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Showing posts with label MEW. Show all posts
Showing posts with label MEW. Show all posts

Monday, October 06, 2008

The Impact of Less Equity Withdrawal on Consumption

by Calculated Risk on 10/06/2008 08:13:00 PM

Earlier today I posted the Q2 2008 home equity extraction data provided by the Fed's Dr. James Kennedy. This shows that equity withdrawal has fallen almost to zero as of Q2.

Kennedy Greenspan Mortgage Equity Withdrawal Click on graph for larger image in new window.

For Q2 2008, Dr. Kennedy has calculated Net Equity Extraction as $9.5 billion, or 0.3% of Disposable Personal Income (DPI).

Note: This data is based on the mortgage system presented in "Estimates of Home Mortgage Originations, Repayments, and Debt On One-to-Four-Family Residences," Alan Greenspan and James Kennedy, Federal Reserve Board FEDS working paper no. 2005-41.

Equity extraction was close to $700 billion per year in 2004, 2005 and 2006, before declining to $471 billion last year and will probably be less than $100 billion in 2008.

The questions are: how much will this impact consumption? And over what period?

Unfortunately there is no clear answer. Fed Chairman Bernanke has argued that falling house prices, not equity extraction, impacts consumption (from the WSJ in 2007):

"Our sense ... is that consumers respond to changes in the value of their home essentially because there’s a change in their wealth, not because there’s a change in their access to liquid assets."
...
Mr. Bernanke went on to reiterate it’s the price of homes, not MEW or financial contagion that represents the biggest risk of spillover from the housing slump. ... [H]e said a hit to consumer spending could be expected on the order of “4 cents and 9 cents on the dollar” of lost home wealth.
Others place more weight on MEW. Since equity withdrawal is a somewhat recent development, and there are many factors that impact consumption, it is hard to develop a predictive model on the impact of MEW on consumption. Equity withdrawal probably started in earnest with the Tax Reform Act of 1986 that eliminated the interest deduction for credit cards and consumer loans.

In an Economic Letter in 2006, Fed economist John V. Duca wrote:
We can think of the overall impact of home prices on consumption as the combination of two parts—the traditional wealth effect and the relatively new and growing phenomenon of mortgage equity withdrawal (MEW). In recent years, U.S. households have been extracting housing wealth through home-equity loans, cash-out mortgage refinancings or by not fully rolling over capital gains from sales into down payments on subsequent home purchases. Because home-equity loans and mortgages are collateralized, they usually carry lower interest rates than unsecured loans; thus, homeowners can borrow more cheaply. Also, by making housing wealth more accessible, financial innovations have opened new avenues for families to act more quickly on their consumption preferences.

Consistent with a growing liquidity, or MEW effect, some new studies have found wealth effects are now greater than earlier research suggested. One estimates that a $100 rise in housing wealth leads to a $9 increase in spending. Another finds that increases in housing wealth generate three times the spending from stock-price gains. Neither study, however, directly examines whether housing wealth has a greater impact on consumption today because of the greater ease of accessing home equity.
...
The limited U.S. econometric evidence indicates that the strong pace of MEW may have boosted annual consumption growth by 1 to 3 percentage points in the first half of the present decade. This implies that a slowing of home-price appreciation into the low single digits might shave 1 to 2 percentage points off consumption growth and 0.75 to 1.5 percentage points from GDP growth for a few years.

While these estimates provide an idea of housing’s potential economic impact, considerable uncertainty exists about how much a slowdown in MEW might restrain consumption growth.
Duca didn't mention the impact of falling house prices.

As far as when the impact occurs, on the wealth effrect, Carroll, Otsuka, and Slacalek, How Large Is the Housing Wealth Effect? A New Approach October 18, 2006 suggested that the impact would be over several quarters:
[W]e estimate that the immediate (next-quarter) marginal propensity to consume from a $1 change in housing wealth is about 2 cents, with a final long run effect around 9 cents.
For MEW, it is also uncertain. Kennedy and Greenspan tried to quantify the data in Sources and Uses of Equity Extracted from Homes, however:
Our results do not provide an estimate of the [marginal propensity to consume (MPC)] out of housing wealth; nor do they address the question as to whether extraction of housing wealth has an effect on PCE in addition to the standard wealth effect.
My guess is that the MEW effect lasts over several quarters (only a guess). Greenspan estimated that approximately 50% of MEW is consumed, and in interviews he suggested it is probably consumed over several quarters. Since MEW was $471 billion in 2007, and will probably be under $100 billion in 2008, we can estimate that half of the $400 billion or so decline in MEW (or $200 billion) is the drag on PCE in 2008 from less MEW.

That is a big number, but to put that in perspective, PCE increased over $500 billion from 2007 to 2008. So nominal PCE will increase in 2008, although consumption will probably slow sharply.

PCE will also be impacted by lost jobs and changes in consumer psychology (all the scary news will probably lead to less consumer spending).
Nearly six out of ten Americans believe another economic depression is likely, according to a poll released Monday.

The CNN/Opinion Research Corp. poll, which surveyed more than 1,000 Americans over the weekend, cited common measures of the economic pain of the 1930s:

  • 25% unemployment rate;
  • widespread bank failures; and
  • millions of Americans homeless and unable to feed their families.
  • So once again it will be difficult to separate out the various factors impacting consumption. This will probably be an area of significant econometric research over the next few years.

    It does appear that real personal consumption expenditures declined in Q3 2008 for the first time since 1991. And some of that decline is probably related to the decline in MEW.

    Q2 2008: Mortgage Equity Withdrawal Plunges to Near Zero

    by Calculated Risk on 10/06/2008 11:13:00 AM

    Here are the Kennedy-Greenspan estimates (NSA - not seasonally adjusted) of home equity extraction for Q2 2008, provided by Jim Kennedy based on the mortgage system presented in "Estimates of Home Mortgage Originations, Repayments, and Debt On One-to-Four-Family Residences," Alan Greenspan and James Kennedy, Federal Reserve Board FEDS working paper no. 2005-41.

