The Moral Hazard of Market Supports and HELOC Abuse

What will be the enduring legacy of market price supports and HELOC abuse? Will there be valuable lessons learned, or have we tainted the next generation by policies loaded with moral hazard?

Today’s featured property is yet another HELOC abuse case where they more than doubled their mortgage, and now they are walking away.

91 Legacy Way Kitchen

Asking Price: $499,000

Address: 91 Legacy Way, Irvine, CA 92602

The Legacy — Iron Maiden

But do you think that they care
They benefit from death and pain and despair

Have you ever stopped to ponder the issue of moral hazard? At its most basic, moral hazard is any change in behavior that comes about when people believe their actions have no consequences.

The housing bubble was built on moral hazard. None of the parties to the real estate transaction believed they had any risk. Borrowers and lenders both believed real estate always goes up, so there was no market risk. Some savvy borrowers realized that 100% financing was transferring all the risk to the lender, so they risked nothing other than their credit score. Most lenders believed they were transferring the risk either to investors or counterparties to their credit default swaps. The people assuming these risks ran their fancy actuarial analyses and determined the risk to be minimal. Nobody grasped the systemic risk that took down the entire house of cards.

The moral hazard of investing in California real estate has gotten worse with each subsequent real estate bubble. Prior to our first bubble in the 1970s, real estate prices were around three-times income just like the rest of the country (that would be like a $275,000 median in Irvine today). The fallout from this first bubble ruined the fortunes of many, but it did not wipe out everyone. The people who profited from this bubble spread the word of riches in California real estate — if you know how to play the game.

Prices never did fall back down to pre-bubble fundamentals. At three-times income, there is a premium for rental (as there should be). Once people equated ownership with investment, people concocted an ownership premium, and a new era dawned.

The bottom of that first bubble saw price levels reach four-times income. This is the approximate level of rental parity in the market. As prices found support here in the mid 80s, it was only a matter of time before the toxic beliefs spawned by the moral hazard of the first bubble inflated the next one.


The bubble of the late 80s pushed prices up even higher, and when it collapsed, it resulted in widespread economic malaise, across-the-board declines in home prices, and more survivors who profited from the bubble. As interest rates declined during the 90s, prices became artificially supported at higher levels, and the decline was blunted. If interest rates had not declined 30% from 1990-1997, the overall market declines almost certainly would have been greater.

The bottom of that second bubble also saw price levels reach four-times income. With the lower interest rates, this was likely an improvement over rental parity in most markets. There was an overshoot of fundamentals caused by adverse market psychology. Everyone sobered up from kool aid intoxication.

I do not believe market bubbles are inevitable, but since California has a history of this behavior, it is prone to fall victim to its Siren’s Song. The State is a bit like an alcoholic: one drink of kool aid and California goes on a bender. In the late 90s, the markets witnessed several years of sustained appreciation. Many were still skeptical, and in 2000, there were open grumblings about prices being too high. They were. When they kept going up from here, we saw all the pent-up beliefs of kool aid intoxication get released on the populace. The Great Housing Bubble began to inflate.

The moral hazards of this latest housing bubble abound. People who bought between 2001-2003 paid too much. Right now, these people believe they are financial geniuses. If the market is not allowed to take its natural course down to 2001 price levels, people who overpaid at the beginning of the bubble will be imbued with moral hazard. They will not be punished for their mistake. We will create a new generation of people who believe in the myths of California real estate, and we will inflate another housing bubble — assuming of course that the lenders enable it.

In my opinion, all of the policies coming out of Washington that seek to prop up a flagging market only serve to create moral hazard. Another generation will have to endure a housing bubble complete with its commensurate fallout recession. If prices do not crash, if everyone who participated is not punished for their foolishness, we will almost certainly do this again. Perhaps Washington will put regulatory controls in place that prevent lenders from enabling this behavior, perhaps these regulations will be effective, and perhaps they will not be repealed before kool aid intoxication is purged from our collective memories. Perhaps not. I don’t have much faith in Washington getting it right.

