As Credit Lines Dry Up, Homeowners in Withdrawal

Consumers have been living beyond their means for a long time. The three primary ways to do this have been cash out refis, credit cards, and home equity lines of credit [HELOCs].

In Love Affair With Credit Cards Is On The Rocks we noted how Bank of America (BAC) and other lenders have raised interest rates on credit cards out of fear of rising defaults.

Citigroup (C) put a Strange New Definition On "High Risk" by canceling customers who actually paid their bills on time.

In regards to Home Equity Lines, Countrywide And Chase Shut Off The Cash Spigot. Now, the Washington Post is noting that Bank of America (BAC) and USAA Federal Savings Bank are following suit.

Let's review the Washington Post story Homeowners Losing Equity Lines.

In one brief phone call, Nancy Corazzi's lender yanked away what was left of the $95,000 home equity line of credit that she and her husband took out five months ago. The lender informed her that her Howard County home had plummeted in value and the company did not want the risk that she would owe more than the house was worth. "I got off the phone and I was shaking," said Corazzi, who was using the money to pay preschool tuition for her twins ."I was near tears. We needed this credit line to get us through some tough times."

My Comment: If this is a typical reaction, and it might be, many consumers are still in denial. Home prices are not going up and attempting to meet ordinary expenses by tapping lines is not going to work.

"Nearly all the top home equity lenders I know of are doing this or considering doing this," said Joe Belew, president of the Consumer Bankers Association, which represents some of the nation's largest home equity lenders. "They are all looking at how to protect themselves as real estate values go down, and it's just not good for the borrowers to get so overextended."

• Countrywide Financial, the nation's largest mortgage lender, suspended the home equity lines of 122,000 customers last month after reviewing their property values and outstanding loan balances.
• USAA Federal Savings Bank froze or reduced credit lines for 15,000 of its customers, including Corazzi, and will not reconsider its decisions until "real estate values improve substantially," the company said in a statement.
• Bank of America is starting to do the same and is contacting some borrowers, said Terry Francisco, a bank spokesman

My Comment: Lending restrictions have tightened dramatically, across the board. Banks are trying (and failing), to prevent ballooning balance sheets. One reason they are failing is that the pace of "walk aways" is increasing. Many homeowners are not even waiting a full 90 days delinquent before turning over the keys.

In case you missed it, please take a look at Evidence of "Walking Away" Found In WaMu Mortgage Pool

As stunning as it might seem, a Washington Mutual (WM) Alt-A mortgage pool created in May 2007, 92.6% rated AAA is now 15% in foreclosure or REO status, after a mere 8 months. See the above link for details.

Banks are clearly spooked by this trend and are blatantly asking Congress for bailouts. Inquiring minds may wish to consider the "moral hazard" of Bank of America Asking Congress for a $739 Billion Bank Bailout.

Returning to the Washington Post article...

Maggie DelGallo did not realize that when she took out a home equity line a few years ago on her home in Loudoun County. Her lender recently froze the line.

DelGallo, a real estate broker, has used some of her credit line over the years. Had she known the freeze was coming, "I would have drained it," she said. "I would have taken every dime and possibly placed it in a money-market vehicle."

DelGallo said she does not think she is in dire straits. "It's more like a huge disappointment," she said. "I have this line of credit attached to my home that's useless."

My Comment: Attitudes like DelGallo's give banks all the more reason to shut down lines of credit. The point of an equity credit line is to tap equity. DelGallo is proposing tapping non-equity as if that was some God-given right.

By showing willingness to borrow money at 8.5% or so, and putting it in the bank at 3% or so, DelGallo has proven the willingness to get into "dire straits" even if she is not there now. Banks reading the Washington Post article like likely to become even more spooked.

Five months ago, the [Corazzi's] Ellicott City house was appraised at $560,000; the lender says it is now worth $469,100.

"I told them, 'You guys are wrong,' " Nancy Corazzi said. "They said, 'Sorry, this is what we're doing in the entire area.' "

Corazzi said she was blindsided by what's happened. "I didn't know they could do that. I thought I was too smart to have something like this happen to me."

