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Thursday, March 27, 2008

The next wave of credit crisis
Posted by Jill | 7:41 AM
It's interesting to watch Joe Scarborough try to talk up the economic news every morning. Every time the Dow takes a breather and goes up a few points, it's happy days are here again. The giant turd of subprime mortgages may be past the halfway mark in working its way through the colon of the financial markets, but anyone who thinks that's the end of it is delusional, because the next wave, that of bad equity loans, is just getting started:

Little by little, millions of Americans surrendered equity in their homes in recent years. Lulled by good times, they borrowed — sometimes heavily — against the roofs over their heads.

Now the bill is coming due. As the housing market spirals downward, home equity loans, which turn home sweet home into cash sweet cash, are becoming the next flash point in the mortgage crisis.

Americans owe a staggering $1.1 trillion on home equity loans — and banks are increasingly worried they may not get some of that money back.

To get it, many lenders are taking the extraordinary step of preventing some people from selling their homes or refinancing their mortgages unless they pay off all or part of their home equity loans first. In the past, when home prices were not falling, lenders did not resort to these measures.

Such tactics are impeding efforts by policy makers to help struggling homeowners get easier terms on their mortgages and stem the rising tide of foreclosures. But at a time when each day seems to bring more bad news for the financial industry, lenders defend the hard-nosed maneuvers as a way to keep their own losses from deepening.

It is a remarkable turnabout for the many Americans who have come to regard a home as an A.T.M. with three bedrooms and 1.5 baths. When times were good, they borrowed against their homes to pay for all sorts of things, from new cars to college educations to a home theater.

Lenders also encouraged many aspiring homeowners to take out not one but two mortgages simultaneously — ordinary ones plus “piggyback” loans — to avoid putting any cash down.

The result is a nation that only half-owns its homes. While homeownership climbed to record heights in recent years, home equity — the value of the properties minus the mortgages against them — has fallen below 50 percent for the first time, according to the Federal Reserve.

Lenders holding first mortgages get first dibs on borrowers’ cash or on the homes should people fall behind on their payments. Banks that made home equity loans are second in line. This arrangement sometimes pits one lender against another.

When borrowers default on their mortgages, lenders foreclose and sell the homes to recoup their money. But when homes sell for less than the value of their mortgages and home equity loans — a situation known as a short sale — lenders with first liens must be compensated fully before holders of second or third liens get a dime.

In other words, when homeowners have to choose between paying the first mortgage and the second, the first one has priority. And with the number of mortgageholders (I'm not about to call people who bought a $500,000 POS with a no money down mortgage for $500,000 and other $50,000 to remodel the kitchen "homeowners") already sitting on first mortgage balances in excess of what their homes are now worth, the equity lenders are going to get hosed. And thats where things get really interesting.

It's no secret anymore that the consumer binge of the last eight years wasn't done via increased income for most Americans, it was all done with the hot checks of easy credit. Why pay taxable interest on a loan for that fifty grand SUV when you can borrow on your house? Why just replace the countertops and the floor when you can take out a loan for seventy-five grand and gut the whole damn thing? Why just take an ordinary mortgage when you can get a couple of piggyback loans, knock the thing down, and build a big ugly box out of particle board and vinyl that extends to within 8' of the property line and blocks the sun from your neighbor's house but has a bigass chandelier overhanging the "bridal staircase"?

When I was a kid, my parents used to talk about the dream of going from a $25,000 house to a $30,000 house, the latter of which maybe had an extra bath and a pool in the backyard. They knew that such things were probably just a dream, out of financial range for people like them. People like my family drove Dodge Darts and Ford Falcons, while only rich people drove Cadillacs and Mercedes and BMWs.

Then the 1980's came along, and people watched Lifestyles of the Rich and Famous on television and got this idea in their heads that they could have everything that rich people had, even if they had to go into hock up to their eyeballs to get it. You could drive a luxury car by leasing it. You could have that extra bathroom by taking out an equity loan. You could have the trappings of the rich -- the bigass entry foyer with the chandelier, and the luxury cars and the multiple garages and the vacations in St. Barths -- and the fact that the rich could buy this stuff out of ready cash while ordinary Americans had to go into hock to do it never occurred to people.

