Wednesday, March 12, 2008
It seems hard to believe that, just a few years ago, those at the highest levels within the Federal Reserve actually told the nation that things were going to be OK because homeowners had sufficient "equity cushions".
Remember the words of former Fed Chairman Alan Greenspan back in late-2005?
In summary, it is encouraging to find that, despite the rapid growth of mortgage debt, only a small fraction of households across the country have loan-to-value ratios greater than 90 percent. Thus, the vast majority of homeowners have a sizable equity cushion with which to absorb a potential decline in house prices.Here in 2008, that once-small fraction of households with high loan-to-value ratios is growing larger every day and is now having the expected untoward impact on an already troubled banking system, the latest evidence coming in this story($) in today's Wall Street Journal:
Here comes another headache for banks suffering from the mortgage downturn: Losses on home-equity loans are soaring, even at some lenders that avoided big blunders on subprime loans.I'll never forget that 2005-era "personal finance lunch-time session" where I used to work when the Citibank representative referred to unused home equity as "dead money". He attempted to cajole a room full of well-paid, doe-eyed engineers into "putting that money to work" by using it as the down payment on some investment property.
When times were good, banks raked in billions of dollars in profit from home-equity loans, which allow borrowers to tap the accumulated value in their property with either a loan for a specific amount or a line of credit. As long as home prices were rising, lenders had little to worry about.
But falling home values are leaving banks with little or nothing to collect on many home-equity loans in case of default. Some stretched borrowers are keeping up with their mortgage and credit cards -- but not their home-equity loan.
Originally used to finance home-improvement projects, borrowers increasingly turned to home-equity loans to pay off other debts, such as credit cards. Home-equity loans also became a popular way to fund vacations and expensive electronics -- or to buy a house with little or no money down without paying for private mortgage insurance.
Now, the steep decline in housing prices and weak economy are turning the home-equity business upside down.
"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," Mr. Scharf said. J.P. Morgan is "rolling our changes back to represent that kind of product."
"That money is just sitting there", he said.
The banks are getting what they deserve - it's too bad they're not getting it a little harder and a little faster.