    Kennedy Greenspan Mortgage Equity Withdrawal Click on graph for larger image in new window.

    For Q2 2008, Dr. Kennedy has calculated Net Equity Extraction as $9.5 billion, or 0.3% of Disposable Personal Income (DPI).

    This graph shows the net equity extraction, or mortgage equity withdrawal (MEW), results, both in billions of dollars quarterly (not annual rate), and as a percent of personal disposable income.

    Last week the Bank of England reported that MEW was slightly negative in the UK in the 2nd quarter.

    Less equity extraction means less consumption over the next few quarters. I'll have more on this later ...

    Saturday, October 04, 2008

    UK: Homeowners Stop Mortgage Equity Withdrawal

    by Calculated Risk on 10/04/2008 08:43:00 AM

    This is interesting ... from The Times: Homeowners steer clear of equity release loans

    Fearful homeowners have finally called a halt to a decade-long spree of cashing-in on the value of their properties to pay for big-ticket consumer spending and paying off debt, the Bank of England revealed yesterday.

    The Bank’s latest figures show that Britons have abruptly abandoned the habit of borrowing against their houses and flats through mortgage equity withdrawal, bringing to an end a decade-long era of the nation using its homes as cash machines.

    Second-quarter figures for equity withdrawal showed that, rather than raising borrowed cash against their properties, homeowners injected a net £2.8 billion of new equity.
    ...
    In practice, this means that homeowners collectively invested more capital in properties during the second quarter, either through paying down mortgages or cash payments to buy, than they raised through home loans.

    The news marks a big turnaround.
    The following graph shows home equity extraction in the U.S. through Q1 2008 (NSA - not seasonally adjusted) provided by Federal Reserve economist Jim Kennedy based on the mortgage system presented in "Estimates of Home Mortgage Originations, Repayments, and Debt On One-to-Four-Family Residences," Alan Greenspan and James Kennedy, Federal Reserve Board FEDS working paper no. 2005-41.

    Kennedy Greenspan Mortgage Equity Withdrawal Click on graph for larger image in new window.

    Just like in the UK, there was a surge of equity extraction in recent years. And just like in the UK, equity extraction has fallen off a cliff.

    I've contacted Dr. Kennedy's office, but unfortunately data isn't available yet for Q2. However the US data probably looks very similar to UK data.

    Here is what I wrote last year:
    As homeowner equity continues to decline sharply in the coming quarters, combined with tighter lending standards, equity extraction should decline significantly and impact consumer spending.
    As of Q1 homeowner equity had declined sharply, lending standards had tightened, and equity extraction had declined significantly. And now, based on the recent monthly data from the BEA on Personal Consumption Expenditures (PCE), it appears consumer spending has slowed sharply. My recent comment was: "[T]this will be the first decline in PCE since Q4 1991. This is strong evidence that the indefatigable U.S. consumer is finally throwing in the towel."

    It appears that less equity extraction is finally having a significant impact on consumer spending. Of course consumer spending is also being impact by job losses and the recession.

    Friday, June 13, 2008

    Kasriel On MEW and the Fed

    by Calculated Risk on 6/13/2008 07:46:00 PM

    Northern Trust chief economist Paul Kasriel discusses active MEW:

    Economists refer to something called the “wealth” effect. It is hypothesized that households tend to spend relatively more of their income when their wealth is increasing and vice versa. Mind you, households do not have any more cash in hand to spend when the value of their stock portfolios or houses go up. They are just wealthier “on paper.”

    In this past cycle, it had become very easy for households to turn their increased “paper” housing wealth into actual cash by borrowing against their increased home equity. This borrowing is called mortgage equity withdrawal, or MEW. Active MEW can be defined as mortgage equity withdrawal consisting of refinancing and home equity borrowing. In contrast, inactive MEW consists of turnover. At an annualized rate, active MEW peaked at $576 billion in the second quarter of 2006. Active Mew has slowed to only $114 billion in the first quarter of this year – the smallest amount since the fourth quarter of 1999 (see Chart 3 [at link]). There is no doubt in my mind that active MEW, which actually puts additional cash into the hands of households, played an important role in boosting consumer spending in this past expansion. And there is no doubt in my mind that the recent and likely continued decline in active MEW will play an important role in retarding consumer spending in this recession. Because it has been easier to borrow against the increased wealth in one’s house than in one’s stock portfolio, dollar-for-dollar, falling house prices will have a more important negative effect on household spending that will falling stock prices.
    Note: my graphs have focused on MEW including turnover. Active MEW is a subset of the data I've presented and consists of cash out refis and HELOCs.

    And on Fed tightening:
    It is conceivable the Fed could engage in a one-off 25 basis point hike in the funds rate, which could not make a material difference on business activity because the Fed has taken radical preemptive action as an insurance against the possibility of a severe economic downturn and/or continued financial market disruptions. ... But, there is a distinctly stronger probability attached to the likelihood of an unchanged federal funds rate well into 2009 ... In other words, in our estimation, the Fed may not need to translate rhetoric into action given the fragile economic environment and the likelihood that inflation will be moderating in the second half of the year.
    Goldman Sachs has the same view (no link): Could They? Yes. Will They? We Don't Think So.
    [W]e still believe that tightening is both inappropriate and unlikely anytime soon. It is inappropriate because: (1) the economy is fundamentally weak, with tax rebates driving the surge in retail sales; (2) financial markets remain fragile; and (3) worries about inflation are overdone ...

