The American consumer is showing strain:
US consumers are defaulting on credit-card payments at a significantly higher rate than last year, raising the prospect of problems in the stricken US subprime mortgage market spreading to other types of consumer debt.
Credit-card companies were forced to write off 4.58 per cent of payments as uncollectable in the first half of 2007, almost 30 per cent higher year-on-year. Late payments also rose, and the quarterly payment rate – a measure of cardholders’ willingness and ability to repay their debt – fell for the first time in more than four years.
Why?
Analysts at Moody’s, the rating agency, said the trend could be related to the slowdown in the US property market and a fall in the number of borrowers rolling their mortgage debt into new and cheaper home loans.
They express doubts some people have about that connection, but Megan McCardle fills in some of the reasons I find it compelling:
There are multiple avenues for the spread. The credit contraction, to begin with; just as it’s making it hard for strapped borrowers to refinance, it’s also cutting down on those zero balance transfer deals that some people use to get themselves out of trouble, or at least stave off the bailiffs.
But of course, there’s also the fact that for the last ten years, many homeowners have resolved crushing credit card debt by borrowing money on the value of their homes. That’s suddenly gotten much harder to do, which may be forcing people into default.
And, obviously, people who are having trouble meeting their mortgage payments may decide that Visa and Mastercard need to get in line behind the bank with the power to kick them out of their house.
I think everybody knows what I think. This has been a long time coming and I suspect will be a very hard fall for many people. How important is this?
Over the 6 years from 2001-06, Americans pulled $6.1 trillion of cash from the value of their appreciated homes, more than $1 trillion per year on average. The freed-up dollars came from 1) the sale of homes where the seller downsized, 2) home equity loans, and 3) cash taken out in a refinancing transaction (source: Federal Reserve).
That has pretty much dried up.
How about this for a fun statistic to verify what I suspected about where all the trouble was going to be the worst:
2 OUT OF 50 – Just 2 states (California and Florida) accounted for 32% of all the home foreclosure filings in the nation during the month of July 2007 (source: RealtyTrac).
That was a train wreck waiting to happen.
Is the collapse of the housing market for many a bit like watching NASCAR is for many fans? I suspect many who have been predicting doom and blaming it on the administration’s economic policies do feel that way. It is disturbing, but compelling, and oddly satifsying. For much different reasons I feel a bit that way myself.
Bad, bad blogger.
Meh. I am not terribly impressed with this whole “housing contagion” meme. Bankers are a notoriously conservative bunch (in the investment sense; i.e. risk averse), so the fact that they have collectively got their panties in a bunch is none too impressive IMHO. Considering the fact that “subprime” is usually designated as that class which routinely defaults 20% of the time, I’m not at all worried about the long term prospects of the current market correction.
I was told a long time ago that banks do not want to foreclose on your home (or business) because they don’t want to be in the real estate business. They simply don’t have that expertise. I think, with some grounding in personal experience, that lenders decide to get in on the real estate boom and they got slightly singed. Now they are reacting like Chuchundra and running back to the edge of the room where it’s safe (so they think).
In short, the current market problems are more indicative of banker squeamishness than any real structural problem. We’ll survive this market correction, just like we have all others (provided that the “helpinh hand of government” doesn’t make an appearance; in which case all bets are off).
I have to disagree. This is not a liquidity problem, it is a default and housing value problem. I guess I say I agree in that we will survive, and that we might even avoid a recession. We will not avoid fundamental economic impact. Housing prices falling 5-15% is huge. It implies 40-60% declines in housing volume. It implies a massive hit to peoples ability to refinance and extract funds.
That is what drives the contagion. The liquidity and subprine issues are only the tip of the iceberg. It is the rest of our houses that stagnate or fall where the real impact comes from. Thus the credit card impact is beginning to show. That has less to do with subprime than a extremely overvalued market. Subprime however is where we will see the first and most severe impact on individuals.
I’m assuming by this you mean in sales, not supply.
But, again, it likely won’t comprise more than 20% of the subprime market, and from what I understand, there are a select few places that were most overvalued. The DC market, where I am, certainly saw some overvaluation, but nothing catastrophic, and there are still homes selling here for over the asking price.
I don’t mean to belittle the credit crunch. There isn’t any doubt that some home-buyers were unqualified for the mortgages they took out. But the current attitude is just as large a lurch (sp?) in the opposite direction (also IMHO). What bankers nver take into consideration is debt-carry, which is all that is required to weather the latest slump. If anyone is well situated to take on such a risk it’s banks (and mortgage lenders if the banks would lighten up a bit). While they shouldn’t have gotten into the real estate business to begin with (e.g. making stated income loans, etc.) now that they’re in, it doesn’t make much sense to stick their heads in the sand now. I know you disagree (and I submit to your deeper understanding of the issue), but I’m of the opinion that liquidity is the whole problem. Let the lenders loosen up a bit, cover the debt-carry, and in a few years they’re making tons of money again.
