Latest Bank Headache: Home Equity Loans
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"This product was meant to help people do construction on their house, [and] do debt consolidation -- not to take out every last dollar of equity in their home to finance a different kind of lifestyle."
-Charles Scharf, head of J.P. Morgan's retail business.
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That is, in a short phrase, the reason that the US consumer is all spent out. They used debt and home equity -- as opposed to Income gains -- to finance an improving lifestyle. After the vacations are passed, the big screen TV and new cars become old, what are you left with?
Appreciation in the value of your home has long been considered a form of forced savings. (As in don't eat your seed corn). The economic boost is over, the savings impact is significant, and you are left with a financial hangover. Talk about a negative wealth effect.
For the banks, it raises all different manners of headaches. Unlike Mortgages, Home Equity loans are secondary against the collateral -- the house itself:
"While banks can foreclose on a first-lien mortgage, lenders often have little recourse when trying to collect a delinquent home-equity loan, especially if another bank holds the primary mortgage. Banks holding home-equity loans generally can only seize the collateral -- a house -- after the mortgage is paid off.
When another bank holds the mortgage and the mortgage payments are current, the home-equity lender is effectively powerless to collect the debt.
Unfortunately for home-equity lenders, many borrowers understand that pecking order, concluding there are few repercussions if they stop making payments on their home-equity loan . . . Other types of consumer loans also are souring, including credit cards and auto loans. But delinquent home-equity loans are rising faster, representing 12.5% of all delinquent loans in the fourth quarter at Bank of America Corp., the largest U.S. bank in stock-market value. That was up from 9.4% in last year's first quarter, according to research firm SNL Financial.
Pretty amazing stuff.
The bankers are finally asking themselves "How the hell did we get into this mess?" The answer surprises no one:
Leaning on outside mortgage brokers for home-equity business was "one of the biggest mistakes we've made." Those loans have performed worse than home-equity loans generated by J.P. Morgan.
-Charles Scharf, head of J.P. Morgan's retail business.
Indeed . . .
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Source:
Latest Trouble Spot for Banks: Souring Home-Equity Loans
Losses May Hit Lenders That Skirted Subprime; Surprise Delinquents
ROBIN SIDEL
WSJ, March 12, 2008
http://online.wsj.com/article/SB120527998662928743.html
Wednesday, March 12, 2008 | 07:58 AM | Permalink
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Comments
"This product was meant..."
"meant"... hmmm. I'd say there is a problem. Business is business and you do it by the numbers, not by the meanings, the shadings, the leanings.
Posted by: wally | Mar 12, 2008 8:22:14 AM
If people actually planned on staying in their homes forever, they'd think twice about doubling the size because they'd intuitively realize that they'd be retiring with debt.
Now, housing is another commodity. You buy the big house thinking you'll live there for a few years and just sell it when you enter a new stage in life.
The problem is that we're going to get a big wave of Boomers who are going to want to sell to Gen-X and they're finally going to understand how our system is based on a Ponzi scheme. You always need more people behind you for the system to keep on working. For the first time in decades there won't be as many buyers down the pipeline as there were for the older group! Unless of course you open the borders to foreigners... but historically the US has not been very open to the world in times of crisis.
Yes population will grow over the long term (20-50 years) and buy up the excess real estate but over the next 5-10-15 years, we're going to feel the impact of a small Gen-X cohort with not much money and Boomers trying to cash out to live their retirement according to the standards of Freedom 55.
Posted by: D. | Mar 12, 2008 8:22:31 AM
I used to sit in HB meetings with ever-so-slick and shiny Mortgage Brokers (having just parked their new $100K+ automotive toys in the visitors lot), who would announce, with an air of smug entitlement, that they had come up with some innovative new "products" that could get virtually any buyer into a new home. The execs liked them, the salespeople liked them, the HBs marketing staff didn't understand them. I understood them, and the danger they posed to the long term viability of my clients' businesses.
Of course, I was the stick in the mud - the guy who wouldn't go along. The thought of money makes some people drool.
The kicker was this deal: No doc, 1st mortgage, 100%, interest only ARM. 2nd mortgage (remember, this is going in to the deal) to cover buy downs, condo/HOA fees/settlement costs, no doc, ARM, 2-3 year balloon.
Who made money on this deal? The Brokers, via commissions and fees. The builders seemed to make money, but they actually signed-up for the death of their businesses by attrition.
We are harvesting a crop of fraud.
Somebody(ies) should be jailed.
Saw one of these fella's recently at a troubled condo project in NOVA. He still had the car and the shiny suit, but he looked worried when I asked him how business was going. He'd have been much more worried if he had known how badly I wanted kick his ass and haul him to the authorities to collect my bounty.
Goddamned criminals.