    Thursday, June 12, 2008

    BMW hit by MEW

    by Calculated Risk on 6/12/2008 05:08:00 PM

    From Bloomberg: BMW Buyers in U.S. See a Ford in Their Future (hat tip James)

    Purchases of luxury autos were down nearly 100,000 units, or 14 percent, through May 31, compared with an 8.4 percent drop in all U.S. sales.
    ...
    ``This gas panic has extended even to luxury buyers who are deciding they'd rather step down to a Ford with all the amenities rather than get a new Mercedes,'' said David Healy, an equity analyst with Burnham Securities Inc.
    Gas prices have probably played a role, but I think the decline in MEW (mortgage equity withdrawal) is a more important factor in the decline in luxury car sales.

    (see previous post on MEW)

    Q1 2008 Mortgage Equity Withdrawal: $51.2 Billion

    by Calculated Risk on 6/12/2008 03:00:00 PM

    Here are the Kennedy-Greenspan estimates (NSA - not seasonally adjusted) of home equity extraction for Q1 2008, provided by Jim Kennedy based on the mortgage system presented in "Estimates of Home Mortgage Originations, Repayments, and Debt On One-to-Four-Family Residences," Alan Greenspan and James Kennedy, Federal Reserve Board FEDS working paper no. 2005-41.

    Kennedy Greenspan Mortgage Equity Withdrawal Click on graph for larger image in new window.

    For Q1 2008, Dr. Kennedy has calculated Net Equity Extraction as $51.2 billion, or 1.9% of Disposable Personal Income (DPI). Note that net equity extraction for Q4 2007 has been revised upwards to $92.3 billion.

    This graph shows the net equity extraction, or mortgage equity withdrawal (MEW), results, both in billions of dollars quarterly (not annual rate), and as a percent of personal disposable income.

    MEW declined sharply in Q1 2008, however these numbers are not seasonally adjusted. MEW in Q1 2007 was $135.7 Billion, so MEW has fallen over 60% from Q1 2007.

    How important is MEW?

    ********************

    Here is what I wrote last year:

    As homeowner equity continues to decline sharply in the coming quarters, combined with tighter lending standards, equity extraction should decline significantly and impact consumer spending.
    So far homeowner equity has declined sharply, lending standards are tighter, and equity extraction has declined significantly.

    But that still leaves the most important link; the impact on consumer spending. No one really knows how much MEW impacts consumption, and the estimates vary widely.

    I've been using some estimates from Greenspan that about half of MEW flows to consumption and the other half flows to savings and investment. MEW totaled $682 billion, in 2006 and declined to $473 billion in 2007. That is a difference of $209 billion, and if half flowed to consumption - the drag on consumption from declining MEW was about $105 billion in 2007.

    Since nominal Personal Consumption Expenditures (PCE) increased $510 billion between 2006 and 2007, we can estimate that if MEW had been steady, consumption would have increased about $615 billion (another $105 billion). Still, PCE increase 2.9% in real terms between 2006 and 2007 - below the average of 3.7% for the previous 10 years - but still pretty strong. Here was my estimate for 2007:
    [T]he estimated drag on consumption would be $110 Billion. If we assume 2006 GDP of $13.3 trillion that would mean a drag of about 0.8% in 2007 due to the decline in MEW.
    In 2008, MEW will probably decline to around $200 Billion, a decline of $273 billion from last year. So my estimate - doing the same calculation as above - is that MEW will be a drag of about $135 billion on PCE in 2008, or reduce PCE about 1%, all else being equal (of course the economic slowdown will also impact PCE).

    But we also have to consider the other half of the decline in MEW; the portion that flows to investment and savings. Some of that investment went to residential investment for home improvement, and declining MEW will also impact this investment spending (I'll have more on this soon).
    Read on ...

    Sunday, April 06, 2008

    Credit Crunch Hitting Higher Income Homeowners

    by Calculated Risk on 4/06/2008 08:34:00 PM

    The San Francisco Chronicle has a story about how the credit crunch is hitting higher income homeowners: Lenders retreat as housing market plummets

    [Brent] Meyers began his landscaping project in January, expecting to draw on his home equity loan to pay [the landscaper $75,000 for the project].

    When Meyers took out the credit line in November 2006, his home was valued at $1.475 million. With less than $1 million in principal outstanding on his first mortgage, he had a comfortable equity cushion to cover the line.

    A few weeks ago, Meyers got a letter from Bank of America informing him that the line had been suspended in its entirety. When he called to ask why, he was told that his house had dropped to an estimated $1.09 million in value, which left insufficient equity to cover the line.
    ...
    Meyers isn't exactly a hardship case. Unlike some who have had their credit cut off, he has other resources to fall back on. He intends to complete his landscaping project and will sell stock to pay for it.
    ...
    Still, losing the credit line is prompting him and his wife, Deborah, to retrench.

    "I'm going to change my spending behavior because I lost access to $180,000," he said. "We're going to be deferring other expenditures to build a pot of money to replace what Bank of America took away."
    This shift from borrowing to savings is probably happening all across the country as the "home ATM" is being closed. In the long run this is healthy for the economy. In the short run, more savings has a negative impact on consumer spending and home improvement spending.

    Thursday, April 03, 2008

    IMF: Central Banks Should "Lean against the Wind" of Asset Prices

    by Calculated Risk on 4/03/2008 05:21:00 PM

    The IMF has a new report out on housing: The Changing Housing Cycle and the Implications for Monetary Policy (hat tip Glenn)

    Note: the IMF chart on page 13 is incorrect. This is the same error Bear Stearns made last year: see Bear Stearns and RI as Percent of GDP. It doesn't make sense to divide real quantities, since the price indexes are different. Dividing by nominal quantities gives the correct result. This Fed paper explains the error in using real ratios from chained series, and recommends the approach I used. See: A Guide to the Use of Chain Aggregated NIPA Data, Section 4.

    The IMF piece analyzes the connection between housing and the business cycle (housing has typically led the business cycle both into and out of recessions). They also discuss the spillover effects of a housing boom on consumer spending, and finally the IMF argues the Central Banks should 'lean against the wind' of rapidly rising asset prices.