I think this is one of those “everyone is right” deals. 1) There is a housing value problem (in the sense that new construction will force prices in some areas back down to the replacement cost). 2) The subprime problem is sometimes overblown (in the sense that even if 30% of subprime ends up in foreclosure, subprime is just 13-15% of outstanding mortgages and the US mortgage market is funded globally. So, 0.3 x 0.13, then applied to the US mortgage market share of total available finance, well, you just don’t get a magnitude that can explain the current financial disruptions by itself. But, folks in the know have strong evidence that…
*** 3) The subprime problem is the tip of the iceberg. ****
The real housing-finance problem is coming down the pike in a portion of the market called Alt-A. Alt-A is not generally poor people with bad credit. Rich people in high cost areas that want to buy a second home for investment purposes often turned to Alt-A, especially in the summer of 2005 through the Summer of 2006. They often lied about their income to qualify for larger loans and used a 2/28 interest only loan – planning to refinance or sell after 2 years and capture the house price appreciation in California. Well, those loans are beginning to reset now and they will do so over the next year – and California real estate prices are moving in the wrong direction. Do a google-search for a study by Chris Cagan called Mortgage Payment Reset.
4) There is now a serious information problem in existing mortgage backed securities and justifiable concern about the reliability of the ratings of all collaterlaized debt obligations. Because investors do not yet know which of the trillions of dollars of existing MBS have poorly underwritten and speculative loans – it is difficult to trade any of them until experts have time to evaluate all the loan documents. This may be particularly difficult for overseas investors. Existing MBS are temporarily illiquid and some of them will have to be significantly discounted. The burned investors are now blaming the ratings agencies for “getting it wrong” the same way bookies got the point spread on the super bowl wrong.
5) The MBS episode has alerted investors in other collateralized debt (auto loans, credit cards, student loans,…) that the boom years of 2001-2005 may have seriously caused overconfidence – in the sense of underestimating risk and underpricing risk. All securitized loans – housing or not – need to have their risk re-estimated. That takes time, which means their liquidity is suffering temporarily.
6) The Fed does not have access to the balance sheets of leveraged MBS investors the way it has access to the reserves of banks. Therefore, its traditional tools can not directly provide liquidity WHERE IT IS NEEDED. In any case, the Fed monetary policy can not transform illiquid assets (lemons-tainted MBS) into liquid assets. It simply will take time to process the documents. Think of discovery in a large antitrust case and multiply it by a million.
7) The mortgage market and the housing market are both going to get a lot worse between now and next summer. Other financial markets will also go through some volatility as various studies emerge that either confirm or alter old risk-labels of those collateralized debt instruments. Expect credit cards to take it hard (just a prediction).
Sorry for the long post. great blog – I’m a first-time visitor.
“evildr”? C’mon. Does that make me the “Evil Surgeon General”?
All kidding aside (and knowing your access to info that not all of us have):
I’ve heard that California is especially hard hit. How much does that affect the whole market? And how static is the analysis — i.e. assuming no further “saves” via the Fed or other givernment agencies? If the problem is assymetrical info, aren’t there ways of encouraging the necessary info to get to the market?
I also recently heard something about China getting a bit panicky since they have something like $30 Billion tied up in the sub-prime market (or, at least, partially so). I assume it’s the same for other globally involved financiers. Which just leads me to believe that there will be political fixes involved. Not that I want that, but that it is the most likely scenario. At some point, if thing get really dicey, governments will step in and minimize the risks of lending. That IS NOT a good thing IMHO, but it will happen. What are the consequences?
But why? Is other debt subject to same types of risk? The problem with housing was that there was a run on the best places, driving up the value (i.e what people would pay with the bank’s money) of all those second (and third, and fourth, ect.) best places. Does credit card and car debt carry the same sort of risk? That’s not really “collateralized” is it? It seems to me the difference in lending to home buyers was that lenders mistakenly thought they could reap the benefits of real estate equity without feeling any pain. They’re getting rapped on the knuckles now and going into a panic.
Again, there are ways to encourage information to enter the market. The difference between the current situation and your example is that this isn’t necessarily an adversarial case. The lenders and the borrowers both want to increase liquidity, and therfore should be incentivized to co-operate in some level with respect to information. Moreover, there is still a lot (and I mean A LOT) of private equity money out there, which outfits aren’t as afraid of absorbing some hits. I have to think that far from there being a crisis, there is an opportunity of which some people will take advantage and make a lot of money (until Congress steps in and rakes the profits, that is). Either way, the market is capable of dealing with a “lemons market”. The question is, why wouldn’t it?
Of this I have no doubt. The biggest problem, in my estimation, is that we’ll be hitting a recession right about the time that the housing and credit markets are recovering. That may do to slave over the impending slump, and make it another “shallow” dip, but unless there is a Democrat in the White House I fear that the same sense of malaise perpetually emanating from the chattering classes and fueling the fears of Wall Street. Hmm … maybe that’s another reason to vote for Hillary
Great to see you here, Doc. Make your comments as long as you wish.
I think we are talking past each other. The credit crunch is but a product of the real problem. The huge downside scenario is the fundamental problem causes a long lasting credit crunch. But the credit crunch is not the real issue. My post talks of the housing contagion, not a subprime or credit contagion. Those are caused by the fundamental problem which is housing is far too high. Even the reasonable housing markets are fully valued. That is the problem, and housing has a huge impact on the economy. Much larger than the tech meltdown in 2000. Thus I expect a significant slowdown. All the problems you mention can be worked out. You are right, but that takes time. In the meantime the economy struggles, and at worst a serious recession.
For one estimate of the level of overvaluation I have posted an index of housing prices in my latest post.
Evildr,
A nice discussion. Keep hanging around. Eventually I will get into this in far more detail. It just takes time to do it right and hook it into other issues.