And so the debt culture was born. Creative forms of debt allowed ordinary Americans to kid themselves that they were gaining entry into "the club" -- and now they too could look down on the poor and the "welfare queens", because those above them on the economic ladder were opening the doors and saying, "Come on in! The free lobster buffet is straight ahead on the right." Except that there was no free lobster buffet, and the debt culture was designed not to enrich the lives of the middle class, but to anesthetize it to what was really going on -- a massive transfer of real wealth to the richest Americans, hidden by the debt being made available to the middle class.

And now the bills are coming due and Americans are only now realizing that the free lobster buffet is off limits to them. But instead of blaming the people who made the debt available and helped them get in over their heads, they're still pointing their fingers down the economic ladder and preparing to elect another Republican president who will continue to screw them over seven ways to Sunday until there's no more blood that can be wrung from the dry stone that used to be middle class life in America.


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Anonymous Anonymous said...
It's amazing, isn't it, how people fool themselves? In 1993, I was living in this poor-ass county in Wash. state and the local paper had an article about a great new loan program that was allowing people to "buy" homes with no money down. I wrote a letter to the editor asking, in what sense are these people homeOWNERS if they have zero equity? The real estate agency I worked for briefly was excited about loan packages the wrapped in the costs of renovation, so the "buyer" went into the new home with negative equity. Stupid, stupid, stupid.

Blogger lutton said...
I really believe this whole debacle is predicated on the loosening of regulations, then brokers, lenders, basically everybody in the system, gaming that system to gorge on fees, etc as long as it lasted.

They never really cared about earning the interest or getting paid back, since they we're not responsible for the funds once the loan was slice and diced and sold off.

Now that the party based on home lending is coming to an end, I'm curious to see where they turn next. ('cause like an addict, I don't think they can stop)

I've noticed a huge uptick in splashy advertising - even on major networks - for student loan lending, mostly from obscure companies that I've never heard of before.

And just the other day, I was reminded that one of the Tolls - of Toll Brothers builders - bought into one of the largest auto dealerships in the Philadelphia region a couple years back.

It makes you wonder if they're all looking for the next place they can skim some cream off the top...

Anonymous Anonymous said...
You maybe over-simplify where the appetite for credit comes from. It wasn't Lifestyles of the Rich and Famous. It was the inflation of the 1970's and early 80's. It actually made tremendous sense to borrow money to buy real stuff, because the value of the dollar was falling so rapidly that one would actually pay loans back with cheaper dollars. Unfortunately, that kind of debt philosophy worked its way into our psyche in such a way that Americans now have no idea what it means to save for stuff that we can't afford.

Blogger Weaseldog said...
"It makes you wonder if they're all looking for the next place they can skim some cream off the top..."

Of course they are!

A con is always looking for his next mark.

The Gov can always use it's virtual money presses to start another bubble, to impoverish us with.

Anonymous Anonymous said...
It's sad, when I, a 21 year old, seems to understand this better than people twice my senior... Our culture is sick, and we need to stop kidding ourselves, tax greed, and instill fiscal responsibility back into the culture. I feel like this whole country has gone god damn insane. Thing is, I knew it years ago working at the largest car wash chain in Chicago. People in 65k Beamers and Hummers, who wouldn't even tip one fucking dollar for drying off their insanely large and expensive car.

It get's more and more sickley the closer the suberbs are to the city. What pisses me off the most is people like me, who are smart, and invest and save, are still hurt by everyone elses idiocy. Everyone's taking everything they can get and no one's creating anymore, and yet creative, intrinsic, innovative people are still kept at the lowest rungs while ass-kissers move further and further up the debt-chain... Meanwhile, the top .1% is getting richer and richer. Wake Up!

Anonymous Anonymous said...
If I were to hazard a guess as to when (we know it's no longer an "if") the home equity crisis will hit, I would say the beginning of next quarter, which would be around the beginning or middle of June. I noticed that the bank crises, market crashes, etc. seem to happen every three months, and it most likely has to do with the reporting of bad numbers from the previous quarter.