    The main conclusion of this analysis is that changes in housing finance systems have affected the role played by the housing sector in the business cycle in two different ways. First, the increased use of homes as collateral has amplified the impact of housing sector activity on the rest of the economy by strengthening the positive effect of rising house prices on consumption via increased household borrowing—the “financial accelerator” effect. Second, monetary policy is now transmitted more through the price of homes than through residential investment.

    In particular, the evidence suggests that more flexible and competitive mortgage markets have amplified the impact of monetary policy on house prices and thus, ultimately, on consumer spending and output. Furthermore, easy monetary policy seems to have contributed to the recent run-up in house prices and residential investment in the United States, although its effect was probably magnified by the loosening of lending standards and by excessive risk-taking by lenders.
    We've discussed this many times: increasing asset prices (and mortgage equity withdrawal) probably increased consumer spending significantly as asset prices increased, and declining assets prices will likely now be a drag on consumer spending.

    And on Central Bank policy:
    [C]entral banks should be ready to respond to abnormally rapid increases in asset prices by tightening monetary policy even if these increases do not seem likely to affect inflation and output over the short term. ... asset price misalignments matter because of the risks they pose for financial stability and the threat of a severe output contraction should a bubble burst, which would also lower inflation pressure.

    Saturday, March 15, 2008

    Trade Deficit and Mortgage Equity Withdrawal

    by Calculated Risk on 3/15/2008 05:07:00 PM

    The following graph shows an interesting relationship (Caution: correlation doesn't imply causation!). As Mortgage Equity Withdrawal (MEW) rose, so did the trade deficit. Note: both are shown as a percent of GDP.

    Now that MEW is falling, the trade deficit is also falling - especially if we exclude petroleum imports.

    Trade Deficit as Percent of GDP Click on graph for larger image.

    The dashed green line is the Kennedy-Greenspan MEW estimates as a percent of GDP.

    Clearly the housing bust led to less MEW, and less MEW might have contributed to the declining trade deficit. (Something I predicted in 2005).

    Looking forward, it appears MEW will decline sharply in 2008, as housing prices decline further, lending standards are tightened, especially for HELOCs, and since homeowner percent equity is already at record lows. In other words, the Home ATM is closing.

    This suggests that the trade deficit (especially ex-petroleum) might decline sharply too. Part of the decline in the trade deficit is related to the falling dollar and higher U.S. exports (See Krugman's Good news on the dollar)

    However, to complete the global rebalancing, two things must happen: both petroleum imports (in dollars) and the deficit with China must decline. The good news is the January trade deficit with China - although still huge at $20.3 billion - was actually less than the $21.3 billion in January 2007. The bad news is oil imports (in dollars) were at record levels.

    Unless we see these key components of the trade deficit start to decline (oil and China), other exporters to the U.S. will have to bear the burden of the possibly sharp rebalancing of global trade.

    The Economist: KAL's Cartoon
    Added: On oil, here is a KAL's cartoon from the Economist:

    Click on image to see cartoon at The Economist.

    Monday, March 10, 2008

    Q4 Mortgage Equity Withdrawal: $76 Billion

    by Calculated Risk on 3/10/2008 10:00:00 PM

    Here are the Kennedy-Greenspan estimates (NSA - not seasonally adjusted) of home equity extraction for Q4 2007, provided by Jim Kennedy based on the mortgage system presented in "Estimates of Home Mortgage Originations, Repayments, and Debt On One-to-Four-Family Residences," Alan Greenspan and James Kennedy, Federal Reserve Board FEDS working paper no. 2005-41.

    Kennedy Greenspan Mortgage Equity Withdrawal Click on graph for larger image.
    For Q4 2007, Dr. Kennedy has calculated Net Equity Extraction as $76.3 billion, or 3.0% of Disposable Personal Income (DPI). Note that net equity extraction for Q3 2007 has been revised downwards to $119.3 billion.

    This graph shows the net equity extraction, or mortgage equity withdrawal (MEW), results, both in billions of dollars quarterly (not annual rate), and as a percent of personal disposable income.

    MEW was declining in Q4 2007, however, these numbers are not seasonally adjusted. MEW in Q4 2006 was $94.6 Billion, so MEW has only fallen 20% from Q4 2006.

    As homeowner equity continues to decline sharply in the coming quarters, combined with tighter lending standards, equity extraction should decline significantly and impact consumer spending.

    Thursday, March 06, 2008

    Households with Mortgages: Percent Equity Close to 30%

    by Calculated Risk on 3/06/2008 02:20:00 PM

    One of the headlines from the Fed's Flow of Funds report this morning was that household percent equity had fallen to a record low 47.9%. This is a simple calculation: divide home mortgages ($10,508.8 billion) by household real estate assets ($20,154.7 billion) gives us the percent mortgage debt (52.1%). Subtract from one gives us the percent homeowner equity (47.9%).

    But what does this tell us?

    What we really want to know is how much more equity can be borrowed on U.S. household real estate. According to the Census Bureau, 31.8% of all U.S. owner occupied homes had no mortgage in 2006 (most recent data). These homeowners tend to be older, or more risk adverse, and few of them will probably borrow from their home equity.

    You can't do a direct subtraction because the value of these paid-off homes is, on average, lower than the mortgaged 68.2%. But we can construct a model based on data from the 2006 American Community Survey (see table here).

    Household Distribution by Valuation Click on graph for larger image.

    This graph shows the distribution of U.S. households by the value of their home, with and without a mortgage. This data is for 2006.

    By using the mid-points of each range, and solving for the price of the highest range to match the then Fed's estimate of household real estate assets at the end of 2006: $20.6 Trillion, we can estimate the total dollar value of houses with and without mortgages.

    Using this method, the total value of U.S. houses, at the end of 2006, with mortgages was $15.27 Trillion or 74.2% of the total. The value of houses without mortgages was $5.32 Trillion or 25.8% of the total U.S. household real estate.

