Home Equity Loans


I remember when I was working for Morgan Stanley back in the early nineties and the big deal of the week was lobbying our state rep to repeal Texas' very old prohibition against home equity loans. I remember being the only person in the office vocally opposing this idea. It was a bad idea. A bad idea for Texans, a bad ideas for Americans and ultimately in the long run, a bad idea for the banks. Of course, politics prevailed over common sense.

But guess what?

I was right about what would happen:

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.

Read the rest of the essay. It's worth your time.

Another thing I have been thinking of is the possibility of a commodity bubble. On the one hand, if the US goes into a recession then the price of commodities should go down, right? But what if all that cash out there props commodities up and we have a weird kind of hybrid emerge, with rising commodity prices buy deflation in the US? Is something like that even possible?


Sean Paul Kelley March 27, 2008 - 9:09am
( categories: Economics: USA )

There will be an attempt to have another bubble somewhere as there is too much money chasing money at the top of the world economy.
If we were smart and lucky, there would be a green bubble: transportation, green energy, electric, water, etc.infrastructure.
At least something useful would be left when it pops.
But I am afraid that too many of our leaders are acolytes of the Shrine of the Free Market with the famous invisible hand of the priest in their pants.
We will probably just have an old fashioned commodity bubble that will burst, leave a lot of heartache and the True Believers will go on looking for the Next Best Thing.
Most of them the Oil Barons and their minions who are bailing on the US as fast as possible. Think Halliburton's move to Dubai.

JT March 27, 2008 - 10:01am

... a green bubble would be great. And to some extend other countries may already be through the first wave of one one: Check out this chart of a typical solar play in Germany.

On the other hand I think your scenario is not only possible but very likely. All sorts of investments have been burnt but there is still too much cash out there losing value at the prevailing interest rates. We may very soon see that the resource prices dislodge from the fundamentals as more investors get into the game. This could very well go on until the entire world economy is chocked to death. Possibly the only way the rest of the world could avoid this fate is to dump the US dollar sooner than later i.e. take the substantial pain now rather than wait for the mother of all depressions.

quax March 27, 2008 - 10:24am

"I remember when I was working for Morgan Stanley back in the early nineties and the big deal of the week was lobbying our state rep to repeal Texas' very old prohibition against home equity loans. I remember being the only person in the office vocally opposing this idea."

I'm trying to remember the dates; it sees to me the bandwagon began to roll in the 80s, and we were one of the last holdout states.

http://mauberly.blogspot.com/

mauberly March 27, 2008 - 10:29am

the commodity bust is more likely than not, in my view.

http://mauberly.blogspot.com/

mauberly March 27, 2008 - 10:32am

I've noticed the same thing. But are commodities becoming a bubble when priced in Yen or Euros? Consider the following loose timeline:

After the tech bubble and recession, companies tighten their belts, reduce workforces, and offshore manufacturing, which weakens the economy. Several corporations declare bankruptcy and/or demand wage relief from workers, a la US Air, American Airlines, Northwest, etc. Productivity increases, and this is reflected in stock prices to some extent, but not in wages, except for the CEOs.

The economy is kept afloat with lax lending policies (aka "innovative financing" and an explosion of credit card issues. The easy money pushes up home prices. Homebuyers sell old properties for a profit, or move up to more expensive houses. Eventually, the whole thing underlying the market, the financial health of the vast majority of Americans hasn't really improved and by some indicators (median income) gets worse. The economy/financial health of the middle class catches up with individuals at roughly the same time. Many go belly-up, have their homes foreclosed, and this causes mortgage-backed derivatives to have problems. In a case of the dog wagging the tail, investors get out or avoid these derivatives; the world credit market evaluates US real estate to be overvalued, and as such, home values go up in smoke.