We seem destined to live in fear
And some that would say Armageddon is near
But where there’s a life while there’s hope
That man won’t self destruct

91 Legacy Way Kitchen

Asking Price: $499,000


Income Requirement: $124,750

Downpayment Needed: $99,800

Monthly Equity Burn: $4,158

Purchase Price: $299,000

Purchase Date: 7/27/1999

Address: 91 Legacy Way, Irvine, CA 92602

Beds: 3
Baths: 3
Sq. Ft.: 1,500
$/Sq. Ft.: $333
Lot Size: 3,211

Sq. Ft.

Property Type: Single Family Residence
Style: Other
Year Built: 1997
Stories: 2
Area: West Irvine
County: Orange
MLS#: P674420
Source: SoCalMLS
Status: Active
On Redfin: 3 days

Spacious three bedroom/2.5bath in a desired neighbourhood. Windows in
each room, bathrooms, and even in the walk-in-closet. Very bright and
cozy. Close to 261, Jamboree and walking distance to the elementary
school. Attached two car garage has storage unit; Kitchen has pantry;
Inside laundry located upstairs; Master bedroom has a huge walk in
closet and roman bathtub; Build-in speakers in each bedroom and living
room; Lighting fixtures at the ceiling in bedrooms; Build-in propane
BBQ in a back yard; The toilet cover (washlet; wash-toilet)in a
downstair bathroom stays. No association dues, Low Mello Roos.


washlet; wash-toilet. You have to check out this website. It is hilarious. I had no idea what a washlet was…

Today’s featured property is a profile in HELOC abuse. Look at what these people did:

  • This property was purchased on 2/27/1998 for $299,000. The owner used a $239,200 first mortgage and a $59,800 downpayment.
  • On 12/12/2002 the owner opened a HELOC for $30,000.
  • On 6/3/2004 he refinanced with a $472,500 first mortgage.
  • On 3/15/2006 he refinanced with a $576,000 Option ARM first mortgage.
  • Total property debt is $576,000 plus negative amortization.
  • Total mortgage equity withdrawal is $336,800 including his downpayment.

If this property sells for its asking price, and if a 6% commission is paid, the total gain on the property will be $170,060. The total loss to the lender will be $106,940 plus negative amortization. Lenders are stupid.

How are these people being punished? Is the lack of consequences for their behavior also creating moral hazard? Yes, it is.

I argue that the greatest moral hazard to come from the Great Housing Bubble is the enabling of HELOC abuse. Think about how desirable HELOC abuse makes California real estate. If you buy property in a state with price volatility as extreme as ours, you have the opportunity to convert this equity appreciation to cash and spend it with little or no repercussion for your activity. The greater the amount of volatility, the more money you can extract from your lender and spend. Why would anyone own in Kansas where prices are stable when they could own in California where they can live the good life off their houses?

The kool aid intoxication from appreciation created by the previous bubble helped inflate this last bubble. Add to that the ability to convert this appreciation to cash, and you have a recipe for major kool aid addiction. If previous bubbles brought us kool aid that is as addictive as cocaine, this last bubble with its refined ability to access the appreciation through HELOCS is as addictive as freebasing crack.

So what is the natural result of all the moral hazard we have created? We now have a population of kool aid intoxicated fools
waiting for the next credit cycle to enable them to bid up house
prices, create false equity, and convert that equity to cash so they
can spend it like the entitled, Nouveau riche they have become…

Just let me buy my house first.


We seem destined to live in fear
And some that would say Armageddon is near
But where there’s a life while there’s hope
That man won’t self destruct

Iron Maiden - A Matter Of Life And DeathWhy can’t we treat our fellow men
With more respect and a shake of their hands
But anger and loathing is rife
The death on all sides is
becoming a way of life

We live in an uncertain world
Fear understanding and ignorance
is leading to death
Only the corpses are left
For vultures that prey on their bones

But some are just not wanting peace
Their whole life is death and misery
The only thing that they know
Fight fire with fire life is cheap

But if they do stop to think
That man is teetering right on the brink
But do you think that they care
They benefit from death and pain and despair

The Legacy — Iron Maiden

73 thoughts on “The Moral Hazard of Market Supports and HELOC Abuse

  1. Gindy

    According to the photos, they didn’t spend much of the HELOC on the house. That kitchen is definitely what the house came with when first built. Maybe a bathroom or two were redone, a grill erected in the back, and possibly some landscaping. Certainly nothing close to what they HELOCed out of the place.