    Assuming 74.2% of total assets is for households with mortgages ($14,954.8 billion), and since all of the mortgage debt ($10,508.8 billion) is from the households with mortgages, these homes have an average of 29.7% equity. It's important to remember this includes some homes with 90% equity, and 8.8 million homes with zero or negative equity (8.8 million estimate from Mark Zandi at economy.com).

    Saturday, February 23, 2008

    Banks Freezing HELOCs

    by Tanta on 2/23/2008 09:42:00 AM

    The Washington Post reports on the freezing of Home Equity Lines of Credit:

    "Nearly all the top home equity lenders I know of are doing this or considering doing this," said Joe Belew, president of the Consumer Bankers Association, which represents some of the nation's largest home equity lenders. "They are all looking at how to protect themselves as real estate values go down, and it's just not good for the borrowers to get so overextended."

    Countrywide Financial, the nation's largest mortgage lender, suspended the home equity lines of 122,000 customers last month after reviewing their property values and outstanding loan balances. The company, like others, has an internal automated appraisal system that tracks values.

    The company declined to disclose how many of the affected borrowers lived in the Washington area. About 381,000 borrowers in the region had home equity lines at the end of last year, according to Moody's economy.com.

    USAA Federal Savings Bank froze or reduced credit lines for 15,000 of its customers, including Corazzi, and will not reconsider its decisions until "real estate values improve substantially," the company said in a statement.

    Bank of America is starting to do the same and is contacting some borrowers, said Terry Francisco, a bank spokesman.

    "We know this can cause hardship to our customers," Francisco said. "If they used the credit to make payments that are in the pipeline, we will work with them to make sure the payment goes through."
    Well, that last sentence pretty much took care of any desire I had for breakfast.

    The obligatory borrower anecdotes are, I must say, priceless examples of the genre. You have a realtor and a mortgage-loan processor, neither of whom seems to have grasped the "equity" part of HELOC. This implies that people who don't work in the industry probably think things I don't care to know about.
    Larry F. Pratt, chief executive of First Savings Mortgage in McLean, said most mortgage documents he has seen give lenders wide latitude to suspend or freeze credit lines.

    "A layperson would not recognize the language because it's not that blatant," Pratt said. "It talks about deterioration of the value of the asset or the value of the collateral. . . . It's not boilerplate language by any means."

    Maggie DelGallo did not realize that when she took out a home equity line a few years ago on her home in Loudoun County. Her lender recently froze the line.

    DelGallo, a real estate broker, has used some of her credit line over the years. Had she known the freeze was coming, "I would have drained it," she said. "I would have taken every dime and possibly placed it in a money-market vehicle."

    DelGallo said she does not think she is in dire straits. "It's more like a huge disappointment," she said. "I have this line of credit attached to my home that's useless."

    Last year, 34 percent of borrowers said they used their home equity lines to pay off other debt and 29 percent used them for home renovation, according to a survey of lenders by BenchMark Consulting International. Another 31 percent used them to pay for other things, such as medical bills, weddings or vacations.

    Corazzi initially used her line to consolidate debt. She and her husband took out the credit line in October because they thought her job was in jeopardy.

    It was. In December, her salaried position as a loan-processing manager at a local mortgage bank changed to a commission-only job.

    Given the slowdown in the industry, Corazzi has collected only one paycheck since then. Her husband, Ron, sells large-format copiers and printers to builders, and his salary alone cannot support them and their four children, ages 4 to 8.

    By the time their lender called, the couple had $45,000 remaining unused on the credit line. Ron Corazzi is now looking for a second job, and his wife is hoping to pick up work as a substitute teacher.

    Meanwhile, they are trying to open a new home equity line elsewhere, but chances are slim given the change in Nancy Corazzi's job status and the drop in their home's value. Five months ago, the Ellicott City house was appraised at $560,000; the lender says it is now worth $469,100.

    "I told them, 'You guys are wrong,' " Nancy Corazzi said. "They said, 'Sorry, this is what we're doing in the entire area.' "

    Corazzi said she was blindsided by what's happened. "I didn't know they could do that. I thought I was too smart to have something like this happen to me."
    There's an old apocryphal story that has been told in banking circles for decades about the customer who cries, "But how can I be overdrawn? I still have checks left!"

    At least, I always thought that was apocryphal.

    Tuesday, February 19, 2008

    Home Overimprovement Trending Down

    by Tanta on 2/19/2008 09:52:00 AM

    One of the regular battles we'd get into in the comments on this blog in 2005-2006 was the "Good MEW/Bad MEW" thing. It would go like this: CR would post some data on Mortgage Equity Withdrawal and its impacts on consumer spending. Immediately, folks would pipe up to disagree with a claim CR never, actually, made, which is that "MEW" is "bad spending." The favorite "justification" of MEW was that it was being spent on "home improvement," which was--you see--an "investment," not "consumption." This was always opposed to those "bad spenders" who blew it on TVs or something.

    So we're pretty thoroughly past that historical moment when the "investment" argument could be unproblematically deployed. My own interest in the subject, like CR's, was not to make some moralistic claim that consumption via MEW was intrinsically "bad," just that it was unsustainable, and the extent to which consumer spending was being brought to you by mortgage debt rather than disposable income did not bode well for the economic future. But I did think--and still do--that is worthwhile to try to distinguish between rehabilitation/renovation of elderly housing stock; luxury modifications of perfectly serviceable newer housing stock; financing routine repair, maintenance, and decorating; and cosmetic fixing-upping (generally a kind of correction for delayed maintenance or decorating, like paint and carpet) for the purpose of flipping the property. All of those things can fall under the rubric of "home improvement," but only the first and to a lesser degree the second really count as capital improvement in my mind. Insofar as these projects truly do increase the value of the real property, they are not MEW, even if they are financed with a cash-out refi or HELOC money; conceptually, MEW is an increase in mortgage debt greater than the increase in value of the property.

