Our economy depends on Ponzi borrowing to the point that the government actually encourages this behavior despite the fact that millions lost their homes because of it. The ability to freely access and spend home equity creates moral hazard. It encourages over-borrowing and overpaying. It was one of the primary contributors to the housing bubble. The desire for HELOC booty motivated the foolishness.
Many people run up $10,000 to $15,000 per year in credit card debt because they are fiscally irresponsible and fail to live within their means. During the bubble, loan owners would go to the housing ATM machine, pull out a year’s worth of irresponsible spending, and pay off their credit card debt. After two or three years of this, they come to rely on this yearly cash infusion. Rather than seeing their annual $10,000 to $15,000 spending as irresponsible, they see their house as another breadwinner, and the yearly ATM visit becomes an entitlement. The connection is lost between the foolish action — spending their home equity on consumer goods — and the consequences of their actions — being broke and losing their homes.
Those of us that chose not to borrow this stupidly are being forced to pay for the foolish mistakes of others, and to make matters worse, the bailouts we are funding will encourage more of this foolish behavior in the future. The powers-that-be even coined a polite euphemism, the wealth effect, to make this idiocy sound reasonable and respectable. For the first time in our history, parties to private contracts now have direct access to our pocketbooks through our taxpayer funded bailouts.
By Alex Kowalski and Elizabeth Dexheimer – Sep 18, 2012 3:52 PM PT
For the first time since the recession, there’s potential for rising U.S. property values to boost consumer spending and give the economy a nudge.
Housing’s so-called wealth effect has been a drag on household purchases since 2008. A projected 2 percent gain in home values next year will start to lift consumer spending in the second half of 2013, according to Michelle Meyer, senior economist at Bank of America Corp. in New York.
Meyer predicts the wealth effect will add 0.1 percentage point to spending per quarter, swinging from a 0.9 percentage point drag at the height of the housing crisis in the first quarter of 2009. The contribution represents a long-awaited turning point at a time when a struggling labor market impedes wage growth and manufacturing provides less support for the three-year expansion.
“There are a lot of encouraging signs in the housing market,” Meyer said. “It will still be a gradual recovery unless you see the overall economy turn stronger, but price data continues to come in strong even into the summer and early fall. I definitely have gotten more convinced of the turn in housing.”
I’m relieved to here she’s convinced, aren’t you? Her statement about price data coming in stronger is not true everywhere: Home Prices Drop in August: Zillow.
Home prices in the second quarter increased 2.2 percent from the previous three months, the best performance since the fourth quarter of 2005, according to S&P/Case-Shiller data. The lowest mortgage rates on record, a smaller inventory of available homes and a drop in distressed property sales have fostered the pickup.
Federal reserve stimulus plus bank’s slow processing of delinquent loans has engineered a bounce.
Adding to signs of a recovery: confidence among U.S. homebuilders climbed in September to the highest level in more than six years, according to the National Association of Home Builders/Wells Fargo builder sentiment index released today. …
Removing the competing REO supply from the market is making the builders very happy.
Rule of Thumb
Rising home values stimulate household spending through a channel economists call the wealth effect,
A phenomenon I call HELOC abuse.
which posits that homeowners lift spending in proportion to anticipated changes in wealth over time. A common rule of thumb is that for every dollar increase in housing wealth, consumers will purchase an average of 4 cents more, according to Meyer.
That description doesn’t capture the mechanism involved. People are not staring at their pile of their secure liquid savings and suddenly deciding to spend some of it. They are increasing the debts held against their properties to obtain this spending money. There is a world of difference between the two. Spending liquid savings has an opportunity cost in lowered investment income, but no real out-of-pocket expense. By contrast HELOC abuse increases the spenders monthly debt service obligations, and once those obligations pile up, they are very difficult to expunge.
Among those getting a boost from rising property values is Kyle Perkinson, 42, who bought a home in Concord, North Carolina for $204,000 in May. Since then, he said, its value has increased to $220,000.
Perkinson, who works for Electrolux AB, said the gain was one reason why he decided to buy a new Jeep.
“I felt comfortable that the economy is starting to turn and there are brighter times in the future,” he said. “I’m going to continue to upgrade my property with landscaping and new visual accents, like a rocking chair on the front porch.”
If an improved economy inspires people to spend their savings, that’s fine, but if they thing it’s a good idea to increase their 30-year debt obligations, that’s foolish. If people haven’t learned the perils of that form of borrowing, we will have another housing bubble and another huge credit crunch when the bills overwhelm people.
