Risk and Return

We should start out with some humor:

A robber in a ski mask blamed the bank for what he was about to do, The Associated Press reported Feb. 22.

“You took my house, now I’m going to take your money!” the assailant hollered. Talk about a reverse mortgage!

The FBI plans to review the bank’s foreclosure records for clues.

The suspect is presumed to be ARM’ed and dangerous.

The New York Times reports that bailing out homeowners is becoming increasingly talked about. This graphic explains why:

Alan Blinder wants the Feds to enter the mortgage business as they did in the great depression. Hat tip: Greg Mankiw

Edmund Andrews worries that Mortgage bailouts could create moral hazard issues. Uh, you think?

Tanta is pretty unimpressed, though she does give us some thoughts on the issues around making mortgage securitization less of a disaster than it has been this time around.

Dean Baker points out that plans to buy up the mortgages does carry some risk. Throw in his lack of conviction that raising the ceilings for the mortgages that Fannie Mae and Freddie Mac can purchase in areas with high-priced homes will help.

This post on worries about the credit worthiness of Fannie and Freddie shows the markets are pretty unsure about them as well.

Mark Thoma gives his thoughts here and here.

Yves Smith has the most realistic reaction to all these proposals for solving these issues. They probably will not work, expose us to moral hazard, and would be far more expensive than Alan Blinder believes. Many of the solutions look at this as a temporary problem of credit markets and people who couldn’t afford their homes. That is true, but more fundamentally homes need to come down in price. Plans that assume the need to stabilize home prices, or help out borrowers who are over extended, are building in failure. Prices will likely not stabilize, and probably shouldn’t. James Hamilton seems to agree as well:

To the extent that analysis is correct, a “pause” in the foreclosure process will be helpful only if house prices are finished falling. But house prices decline sluggishly in response to market pressure, given the unwillingness of many sellers to acknowledge the magnitude of their capital loss. Even if the number of homes sold were to rebound tomorrow, there would remain a large inventory of unsold homes that will continue to push prices down.

Calculated Risk looks at the merits of the various home price indexes. James Hamilton weighs in on the topic as well.

The National Association of Home Builders remains cautious about the market going forward despite a slight up tick in activity. The fact that permits fell, starts were flat, and for single families at the lowest level since 1991 might have something to do with it (pdf.).

As abandoned homes pile up neighbors in Minneapolis are being urged to “adopt” their neighbors homes .

Barry Ritholtz lets us know about Rotten Neighbor.com .

Some believe this whole mess is part of a fundamental shift in the American landscape, with cites doing better, suburbia declining and taking on some of the characteristics of decaying inner cities. Extreme, but some of it has a ring of truth as urban living becomes more desirable and desired.

But we could be Britain!

Britain’s housing market is a “house of cards” that is set to implode after years of reckless mortgage lending, chronic oversupply of new flats and widespread fraud, a leading analyst said yesterday. (The Times) (via Barry Ritholtz )

Now for a Little discussion of the past

One of the ongoing debates over the last few years has been the economic impact of home equity withdrawal through home equity lines of credit and loans, cash out refinances, etc. How important was it? Was it sustainable?

I think those of us who worried about it can claim that it is now fairly clear it wasn’t sustainable. So let us go down memory lane and look at what was of such concern by the end of 2005:

Notice the two previous big drops came with pretty large economic downturns. The drops worsened the downturns and the downturns worsened the drops. That seemed pretty obviously something to be concerned about, but we negative Nellie’s were told to pipe down time and again. By this Summer that trend was reversing :

The problem for the market:

One would expect to see profit margins coming under pressure, even without the mortgage meltdown. Historically a housing downturn has been bad for the economy, despite claims by some that it would be “contained” and is a small part of the overall economy. Once again, that is without the mortgage and credit market meltdown we are now experiencing:

Nevertheless people still argued that Mortgage Equity withdrawal was somehow different than other debt because it was being used on improvements. Well that economic engine has gone into reverse:

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.”

Tanta goes back over the argument at length at Calculated Risk, but obviously it has not been sustained. Nor was any where near all the equity withdrawn going to improvements on homes, so we can expect declines across a range of goods and services.

Tellingly, banks and lenders now agree on that fact:

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.

Paying off other debt in many cases only meant freeing up the ability to run those credit accounts up again. The assumption being that home appreciation would continue so they could do it again, or just plain didn’t have any plan at all. So the banks are now freezing people’s Home Equity Lines of Credit :

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.”

Across the nation many borrowers are upset. This will put a crimp in consumer spending moving forward.

Hat tip: as always some of this is from Abnormal Returns. Even if not, go there.

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Technorati Tags bailout, credit crisis, Economics, economy, home equity, home equity loans, housing, subprime

Tags: bailout, credit crisis, Economics, economy, home equity, home equity loans, housing, subprime

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