Meanwhile however, improvement in the global economy demands more commodities, driving prices up to some extent. As Bernanke lowers Fed rates, he devalues the dollar, and commodities priced in dollars therefore skyrocket. The flip side of this is that Europeans and Asians don't want to pay more for oil or copper or corn, so their currencies become more valuable in order to accommodate the price inflation of commodities. Furthermore, commodities prices are not likely to go down quickly if the US goes into any sort of recession; even if we don't consume these commodities, the rest of the world will, until they, too are in a recession.

The upshot is that that yes, middle class workers are seeing deflation in their largest assets--their homes--while they are getting laid off or taking wage cuts, just as inflation is eating away at the buying power of the money they still have. If the price of gasoline and the price of everything that relies on gasoline for its production (food) increases 50%, 60%, 70%, it takes that money right out of the economy. This in addition to the exponentially increasing costs of healthcare, education, you name it.

Stack up the price increases for all of these things versus the median wage during the same time, and it's hard to see how Americans could have made up the difference without credit. There has been massive wealth redistribution throughout the country.

The strange thing is that although the stock market has taken a hit, it hasn't deflated nearly enough to reflect the state of the US economy, the global credit market, commodities prices, and the decline of the US dollar. What would it take for traders to realize that the US is effectively bankrupt?

And all along the way, the GOP and George Bush and the money men greased the skids for this catastrophe. They opposed legislation to make healthcare universal, or even affordable. Even for children (S-CHIP). They cut student loans and cost of living increases for social security. They dismantled welfare programs that rehabilitate individuals into productive consumers. They made it easier for corporations to offshore jobs. They deregulated the markets--the new conservative talking point these days is "liberalized" the markets. And lending standards. And accounting standards.

Well, the party's over.

Jonathryn March 27, 2008 - 10:35am

"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"

Here in California, the Banks are already not getting home equity loan money back. In a 100% loan, it is typically a first - 80% ARM, and a second - 20% home equity.

When the home is foreclosed or sold short, the holder of the home equity loan looses first -- typically all of the home equity loan is lost, and the holder of the ARM, looses about 10% of the value of the ARM.

My belief is the Banks are increasingly worried they will loose much, much, more money, this hits their capital ratios, the Banks become technially insolvent, and the fed bails them out. Unless the Banks have already moved their Home Equity portifolio to offshore SIVs to hide the losses.

Numbers - There are 900 home in Forclosure in Garden Grove, 1100 in Santa Ana, 1700 in Corona, a total of 17,000 in Riverside and about 11,000 in San Bernardino Counies..

These numbers, from the public records, are people who are either over 90 days late (in default), have a foreclosure sale scheduled, or Bank owned properties. The actual numbers are worse, becuse the Banks know how many people are 30 to 90 days late, and these numbers a not public record. We also know that 95% of people who become late, loose the home.

One indicator is Banks are very quick to sell Bank owned properties, as if their instructions were "sell them quick, we have a lot more coming, and we don't want to loose even more money".

Synoia March 27, 2008 - 10:38am

The rights of the second mortgagee (which is essentially what most HELOC issuers are) vary tremendously by state. HELOCs should be thought of as credit cards, not mortgages. It is perverse to think that the noteholder would simply relinquish the debt because the house has been sold for less than the cumulative value of the first and second mortgage. To me, the real issue is not that the loans are being given, it is that lenders are allowed to finance right up to the 99th percentile of the so-called appraised value of the dwelling, which is basically a fictional value anyway.

Barbara March 27, 2008 - 11:31am

Another thing I have been thinking of is the possibility of a commodity bubble. On the one hand, if the US goes into a recession then the price of commodities should go down, right? But what if all that cash out there props commodities up and we have a weird kind of hybrid emerge....

Contemporary bubbles are dislocations caused by excess liquidity. The CB's are still flooding markets with liquidity and will continue to do so as long as things look deflationary overall. That liquidity has to go somewhere; however, the CB's cannot direct where the liquidity they are providing will go.

It obviously won't go into the junk that is causing the problems, unless that junk is marked way down, leading to the asset shrinking that CB's are attempting to avoid in the name of fighting recession.