Posted by: Marcus Aurelius | Mar 12, 2008 8:29:19 AM
funny thing about every single ad I have seen on TV or mailing I have gotten pushing helocs????
all mentioned vacations and boat buying as if that was the proper use of home equity. Does this banker ever look at his own marketing material? I hate this kind of after the fact lecture from the very same greedy assholes who won't take resposibility for their contribution to duping stupid consumers...reap what you sow big banker.
Posted by: lurker | Mar 12, 2008 8:41:24 AM
That distinction between "debt consolidation" (good) and future spending (bad) is fallacious.
What is the difference between taking a cruise, buying new furniture, etc., on a credit card and later "consolidating" debt by taking it of home equity, or reversing the order?
Posted by: Bob_in_MA | Mar 12, 2008 8:53:23 AM
all mentioned vacations and boat buying as if that was the proper use of home equity. Does this banker ever look at his own marketing material?
This cannot be repeated enough. All this blame-game is doing is convincing me that CEO asset seizure is a good idea.
Posted by: Walker | Mar 12, 2008 8:53:39 AM
Bush has taken credit for "Ownership" the last few years. He and GOP Congress's 2004 Bill for zero-down financing show you which way the "values party" feels about the values of thrift.
They should call themselves the Lifestyle party. FOX news: Fair and Fashionable.
Posted by: VennData | Mar 12, 2008 8:58:34 AM
It is stunning how many banks were sucked into this mess. March of the lemmings?
How could they think that mortgages at 6 to 10 times borrower earnings could go on for long, even if they could bundle their loans and sell to the greater fool? The housing bubble driven by a Greed Bubble, HELOCs welcome.
Posted by: Lars | Mar 12, 2008 8:58:53 AM
Interesting table!
Percentage of all home-equity loans that defaulted is only 0.23%!
If you listen to US opinionated media, you will get an impression as if it is 23%.
Posted by: Via Aurelia | Mar 12, 2008 9:05:46 AM
It's not quite correct to say that there is no recourse for home equity lenders. They can still foreclose their loan, and get the tail of the equity in their pockets--which would of course be meaningless if there really isn't any tail to pocket. I think that's why they rarely are pursuing any type of remedy.
Which points to the bad business decision on their part in lending money against an asset that absolutely requires appreciation of the asset in order for their loan to be truly secured.
Holman Jenkins has a good article in the WSJ today on why the fed needs to let the markets find a bottom, but is doing just the opposite w/ its myriad programs amounting to covert nationalization of the mortgage industry--http://online.wsj.com/article/SB120528077518628769.html?mod=todays_columnists
Until the market is allowed to find a bottom in prices, there won't be any real recovery. We are, it seems, all Keynesians now, throwing government money at the housing industry whilst hoping against hope that it remains solvent for longer than it stays irrational.
Posted by: DonKei | Mar 12, 2008 9:09:09 AM
Posted by: Via Aurelia
____
You miss the larger point: This is what has been driving consumerism via available debt (credit) for the past decade or so. It was based on fraudulently valued collateral and the false, viral marketing meme that housing prices never go down. Now, it's gone.
Posted by: Marcus Aurelius | Mar 12, 2008 9:20:42 AM
What struck me is the comment about the mortgage brokers arrogance during the good times. A high tide allowed the some jokers to do very well for a couple years and they were all too happy to flaunt how great things were and smart they were. At a local law office my friend worked at (since laid off) they had a company limo and a party life style during the workday (booze and employing pretty woman who were not even close to qualified, etc.). It sounded more like a college party atmosphere than a place of business and I guess the scene was all too common in the industry.
Posted by: Joe | Mar 12, 2008 9:27:25 AM
I get that this has all been an utter fraud. And it's really not correct for me to say the markets are behaving irrationally, except perhaps from the homebuilder/bank perspective. (Sometimes even if we are all Keynsians, the quotes just don't quite fit.)
In any event, the point is that the housing market won't recover in any real way until the fraud of inflated values are threshed from the system, and the fed is acting at cross purposes to that end.
Posted by: Donk | Mar 12, 2008 9:29:23 AM
That last one should have been by "DonKei", not "Donk"...
Posted by: DonKei | Mar 12, 2008 9:32:00 AM
Get ready for the 1,000,000 dollar bill.
There is a consensus among a wise breed of economists that the Fed does not have the conventional weapons to win this insolvency war.
Indeed, Mr. Bernanke has little to show for each of the monetary attacks he has launched so far.
By failing to win the battles he chooses to fight, Mr. Bernanke looses credibility. Yet he projects a dangerous false sense of assertiveness that he'll prevail.
The sad truth is that, in the end, Mr. Bernanke only option is to print enough money to bring inflation to the level of overvalued housing prices.
