Homeowner equity and other signs of tight times
Economist Charles W. McMillion made this graph putting into context the country's record-low homeowner equity in the first three months of the year:
That's one of the issues I mentioned in today's story about the variety of new economic measures confirming that you're not alone if you're feeling budgetary pain. Here's a taste:
The unemployment rate rose 0.5 percent in May, to 5.5 percent, the biggest one-month jump since early 1986, the federal government said yesterday. Continued job cuts are putting adults out of work and leaving in the lurch many teenagers looking for summer income.Meanwhile, net worth is falling as people's homes lose value. Americans were worth $1.7 trillion less in the first quarter than they were at the end of last year, the Federal Reserve said this week. Household debt compared with net worth? At record highs.
If you hold stocks in a retirement account or outright, yesterday brought more bad news: The Dow Jones industrial average fell nearly 400 points, while the Standard & Poor's 500 and Nasdaq composite indexes both shed about 3 percent.
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Comments
This is a reflection of 100% financing schemes that were created over the past decade. When homes had to be bought with 20% down the you only had do borrow 80% to leverage 3x your salary.
That rule of thumb worked well in balancing risk to the banks. The banks also had the security that the homeowner had skin in the game and would do anything to keep the house.
The creation of 100% financing through the 80/20 scheme with 1 bank taking the first lien and another bank making the downpayment money of 20% and creating a second lien was great in getting people who could not save into homes. But this is also create an incentive that if the house loses "value" the homeowner has no "skin" in the game.
Since the house can't extend anymore credit, people are more concerned about keeping credit cards current than the house. This is the shift in the dynamic the banks computer generated credit models did not anticipate. Ironically when the banks changed the bankruptcy code a few years ago to make it harder to discharge credit cards they set themselves up large defaults.
Goes to show you just like black box (computer robots)trading of commodities going on right now, eventually a human element that they did not anticipate will cause the whole thing to come crashing down.
Anyone who have ever bought money in the stock market on margin and lost it knows what I'm talking about. Except now we are doing it with houses. Banks are behaving just as they would with stocks. If you can't pay the margin call we are taking your assets to cover it.
Leverage is great on the way up, but compounds on the way down.
2 years from now after we roll through the bank failures I imagine the only loans that will be left will be the 30 year fixed and 1 year ARM for the vast majority of homeowners with at least 20% down.
The bankers of this generation will remember this crisis till they retire and now allow this over leveraging of the consumer to happen as long as they live.
Till then all we can do is just hold our hats and see how bad it gets.
Posted by: Adam | June 7, 2008 11:43 AM
Adam said: "This is the shift in the dynamic the banks computer generated credit models did not anticipate."
Not just banks.
The old saw of a 3-5% appreciation rate that (I presume) was in those spreadsheets was also based on the old saw of "having skin in the game". They forgot the second part.
Posted by: MrRational | June 7, 2008 3:03 PM
I think the bankers should have known what they were doing. If not, they should return the money received. Some penalties should be imposed after all.
Posted by: Don Bosczowicz | June 8, 2008 6:15 PM