As Prices Rise, Homeowners Go Deep in Debt to Buy Real Estate

I know I said we were done, but today’s front page WSJ article will be it for a while:

"Five years into a housing boom that has boosted U.S. home values an average of 50% and added an estimated $5.5 trillion to the total market value of residential real estate, many Americans no longer think of their home as just a place to live. Instead, it’s a cash machine that can be used to rapidly build wealth. To that end, a growing number of people are tapping into their home equity to invest in more real estate.

That’s a lot like using a margin account — a line of credit backed by securities in an investor’s portfolio — to buy stocks. During the 1990s, many investors used such accounts to buy shares in fast-rising tech stocks. When the dot-com bubble burst, the value of the shares bought on credit cratered and investors’ borrowing worsened their losses. Economists say today’s debt-fueled investment binge in real estate is fanning the flames of an already overheated housing market, and making demand from people who actually need houses to live in seem stronger than it truly is."

That pretty much sums it up. Whether we describe it as bubble or not, the economic  benefits of a rapidly rising asset class cannot go on forever; especially if its financed via debt or worse, excessive leverage.

click for larger chart


graphic courtesy of WSJ

Oh, but there’s more:

"A riskier and more aggressive way to use home equity is to plow it into investment property, as the Epsteins did. A survey by SRI Consulting Business Intelligence, a research firm in Menlo Park, Calif., found that nearly 2.2 million households used their home equity to buy additional real estate in 2004, up from roughly one million a decade earlier. "As long as there isn’t a major change in the marketplace or a bubble burst, it will go up again," says Larry Cohen, director of the SRI division that does financial-services research and consulting.

To make the deals work, [some] turned to so-called option adjustable-rate mortgages, or option ARMs, which carry introductory interest rates of less than 2% and give borrowers multiple payment choices. Option ARMs can be particularly risky because the interest rate adjusts as often as once a month. If rates rise, borrowers who elect to make the minimum payment can see their loan balance grow, a plight known as negative amortization.

What Americans are generally not doing with their equity is letting it build, as homeowners traditionally did. The huge rise in home values translates into more equity for homeowners. But many of them have extracted those profits from their equity, and many people buying homes now borrow a larger share of the price than they did years ago. So mortgage borrowing has grown even faster than home values have. As a result, homeowners’ equity as a percentage of the market value of all homes declined to 56% at the end of 2004 from 57% five years before, according to data from the Federal Reserve."

I could excerpt nearly the entire piece — its that dead on. Rather than do that, I suggest you read it in its entirety.

As Prices Rise, Homeowners Go Deep in Debt to Buy Real Estate
Economists Say Move to Tap Equity May Inflate Bubble; Like Buying on Margin
Deal Sours for Mr. Drogsvold
James R. Hagerty And Ruth Simon
The Wall Street Journal, May 23, 2005; Page A1,,SB111680569071440252,00.html

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What’s the U.S. Savings Rate Really?



Are we spenders or savers?

That’s a significant question looked at by Dan Gross in the Sunday NY Times. Its an issue that has significant ramifications for the economy, interest rates, and the ongoing social security debate.

Gross references Bear Stearns Economist David Malpass:

"Some say that a flaw may exist not in our national character but in the way the government calculates savings: because the bureau’s method of tallying income and consumption doesn’t take into account structural changes in the finances of Americans, it may systematically understate income and overstate consumption.

For example, income includes wages and salaries, interest on bonds, and stock dividends. But it doesn’t include capital gains on stocks, profits from selling a house, or withdrawals from 401(k) plans. Nearly 70 percent of families own homes, nearly half of all households own stocks and mutual funds, and an increasing number of baby boomers are turning to 401(k)’s for income. Those trends, some say, can make a big difference. "The structure of the household portfolio has changed over time," said David Malpass, chief economist at Bear Stearns.

Convinced that Americans aren’t frittering away all their income, Mr. Malpass plumbed the Federal Reserve’s Flow of Funds data, a trove of information on Americans’ spending and saving habits. In 2004, he found that the net worth of all households – their assets minus their liabilities – stood at $48.525 trillion, up 9.6 percent from 2003. Sure, rising home prices helped. "But even if you take out houses completely, it still shows huge savings," he said.

The problem with Malpass’ analysis is that he is taking a mathematical approach to what is essentially a behavioral issue. (Hey, it happens) Call it a rationalization. We tend to see those from both the Bullish and Bullish contingencies, as way to feel comfortable with those ideologies.

Let’s state this another way:  As a nation, are we spenders or savers?

It raises a host of issues, some net positive, others more troubling. How does our behavior as consumer impact economic downturns? (It seems to smooth them out, at least recently). Why haven’t Businesses been as spendthrift as Consumers this recovery?  (My theory is execs are afraid to see their options go underwater again). And the $64,000 question, how might this low savings rate impact retirees when the Baby Boom generation starts playing shuffleboard?   

I believe we are not savers. The fact that so many pension plans, 401ks and IRAs go unfunded is a big clue as to that. (It also reveals how Tax ignorant all too many people are).

But stop for a moment to contemplate this: That people would rather spend their money consuming, rather than put it into a 401K where their employer does dollar-for-dollar matching is proof positive of our savings mindset.

That’s right, as opposed to GETTING FREE MONEY, many Americans still prefer to shop — rather than save.

I’m curious today iof Malpass is correct. So here’s a suggestion for what would be a signifcant and useful analysis:  Use Malpass’ methodology for calculating the national savings rate — and then apply it to as many countries we can get data for. I’d like to see a list that includes at least: the U.S., Japan, Great Britain, Norway, Sweden, France, South Korea, Italy, Germany, Australia, Canada, Spain, Israel and South Africa. That’s a short list, but we want it as extensive and complete as possible.

The goal is to determine whether or not, as judged against a planet of our peers, we Americans are — relatively speaking — savers or spenders.

Should be a rather interesting discussion . . .


UPDATE May 22, 2005 4:20pm
There’s a long but fascinating discussion on related topics at Whiskey and Gunpowder. You can see excerpts and related graphics below.


Is It a Savings Crisis or a Math Error?
By Daniel Gross
NYT, May 22, 2005


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