Rather, it will go in the direction of greatest perceived return commensurate with risk. Risk appetite is also shrinking as uncertainty rises due to lack of transparency and the specter of increasing insolvency. Right now, low risk government paper is rising and commodities are holding up too. It looks like commodities will be a speculative vehicle in this cycle, and some commodities will be investment vehicles also. Foreign wealth can be expected to retreat from paper into "real wealth" like precious metals, for example, since that is a traditional strategy. Plus, at the end of this cycle of realignment, whoever owns the gold gets to play king of the mountain, as the US did after WWII.

Demand is created not only by "real" use value --production -- but also by financial use value, such as safety. Even though commodites might be expected to crash because of lowered real demand for production, the excessive increases in liquidity consequent on "reflation" to avoid deflation are undermining the value (purchasing power) of currencies -- and there is a lot of junk out there that folks are unloading and searching for greater safety. Therefore, some of those funds will also chase things of "real" value, such as commodities, for financial reasons.

However, very few things other than moving averages are linear. There will be many ups and downs in commodities. For example, irrational exuberance, short selling and fear of losses will lay some nasty bear traps.

tjfxh March 27, 2008 - 11:10am

For that matter, if I remember the advertisements of a few years ago, you could borrow over 100% against your home if your income was strong enough.

The only circumstance in which banks could justify such loans, with no collateral cushion whatsoever, would be a) the borrower's income would continue to rise to cover inflation costs and the cost of repaying the loan, and b) housing prices would rise forever to allow for refinancing if the borrower got into trouble. Probably circumstance b) was the real clincher to get banks to books such loans, though we shouldn't underestimate the process of securitization in this. If some nameless investor was going to ultimately buy this paper, then the banks didn't really have to care as the default risk was passed on to others.

Now suddenly they have to care because assumption b) has proven terribly wrong. Without that assumption, they find that they are holding a second lien with little or no collateral protection, with all proceeds from a short sale going to the first lien holder. They can muck up the short sale and try to use this tactic to extort something from the first lien holder, but that is the extent of their power.

This was supposed to be the "safe" product for banks. The article is right to point out that this time bomb is much more devastating for banks than the subprime mess. At least those loans were mostly passed to investors. Banks held on to a lot of the HELOCs because of their "safety" and customer relationship benefits. This is a real abyss they are staring into if housing values continue to decline and the economy stagnates or worse still, declines.

Numerian March 27, 2008 - 12:12pm

into credit card debt. I suspect that the big reason behind the Visa IPO was there was dread that that the house of cards is going to collapse. No bankruptcy legislation will get blood out of a stone.

Wall Street saw the IPO as a wonderful thing, but I'm not as optimistic.

Maybe it's time for Congress to save the economy by reinstating debtors' prisons...

Petronius March 27, 2008 - 2:22pm

Hmmm....

Free health care, 3 meals a day, no collections phone calls, light exercise, a library....

No, sounds too much like socalism.

Synoia March 27, 2008 - 3:03pm

13% of car loan debts are late, 7% of Target card debt is late, 8% of Macy's credit card debt is late, and overall Visa debt payments falling behind is approaching 6%.

These numbers are typically south of 4%.

As far as commodities, show me a commodity that is overpriced and I will believe you. Oil supplies available to the West have been flat and declining since May 2005, even a declining demand trend would only match the declining supply trend right now. Look at Mexico, exports are down 20% in 2007 compared to 2006, and are forecast to fall greater than 10% in 2008 - our number 2 supplier. They are now a net importer of gasoline. Britain is now a net importer of oil for the first time in 2007. India and China have also generally uncoupled from the United States, India for sure. Russia is uncoupled from the United States, which means that weakness here does not translate into weakness there. The middle east is uncoupled with the united states. So demand for oil has no reason to go down, and supplies will continue to tighten even in the face of weakness in the US. That is exactly what is happening. We are in recession and oil prices are rising. How can that be? Shortage.

