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> As the economy shows its true face, one item that continually gets
ignored
> is the level of debt buildup.
> An article on the front page of The New York Times today entitled, "Equity
> Shrivels as Home Owners Borrow and Buy
> <http://www.nytimes.com/2001/01/19/business/19BORR.html>."
> The article points out the perils and pitfalls of borrowing too much
money,
> it illuminates living beyond one's means and also illustrates how the
"long
> term" (everyone's favorite investment horizon) can be interrupted due to
> unforeseen problems. Said differently, it shows how life issues its margin
> calls at the wrong time.
> Owe say can you see. . . With all the hype and hyperbole about said new
era,
> here are a few sobering facts. From the end of 1994 to 2000, gross
domestic
> product was up $2.72 trillion, corporate and consumer indebtedness was up
> $4.75 trillion, indebtedness in the financial sector was up $4.15
trillion,
> therefore total credit and debt creation was up $8.9 trillion. We can see
> then that debt growth was three times faster than GDP growth. More like a
> good old-fashioned period of printing money and leveraging it up. Not
> exactly what one would expect to see in a period of miraculous
productivity
> or in a "new era."
> Over the same period, the personal savings rate, which is measured by
> percentage of disposable income, has declined from 8.7 percent into
negative
> territory. Corporations have engineered themselves into a funding deficit
as
> well. Of course, these figures are very rarely discussed, but
nevertheless,
> they are real. This morning's article in The New York Times gives you a
> small taste of an immense problem. Just another reason why, regardless of
> what anyone's wishes are, the unwinding of this bubble will be an epic
> disaster.
>
> -------------------------New York Times
> Article------------------------------
> Equity Shrivels as Homeowners Borrow and Buy
>
> January 19, 2001
>
> By LOUIS UCHITELLE
>
> When Erica Hutchinson and her fianc , Lynn Corbett, bought their
> brownstone in the Clinton Hill section of Brooklyn for $175,000
> three years ago, they persuaded a bank to lend them $230,000. Their
> argument was that the value of their new home would jump once they
> used the extra mortgage money to gut the three-story building and
> fill it with new bathrooms, a new kitchen, new flooring, new
> windows new everything.
>
> They were right, of course. The Corbetts, now married, say that
> after several years of a flush New York economy their brownstone
> would easily sell today for at least $370,000. Their bankers seem
> to agree. The couple recently added a $30,000 home equity loan,
> using the new money to pay off credit card bills. "The construction
> costs were more than we had anticipated so we charged them," said
> Ms. Corbett, who is 30, like her husband, "and we paid for our
> wedding with credit cards, too."
>
> For most American families, their home is their biggest
> investment, and after years of prosperity in which home prices rose
> substantially, family wealth has increased as well. But like the
> Corbetts, millions of households borrowed heavily against their
> homes, often to help support greater spending.
>
> The borrowing has been so extensive, in fact, that homeowners,
> after building up equity through much of the 1960's and 1970's,
> have let their ownership shares deteriorate over the last two
> decades to the lowest level on record, the Federal Reserve reports.
> The borrowing even accelerated in the 1990's, helping to explain
> how Americans managed to easily outspend their incomes through two
> long economic expansions.
>
> Now a slowing economy catches the average household owning less of
> a stake in its home than in any economic slowdown since the advent
> of the modern mortgage in the 1930's. If a recession develops and
> people start worrying that they have too little equity left to
> continue borrowing safely against their homes, the blow to spending
> could turn a mild recession into a prolonged one. That would
> certainly happen, economists say, if a downturn causes home prices
> to fall, shrinking even more the equity stake that households still
> have in their homes.
>
> "When you make borrowing dependent on your home, then you erode
> the fire wall that protects your standard of living and we are
> going into this slowdown with the fire wall clearly eroded," said
> Nicolas Retsinas, director of the Joint Center on Housing Studies
> at Harvard. "The home is not just a financial transaction, it
> defines who you are and what kind of community you live in. When
> all of a sudden you get into trouble, you can't just rip it up like
> a credit card."
