & Analytics.
“capitalizing on the strength of home price appreciation?” Is this the new euphemism for taking and spending nearly-free money? Using the word “capitalizing” makes this sound sophisticated and perhaps even noble. It’s neither.
Mortgage holders have gained about $1 trillion in home equity collectively over the past year. On an individual basis, borrowers doing cash-out refinances are taking an average $65,000, which is comparable to what borrowers did in 2006, the height of the last housing boom.
While the jump is significant, the volume is still nowhere near where it was back then. In fact, volume is still 80 percent below where it was at the peak in 2005.
That is not the only difference. Today’s refinancer is in a far more solid equity position in his or her home, compared with borrowers then, who used their homes like ATMs, pulling out every available dollar. Even after tapping equity, the average resulting loan-to-value ratio for today’s borrowers is 68 percent, meaning the borrower has only leveraged 68 percent of the home’s current value. That is the lowest level in a decade. …
Keeping the loan-to-value below 80% is the only hope we have of stopping this from getting out of control.
Cash-out refinances were most popular in California, accounting for 30 percent of all volume, according to Black Knight. … it is unlikely today’s highly cautious, litigation-leery lenders will allow borrowers to take out more cash than is prudent.
Let’s hope so.
I suppose it doesn’t matter. It’s not like the free-market capitalist bankers will ask for a government bailout if the housing market blows up again, right?