Oct182011

The devastating aftermath of mortgage equity withdrawal

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.HELOC_abuse_3

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 is still plaguing the country. Our banks are imperiled by the toxic debts polluting their balance sheets, and borrowers are burdened by debt service payments to the ailing banks. This debt service is money that could be circulating in the economy as demand for goods and services. Instead, the money that should be creating aggregate demand is being sucked into the black hole of banking losses and dragging down the entire economy.

Housing’s Job Engine Falters

Employment Lost in Property Crash Weighs on the Economy’s Chance of Recovery

By S. MITRA KALITA — October 5, 2011

HAGERSTOWN, Md.—Joshua Bradley says it was the easiest job he ever had: power-washing windows of new suburban houses. Then, about three years ago, business dried up and he found himself out of work.

“People don’t want to get anything done to their houses anymore,” says Mr. Bradley, 28 years old. “They do it themselves to save money.”

His experience wasn’t unusual.

Over the past decade, the housing market has been a powerful engine: It helped the U.S. economy out of a recession and created jobs as construction firms took on workers and new homeowners hired contractors to decorate rooms and maintain the lawns, or purchased new furniture for indoors and outdoors.

But today, as the sector endures a prolonged slump, many of the jobs it created are gone, and housing has now become part of what many economists see as a vicious circle that has left the wider economy struggling to gain altitude.

Americans aren’t spending because their home values are declining and employment prospects are dimming, and housing and employment is struggling because Americans won’t spend.

“People are losing their jobs and never getting equivalent jobs,” says Yale University economist Robert Shiller. “That fear is spooking everyone, so people aren’t in a mood to expand.”

It isn’t that people won’t spend, they can’t spend. Borrowers everywhere have too much debt, and they aren’t being given more Ponzi loans to make payments and buy more stuff. It’s the natural result of a massive credit binge. Take a look at the size of the green area representing disposable income in the chart below.

In the past 10 years, housing and related sectors grew to represent an outsize portion of the economy, accounting for 16.8% of GDP in 2005, according to Capital Economics. That fell to 13% in the second quarter of this year, the lowest share since 1982.

The whole U.S. economy in this last decade was built on housing and the services that come with it: mortgages, moving, furniture,” says Steve Blitz, director and senior economist at ITG Investment Research in New York.

Our HELOC economy has collapsed.

That is evident in such boom-to-bust markets as Hagerstown. Like Mr. Bradley, many now-unemployed workers in the city, which lies 75 miles from Washington, D.C., had a direct or indirect connection to housing. Some worked in the construction jobs supported by the surge in development; others worked in nearby distribution centers for retailers such as PetSmart and Staples, where new homeowners shopped. Some created small businesses catering to new residents, often tapping into home equity to do so.

Does anyone else think this is a bad idea? Is it wise to risk the family home on a business start up?

But then the housing bust arrived. The number of building permits for new construction in Hagerstown fell nearly 75% between 2006 and 2010, from 212 to 55, according to Sage Policy Group Inc., a Maryland economic-consulting firm. In July, the median price of a home in Washington County was $130,450, down nearly 45% from its $235,000 peak reached in June 2007.

Unemployment in the city has been particularly stubborn, climbing to 11.3% in June from 10.7% a year earlier. The national rate fell from 10.5% to 9.8% over the same period.

During the boom years, Hagerstown ranked among the highest for positive mortgage equity withdrawal—meaning people pulling cash out of their houses. Now, it ranks among the most negative, meaning families are defaulting or paying down debt, according to Moody’s Analytics.

Hagerstown was taken over by Ponzis. The few who didn’t participate get to pay the price in government bailouts and lowered property values.

On a recent afternoon, amid vacant storefronts and “for rent” signs, Karla Auch stood before her downtown gift shop, the Rainbow Connection, opened six years ago with a home-equity loan. “Going out of business,” announces a sign on the front.

“A lot of new businesses came in with all the people. We tried. It never really boomed,” Ms. Auch says.

People such as Charles Wible, a lifelong Hagerstown resident who left school in the 11th grade, see an uncertain future ahead. Mr. Wible, 39 years old, installs garage doors and says he had a nice life during the housing boom.

Ten years ago, I was making $60,000 a year and working half as hard as I am now,” he says. “Now I’m making $25,000 a year and scrounging for work.

Everyone who depended on real estate is facing this problem. How many realtors are complaining about the same issue?

The loss of jobs and businesses has led to high foreclosure rates across the U.S.; according to the National Association of Realtors, 31% of transactions in August were distressed sales. Credit, meanwhile, is tight, and banks are loath to lend in areas like Hagerstown, with home prices still falling.

Hagerstown resident Machiel van de Geer says he and his neighbors take turns mowing the lawn of foreclosed properties.

There is no obvious fix to the city’s economic quandary—or the country’s. “The only solution here is jobs,” says Anirban Basu, chairman and chief executive of Sage Policy Group and an expert on Maryland’s economy. “In the absence of a resurgence of employment, a recovery in Hagerstown’s housing market is impossible.”

But where the jobs will come from remains elusive. Mr. Bradley, for example, switched industries and found work as a shift supervisor at the Hard Times Café, a local restaurant. But every day brings a slew of people just like him to the restaurant looking for work, he says.

“We’ve got to invest in software, technology, manufacturing,” says Mr. Blitz, the ITG economist. “It’s these industries that will create more jobs and income. We are transitioning from an economy built around the leverage on housing and finance to an economy built on real goods.”

The economy won’t recover until some sector other than real estate creates new jobs. Once some other sector creates jobs, new households will form which will in turn create demand for real estate. With fresh demand for real estate, housing employment will start to recover, and the demand will snowball from there. The catalyst will not be housing. It must start in another sector of the economy.

Here, officials point to a business-technology park under construction. It would link Hagerstown Community College with the city’s new hospital, in hopes of spurring jobs in biotechnology, health sciences and information technology.

For some it will come too late. Mr. Wible says he didn’t expect a turnaround in his lifetime, so he’s banking on his four sons.

“They are not building houses like they used to,” he says. “So I try to instill in my boys to stay in school. I don’t want my boys out there fighting for work like I have to.”

—Nick Timiraos contributed to this article.

That is capitulation.

HELOC Abuse and Pascal’s Wager

During 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.