My Comment: This is a clear case of denial, not understanding the law, not understanding the housing market, and refusal to live within one's means.

Like it or not, both DelGallo and Corazzi will be forced by the market to live within their means. Should they refuse, they will go bankrupt. It's that simple. Hundreds of thousands of others may be forced to make a similar choice.

Do Social Moods Drive Action?

Clearly the attitudes of DelGallo and Corazzi did not change, at least on their own accord. Some no doubt will look at that as evidence that social attitudes do not drive action.

Before we go further, let's recap "Social Mood Darkens", point 5 of Professor Depew's "Five Things" on How It's Gonna End.

According to Professor Depew, "Social mood drives social action, not the other way around. Cautious people cause home prices to plunge. Cautious businessmen cause credit to tighten. Fearful people suddenly view debt as harmful, not helpful."

Clever readers will quickly see why Professor Depew's socioeconomic thesis is indeed correct. In this case, cautious (even fearful) bankers are tightening credit. Why? Because it all started with cautious consumers refusing to play the greater fool's game with home prices. The attitude change by consumers caused an attitude change by banks. The attitude change by banks will cause a souring attitude in those who were still in denial and still willing to party.

And so the cycle feeds on itself, and will continue to do so until it reaches an extreme in caution and fear.

Attitudes are like pendulums. Momentum carries both pendulums and attitudes to extremes. The pendulum of consumer recklessness has now reversed, having recently reached a secular peak. It will not stop at equilibrium on the way down. Instead, momentum will progress to a point of complete exhaustion marked by cautious saving instead of reckless spending.

The attitudes of DelGallo and Corazzi from the Washington Post article just may be an indication of how much more attitudes need to change before things bottom. We are a longs ways off in terms of both time and price.

Comments

[Howard Sherman:]

Your article was spot on. Too many consumers have absolutely no idea what credit really is and what it really does to their balance sheet and their cash flow.

Your message is clear; Live within or, better still, below your means.

2008 Feb 27 05:09 PM

[AIG99:]

I get (and agree) that you are anti-consumer debt, and that lenders need to adjust HELOCs down where equity deteriorates - but it is somewhat ridiculous that some lenders exploit the situation where a particular customers fundamentals have not changed (e.g. BOA credit card rate spikes)

2008 Feb 27 05:39 PM

[helplessobs...:]

I too read that WP article and was stunned by the attitude of the borrowers. Lets face it the banks are out of money and are running scared. My wife got a first time ever call from BBT requesting she renew her CD while offering a reduced interest rate. From management to the trenches it is not business as usual in the banking industry.

2008 Feb 27 10:56 PM

[sf:]

If Corazzi is typical, it is amazing the sense of entitlement that has swept America. She says she is going through tough times because she needs to pay 95 thousand for pre-school tuition. To consider this a necessity is quite unbelievable.

2008 Feb 28 03:48 AM

[User 158137:]

All I have to say is that I'm a pretty middle class American and over the last few years it seems like our expenses have gone up higher than my income. We've always tight and on a budget but it somehow has gotten away from me. And I don't have a new car or new pool oe something huge to show for it. Heck I drive a 96 Honda Accord with 180000 miles on it.

But for us our situation is going to change. It's just getting there. We've always been a one income family. My wife wanted to stay home with the kids but she is a few weeks away from finishing her RN. Once she's working, knocking off debt and living within a budget is priority #1. Until then, I dip into equity to help pay the monthly bills. And I don't have a huge house. My mortgage is around 1100. It's just the cost of living has gone up higher than my ineffective, your-doing-a-great-job... 3 % raises from the multi-billion $$$ a year media company I work for. Gosh I sound like a populist!!!!

2008 Feb 28 06:35 AM

[Bhakta:]

I always enjoy and appreciate Mr. Shedlock's insights, with which I rarely have any disagreement. Personally, I feel the real estate debacle in the USA is only starting to run. I am short builders and banks for the time being, and view the recent rally as a dead cat bounce only in the builder and finance sector. I have had Citibank recently cancel my credit cards because "I have not used them"! I don't want to be over my head in debt, so I am careful when using these cards; therefore Citibank punishes me! I wrote them and told them I am happy to use the services of more customer friendly banks.