I don't see much happening between now and late spring.

Anonymous Anonymous said...
The only thing that has ever trickled down in a trickle down economy, is debt load.

Blogger Stupid Git said...
Great article! Depresssing yet very well thought out and much appreciated.

"What pisses me off the most is people like me, who are smart, and invest and save, are still hurt by everyone elses idiocy." - Anon

That's the problem with our magical fantasy land of imaginary money based on credit. People who are wise to invest and save are unfortunately only investing and saving imaginary money that can just as magically disappear.

Anonymous Anonymous said...
I never see anyone put the blame where most of the blame belongs.
Home prices only matter when you buy or sell a house. Taxes and Insurance are affected by the value of the house.
Whether 100% or 80% or 50% are mortgaged doesn't matter that much either, it is the Variable rate that will hurt people.
Most of those affected bought at about 4% rate when the Fed rate was down to 1%. On 17 straight occasionss the Fed raised the interest rates 4.25% (.25% each time). This had the effect of raising mortgage payments which many could no longer afford, forcing them into getting out of the house only to discover that the home value is now less than what they owe on it, and the financial institution is usually the ones getting stuck. The Feds need to look for some other tool to prevent 'perceived' inflation they see sometime in the future.

Anonymous Anonymous said...
We'll, I think this mess is about half over, and it's not like Chase didn't have tons of money to swoop in and buy out Stearns right? There was a lot of people who out-right ruined their credit and a bunch of bandits who made off with billions in stolen wealth by praying on these stupid people, but not everybody was as stupid as some of these people. Not everyone was dumb enough to believe that with rising energy prices, that huge house with a walk-in foyer and 5 bedrooms was a good buy. The real problem is that their isn't going to be any building going on for a long time, and thats a significant part of our workforce. These people are going to need new training and new jobs. Tech is still actually pretty healthy even know consumer spending was at a low not seen since 2001. Problem is, will these drunks be willing to go back to school and learn? (No, not all construction workers are, but I have friends in the biz, and they tell me all about their co-worker's "character."

Blogger Unknown said...
There's another issue that is going unsaid that I'm concerned about: student loans.

First, the cost of education has risen sharply over time while incomes haven't. What impact is this having on people's ability to pay back student loans - and get ahead.

Secondly I've seen a lot of student loan ads, websites, etc. I'm wondering what the rates are like for these - and how much student debt is run up with high interest rates.

I'm not sure what (if anything) is happening, but I am concerned about that being another wave a few years down the line.

Anonymous Anonymous said...
I suspect Canada is not far behind. The houses being built, and the cars being driven, astonish me. Million dollar homes and $100,000 cars are commonplace. My wife and I do reasonably well, I guess, and I couldn't dream of owning one of those cars, let alone one of those houses. Either there's some secret I don't know, or all those people are living on top of a debt bubble. Anyway, our grasping, greedy, consumptive society is getting it's comeuppance.

Anonymous Anonymous said...
The one place that more loans and looser credit were truly needed - student loans - was the one place they never arrived.

Just imagine what an educated society would lead to: better fiscal restraint and higher incomes to pay off debts. Instead, ignorant McJobbers could borrow $100,000 and be indentured for life. The one question nagging in my brain is, was this pyramid scheme and collapse part of the plan, or were bankers so idiotically and overly optimistic that they considered the best case scenario to be pessimism?

I'm not wealthy, but I'm not in debt up to my eyeballs either. When the crash comes, I'll be solvent and amazed at the devastation and counting the suicides.

Anonymous Anonymous said...
Well I just finally took on a student loan, and I'm working full-time too. I got it through Sally Mae, which I would trust, as it's backed by the fed, that it was my best decision. Being able to go to school online is great because I can still work, save, and invest, and have money to buy my supplies outright. I made sure to wait until I was absolutely sure about what I wanted to do and my ability to be successful in said career. I chose game design, which is proving to be quite recession proof so :) Not to mention quickly outpacing the movie industry as a gross domestic product. Too many of my fellow students went off the school with no goal and the intention to party, and made fun of me for taking my time and now I believe they will actually be the one's losing in the end. I don't talk to those friends much anymore anyways.