>
> The average homeowning household owed lenders 46 percent of the
> market value of its residence during last year's third quarter, up
> sharply from about 30 percent in 1982 and 40 percent in 1991, at
> the start of the current economic expansion, the Fed reports show.
> For a typical family with a home worth the median market value of
> $144,000 late last year, that meant their equity was $77,760 while
> their debt was $66,240.
>
> That still sounds like a relatively safe cushion. But American
> society once exalted a different norm a 20 percent down payment
> and the balance paid off through a 30-year fixed-rate mortgage. The
> Champagne toasts and mortgage burnings that celebrated the final
> payment are gone today. Instead, a growing number of Americans are
> approaching or entering retirement still making hefty home
> payments.
>
> In many ways, the shift makes sense. Home equity loans and the
> refinancing of mortgages have become vehicles for converting
> standard consumer debt into loans that usually enjoy tax breaks,
> lower interest rates and smaller monthly payments. Millions of
> people have managed to borrow against their homes at rates under 10
> percent, while channeling other funds into retirement plans and
> into a stock market that until recently achieved average returns of
> 15 percent or more a year.
>
> Whatever the justifications, the family home is now more at risk
> as collateral for the spending that underpins economic growth.
>
> The vulnerability cuts two ways. For people like the Corbetts,
> convinced that their brownstone on St. James Place can only rise in
> value as their neighborhood improves, there is still room to borrow
> more and spend it avidly, softening any downturn. "We are
> definitely ahead of the game," said Ms. Corbett, who works in the
> fashion industry. Her husband runs a Boy's Town center in Brooklyn
> and their income is $120,000 a year, not counting the $1,300 a
> month they receive as rent for an apartment in their brownstone.
>
> But for homeowners like Thomas Murray, an executive for a
> Cincinnati company that cleans food processing plants, even a
> leveling off of home prices would be chilling. He is painfully
> aware that if he sold his four-bedroom brick suburban home for the
> $220,000 that he thinks he can get for it and then paid off his
> mortgage and his home equity loan, he would walk away with as he
> puts it "$8, maybe $9."
>
> "If I had to take a pay cut or had to accept another job for a
> lower level of pay, then I would have the credit card problem
> again, and no equity left in my home to solve it," said Mr. Murray,
> 36, who landed his present job last spring at a sharp increase in
> salary, to above $100,000. Over the last five years, he had made
> less than $80,000 a year. As a result, the family accumulated
> $20,000 in credit card debt, which he and his wife recently
> converted to a $25,000 home equity loan.
>
> "Car repair, dental bills, mandatory home repairs, clothing for
> the kids, birthday parties, you cannot afford all this and stay out
> of debt," Mr. Murray said. "Unless you have a big enough income,
> which I have now."
>
> The big concern among economists is not a relatively short
> recession, but a longer one, lasting a year or so. "In a brief
> recession, the extra borrowing and spending would even soften the
> downturn," Mark Zandi, chief economist at Economy.com in West
> Chester, Pa., said. Indeed, a new surge in mortgage refinancing as
> interest rates fall the fourth surge since 1993 is likely to
> give a lift to spending as some people go further into debt,
> pocketing the extra mortgage money without increasing their monthly
> payments.
>
> "But in a longer recession," Mr. Zandi said, "housing prices would
> weaken and many homeowners could easily find themselves owing more
> on their homes than the homes were worth."
>
> If that happened, the abrupt pullback in spending as these
> families tried to work down their debts and preserve their homes
> would exacerbate a recession. Many Japanese behaved in just this
> way after the collapse in real estate prices in that country a
> decade ago.
>
> Or, with monthly mortgage and home equity payments in the United
> States at a record level as a percentage of disposable income,
> trouble on the job layoffs, for example, or cutbacks in overtime
> pay could quickly restrict spending, also deepening a recession.
>
> Alexander Wright, a 40-year-old aircraft mechanic for Northrop
> Grumman in Jacksonville, Fla., is currently going through just this
> experience. He is among the millions of relatively new homeowners
> who could not meet the old requirements for a down payment to
> purchase a home, but achieved his goal as lenders relaxed their
> standards, offering mortgages that cover nearly the entire cost of
> a home. (California is the biggest offender in this category)
>
> Mortgage insurance has encouraged this expansion of homeownership.