  2. NoWowway

    What does it mean when someone carpets the garage? Is this b/c they move another family into the home for help with the rent/mortgage? Obviously there will be no cars parked on the carpet, right?

      1. AZDavidPhx

        The website is quite cheesy – they talk in inuendo that likens the product to a male enhancement pill. Perhaps if you order in the next 5 minutes they will include the baby powder blower (a 60.00 value) free of charge.

        My favorite sales pitch is how regular toilet paper “redistributes the problem” – thanks for the visual.

        I have heard of these things being used in other countries but to me it seems semi-perverted, emasculating, and impractical – but that’s just me.

        Either way, I think it beautifully sums up today’s post and the other turd loans of the housing bubble; our modern day tragedy “Washlet”. Shakespeare would be so proud.

        1. pianist

          “I have heard of these things being used in other countries but to me it seems semi-perverted, emasculating, and impractical – but that’s just me.”

          You’ve got to get out and travel more then, or at least talk to a proctologist about the applicability for hemorrhoid sufferers πŸ™‚

          1. gorobei

            Or just ask yourself if you’d want to eat a restaurant that carefully cleans the plates and utensils with paper towels.

            Feel just a little dirty now?

    1. pianist

      Oh, these comments are going to be good. The device doesn’t spray used water on you! And these things are expensive. I’ve seen several of these in homes, both Anglo and Asian. I just saw one in the Ladies’ room of a Japanese restaurant in Honolulu. My sister tells me they’re all over Japan in public facilities.

    2. Walter


      “The washlet has more in common with a laptop computer then any toilet seat you have known.”

      These things sound like a tour de force of household technology. If the City of Irvine mandated these, property values just might stabilize.

      1. Major Schadenfreude

        “If the City of Irvine mandated these, property values just might stabilize.”

        And people would smell nicer too!

    3. Mckenzie

      I noticed that the washlet is installed in the powder room which I find kind of odd. Why not install it in the master bath room.

      1. Ken

        I think I can answer that. I have a two-story townhouse in Anaheim with a half-bath “powder room” downstairs, and that downstairs half-bath gets most of the crapper traffic in the house; I’m downstairs most of the time, any visitor will also be downstairs, and it’s the most convenient crapper in the house.

        I assume “Washlet” is Newspeak for the toilet with built-in bidet washoff like they have in high-end Japanese hotels. Good idea, but sounds expensive.

        1. KP

          does the sound of your (or your lender’s) money being flushed down the drain sound any different on a washlet?

  3. maliburenter

    “None of the parties to the real estate transaction believed they had any risk.”

    And many of them were right. People with no money down only had credit rating risk. Mortgage brokers only had the risk of losing a job later. Banks typically weren’t retaining much of their mortgage portfolio. Credit rating agencies have in the past avoided being liable to investors the great majority of the time.

    So who got stuck? MBS purchasers, private mortgage insurers (who I am still stunned to see in business), banks on their retained portfolios (especially HELOCs), Fannie and Freddie (though their default rate is lower than elsewhere, it’s still huge in $ terms), the FDIC, and the taxpayer.

    1. mav

      “So who got stuck?”

      The entire economy, with the tax payer at the front of the line…. paying for the collapse of debt spending.

    2. Walter

      Unlike the borrowers that just walk away, many of the banks ended up bringing off balance sheet junk in SIVs and the like back into the bank resulting in huge losses.

      So much for transferring the risk.

  4. maliburenter

    I know a few people who saw HELOC lines being cut who took out the max under their HELOC and put it in a “safe” investment to make sure they had liquidity. Hopefully they chose treasuries or CDs and didn’t get into the stock market.

  5. OC Progressive

    I was impressed by that 3,211 square foot lot,and the the spaciousness of 1500 square feet of living area.

  6. movingaround

    IR – your post today sounds like you actually think they may be able to stop the fall of prices – I don’t think I have heard that from you before. Which of the numerous measures that they are trying to enact do you think might actually stop falling prices??

    I just don’t get it – keeping housing prices high is so horrible for CA economy – one of these days businesses are finally going to see the light and get out of CA because they can’t afford employees.

