Underwater Borrowers Shift the Wealth Effect into Reverse
The Housing ATM Shuts Down for Good
During the heydays of the mortgage bubble, rising asset prices were all it took to get consumers to spend themselves into deeper and deeper into debt.
However, the reverse is actually true these days.
Because according to the Federal Reserve, U.S. household net worth fell by $1.3 trillion in the first quarter, proving that green shoots are something of a fairy tale for the U.S. consumer at least.
In fact, since its peak in the third quarter of 2007, household wealth has decreased by 21.6%, or more than a fifth. That is the most dramatic fall in the series since reporting began more than 50 years ago.
Yet somehow, the bulls keep pounding the table, saying there is light at the end of the tunnel, even though consumer spending is over 70% of the U.S. GDP.
The truth is when consumers take huge losses-whether realized or not—belts get tightened, not loosened.
Meanwhile, a good portion of those people that cashed-out a few years ago are now hopelessly underwater.
From the Wall Street Journal by Nick Timiraos entitled : Study Finds Underwater Borrowers Drowned Themselves with Refinancings
Why are so many homeowners underwater on their mortgages?
In crafting programs to prevent foreclosures, policymakers have assumed that the primary reason homeowners owe more on their home than it is worth is that they bought at the top of the market. In other words, they've lost equity primarily through forces beyond their control.
A new study challenges this premise and finds that excessive borrowing may have played as great a role.
Michael LaCour-Little, a finance professor at California State University at Fullerton, looked at 4,000 foreclosures in Southern California from 2006-08. He found that, at least in Southern California, borrowers who defaulted on their mortgages didn't purchase their homes at the top of the market. Instead, the average acquisition was made in 2002 and many homes lost to foreclosure were bought in the 1990s. More than half of all borrowers who lost their homes had already refinanced at least once, and four out of five had a second mortgage.
The original loan-to-value ratio for these borrowers stood at a reasonable 84%, but second and third liens left homeowners with a combined loan-to-value ratio of about 150% by the time of the foreclosure sale date.
Borrowers, meanwhile, took out around $2 billion in equity from their homes, or nearly eight times the $262 million that they put into their homes. Lenders lost around four times as much as borrowers, seeing $1 billion in losses.
Borrowers that bought homes without ever putting any or little equity in their homes could have seen huge returns on investment simply by extracting cash through refinancing. "Why such borrowers should enjoy any special government benefits such as waiver of the income taxation on debt forgiveness or subsidized loan modifications to reduce their borrowing costs is at best unclear," the authors write." (emphasis mine)
Granite countertops, Hummers, trips to Mexico, and your own cement pond out back.
Boy those were the days. Too bad they aren't coming back.
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