Posted by: Steelduck | Mar 12, 2008 9:32:49 AM
The issue is not how many loans are delinquent, as many will be soon, after "homeowners figure out what they are paying on an underwater asset. The problem is what happens five years from now when more and more boomers face retirement with little home equity, no defined benefit pension, and fewer Wal-Marts to get a greeter job for food.
Posted by: larster | Mar 12, 2008 9:37:14 AM
Of course, Wall Street always benchmarks against last year's bonuses rather than last year's risk.
Those models of default were valid when the biggest loan amount was a 36% DTI. That's the rate even for the new deal's governmental mortgage agency (i forget the acronym.) If today's DTI is 125%, how would the default rate NOT be higher?
However, this doesn't surprise me. Business majors can't handle engineering math.. and we're shocked they forgot to check their assumptions?
Posted by: Unsympathetic | Mar 12, 2008 9:37:49 AM
to Marcus Aurelius, together with this broker the whole bunch of prosecutors should be jailed for not grading consumers interests plus this greedy imbecilic bankers. As about the chewing and farting and buying the cheap Chinese crap, we have to wait for the gen pool to clean itself. On the second thought with the midgets running for the president I don't think it will.
Posted by: sergtat | Mar 12, 2008 9:49:32 AM
In the mid to late 90's I used to hock equity loans at BofA. I can tell you BofA used to have very stringent credit criteria. I remember having to tell a lot of people no. Anything less than excellent credit was an automatic denial. Debt to income ratio's had to be low and you had to have at least 80% equity AFTER the loan/line was established. My how quickly things changed!
Posted by: Mike M | Mar 12, 2008 9:52:40 AM
This has been said in different ways above. Here's my take on the situation.
1. We have an excessive debt situation in this country. Debt/GDP= 300% plus. A record high and growing exponentially. By excessive debt my definition is debt that can never be paid off.
2. There are only two options, as I see it:
-Go through a deflation, much like we did in the 1930s.
-Inflate your way out of debt. THis would seem to solve a lot of problems, like the Federal deficit, the trillions floating around overseas, and maybe the Medicare mess
Inflation seems to be the road Bernanke is taking and indeed he has written and talked about this plan. He famous talk about using helicopters to spread money around was all too telling.
The only problem is inflation (especially the hyper kind) is very destructive of governments.
From Wikipedia
"In 2002, when the word "deflation" began appearing in the business news, Bernanke gave a speech about deflation.[10] In that speech, he mentioned that the government in a fiat money system owns the physical means of creating money. Control of the means of production for money implies that the government can always avoid deflation by simply issuing more money. (He referred to a statement made by Milton Friedman about using a "helicopter drop" of money into the economy to fight deflation.) Bernanke's critics have since referred to him as "Helicopter Ben" or to his "helicopter printing press". In a footnote to his speech, Bernanke noted that "people know that inflation erodes the real value of the government's debt and, therefore, that it is in the interest of the government to create some inflation."[11]"
Posted by: farmera1 | Mar 12, 2008 9:58:46 AM
Business followed the lead of their MBA President.
Massive criminality ensues.
Never elect a failed, yet wealthy, businessman to be your President.
Posted by: Marcus Aurelius | Mar 12, 2008 9:59:21 AM
Any candidate that I actually believed would purge the halls of those accountable and haul asses off to jail, all of them, would get my vote, irrespective of party loyalty.
Posted by: Stuart | Mar 12, 2008 10:06:05 AM
Comment on short term management.
The banks (read upper management) by classic short term thinking. Manage to this quarters numbers (and oh by the way maximize your personal pay by getting the earnings growth and there fore stock price.) When it comes to your own pay you can justify almost anything in your own mind. Why worry about next year or a few years down the road, chances are you will have moved on anyway.
So the banks got involved in all kinds of loans, securitizations/derivatives that any second year accounting student could have told them would eventually blow up, but the banks showed good earnings, and the stock price did very well thank you. But now we've reached d-day, with the fed desperately trying to keep everything together. With a continuation of this Greek
tragedy the poor/government are paying to save the rich bankers from themselves.
Posted by: farmera1 | Mar 12, 2008 10:07:09 AM
Now that the HELOCs are no longer available to the general public to artificially inflate their incomes, perhaps they will notice how their stagnant middle-class income trend means their standard of living is actually lower than it was for the past few generations. The growing income disparity between the upper-class and the "average joe" was also no big deal when "joe" could live beyond his means through easy credit.
Maybe now the unwashed masses will wake-up and demand a bigger share of the pie....if there is any pie left after the implosion.
Posted by: The Spoiler | Mar 12, 2008 10:12:53 AM
They did so to maintain their living standards, not to improve it. Living standards for the middle class have declined over the past 30 years.
The next class to suffer a big drop will be the 80-95% group, since the middle classes bones have been picked clean, the vultures have to move on to the next course.
Posted by: pft | Mar 12, 2008 10:26:45 AM
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