May242013

Necessary deleveraging and a lack of HELOC abuse is keeping the economy down

In the short term, a lack of consumer spending is keeping the economy down. Of course, everyone looking for a quick fix decries the lack of consumer spending and blames the consumer for our woes. It isn’t the consumer’s fault they were given too much debt during the housing bubble.

All this excess debt is causing consumers to delverage. Some are succumbing to their debts and declaring bankruptcy to get a fresh start. Some are walking away from their mortgage obligations and waiting for their lender to put them out of their homes — and their debts. Some are dutifully paying off the excesses of the credit orgy of the 00s. The first two groups, the ones that declared bankruptcy or strategically defaulted, now have bad credit, and their spending power is limited to their wage income — a good thing in the long term, but a short-term drag on consumer spending. The ones that are paying off their debts are spending less because they are paying off their debts. With so many people deleveraging, people simply aren’t spending like they used to.

U.S. households whittle down debt again

Consumers reduce mortgage balances, use credit cards less

May 14, 2013, 12:29 p.m. EDT

WASHINGTON (MarketWatch) — The total amount of debt held by Americans fell again in the first three months of the year and stood at the lowest level since the middle of 2006, the New York Federal Reserve said Tuesday.

The steady retreat in household debt is a good sign for the economy. With fewer loans to pay off, Americans are in a better position to spend and drive U.S. growth higher, especially if they become more confident about the future. Many economists have cited weak household finances as a chief cause of the slow U.S. recovery nearly four years after the Great Recession ended.

In the long run, deleveraging is a good thing, not because it will enable borrowers to releverage later, but because less debt means less debt service and an increase in discretionary spending.

The level of household debt in the first quarter fell by $110 billion, or 1%, to $11.23 trillion, mainly because consumers reduced mortgage balances and used their credit cards less.

Household debt is now 11.4% lower versus a peak of $12.68 trillion in 2008.

Ralistically, that’s all you need to know to explain the ongoing economic weakness. Deleveraging is always economically painful in the short term. Unfortunately, we had so much excess debt that the short term has dragged on for six years now.

Mortgage debt slid to $7.93 trillion from $8.03 trillion to mark the lowest amount since late 2006. Mortgage debt fell in the first quarter even though more home loans were issued than in the last three months of 2012.

Lower interest rates have allowed many homeowners to refinance their mortgages and sharply reduce their monthly payments. A high, though falling, level of foreclosures also contributed to the decline in mortgage debt.

Foreclosures accounted for all of the decline in mortgage debt. It isn’t like people suddenly got rich and decided to pay these debts off on their own.

Credit card debt, meanwhile, fell 2.8% to $66 billion, as fewer people applied for new cards.

It’s no secret that I despise consumer debt.  I loudly applaud any decline in credit card debt.

The value of auto and student loans rose, however.

The increase in the value of auto loans was the smallest in four quarters, suggesting that car companies might have cut prices to attract buyers as demand for new vehicles slackened. Still, auto loans rose $11 billion to $794 billion to mark the ninth straight quarterly gain.

Student loans, which climbed $20 billion in the first quarter, have surged 46% since the end of the recession to an all-time high of $986 billion. More students are going to college or remaining in school longer to obtain graduate degrees to improve their chances of finding a job amid a slow economic recovery.

Yet the escalation in student loans is also leaving many young people saddled with large debts. Although the delinquency rate on student loans fell slightly in the first quarter to 11.19%, that’s still the second highest rate ever. Before the recession, delinquencies averaged around 7%.

An 11.19% delinquency rate on student loans is amazingly high. These loans can’t be wiped out in a bankruptcy, and they are all 100% guaranteed by the federal government.

Hold Your Houses: The Housing Recovery May Take Longer Than You Think To Reach Consumers

PIMCO — Joshua Anderson, Emmanuel S. Sharef, Grover Burthey — May 2013

In the wake of the financial crisis, the U.S. consumer has embarked on a necessary path of deleveraging. Now, more than five years into the deleveraging cycle, a recovery has begun, but will housing sector improvements lead to a broad, consumer-based economic recovery?

We believe that housing fundamentals remain strong, but that the impact on growth depends on the ability and willingness of consumers to gradually re-expand their balance sheets. The full benefits of the recovery will take years to realize, with only moderate upside over the coming 12-18 months. …

In other words, we need a return to rampant HELOC abuse with lenders giving out free money to everyone with their name on a house title (see: Did stopping HELOC abuse kill the economy?)

