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People Troubled Over Mortgage Equity Problem
For hundreds of different reasons, millions of homeowners borrow against the value of their home. Ultimately, some borrow too much or too often and end up owing far more than their home's current value.
Another contributing problem is the decline in home values across the nation, as more homes become available for purchase (due to foreclosures or the overbuilding of new homes). Though a home may have been valued at $200,000 a year ago, that same home now may only be worth $185,000. A spinoff problem is that those consumers who used equity to make new purchases, but who can longer get equity loans due to the imbalance of the home's current value versus mortgage balance already owed, consumers in this position are spending less and thus further impacting the economy.
Hence, the economy could be headed for a substantial slowdown; maybe even a recession, due to the choked cash availability for consumers who can no longer borrow against the value of their homes due to a poor debt to value ratio or bad credit.
Per Dave Simonsen, a senior vice president for NAI Alliance (an industrial real estate firm in Reno): "Everybody was basically using their house as an A.T.M. machine. Now they are upside down on their house without that piggy bank to go back to."
From 2004 through 2006, Americans pulled about $840 billion a year out of residential real estate, via sales, home equity lines of credit and refinanced mortgages, according to data presented in an updated working paper by James Kennedy, an economist, and Alan Greenspan, the former Federal Reserve chairman. These so-called home equity withdrawals financed as much as $310 billion a year in personal consumption from 2004 to 2006, according to the data.
But in the first half of this year, equity withdrawals were down 15 percent nationally compared with the average for the last three years, and consumption supported by such funds plunged nearly one-fourth, according to the Kennedy and Greenspan data.
This summer, the size of withdrawals fell even more sharply to about one-third below the level of late last year, according to Mark Zandi, chief economist at Moody's Economy.com.
"This slide in equity withdrawal is very recent," Mr. Zandi said, "so you wouldn't expect the drop in spending to occur until now, or Christmas."
Only a year ago, money taken out of houses was still more than 9 percent of the nation's disposable income, Mr. Zandi calculated, using a sampling of Equifax credit reports to supplement Fed data. By this fall, it had dropped to about 5 percent, a difference of about $350 billion a year.
Much of the attention in the recent collapse of the housing boom has focused on those in danger of losing their home or facing higher monthly payments in their adjustable mortgages. But the broader effect on the economy is likely to come from the much larger group of homeowners who can no longer count on rising home values to bolster their wealth.
Consumer spending accounts for about 70 percent of all economic activity in the United States, or about $9.8 trillion, so even a slight dip in home borrowing takes huge amounts of money out of the flow. The prospect of a slowdown, combined with the squeeze on households from higher oil costs, is sending shivers through the retail world, as apparel merchants, furniture dealers and electronics stores brace for the possibility that the all-important holiday shopping season will disappoint. Automakers are bemoaning sluggish sales.
"A fall of 2 percent in consumption would be big enough to trigger a recession," said Christian Menegatti, lead analyst for RGE Monitor, a consulting firm in New York.
Many a premature obituary, of course, has been written for the American consumer — only to see spending continue apace. Just last week, the Commerce Department announced the economy grew a healthy 3.9 percent during the summer, largely on the back of growing consumer spending.
Other forces, like increased exports and continued gains in jobs and incomes, may compensate enough for the loss in home borrowing to avoid an economic downturn next year. But many economists say a slowdown in spending is overdue as Americans are forced to curb their appetite for goods to restore balance to an off-kilter global economy.
The United States has for years been running huge trade deficits while borrowing heavily from China and Japan. This makes Americans vulnerable to the possibility that foreigners could slow purchases of American debt, sending the dollar plummeting and forcing the Fed to raise interest rates. Some say the best way to avoid such a situation is for Americans to start saving more and spending less.
"If you take the 10-year view," cutting consumption is "the least bad outcome," said Robert A. Barbera, chief economist at research firm ITG.
In the near term, though, any dip in consumer spending is likely to sow pain. Strong sales for American companies abroad may keep the United States out of a full-fledged recession even if spending slips at home, Mr. Barbera said, but nonetheless "it will feel like a recession."
Sprawled across desert flats and framed by the rugged peaks of the Sierra, Reno encapsulates, in concentrated form, the forces at work on American consumers. In Nevada, and in neighboring California, home equity finance was about 20 percent of all disposable income at the end of last year, according to Economy.com. This September, it was down to about 9 percent.
While best known for its gambling, Reno has in recent years diversified, using low taxes to entice major companies like Cisco Systems and Microsoft. With land cheap, the area has been a magnet for Californians who sold homes for spectacular gains, then moved here to buy more space for less money. The metropolitan area's population has swelled to 409,000, up 50,000 since 2000.
Many of the newcomers settled in developments on the edge of town. Ranch land that less than a decade ago was still a moonscape of sun-baked soil dotted with sagebrush has been transformed into golf courses and Spanish-style houses on streets with names like Painted Vista Drive and Rio Wrangler.
Free-flowing credit and rampant speculation drove residential sales. From May 2002 to September 2005, home prices in Reno and the adjacent city of Sparks more than doubled, according to First American LoanPerformance.
Since then, however, the median house price has slipped 15 percent.
Local businesses are already suffering the effects of consumers who are less inclined to buy. A Volkswagen dealership downtown said sales were down two-thirds from a year ago. At the Flowing Tide, a bar and restaurant in south Reno, the co-owner Justin Moscove said business was down 10 to 15 percent.
At the Meadowood Mall, near the airport, shoppers were scarce. "We're dead," said Cendy Rodriguez, manager at Lane Bryant, the plus-size women's clothing store, who said business was down 25 percent over the last two months. "I don't think it's going to be nowhere near the Christmas we had last year."
At Sierra Nevada Spas and Billiards, Ezra O'Connor, the sales manager, complained that not even drastically lower prices were attracting shoppers. "We're way down, 35 percent down from last year," Mr. O'Connor said. "People just aren't wanting to spend."
Mr. Whittey once seemed an unlikely member of that cohort. A sales manager at a flooring and tile company, he exudes the unflappable air of someone raised amid the easy money of the casino world. Until recently, he and his wife regularly embarked on shopping sprees of $1,000 and up.
He bought a 21-foot boat and two flat-screen televisions for their home. He sold his old truck and bought a new one, he said, "just 'cause I didn't like the color." Mr. Whittey could live in such fashion because his company was making good money and his house was appreciating.
But today, the value of his own home, which reached $500,000, has fallen and a separate investment property he bought seems likely to fetch far less than the $580,000 he owes the bank. His commissions have diminished, so his income is down. His neighbor recently fell behind on house payments, prompting the bank to foreclose. Anxiety reigns.
"We used to go out to eat three or four nights a week," Mr. Whittey said. "Now, we don't go out at all."
Even among those who indulged lightly in the credit bonanza, tightness is increasing.
Stephanie Lerude, her husband and their two boys have lived for five years in their ranch house on a quiet street in an older part of Reno. Wicker furniture sits on porches, basketball hoops dot driveways and orange leaves crown the tops of cottonwood trees.
Three years ago, Ms. Lerude and her husband, a lawyer, opened an $80,000 home equity line to invest in three commercial properties. She uses one as the office for her company, which provides gift baskets for real estate offices.
Their payments are manageable, and their house is worth about $540,000, about $100,000 more than they paid for it. Still, they are limiting purchases and postponing a kitchen renovation because of what they see happening all around them.
"I'm just not a big consumer," Ms. Lerude said. "We're trying to do less."
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