    1. IrvineRenter

      I don’t think they can stop the price decline, but they can make it less worse than it should be. If they raise the bottom through 4% interest rates, or homebuyer subsidies, they just make the recovery weaker. Anything that supports prices just pulls demand forward and puts them into properties they can barely afford with the subsidy. I have never seen a healthy free market that required a subsidy or other price supports.

      1. mav

        To really stabilize prices and/or partially reflate you would need to revitalize the demand that was pulled forward during the bubble…. those who have already been foreclosed on…. you would need to wipe the slate clean… and allow them to purchase now.

        The problem is that these people were never credit worthy. It required the assumption that these people learned their lesson and will not default on all of their debt again. If they default, then the stabilization/reflation will be temporary and the debt deflation just gets delayed to a later date.

        1. Perspective

          I think we’ll see this. Fannie’s been aggressive increasing the length of time necessary before they’ll purchase a new mortgage to 5 years from foreclosure. That keeps a big portion of potential buyers (i.e. market stabilizers) out of the housing market for a long time. If your goal is to stabilize the market, you’ll probably want to shorten that time-frame down to 1 or 2 years. This conflicts with your goal to discourage walkers however…

        2. freedomCM

          mav, I think you are wrong (mostly) about them being credit worthy.

          maybe the sub-prime buyers weren’t, but buyers like these clearly were for the $300k loan, just not for the $600k loan.

          I think it is buyers like these who we will see more of in the coming year. half or less of the income needed for their refi’d optionARM, but perfectly fine for their 4x income purchase loan from ten years ago.

    2. lunatic fringe

      That’s because IR is really an optimist at heart…

      But I am not, not one little bit. I need to be shown how Bernanke and friends are going to be able to finance all this debt they think will get us out of this mess. Somehow I don’t think it’s going to be all that easy.

      I look forward to the day of sub-3x median income home prices.

  7. Will

    Neighbourhood is an effort to sound English…making it more “classy.” They should have called it…”Ye Olde Foreclosure Special.”

    1. Chris

      I guess IR failed to **realise** that **neighbourhood** is British.

      Careful, they’ll be pissed when you try to correct their English. After all, it is *English* and not “Americanish” πŸ™‚

  8. maliburenter

    The 1970s were not the first CA housing boom. These cycles go back to at least the 1880s,

    “Soon, Southern California became like one gigantic casino as newcomers changed from buying lots to live on and farm to buying lots to sell at high profits. Speculation on real estate became rampant and spiraled out of control. With dreams of a quick profit, everyone gambled on property from the lowly hotel bellboys to doctors and ministers. Everyone seemed to be a millionaire….”

    Anything sound familiar? That was 1886.

    1. IrvineRenter

      That is a well-written article. I suppose I could have provided a more complete history of California land speculation, but the experience of the 19th century probably wasn’t influencing today’s buyers as much as the last 30 years were.

      I was at a BIA event recently where they showed a graph of housing starts for the last 50 years. I did not realize that the early 60s had more housing starts than any time since. We built more houses in 1963 than we did at the peak of the bubble. To me is shows what happens when you introduce a number of land use controls as happened in the late 60s/early 70s. We probably would have had a real estate bubble in the early 60s had supply been limited and prices been allowed to rise.

      1. maliburenter

        I am not sure whether knowledge of prior bubbles would have had any real effect on the most recent bubble. There was a bubble in the late 1980s and early 1990s which many people in SoCal experienced first hand. Many of the same real estate agents, etc., were involved in both bubbles. Certainly, if that firsthand experience didn’t discourage individuals, history from the 1880s wouldn’t.

        If anything, such knowledge will inform policy debate and academic analysis. Maybe we will ultimately find ways of reducing bubbles and their damage that don’t impair the free enterprise system.

        1. IrvineRenter

          One thing I have found interesting in studying some past financial bubbles is that lenders often did not participate in the final stages. In this most recent bubble, lenders stayed and played to the bitter end.

          The paper you linked to said the lenders were not involved, but it did not say how ordinary people were able to come up with the huge sums necessary to inflate a bubble.

          I also read that lenders avoided the Florida bubble of the 1920s. From what I remember, there was an unusual option transfer arrangement that created an unstable debt structure that built that bubble. When the Ponzi Scheme unraveled, cascading defaults often left the property with the original owner at 10% or less of the value of the final note.