My goal to pay off my loan is to continue having good luck in tech, video game, and software stocks and be able to pay off my loan outright shortly after graduating, as artists aren't paid the greatest at first, at least compared to those bastard programmers ;)

Anonymous Anonymous said...
I was a little young to under-state, but talking to my elders, didn't the same thing happen in the 1980s during the last republican cycle anyways? We got out of that one fine right?

Anonymous Anonymous said...
There is another run-on effect that I have not seen mentioned yet, that of declining tax bases for cities and counties as home values drop and as foreclosed owners can't pay their taxes. Virtually all of your local services and infrastructure are paid for through housing taxes (in most states); if the home values keep dropping and foreclosure rates keep climbing, the local till is going to be squeezed.

Supposedly one of the safest investments out there is buying municipal bonds; given the problme with those bonds being paid for through property taxes, you can see where this previously safe investment strategy (and the one many older people are relying on) is on a collision course with reality. I have a friend who designs the infrastructure expansions and water treatment plants for cities, and all the funding for these projects is generated from issuing municipal bonds. Within the last 6 weeks the muni bond market has essentially been frozen, so we'll be hearing about this issue at just about the time Blue Buddha mentioned above.

Blogger Batocchio said...
You're sure right about the debt culture. And with something like a nine trillion dollar national deficit, the Bush administration has been the worst culprits of all.

Anonymous Anonymous said...
It's all these people taken without giving anything worthwhile back. There is an entitlement problem here in the US, and it's spreading elsewhere too. It's what Warren Buffet speaks of when he talks about a "meritocracy."

Anonymous Anonymous said...
Taking* not taken* Oh and overpopulation.

Blogger tc said...
Well said. To me, as a 33 year old, I've never let go of the old adage, learnt as a young thing, that you never get something for nothing. I couldn't believe...well, I could believe but to think that there would be no fall-out from a bubble-which went on with the tech market and then housing over the last decade; I don't know why people are so stupid. I mean, I can understand the temptation. But just because there's a temptation...I don't understand why people don't think these multinationals aren't just trying to steal your money. That's all they want to do. People are suckers. I do agree that there was some serious teasing and misleading going on by all these crooks, but really, why would you believe them? I don't understand why people don't read the fine print in a contract. I don't care how long it takes or whether you have to take it home or have a lawyer read it or anything. Don't sign something, particularly a contract to purchase a home, unless you're totally able to handle the possibly exploding payments you will be making. I think this goes back to the sub-par education system in this country (I only mention this because I went to high school and jr. high in Britain.) People in other countries just do not trust big companies. They recognize that they, and big companies, do not share interests. People do not think critically enough about their investment decisions. They believe the Big Heads On TV and everyone else in on the scam. Americans claim to be rebels and living on the edge but they're suckers. Hopefully not anymore but what a bitter price to pay. I haven't made any large investments, but I'm not up the creek without a paddle either. Greed has brought this country to its knees, whether people want to realize it or not.

Anonymous Anonymous said...
I was a little young to under-state, but talking to my elders, didn't the same thing happen in the 1980s during the last republican cycle anyways? We got out of that one fine right?

You are referring to the S&L crisis where those banks, then freshly unregulated, also made bad loans. S&L's are FDIC insured, so taxpayers got the bail bill for everything - which never did have a final accounting. They stopped counting around $900 billion.

No matter. All of it was just tacked onto the National Debt and it's still co-mingled with the rest of the $9 trillion on the Ultimate Taxpayer MasterCard. It's the long term interest that has to be paid on that which is the real bitch.

If you were just a youngster when that all happened, you'll still be paying for it most of your wage earning life. Not to mention the loss of worthwhile programs and declining infrastructure because that debt service has to be paid right off the top of revenue.

Now go ask your elders if any of them voted for St Ronnie.