Why do lenders and politicians promote HELOC abuse?
Lenders profit from consumer debts, politicians gain finance industry donations, and borrowers run personal Ponzi schemes. What could go wrong?
Macro-economists focus on their financial models and behavior in the aggregate, and they intentionally ignore the incentives and moral implications of decisions made by the individuals who compose the aggregate. A Ponzi borrower is not an irresponsible thief gaming the lending system in the eyes of a macro-economist; instead, the Ponzi is seen as a stimulant to economic growth and a valuable feature of the financial system. As long as they all don’t flame out at the same time, the irresponsible behavior of individuals has a positive aggregate effect.
Economists study the “wealth effect” to determine how important it is to the country’s economic health; unfortunately, they don’t really understand the mechanics, and they probably don’t care. The basic assumption economists make is that people spend more of their liquid savings when assets they own increase in value, an erroneous assumption. In my opinion, The “wealth effect” is the most dangerous euphemism in economics. In the real world, rather than spending savings, the nouveau riche increase their Ponzi borrowing based on inflated asset values — a behavior that lead to millions of foreclosures. The wealth effect is help the economy doesn’t need.
Politicians go along with the macro-economists because for the most part, politicians only care about getting reelected, and a healthy economy helps them. As long as the economy is healthy, politicians don’t really care how it got that way, so they will endorse any short-sighted stimulatory measure to help them get through the next election. When the system finally blows up, they seek to blame anyone and everyone other than themselves.
Lenders should be the most concerned about Ponzis because they endure most of the pain when Ponzis implode; however, lenders convince themselves some other lender will be the greater fool, the bagholder stuck with the Ponzi’s last bad loan.
… Much, and at times most, of what happens in the mortgage market doesn’t have anything to do with homeownership. A sizable percentage of mortgages — including most of the risky ones that were made in the run-up to the financial crisis — are not used to buy a home. They’re used to refinance an existing mortgage. When home prices are rising and mortgage rates are falling, many homeowners choose to replace their mortgage with a bigger one, taking the difference in cash. In other words, mortgages are a way to provide credit.
Refinancing is a relatively modern phenomenon. According to Joshua Rosner, a managing director at the research consultancy Graham Fisher & Company, by 1977, only 8 percent of homeowners had ever refinanced. By 1999, 47 percent had refinanced at least once.
From 1945 to 1977, mortgage interest rates were on the rise, so mortgage equity withdrawal was expensive, plus this generation went through the Great Depression, and they were much more debt adverse than the Baby Boomers who followed.
By the peak of the bubble, homeowners were extensively using refinancings to extract cash. Mr. Rosner also points out that while homeownership peaked in 2004, home prices peaked in 2006, because refinancing drove up prices.
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.
One of the most abjectly false narratives about the financial crisis is that risky mortgages proliferated so that people who couldn’t afford homes could nonetheless buy them. Modern subprime lending was not about homeownership. Instead, the 1990s crop of subprime mortgage makers allowed people with bad credit to borrow against the equity in their existing homes. According to a joint HUD-Treasury report published in 2000, by 1999, a staggering 82 percent of subprime mortgages were refinancings, and in nearly 60 percent of those cases, the borrower pulled out cash, adding to his debt burden. The report noted that “relatively few subprime mortgages are used to purchase a house.” …
Putting the financial crisis aside, the logic behind this is completely messed up. If we want homes to be a vehicle for saving and building wealth, as they used to be, why are we instead encouraging people to increase their indebtedness?
This is the kind of hard question nobody in Washington wants to ask or answer. Politicians give lip service to promoting home ownership as a vehicle for saving and building wealth, but what they really want is for people to use their homes as a way to stimulate the economy. Unfortunately, that policy has consequences.
Even worse, we now know that too much credit results in people who once owned their homes losing them. It creates homelessness, not homeownership.
The problem, of course, is that the conflation of homeownership and consumer credit is so convenient for the powers that be. It allows lenders to cloak themselves in the American-as-apple-pie mantle of homeownership, thereby making it less likely that anyone will crack down on their practices.