> So has the increasingly popular practice of packaging mortgages
> into bonds that are then sold to many investors, thus spreading the
> risk of default. Government-sponsored programs aimed at allowing
> lower-income families to buy a home with little money down have
> helped as well. Together with the robust economy, these forces have
> propelled homeownership to a record 67.7 percent of all households,
> although many of the new homeowners own only a modest stake in
> their homes.
>
> Mr. Wright and his wife, Carvetta, an assembly line worker in a
> microchip plant, are in this situation, having purchased their
> three-bedroom ranch house several years ago for $64,500, obtaining
> a mortgage for the entire amount.
>
> "I've done a lot of renovation, doing the work myself, and I would
> price the house now at $82,000," Mr. Wright said. He has worked the
> mortgage down to under $55,000.
>
> But the family also owes $30,000 on a home equity loan the Wrights
> took out to pay off credit card bills and to help buy a car. With
> two teenagers, they were paying off the debt without undue
> sacrifice, Mr. Wright said, until his overtime suddenly stopped
> last June. Repair work at Northrop Grumman had slowed. The Wrights'
> combined annual income is about $54,000, and the overtime once
> added $10,000 a year. Without it, the payments on the debt
> continue, but family spending is curtailed.
>
> "I am going to try not to draw down the $4,000 that remains on my
> home equity credit line," Mr. Wright said. "We are trying to tough
> it out. We don't go out anymore, and we try not to buy the
> name-brand clothes that the kids want, none of that Tommy Hilfiger
> stuff. We had two dogs, and we got rid of one."
>
> If Mr. Wright is worried, David Murphy, who owns a home in
> Madeira, an upscale Cincinnati suburb, certainly is not. The
> Murphys he sells computer systems to hospitals, she is an
> electrical engineer completed a lavish $130,000 kitchen
> renovation last year, borrowing the full sum to expand the space to
> make room for a stone fireplace and archway. They installed new
> custom cabinets, granite counter tops and a Sub- Zero refrigerator.
>
> That was only the latest renovation to a three-bedroom home that
> the Murphys bought nine years ago for $225,000, putting $50,000
> down and borrowing $175,000. The upgrades include an entertainment
> room and an outdoor cooking center, and the debt against the home
> has risen to $400,000. But Mr. Murphy is confident that he could
> sell his home for $550,000 today. A bank appraiser told him that
> the $130,000 kitchen remodeling raised the selling price of the
> home by the full amount spent on the renovation.
>
> Is that accurate? Or are people overly optimistic about the values
> of their homes?
>
> "We are stunned by the optimism that shows up in our surveys,"
> said David F. Seiders, chief economist at the National Association
> of Home Builders in Washington. "The attitude used to be that
> remodeling is great, but don't expect to get it back in resale
> value."
>
> Mr. Murphy could well be right about his home. But what if he is
> wrong? "There is not yet a problem with house prices," Mr. Seiders
> said, "but if (WHEN) this slowdown continues (WORSENS), you could (WILL)
see
> problems."
>
>
> ====================
> A point of reference. . . I'd like to share a quote that captures the
> speculative mood we are in:
> This is apparent that the public preference for stock is not only as
> marked as ever, but also the will to speculate is still a speculative
fever
> not be overlooked. The prompt return of huge speculations in a liberal
> manner in which current earnings are again being discounted indicate that
it
> will be difficult to quench the fires of stock market enthusiasm for long.
> That quote is from the Barron's trader column of March 24, 1930. The high
of
> the post-crash bounce was on April 17, 1930, from which the market
collapsed
> nearly 90 percent. The moral of that story is that folks shouldn't confuse
> the bounce that is under way with a return to prosperity -- no matter how
> long it lasts -- nor should they think that because the market bounces,
all
> fundamentals can be ignored indefinitely, nor should they assume that Easy
> Al is going to save the day.
>
>
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