    The trouble, then, was dealing with that group who were financing repair and maintenance and telling themselves they were doing "home improvements." First, homes require regular repair and maintenance merely to hold value: it's a carrying cost. Second, it becomes clear that too many owners financed repair and maintenance because they simply couldn't afford the cash outlay. Now that cheap interest-only HELOC money is harder to get, and old HELOC debt rolls into its adjustable rate/principal-payment period, some people are realizing that repair and maintenance are recurring costs they simply cannot afford to pay. You Californians get green pools; we Yankees get leaf-choked gutters; Georgians apparently get critters.

    In that rather nebulous category between improvement and consumption somewhere in the middle, which we shall call "granite countertop syndrome," we're finally catching up with the reality of what lenders and appraisers call "overimprovement." In essence, overimprovement is cost in excess of value created; the problem can range from the McMansion thrown up on a postage-stamp lot in a neighborhood of 1,200 square foot older homes, to the decreasing marginal value of luxury materials. Every home needs flooring in the bathroom, but hand-painted imported tiles don't always increase the sales price of the home to the extent of their cost. My own belief is that a lot of sellers are setting "unrealistic" sales prices not just because they expect to get 2005-2006 prices, but because they expect to be reimbursed, dollar-for-dollar, for luxury "improvements." Sadly for them, one of the reasons we're all subprime now is that, frankly, we've all got granite countertops now. Why pay retail to an existing-home seller for that when the builders are discounting the wholesale price?

    All that's by way of looking at some actual data on "remodeling":

    ORLANDO, Fla. – Those fancy home fix-ups touted in cable TV shows and home magazines are losing their luster with consumers.

    With the shakeout in the housing market, homeowners are worried they won't get their money back from high-dollar redos.

    And lenders are less willing to finance pricey home improvements.

    That has caused a decline in nationwide remodeling.

    "We saw a downturn in 2007, and 2008 looks every bit as tough for the industry," said Kermit Baker, a researcher with Harvard University's Joint Center for Housing Studies. "After some almost record-breaking growth, the market has stalled."

    Per capita home remodeling expenses in the region that includes Texas jumped almost 50 percent between 1996 and 2006. But since then, spending for home upgrades has fallen.

    In a quarterly comparison, nationwide home remodeling expenditures have fallen about 10 percent since their high in 2006.

    Researchers blame the downturn in the overall housing market for dampening the desire for home redos.

    "Homeowners have been scaling back on their remodeling plans as the overall market has weakened," Mr. Baker said.

    "Homeowners are concerned that they may be overimproving their homes relative to their neighborhood and prices in the market."

    Studies back up those concerns. Average returns on a home remodeling project have fallen from 82.5 percent in 2003 to 70 percent last year.

    With home prices depressed in many neighborhoods, homeowners are especially worried that they won't get the bucks back they spend on luxury features such as saunas, European cabinetry and imported tile floors.

    "There are some signs that the emerging weakness may be greater at the upper end of the market," Mr. Baker said. "We are seeing more of a return to basics."

    That means less costly improvements and standard maintenance, he said, rather than "some of the sexier kitchen and bath projects."
    A 70% "return" on remodeling hurts even when you didn't finance the cost with a loan facing a steep increase in the interest rate. When you did . . .

    Sunday, February 03, 2008

    Components of Residental Investment

    by Calculated Risk on 2/03/2008 04:06:00 PM

    This is a follow up to the previous post regarding investment in home improvement.

    This data is from the Bureau of Economic Analysis (BEA), supplemental tables. (see Section 5: Table 5.4.5AU. Private Fixed Investment in Structures by Type, near the bottom)

    This graph shows the major components of residential investment (RI) normalized by GDP.

    Components of Residential InvestmentClick on graph for larger image.

    The largest component of RI is investment in new single family structures. This includes both homes built for sale, and homes built by owner.

    The second largest component of RI is home improvement. As I noted in the previous post (using inflation adjusted dollars), investment in home improvement has held up pretty well. This investment could be seriously impacted by declining mortgage equity withdrawal (MEW) over the next few quarters.

    The third largest category (at least in recent years), has been broker's commissions. This is the only component of existing home sales included in residential investment, and the decline in broker's commissions follows the decline in existing home sales.

    The only other major component of RI is multifamily structures. This includes apartments and some condo projects.

    Most of the focus has been on declining investment in single family structures (declining new home sales) and broker's commissions (declining existing home sales). But so far, with strong MEW, home improvement has held up well.

    Rob sent me this description of what he is seeing in the housing market in Western Washington state:

    I want to echo the observations of the Bay Area home shopper.
    ...
    In nearly every middle class house listing I view, I see upgraded kitchens with granite (usually slab) counter tops . I also see matching stainless steel appliances and high end cabinets.

    Now, these houses and condos are all less than 15 years old, so the owners were not generally replacing worn out or really out-of-style stuff. And these houses did not come equipped like this. I also see living rooms and family rooms that have complete, matching sets of furniture, probably from places like Pottery Barn. Not just one or two pieces, but _every_ single_ piece_. It's like all living, dining and family room furniture was swapped out at exactly the same time. I contrast this with how houses used to be furnished: a piece here, a piece there, a gift from relatives, etc., gradually over the years. No more. Everyone is going for the "showroom" look. ...

    I even see this phenomenon in the low-end condo development where I bought my "starter home" back in 1993. ... when I sold my unit in 2006 after renting it out for a few years, it was "stock." No new cabinets, appliances, granite counter tops, wood or laminate flooring, simple fixtures, etc. And it was in great shape. Well, I have found that many of the units in that development have also been "pimped out" with "designer paint schemes," granite counters, new kitchen cabinets, $300 faucets and appliances, pergo flooring, fancy new mill work, etc.