Plus, lenders know they will get bailed out if the system blows up.
It allows members of Congress, many of whom depend on the financial industry for campaign contributions, to pretend that something that’s bad for us is actually a good thing for which we should be grateful.
There’s an argument that refinancing doesn’t much matter today. Because interest rates can’t go much lower, and home prices aren’t skyrocketing, “refis” will be a smaller part of the market.
This is true, thankfully. (See: More homeowners restart personal Ponzi schemes)
According to Freddie Mac, 28 percent of borrowers took cash out in the third quarter of 2014. But that’s still a significant percentage of the market, and ideally, we’re setting up a housing finance system that should be right not just for now, but for decades to come.
One possible solution would be much tougher standards for cash-out refinancings than for mortgages used for purchases, such as requiring far more equity in a home, or making lenders keep the loan on their own books instead of selling it. Or perhaps Fannie Mae and Freddie Mac shouldn’t be allowed to guarantee payment on a mortgage unless it is used to purchase a primary residence.
In Washington, there’s been scarce public discussion of this. But if we’re going to put government resources behind homeownership, and engage in practices that threaten the safety of the financial system in the name of homeownership, shouldn’t we at least talk about the fact that we’re actually encouraging the opposite?
I would love to have that discussion. I’ve been talking about if for nearly eight years on this blog, but nobody in power wants to deal with the ramifications of change.
HELOC Abusers are not good people
One infrequently-mentioned reason to limit mortgage equity withdrawal is the impact it has on the behaviors and beliefs of ordinary citizens. How do you feel about Ponzis? Are these upstanding people who earn your respect? For me, not so much.
Published: Nov 17, 2014, By Ruth Mantell
… “Further restrictions harm those who may need that equity for education, remodeling or repairs, medical expenses and so on,” said David Crowe, chief economist at the National Association of Home Builders.
Why do they need to raid their home equity for this? Aren’t we simply encouraging poor financial management by allowing this? If mortgage equity withdrawal were banned entirely, people would adapt by saving money in other ways, and they would use their accumulated savings outside of home equity. By allowing and encouraging mortgage equity withdrawal, we discourage people from saving in other ways because they don’t see the need.
“I remember we refinanced a couple of years ago and took out enough cash to cover the closing costs,” said Dean Baker, co-director of the Center for Economic and Policy Research. “We want people to use good judgment in their financial decisions, but that would often mean drawing on the equity in their home especially in bad circumstances like losing a job or unexpected medical bills.”
There are circumstances where drawing on home equity would be necessary even if the borrower is saving in other ways; however, just knowing that home equity is there and can be borrowed stops people from exercising good judgment and saving in other ways.
However, creating rules that severely limit creditworthy borrowers’ refinancing choices are sure to be of concern to observers who are wary of government interference in families’ personal-finance decisions. There are pros and cons to government interventions, Robert Shiller, Nobel Prize-winning economist and housing-market expert, wrote in an email to MarketWatch.“Encouraging refis would be stimulative of the economy,” Shiller wrote. “In a way, encouraging the refis seems fair, since people who are unable to refinance through no fault of their own, just because the housing market collapsed, are paying a lot more than others in interest.”
Nobody is talking about restricting the ability to refinance: I am talking about restricting their ability to cash-out while refinancing. It’s a difference that makes all the difference.
This really doesn’t have to be that restrictive or complicated; Texas shows the way. In Texas mortgage equity withdrawal is limited to 80% loan-to-value, so long-term homeowners never have less than 20% equity in their homes. The inability to extract and spend every penny of equity coupled with much higher property taxes took away the incentive for Texans to drive up home prices, so they didn’t participate in the housing bubble.
While we’ve made great strides in preventing future housing bubble with the new mortgage rules, if we really wanted to provide stability to the housing market and make the family home a true reservoir of wealth, we should limit mortgage equity withdrawal to 80% of the value of the house. The only people who would disagree with this are bankers and Ponzis, and do we really want to give in to that Motley Crew?