Sunday, September 17, 2006

“You have wrought my destruction, too.”

From the NY Times:

A Fable, Adapted From Aesop

THERE is an Aesop fable about a man — Greek, of course — who sees a swallow fluttering about on an unusually warm winter day. Leaping to the conclusion that summer has arrived, the man sells his only coat to buy himself a good time.
...
Some economists say you merely need to replace the Greek with an American, and the coat with a house or condominium to understand the force powering the American economy during the recent housing boom.

In this updated version of the fable, Americans were intoxicated by the leaps in the value of their real estate. Assuming the good times were here to stay, they were unable to resist temptation, impulsively calling the mortgage broker to get another loan to pay for the plasma TV set, the Caribbean vacation and the three-burner barbecue grill.
...
Between the third quarter of 2005 and the first quarter of this year, home equity withdrawals were running at an annual rate of more than $850 billion, according to the Federal Reserve, and amounted to about 9 percent of disposable personal income. The personal savings rate declined into negative territory last year for the first time since 1933. And the economy surged.

In Aesop’s world, winter set in again, the swallow died and the coatless man blamed the bird for his misfortune: “By appearing before the springtime you have not only killed yourself,” he moaned, “but you have wrought my destruction, too.”

17 Comments:

Anonymous Anonymous said...

A bit more of the Aesop fable article, for balance:

". . .But some economists are starting to question the magnitude of housing’s impact on national habits of spending and thrift, concluding that the effect may be smaller than expected: tumbling home prices might not pull consumer spending into the abyss after all.

To begin with, much of the money extracted by Americans from their homes was never spent. Some was used to pay down liabilities like credit-card debt, a sound strategy when credit-card rates are about 8 percentage points higher than rates on a typical mortgage and mortgage interest payments can be deducted from income when paying taxes."

Sorry, Grim. While I very much appreciate what you do here, in this case you altered the entire tone of the article by pulling out only selected paragraphs.

9/17/2006 07:13:00 AM  
Blogger grim said...

Thanks for posting this portion of the article. I debated whether or not to post it, but decided against it, simply because it's poor advice.

So let me take some time to "rip it apart", now.

To begin with, much of the money extracted by Americans from their homes was never spent.

No money was ever "extracted" from the home. The owner simply took on additional debt, secured by the home.

Some was used to pay down liabilities like credit-card debt,

No debt was repaid. The debt was simply transferred.

a sound strategy when credit-card rates are about 8 percentage points higher than rates on a typical mortgage and mortgage interest payments can be deducted from income when paying taxes."

Sorry, but it is an incredibly poor strategy to trade off unsecured debt for secured debt. Now, the house is on the line.

grim

9/17/2006 07:26:00 AM  
Blogger grim said...

Heck, all we need to do is look at the Fed G.19 report on Consumer Credit.

Here is the current G.19:

Consumer Credit

Revolving Credit (in Billions)
2001 - 723.2 (5.9% Increase)
2002 - 742.8 (2.7% Increase)
2003 - 764.2 (2.9% Increase)
2004 - 796.4 (4.2% Increase)
2005 - 819.1 (2.9% Increase)
July 2006 - 840.8
(does not include revolving credit secured by real estate)

9/17/2006 07:40:00 AM  
Blogger lisoosh said...

Grim, permit me to add to your excellent deconstruction of the latter part of the article:

"To begin with, much of the money extracted by Americans from their homes was never spent. Some was used to pay down liabilities like credit-card debt,"


To say it was never spent is misleading. The truth in the above statement is that the money was spent before the HELOC was ever taken out.

9/17/2006 07:57:00 AM  
Anonymous Anonymous said...

"a sound strategy when credit-card rates are about 8 percentage points higher than rates on a typical mortgage and mortgage interest payments can be deducted from income when paying taxes."
depending on the terms if you refi with a traditional 30 yr your now paying %5.5 for 30 yr. not so sound.
sound strategy is like the video posted yesterday " dont buy stuff you can not afford"
Greenspan talked about this strategy about 2 years ago. that people were using their new home equity to pay down other debt. i almost crashed my car. this guy and Ben are leading the flock off a cliff. as Grim said its a transfer of debt you still have to pay no matter what the terms are.

9/17/2006 07:58:00 AM  
Blogger chicagofinance said...

as Grim said its a transfer of debt you still have to pay no matter what the terms are.




except with a cashout or Heloc someone has a direct line to swipe your house - no questions asked

9/17/2006 08:43:00 AM  
Anonymous Anonymous said...

Some was used to pay down liabilities like credit-card debt

I'm not making a judgment about whether or not it is in an individual's best interests to do this--but the point is that not all HELOC withdrawals create ADDITIONAL debt.