How about grains. Lowest inventory since 1945 and lowest days of supply on record. Drought in Ukraine and Australia and Brazil and Argentina and China. ug99 wheat rust hitting Iran, Pakstan, India and all of Africa, a particularly nasty spore that can wipe out 40% of a wheat crop. Think grain prices are going to fall when we are adding 77 million people a year, or a new united states every four years?

How about cement. Surely cement with the collapse of housing. But no, the shortage of cement is unbelievable. That won't be coming down. Roads and bridges crumbling in the US and half the cement of the world going to china.

metals. Same story. Phosphorus, shortage. copper, there is literally none left in the ground. Gold, load shedding of electricity is shutting down the mines and there is - shortage.

Inflation is 7% annually for the first quarter of 2008. Growth is probably -1.5% or worse. That is an astronomical contraction, even as the world continues to grow. The dollar is in free fall. In many respects commodity prices are not up but the dollar is in free fall. The buying power of the Dow is 1/3 what it was in 2000.

What we are watching is the amazing impoverishment of the United States, even as the world continues to grow in wealth. THIS is precisely what happens when you put a complete idiot in the White House.

Scotjen61 March 27, 2008 - 3:12pm

What we are watching is the amazing impoverishment of the United States, even as the world continues to grow in wealth. THIS is precisely what happens when you put a complete idiot in the White House.

I'm not so sure that this was due to idiocy instead of hubris and greed.

And I suspect they think the US can shoot its way out of the corner its backing into, if push comes to shove.

tjfxh March 27, 2008 - 8:28pm

The Visa IPO cash is shared by its member banks. It could be viewed as part of the frantic sale of good assets, though well-played in the market. In any event, the Visa people can be credited as the best market timers in the business. How much is Visa a processor and middleman, v.s. holding credit card debt themselves?

Yes, credit card CDOs are another bomb waiting to go off. Could we mitigate this by clamping down on credit card usury?

“The Playboy reader invites a female acquaintance in for a quiet discussion of Picasso, Nietzsche, jazz, sex.” - Hugh Hefner

Tonsure Wimple March 28, 2008 - 2:34am

"What we are watching is the amazing impoverishment of the United States, even as the world continues to grow in wealth. THIS is precisely what happens when you put a complete idiot in the White House."

I was recently in India and returned thru Amsterdam to US.
Yankee dollar is definitely hurting in Europe and India is certainly not the great bargain it used to be. In fact, if you want to go high quality western style in India (I didn't), it will cost as much as here.
It will certainly be amusing when the Chinese, Indians and Oil Oligarchs are outsourcing sweatshop to Ohio and Alabama. Now won't it?

JT March 27, 2008 - 8:40pm

Let's not forget Cheney and a host of cabinet officials. And then there was the compliant and venal Congress interested only in the wealth they could personally skim off the taxpayers.

Bush had multiple accomplices.

Numerian March 27, 2008 - 10:56pm

that the government is making available short-term 'emergency loans' to invertment firms, to help offset/cover shortfalls in the immediate term.

Anybody else see this as an incredibly bad idea?

I might be a big-government Democrat, but I see it as a very bad idea to get the government this entwined with a business as volatile as investments....if they go down, they'll take the government with them, and I don't think for a moment that other nations like China, India, Russia, and the Arab states will hold off collecting on their debt--not with the way(s) we've pissed on them in the past. There would be a certain amount of vicious satisfaction in foreclosing on a nation like the USA, who's spent so many billions around the world to promote the US at the expense of any and all local industry.

Add to this the Republicans doing everything they can to pad their pockets while/by selling off our lands and industries, and I see a lot of rich Republicans going to live off-shore (Marc Rich in Switzerland comes to mind), to hide their gains, and avoid accountability to the nation they plundered so thoroughly.

-5.75,-4.05
"We're all fucked. It helps to remember that." --George Carlin

justadood March 28, 2008 - 2:59am

Are Dick Cheney's Money Managers Betting on Bad News?