Kathy Brill, who lives in Mechanicsburg, Pennsylvania, is also responding to the improving real-estate market. After seeing the value of her home increase, Brill said she plans to use a home equity line of credit to invest in a new apartment in Washington, where she works.
“We feel great about the economy,” said Brill, 56, executive director of the non-profit Parent to Parent USA, which recently opened an office in Washington.
Stupid is as stupid does. If the investment is cashflow positive after all her costs, then perhaps it will work, but based on her apparent level of financial sophistication, I question whether she can accurately determine if this is a good investment or not.
At the same time, it will take time for the full impact of the recovery in housing to show up in consumer spending. Rising home prices spur spending with a lag, meaning the wealth effect won’t show up this year, Meyer said.
Patrick Campbell, a homeowner in the Capitol Hill neighborhood of Washington, is only now beginning to consider spending more. The 48-year-old said he is more optimistic about spending since learning his home value has increased 12 percent after falling below his purchase price during the recession.
“I have less anxiety,” said Campbell, who said he’s entertaining a big purchase, like taking a vacation. “I don’t have a working plan, but I still don’t mind surfing for ideas now.”
Surfing for ideas might lead him astray.
The reversal will provide “meaningful support” to growth, lifting consumer spending by as much as 0.5 percentage point at an annual rate, according to the UBS economists. That could help the world’s largest economy expand by 2.1 percent this year and 2.3 percent in 2013, they wrote.
Let’s hope they are wrong.
“Rising home prices also lead people to consider investing more in homes,” Matus said. “Very few people actually get in early in a rally, so price increases could potentially be more encouraging for people to join.”
If people start jumping on the bandwagon with enthusiasm, we all know where that leads. Perhaps we will skip the despair stage and go right back to building another housing bubble.
Borrowing against one’s home, nonetheless, is harder for many people in the wake of the recession, damping some of the wealth effect, Meyer said.
Good. It should be harder, particularly considering how much money the banks lost on the HELOCs they gave out last time.
Only one of the 58 senior loan officers surveyed by the Fed said standards for home equity lines of credit, one way housing wealth can stoke spending, were easier in July than they were in 2005. Forty said they were tighter.
“The credit channel is an important part of the story as well,” Meyer said. “That probably made the wealth effect more powerful during the boom,
but I would argue that it’s going to make the wealth affect more muted now.”
We can only hope.
An example of the wealth effect gone wild
- Today’s featured REO was purchased for $191,000 on 4/24/1997. They used a $171,850 first mortgage and a $19,150 down payment.
- On 10/31/2001 they refinanced with a $200,000 first mortgage.
- On 8/15/2002 they obtained a $35,000 HELOC.
- On 10/16/2002 they refinanced with a $235,000 first mortgage.
- On 2/28/2003 they refinanced with a $322,700 first mortgage.
- On 2/28/2003 they obtained a $59,800 HELOC.
- On 7/3/2003 they opened a $100,000 HELOC.
- On 3/26/2004 they got a new $155,000 HELOC.
- On 2/28/2006 they refinanced with a $542,500 Option ARM with a 1.25% teaser rate.
The wealth effect? These borrowers don’t seem particularly wealthy today.
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Proprietary OC Housing News home purchase analysis
$504,700 …….. Asking Price
$191,000 ………. Purchase Price
4/24/1997 ………. Purchase Date
$313,700 ………. Gross Gain (Loss)
($15,280) ………… Commissions and Costs at 8%
$298,420 ………. Net Gain (Loss)
164.2% ………. Gross Percent Change
156.2% ………. Net Percent Change
6.3% ………… Annual Appreciation
Cost of Home Ownership
$504,700 …….. Asking Price
$17,665 ………… 3.5% Down FHA Financing
3.53% …………. Mortgage Interest Rate
30 ……………… Number of Years
$487,036 …….. Mortgage
$130,842 ………. Income Requirement
$2,195 ………… Monthly Mortgage Payment
$437 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$126 ………… Homeowners Insurance at 0.3%
$507 ………… Private Mortgage Insurance
$114 ………… Homeowners Association Fees
$3,380 ………. Monthly Cash Outlays
($327) ………. Tax Savings
($762) ………. Equity Hidden in Payment
$20 ………….. Lost Income to Down Payment
$83 ………….. Maintenance and Replacement Reserves
$2,393 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$6,547 ………… Furnishing and Move In at 1% + $1,500
$6,547 ………… Closing Costs at 1% + $1,500
$4,870 ………… Interest Points
$17,665 ………… Down Payment
$35,629 ………. Total Cash Costs
$36,600 ………. Emergency Cash Reserves
$72,229 ………. Total Savings Needed
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