        2. mav

          You make the assumption that the key take-a-way from a financial bubble is to not let it happen again. Wrong. The key take-a-way is that those who benefit greatly from the pervious bubble are actively looking for the next financial bubble. Financial bubbles are part and parcle to capitalism. It is how the rich get richer and the poor, poorer.

          1. idrnkurmlkshk

            Not to mention they are happening more frequently and getting more extreme. This is due in part to inflation and the dirty little secret that Americans can’t afford the “American dream”, or anything for that matter.

            I think bubbles are analogous to a sinking ship. Bubbles are nothing more than short windows for survival. Remember that scene from Titanic where the lower class passenger were following the rats to higher decks? It’s a rat race just to survive these days.

          2. idrnkurmlkshk

            I’m just afraid of where the next bubble will occur. I have a feeling it will be alternative energy and infrastructure. God help us when that one pops. I wouldn’t mess with such a vital industry as energy.

          3. ockurt

            Yes, look at what happened when they tried deregulation of the CA electric industry…we’re still paying for that mess…and I was at ground zero (utility employee)

          4. maliburenter

            I was involved with several large utilities during the deregulation. It was only deregulation of one side: production and generation. Regular retail consumers paid a fixed rate. California’s electric deregulation was very poorly implemented.

          5. maliburenter

            I don’t think we will get away from bubbles. I hope that they can be recognized more quickly and do less damage.

            Bubbles have a tendency to enable or attract a lot of fraudulent activity. I think that is one of the primary places to slow down a bubble. Keeping leverage away is another. Since most bubbles are built on expectations of price rises continuing for long enough to get out with a gain, being able to credibly warn people when prices or expectations of gain are very far out of line would be very valuable. Especially if accompanied by some sort of policy change.

          6. ockurt

            maliburenter, you are correct. Very poorly implemented which made it easier to game, and led to disastrous results. Maybe they’ll get it right next time when they try it again in another 10 years or so.

            I could go on and on about this but it would take me all day!

  9. Transplant

    The house/story is pretty unremarkable.

    But the “washlet”. Oh. My. God.

    As it happens, Jim the Realtor at bubbleinfo has a house where the previous owner took out the bidet and put in a non-matching tile. Hillarious.

      1. pianist

        Yes, imagine that. Instead of toilet paper smearing residue all over your crevice and leading to skid marks in your drawers, you actually have water rinse the residue off your butt. How backwards is that:question: :question:

        O.K, I’m just having too much fun with the provincialism in the bidet comments πŸ˜‰

        1. ockurt

          This is probably TMI but I have a hard time imagining water getting residue off my butt. Probably take more like a fire hose πŸ™‚

          Plus, I kind of like skid marks in my drawers…

          1. pianist

            Oh, come on. Try the washlet, you might like it! You can give the economy a boost while feeling sparkly clean.

            BTW, this is all in good fun, ockurt

  10. alan

    80-20 problem…

    80% of the abuse took place in 20% of the Country, that’s what Washington doesn’t get.

    What I found interesting was a recent break down of Bear Sterns Mortgage losses. Of the $30 billion in losses at the time they went under, $12 billion was on loans out of Orange County, CA.

    OC really is ground zero.

    1. movingaround

      that is an amazing number Alan – and yet OC is still holding on to their high end prices while the rest of the country is floundering – there is no justice.

      I wonder what the number was if you included all of So. CA!?

  11. Anonymous

    Re: “Have you ever stopped to ponder the issue of moral hazard? At its most basic, moral hazard is any change in behavior that comes about when people believe their actions have no consequences.”

    β€œReagan taught us that deficits don’t matter.”
    -Dick Cheney

    Same attitude ie. deficits don’t matter – because in 4 or 8 years we’re outta here & it’s some other person’s problem…

    1. IrvineRenter

      That particular moral hazard issue did not serve the Republican Congress under GWB very well. Many lifelong Republicans were disgusted with the spending and budget deficits. Hence the loss of seats in 2006 and 2008 (it wasn’t all because everyone hated Bush).