    These condos were built in 1993 and 1994. The counters, cabinets, mill work and most appliances should have been in reasonably good condition and not too dated in appearance. Since those folks have very modest incomes, I know where the money [probably] came from.
    I'm sure these "pimped out" homes are all across the country. And MEW has probably been the primary source of funds for many of these homeowners. Now that it appears MEW lending is being tightened - especially for Home Equity Lines of Credit - this will probably impact home improvement spending.

    Thursday, January 31, 2008

    Lenders Suspending HELOCs

    by Calculated Risk on 1/31/2008 10:49:00 AM

    In the previous post, I noted that mortgage equity withdrawal (MEW) was apparently still strong in Q4. Unlike previous years, this appears to be the result of homeowners drawing down HELOCs as opposed to cash out refis.

    The lenders are starting to be concerned about the risk of homeowners drawing down HELOCs, while at the same time their property value is declining, leaving little or no equity in the home.

    The Implode-O-Meter has posted a letter today from Countrywide suspending certain HELOCs.

    A portion of HELOC customers have already or will soon be notified by CFC Loan Administration that their HELOC draws have been suspended indefinitely. These HELOCs were identified as candidates for suspensions for various reasons including:
    Significant decrease in supporting property value – If the customer's current untapped equity (home value minus all mortgage liens) drops by 50% or more from their HELOC opening date, his/her line will be suspended.

    HELOC payment delinquency – If the customer's payment is made two or more days after the grace period ends, his/her line will be suspended.

    Product Terms/Conditions Violation – In cases where the customer violated terms or conditions of the HELOC Agreement, his/her line will be suspended.

    Examples include, but are not limited to: HELOC on property originated as owner occupied, but now believed to be non-owner occupied or unpaid taxes or insurance on the subject property.

    Be aware that there may be other actions that could trigger draw suspensions.
    This is not a one-time event, but an on-going strategy as we continue to manage our lending risk.

    Advance Q4 MEW Estimate

    by Calculated Risk on 1/31/2008 10:18:00 AM

    Based on the Q4 GDP data from the BEA, my advance estimate for Mortgage Equity Withdrawal (MEW) is approximately $145 Billion for Q4 (just under $600 billion on a SAAR) or 5.6% of Disposable Personal Income (DPI). This would be slightly higher than the Q3 estimates, from the Fed's Dr. Kennedy, of $133.0 Billion, or 5.2% of Disposable Personal Income (DPI).

    The actual Q3 data for MEW will be released after the Flow of Funds report is available from the Fed (scheduled for March 6, 2008 for Q4).

    Advance Mortgage Equity Withdrawal Estimate Click on graph for larger image.

    This graph compares my advance MEW estimate (as a percent of DPI) with the MEW estimate from Dr. James Kennedy at the Federal Reserve. The correlation is pretty high, but there are differences quarter to quarter. This analysis does suggest that MEW was at about the same level in Q4 2007, as in Q3. We will have to wait until March to know for sure.

    MEW had been expected to decline precipitously since mid-summer 2007, with a combination of tighter lending standards and falling house prices. However, in Q3, MEW was supported by homeowners drawing down pre-existing home equity lines of credit (HELOC). The sizable MEW in Q4 was probably related to home equity lines too (as opposed to cash out refis of a couple of years ago).

    The impact of less equity extraction on consumer spending is still being debated, but as HELOCs dry up, I believe a slowdown in consumption expenditures is likely.

    Wednesday, January 16, 2008

    The Economics of Second Liens

    by Tanta on 1/16/2008 11:25:00 AM

    From the Wall Street Journal:

    In some cases, servicers are telling borrowers they will take 10 cents on the dollar to settle their claim, says Micheal Thompson, director of the Iowa Mediation Service, which runs a hotline for homeowners in financial distress. In other cases, they are selling these loans at large discounts to third parties, says Kathleen Tillwitz, a senior vice president at DBRS, a ratings agency.

    Coming up with a plan that will get borrowers back on track is easiest if both the mortgage and home-equity loan are held by the same party. Countrywide will sometimes "whittle down" the payment on the second mortgage to come up with an amount that the borrower can afford to pay for both mortgages, or even eliminate that payment, Mr. Bailey says. The company doesn't publicize such efforts, he adds, because that might encourage "people not to make their payment and see what happens." In either case, "the borrower still owes the principal," Mr. Bailey says.

    Solutions can be harder to come by when the two loans were made by different lenders and are held by different parties. "The people in the first position will say, 'Until you get a deal with the second, why should I make a deal with you?'" says Iowa's Mr. Thompson. Second-mortgage holders are often reluctant to approve a short sale or deed in lieu of foreclosure that could wipe out their claims, he adds.

    FirstFed says it encourages borrowers in financial distress to contact the owner of their home-equity loan and sometimes offers to buy out a home-equity loan with no current value for a small sum -- $2,000, for example -- so that the entire mortgage can be restructured.

    But the company says such offers are often rejected. "It's not worth their while to take the $2,000" because of the costs associated with evaluating the offer and releasing the borrower from the lien, says Ms. Heimbuch, the company's CEO. "The second forces you into foreclosure."
    Scenario A: Expenses $0, Recoveries $0. Scenario B: Expenses $2,000, Recoveries $2,000. Amazingly enough, they're going for A.

    Of course, eventually they'll be able to make it up on volume . . .

    Wednesday, January 02, 2008

    NY Times: Land of Many Ifs

    by Calculated Risk on 1/02/2008 10:05:00 AM

    From Peter Goodman and Vikas Bajaj at the NY Times: In the Land of Many Ifs. This is a look at the economy in 2008, and starts with housing:

    An era of free-flowing credit and speculation has led to a far-flung empire of vacant, unsold homes — 2.1 million, or about 2.6 percent of the nation’s housing stock ...

    This ... will not be whittled down to normal levels, economists suggest, until national home prices fall by at least 15 percent from their peak, reached in the summer of 2006. ...