Housing-related growth and wealth effects essentially derive from three key factors: (a) improvements in bank balance sheets resulting in an increased willingness to lend, (b) increased consumer confidence leading to a lower savings rate and (c) increased consumer spending due to mortgage equity withdrawals and gains from actual sales. These factors face headwinds that will hinder improving house prices from flowing through the broader economy. …

Increased consumer spending through mortgage equity withdrawal? Did we learn nothing from the housing bubble? Are the people in charge of our economy really so thick that they don’t see mortgage equity withdrawal for what it is — a personal Ponzi scheme? We DON’T want to return to the old system, particularly with the US taxpayer liable for the Ponzi theft of the future.

For consumers, the simplest method to spend more is to save less. But the starting point is already low: Savings rates for January and February 2013 were 2.2% and 2.6%, respectively, the lowest since 2007 (see Figure 5). Patchwork government austerity will hurt spending, especially for the already stretched lower- and middle-income consumers. Thus, any tangible impact from reduced savings will likely come from earners in the top 40%, who are also more likely to be homeowners and hold over 70% of consumer credit. To what extent can home price gains influence them to save less and spend more?
Nobody is asking the more basic question. To what extent should home price gains influence people to save less and spend more? None. Why should it? Converting equity to spending money is a Ponzi scheme, so we don’t want that. And spending unrealized gains on home price appreciation through more consumer borrowing and spending is equally as foolish. Why would someone deplete their savings just because their house is worth more?

Meanwhile, consumers in the 60th-89th percentile reduced their mortgage debt the most…, but largely through default. We believe that home price increases mainly spur spending by borrowers who already have substantial positive equity. Home price gains in 2012 increased the proportion of such borrowers only slightly … The most substantial gains occurred in bubble areas like Phoenix and Las Vegas and merely reduced negative equity, rather than creating positive equity. Borrowers whose homes appreciate, but remain “underwater,” do not feel wealthier, and cannot monetize the appreciation. That said, borrowers in the 60th-89th income percentile with positive equity are more likely than their high-income counterparts to use available mortgage credit.

We believe that significant wealth effects from housing are likely to materialize further into the recovery cycle, once more of the negative equity has been erased and credit expansion becomes mainstream.

So PIMCO expects a return of HELOC abuse? I hope they’re wrong.

Our expectations for equity extractions are also muted. The large amount of mortgage credit extraction during the bubble was a sharp divergence historically (see Figure 8). We expect headwinds against further equity withdrawals from both the demand and supply sides. Home price growth in bubble areas creates relatively few new consumers eligible for equity withdrawals (see Figure 7), and many of those who are eligible may initially choose to be more prudent.
But later we expect them to lose their minds and become Ponzis, right?
Meanwhile, cash-out refinance loans will continue to be more heavily scrutinized than purchase mortgages. If mortgage debt increases faster than we expect, it will likely be because borrowers with existing equity were more willing and able to monetize it.
Is that the comfortable euphemism for HELOC abuse now, “monetizing equity?” Sounds very sophisticated and businesslike, doesn’t it?

We believe spending growth from mortgage equity withdrawals will remain muted, and is unlikely to return to the levels of 2005-2007 anytime soon. In fact, the natural paydown of mortgages alone substantially exceeds equity extraction. In 2012, mortgage amortization was $175 billion and write-downs due to defaults and foreclosures were $34 billion in the fourth quarter, compared with approximately $65 billion for mortgage equity withdrawals.

All these factors feed into PIMCO’s mortgage balance forecast, which is based on the key components of amortization, write-downs, new and existing home sales, and mortgage equity withdrawal.

We project that mortgage debt outstanding will decline from its current $9.92 trillion level, bottoming $30 billion lower in mid-2014, then gradually increase again throughout 2015 (see Figure 9). This moderate increase may sound lackluster, but it’s an important milestone after a four-year downward trend.

If Pimco is right, and mortgage deleveraging is about to end, and we return to a culture of Ponzi borrowing, then the economy will improve, but it will be another house of cards. Recessions are supposed to eliminate Ponzi schemes, but everyone seems intent on perpetuating them. That should lead to another devastating crash.