  12. getting rich

    Now that everyone showed the way, it is my turn. Buy my first house at the bottom of the market. Save like crazy to get a second home to rent out. Pull out all my down payment and more with a HELOC when the next bubble hits, and yes it will happen again. Pay off the first house. Its not wrong if those are the rules. No one forced the banks to give out the money.

  13. Say No! to Koolaid

    Low Flow Washlets – energy efficient… Add these to the “Green Energy” section of the bailout package.

    The Government has chosen the powerless taxpayers to purchase as much putrid crap as Wall Street has to offer.

    It only seems fitting that a “washlet” for all clause is added to the bill.

    It will provide the taxpayers a way of cleaning up after the fiscal pounding that we have bent over to receive.

    Hey Obama!, We are not looking forward to this PMITA Administration

  14. For real

    “Windows in each room”

    wow…that’s something new. I thought only prison doesn’t have window in each cell.

    1. ignorantoutsider.

      I liked lighting fixtures on the ceiling too. As for “toilet cover stays” maybe I’m just germ phobic but I would pay extra to make it go. [ or maybe you use it to dry off after the washlet]

      1. pianist

        A good washlet gives you a blow dry after.

        How do I know about this? I just helped a Japanese gentleman plan a bathroom remodel, including a washlet system…I learned more about the product than I ever thought…

  15. IrvineRenter

    I am trying to help a reporter with a story on the walkaway phenomenon. If anyone reading this would like to tell their story to a reporter for the Christian Science Monitor, please email or call:

    Dan Wood


  16. Bitter Renter

    > washlet; wash-toilet. You have to check out this website. It is hilarious.

    That’s awesome. It’s the Brady Butts! πŸ˜†

  17. CulverdaleKidsRock

    To IrvineRenter:

    It was interesting to learn that your background is in land use planning… I have two brothers who have the same background, so I have a general understanding of zoning laws. And I argue with them from time to time, so I hope you appreciate my comments in this context.

    My brothers and I grew up in Irvine and accepted the laws that protected/limited land use and also the architectural integrity of the local association. But I no longer live in Irvine, and now I’ve begun to see things from a different perspective. If homes are expensive in Irvine, why not just change the zoning laws? Why not let anyone build what they want on their land? Wouldn’t this make homes more affordable for everyone, while enriching those who already own property?

    On one hand, liberalizing land use in Irvine seems like a radical concept. But, don’t most residents of Irvine subscribe to free market principles? If so, why do they live in the most controlled environment imaginable?

    This for me is the paradox of Irvine. On one hand, residents agree that free markets are good and are ideal for the economy and society. But even while they have these thoughts, the same residents allow their entire lifestyles to be artfully designed by land use planners. Everywhere they go their decisions are planned (or controlled through the constraints of land supply and land planning) … the location of restaurants, supermarkets, etc. The government’s hand is not invisible, it is omnipresent.

    So I am curious. What is preventing the residents of Irvine from transforming their properties into their highest and best use? What is preventing residents from expressing their views of free market capitalism? What keeps them from transforming their under water properties into sources of income and wealth? Shouldn’t the owners of the property you’ve profiled be able to tear that home down and turn the property (one that they OWN I might add) into a 10 unit condominium? Wouldn’t that make housing more affordable while making existing home owners more wealthy?


    1. Chris

      The answer, my friend, is “property value preservation”. Why do you think there are so many NIMBY homeowners?

      If I turn my property into a brothel, I’d make more money than your 10 unit condos πŸ™‚

  18. newbie

    IR great reporting. As for Washington making moral hazard, you’re assuming they have morals. Republicians and Democrats in Washington have and will continue to encourage bubbles. Look at the proposals for 4.5% 30 year loans. They will likely require 5%, nothing down or negative down for those living in the houses. This will cause another round of refinancing and collection of points by the banks. Then another set of defaults, bailouts, and another set of refinancing. I almost forget to include numerous campain contributions at each step. The best goverment money can buy, but they’re not working for us.

  19. newbie

    What exactly is “kool aid intoxication?” Do it refer to Jim Jones’ Kool-aid, a cheap drink to spike and pretend that it’s fine wine, or what?

    1. IrvineRenter

      That is the historical reference. It has come to symbolize the collection of erroneous beliefs embraced by participants in the housing bubble.

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