9/17/2006 10:25:00 AM  
Anonymous Anonymous said...

but the point is that not all HELOC withdrawals create ADDITIONAL debt.

9/17/2006 11:25:09 AM

You're right, if you took out the hel and shorted the dollar in 2002.

BC Bob

9/17/2006 10:57:00 AM  
Blogger Math, like gravity, is law. said...

Anon 11:25am said "the point is that not all HELOC withdrawals create ADDITIONAL debt."

Are you high???

9/17/2006 01:55:00 PM  
Blogger Math, like gravity, is law. said...

Heloc, sheloc (someone once said they did it to "short" the equity on their house)... is debt on an individuals balance sheet.

9/17/2006 01:57:00 PM  
Anonymous Anonymous said...

Anon 11:25am said "the point is that not all HELOC withdrawals create ADDITIONAL debt."

Are you high???


No. If someone takes out a HELOC and does not draw any of it down except to pay off old credit card debt...it's a wash as far as that individual's balance sheet is concerned.

What part of that don't you understand?

9/17/2006 04:26:00 PM  
Anonymous Anonymous said...

"it's a wash as far as that individual's balance sheet is concerned"

I get it, if we just keep charging, charging,charging, our individual balance sheet is not affected since we wipe out a debt with equity. If you sell your house do you get credited that amount??? So you are just transfering debt. So you continue to rob Peter, your house, to pay Paul, your insatiable appetite to consume. Your net worth continues to decline, with every hel to pay this, but you are balanced. Great game plan. Sounds like a dream, running as fast as you can and losing ground. Balanced thinking.

BC Bob

9/17/2006 05:11:00 PM  
Anonymous Anonymous said...

get it, if we just keep charging, charging,charging, our individual balance sheet is not affected since we wipe out a debt with equity.

I never said that, and you know it. But let's say that someone ran up a big charge--once--on the old credit card to pay for, let's say, a new transmission on the old beater.

It would make sense to wipe out that 18% debt with a small draw-down on the HELOC, exchanging 18% debt with 6 or 7% debt, wouldn't it?

And it wouldn't affect that individual's balance sheet at all.

Nobody said anything about "charging, charging" as you put it, or encouraged anyone's "insatiable appetite to consume."

That's your attempted spin on this, and nothing more.

9/17/2006 06:27:00 PM  
Blogger grim said...

It would make sense to wipe out that 18% debt with a small draw-down on the HELOC, exchanging 18% debt with 6 or 7% debt, wouldn't it?

At least use average rates.

From Bankrate, September 13th:

Rate Roundup

The average home equity line of credit remained 8.21 percent -- 4 basis points below the prime rate.

For all cards (standard, gold and platinum), the fixed-rate card averages 11.74 percent and the variable rate is 14.09 percent.

9/17/2006 07:48:00 PM  
Blogger grim said...

So, assuming average credit and a fixed rate card, our borrower would have an 11.74% interest rate on their credit card, and a rate of 8.21% if they decided to take out a HELOC.

The spread on these is 3.53%.

For the sake of example, the transmission job cost $2,500.

Using a HELOC saves you about $90.

Is saving $90 something to risk your house over?

grim

9/17/2006 07:53:00 PM  
Anonymous Anonymous said...

So, assuming average credit and a fixed rate card, our borrower would have an 11.74% interest rate on their credit card, and a rate of 8.21% if they decided to take out a HELOC.

Sorry, not familiar with credit card interest rates nor HELOC rates--I don't pay or have either one.

I was just making a point in a small way. I would imagine that some folks have $25K in credit card debt and a wider spread between their cc interest rate and HELOC rate.

My point is the same--and at some point, the interest savings would make sense.

But the wider point that the NYT article was attempting to make was that not all HELOC debt, contrary to popular belief, goes towards consumables--only 16% does.

Conveniently, you seem to want to ignore that fact.

9/17/2006 08:43:00 PM  
Blogger grim said...

Money was put to other uses. One survey commissioned by the Federal Reserve of people who refinanced their mortgages in 2001 and the first half of 2002 found that only 45 percent had withdrawn any equity at all. About 26 percent of this money was used to pay down debt, 11 percent to buy stocks or other financial assets, 10 percent to buy real estate or make other business investments and 35 percent to finance home improvements. Only 16 percent of the money was used to finance consumption.

The paper can be found here:

http://www.federalreserve.gov/pubs/bulletin/2002/1202lead.pdf

Keep in mind this piece is 4 years old. I'm not so sure the housing market of 2001/2002 can be so easily compared to what we've seen in the past 2 years.

grim

9/18/2006 06:58:00 AM  

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