    The glut could be exacerbated if an already alarming wave of foreclosures continues to broaden, claiming even those with supposedly good credit.

    Last year, the trouble in the mortgage market was largely confined to subprime loans extended to homeowners with weak credit. ...

    ... default rates on loans to homeowners with relatively good credit are ... rising sharply ... In November, 6.6 percent of so-called Alt-A home loans ... were either delinquent by 60 days or more, in foreclosure, or had been repossessed. That was up from 4.3 percent in August.

    This is a potentially ominous sign, because subprime and Alt-A mortgages issued in 2006 together made up about 40 percent of all mortgages. ...

    The spike in foreclosures is happening even before many mortgages have reset to higher rates, suggesting that borrowers are falling behind because their homes are worth less. Many are having trouble refinancing as banks tighten lending standards.

    All of which explains why many economists expect national housing prices to fall by 5 to 10 percent more in 2008, and perhaps into 2009 as well, before hitting bottom.

    Such a drop could ripple out to the broader economy by depressing consumer spending, which accounts for about 70 percent of all economic activity.
    This touches on several key subjects: there is substantial excess housing inventory, the mortgage problem is broader than subprime, foreclosures are spiking before rates are resetting (because of falling house prices), lending standards are being tightened, housing prices will fall significantly, and Mortgage Equity Withdrawal is falling - probably impacting consumption. A nice overview.

    Friday, December 14, 2007

    Krugman: After the Money's Gone

    by Calculated Risk on 12/14/2007 11:49:00 AM

    Update: Also see Krugman's blog: Why negative equity matters

    [T]he problem with the markets isn’t just a lack of liquidity — there’s also a fundamental problem of solvency.
    Paul Krugman, NY Times, Dec 14, 2007
    Paul Krugman writes in the NY Times: After the Money's Gone
    First, we had an enormous housing bubble in the middle of this decade. To restore a historically normal ratio of housing prices to rents or incomes, average home prices would have to fall about 30 percent from their current levels.
    The WSJ recently had a series of graphs titled: Genesis of a Crisis. Here is the chart of the Price to Rent ratio.

    Price to Rent Ratio Click on graph for larger image.

    This graph is based on a ratio of the OFHEO house price index to personal consumptions on rent. Note: Later today I'll post a graph based on the Case-Shiller index.

    As Krugman notes, house prices would have to fall about 30% to bring the Price to Rent ratio back to a more normal ratio.

    Krugman:
    Second, there was a tremendous amount of borrowing into the bubble, as new home buyers purchased houses with little or no money down, and as people who already owned houses refinanced their mortgages as a way of converting rising home prices into cash.
    The Fed recently released the Q3 Flow of Funds report. The report showed that household percent equity was at an all time low of 50.4%.

    Household Percent Equity This graph shows homeowner percent equity since 1954. Even though prices have risen dramatically in recent years, the percent homeowner equity has fallen significantly (because of mortgage equity withdrawal 'MEW'). With prices now falling - and expected to continue to fall - the percent homeowner equity will probably decline rapidly in the coming quarters.

    Also note that this percent equity includes all homeowners. Based on the methodology in this post, aggregate percent equity for households with a mortgage has fallen to 33% from 36% at the end of 2006.

    Krugman:
    As home prices come back down to earth, many of these borrowers will find themselves with negative equity — owing more than their houses are worth. Negative equity, in turn, often leads to foreclosures and big losses for lenders.

    And the numbers are huge. The financial blog Calculated Risk, using data from First American CoreLogic, estimates that if home prices fall 20 percent there will be 13.7 million homeowners with negative equity. If prices fall 30 percent, that number would rise to more than 20 million.

    That translates into a lot of losses, and explains why liquidity has dried up. What’s going on in the markets isn’t an irrational panic. It’s a wholly rational panic ...
    From the post Professor Krugman mentions: Homeowners With Negative Equity

    The following graph shows the number of homeowners with no or negative equity, using the most recent First American data, with several different price declines.

    Homeowners with no or negative equity At the end of 2006, there were approximately 3.5 million U.S. homeowners with no or negative equity. (approximately 7% of the 51 million household with mortgages).

    By the end of 2007, the number will have risen to about 5.6 million.

    If prices decline an additional 10% in 2008, the number of homeowners with no equity will rise to 10.7 million.

    The last two categories are based on a 20%, and 30%, peak to trough declines. The 20% decline was suggested by MarketWatch chief economist Irwin Kellner (See How low must housing prices go?) and 30% was suggested by Paul Krugman (see What it takes).

    As Krugman notes: The current crisis is not a liquidity problem, it is a solvency problem.

    Wednesday, December 12, 2007

    Q3 Mortgage Equity Withdrawal: $133 Billion

    by Calculated Risk on 12/12/2007 07:55:00 PM

    Here are the Kennedy-Greenspan estimates (NSA - not seasonally adjusted) of home equity extraction for Q3 2007, provided by Jim Kennedy based on the mortgage system presented in "Estimates of Home Mortgage Originations, Repayments, and Debt On One-to-Four-Family Residences," Alan Greenspan and James Kennedy, Federal Reserve Board FEDS working paper no. 2005-41.

    Kennedy Greenspan Mortgage Equity Withdrawal Click on graph for larger image.
    For Q3 2007, Dr. Kennedy has calculated Net Equity Extraction as $133.0 billion, or 5.2% of Disposable Personal Income (DPI). Note that net equity extraction for Q2 2007 has been revised upwards to $159.2 billion.

    This graph shows the net equity extraction, or mortgage equity withdrawal (MEW), results, both in billions of dollars quarterly (not annual rate), and as a percent of personal disposable income. MEW was still strong in Q3 2007, even with tighter lending standards.

    As homeowner equity declines sharply in the coming quarters - household real estate equity declined $128 Billion in Q3 - combined with tighter lending standards, equity extraction should decline significantly and impact consumer spending.