2008 Feb 28 10:45 AM

[Malkiel:]

It seems that Bernanke, Paulson, and the talking heads on CNBC do the scientifically rigorous thing--read trends from statistics--which is causing them to be unable to see what's really bringing on a recession, which is psychology at ground level. I don't know any ordinary working people who aren't being affected by these trends, talking about them, and acting on them, either through fear, ignorance, or wisdom. If companies aren't ramping down their activity at the moment, that doesn't mean we're not suffering an economic downturn, it more likely means they haven't detected and reacted to it yet. In the living rooms of America, though, plans are already being made and bills are going unpaid...

2008 Feb 28 12:23 PM

[User 157527:]

I understand that rising CC rates is increasing bank's margin, but it seem to me that it also drives their borrowers deeper into a hole which increases their risk. Shooting oneself into a foot is appallingly bad risk management IMO.

2008 Feb 28 12:44 PM

[Howard Sherman:]

True enough about the imaginary recession. The media is scaring everyone to death about the economy for no good reason.


As I understand it, the economy has to shrink for two consecutive quarters to be considered in recession.

Hey that reminds me a of neat quote I heard on the Dave Ramsey Show -- "Did you know that the media successfully predicted 2 out of the past 50 recessions?"

I may have warped the joke a little bit in the retelling but I hope the message is clear; ignore the doom and gloom, folks. It's not that bad out there.


Hee hee I love it.

2008 Feb 28 07:02 PM

[mrdon:]

Its not just consumer borrowing. I roughed out what the ratios of increased borrowing (household, government and business) to increased GDP were for various administrations. With the exception of of the Reagan years and the recent Bush years we borrowed less than two dollars for every dollar of increase in the GDP going all the way back to about 1950. During the Reagan and Bush years we have borrowed over five dollars for every dollar increase in the GDP. It is probably possible to distinguish between the Reagan and Bush years inasmuch as recent borrowing almost certainly has less of a component of investment in productivity and more of a liquidation of borrowed money in consumption and housing.

This is not so much a knock on the Bush administration (although it does beg the question of whether anyone in government understands the concept of fiscal responsibility) as it is representative of the possible endgame which occurs when when consumers spend more and more of our borrowed money on bon bons to the point where they are ultimately "borrowed out".

2008 Feb 28 09:12 PM

[Loan Officer:]

Welcome to the world of the haves and the have nots.
I do both residential and commercial lending. I've seen both sides of the fence and it just seems like the middle class is moving down a notch due to excessive spending. They have all lived beyond their means.

I have a lot of clients that have high net worth. They have planned well and done well in life. Unlike Trump, they live very moderate conservative life styles. But I was really shocked at how much debt the middle class had taken on during the 2003 refinance boom. Every night I would come home and remark to my husband how absurdly in debt most of my refi clients were in. They were living way beyond their means.

If you're out there shopping for a home, keep in mind traditionally the maximum debt to income ratio (house, car, credit card, student loans) was 33%. Don't let a loan officer or realtor talk you into biting off more than you can comfortably afford. Just say NO.

Yes, that big fancy house is really appealing, but if you can't sleep nights worrying about how you're going to make the payment, don't do it. It's not worth the stress. The number one cause of divorce is money.

I do agree that the banks and mortgage companies got reckless with their underwriting criteria, but where does the individuals who took out all this debt (and are now walking away from it) take accountability for their own spending habits?

As far as the 'no income verification' loans, those were designed for the self employed. They were never meant for wage earners. They were meant for those who write off a lot of the expenses (car, home office, cell phone, insurance) through their business. They would have had to pay those if they were working for someone else but due to the fact that they are self employed they are legally allowed to write them off against their income. That reduces the amount they show on the bottom line which qualifies them for less mortgage payment. I do not think of these as bad loans if the borrower is self employed.

2008 Mar 01 10:47 AM

[longtermstocks:]

Get out now!!!

2008 Sep 29 09:46 AM