A look at the President and Vice President's financial disclosure forms.
By Steven Goldberg
May 17, 2006

Vice President Cheney's financial advisers are apparently betting on a rise in inflation and interest rates and on a decline in the value of the dollar against foreign currencies. That's the conclusion we draw after scouring the financial disclosure form released by Cheney this week.

As of the end of last year, Cheney and his wife, Lynne, held between $10 million and $25 million in Vanguard Short-Term Tax-Exempt fund (it's impossible to be more precise because the disclosure form lists holdings within ranges). The fund's holdings of tax-free municipal bonds mature, on average, in a little more than a year -- meaning that the fund should hold up well if rates rise. The Cheneys held another $1 million to $5 million in Vanguard Tax-Exempt Money Market fund, which is practically risk-free and could benefit from continued increases in short-term interest rates. And the couple had between $2 million and $10 million in Vanguard Inflation-Protected Securities fund. The principal and interest payments of inflation-protected bonds rise along with consumer prices, making them good inflation hedges.

The Cheneys also had between $10 million and $25 million in American Century International Bond. The fund buys mainly high-quality foreign bonds (predominantly in Europe) and rarely hedges against possible increases in the value of the dollar. Indeed, its prospectus limits dollar exposure to 25% of assets and the fund currently has only 6% of assets in dollars, according to an American Century spokesman.

The Cheneys' total assets could be as high as $94.6 million, according to the disclosure form. The vice-president's advisers say the vice president pays no attention to his investments. His lawyer, Terrence O'Donnell, says outside money managers supervise the investments. "He has nothing to do with it," O'Donnell says.

As for stocks, the couple held between $1 million and $5 million in Lazard International Equity and a like amount in Lazard Emerging Markets funds. The Cheneys' relatively few U.S. stock fund holdings include $1 million to $5 million in GMO Tax-Managed U.S. Equities III.

President Bush may be bold in his public policies, but his private investments appear decidedly on the meek side. Bush and his wife, Laura, reported on their disclosure form that they held combined assets of $7.2 million to $20.9 million.

As of the end of last year, the Bushes' two largest assets were their Texas ranch, valued at between $1 million and $5 million, and a blind trust, also valued at between $1 million and $5 million. Of course, it's impossible to tell how the trust is invested, so it could be heavily in stocks. The White House would not make the trust's managers available for comment.

Beyond the trust, the First Family's investable assets are largely in super-safe Treasury notes, money-market funds and bank certificates of deposit. The Bushes' holdings in these instruments totaled between $1.7 million and $4.4 million. The President also listed a Health Savings Account worth between $1,000 and $15,000.

The Bushes confine most of their stock investing to their relatively small IRAs and to the President's retirement account from when he was governor of Texas. As of last December, that account was worth $108,016 and was invested entirely in Vanguard Wellington, which owns stocks and bonds. The President's IRA, worth $87,074, includes $30,142 in Capital Income Builder, a balanced fund that's part of the American funds family; $30,866 in Growth Fund of America, another American fund; and $24,219 in zero-coupon U.S. Treasury bonds. Nearly all of the First Lady's IRA, worth $8,556, was also in Capital Income Builder.

http://www.kiplinger.com/features/archives/2006/05/president.html

canuck March 28, 2008 - 11:53am

Of course it's possible. Check out just about any third world country you wish to. People pay high prices for things necessary for survival. They have no money for luxury items.

During the transition, an abundance of this junk we have accumulated will cause prices for it to fall. As fuel prices increase huge suburban houses an hour a day away from the work place will become less attractive and lose value.

Government bail-out programs will cause the dollar to lose value and working people's wages are unlikey to maintain pace.

Commodity prices are affected by world-wide markets, not just what happens with the 5% of the world's population we represent. If we won't pay the higher price, someone else will.

I did inhale.

Don March 30, 2008 - 8:42am

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