Bailouts are rescuing the irresponsible at the expense of the prudent, or so we all believe. But didn’t the prudent benefit from the Great Housing Bubble as well?

Asking Price: $654,000

Address: 34 Blazing Star, Irvine, CA 92604

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Glenn Beck on the Housing Bubble

Today we have a guest author, Dejnov. It is good to get differing perspectives and points of view, and I don’t mind taking a break once in a while. So, with that introduction, the IHB presents:

The Bailout for Prodigious Spenders by Dejnov

In numerous housing blogs, there is a current pervasive meme circulating about how responsible prudent renters, to their own personal detriment, are being forced to bailout the spendthrift homeowners. Like Aesop’s fable of the ant and the grasshopper, the industrious ant worked long and hard every day to build a nest egg for the long winter months approaching, while the carefree and lazy grasshopper frittered away the summer days. When winter approached the ant was comfortable knowing that he had enough stores to last until the next summer, while the grasshopper found himself starving. The grasshopper, or homeowner and equity spender, decides to ask the ant, a renter and saver, for charity to help him weather through the winter months. Depending on the version of the fable the grasshopper either is personally rebuked by the ant for his laziness and allowed to starve, the ancient version, or has pity shown upon him by the ant and allowed to weather the winter within the grasshopper’s home, the current Christian version.

Currently, the general consensus on housing related blogs is that a third more sinister version is occurring. The grasshopper, through political influence, has his crony banker buds forcibly steal enough of the ant’s nest egg to make himself whole. While the current news about endless bailouts seems to imply such a schadenfreude inspiring situation, I think that the analogy is incorrect, and given the current situation a different, fourth ending, to the story might actually be occurring; one where the ant wins, and the grasshopper, even with bailouts, loses.

To fully understand the future outcome, the summer months must first be analyzed. During the late 90s and early 2000s our economy enjoyed huge expansions in credit and leverage, with many people being able to assume debt-to-equity and debt-to-income ratios far above what was earlier considered prudent and standard. This allowed house prices to rise and home owners to extract their nominal equity gains through loans and spend that money freely. With credit (and leverage) ratios expanded every year and required equity amounts reduced, those who owned tangible assets saw their net worth increase yearly, while those who had no large tangible asset base didn’t. But this is all old news, and has been stated ad infinitum in many housing blogs. The basic premise is that leverage only helped those with assets and hurt or hindered those who didn’t. The reason such an idea is so pervasive is that it’s easy to quantify and calculate. Houses, and to a lesser degree stocks, are the single largest identifiable line items on an American’s balance sheet. Net worth growth due to house (stock) appreciation is currently tracked by endless agencies and investors. Whole sell-side industries continuously shill about the large appreciation and net worth growth that occurred to help sell their products.

While the earlier assertion is somewhat true, leverage has also helped less asset-heavy Americans’ balance sheets. Karl Denninger on the Market Ticker had a great article about leverage (http://market-ticker.denninger.net/archives/865-Reserve-Banking.html). Leverage is, inherently, not a financially ruinous concept and something to be avoided at all costs. If used prudently, it reduces interest expenses and allows savers to annually save a larger percentage of their earnings. High bank leverage rates for the last ten to fifteen years allowed Americans to finance zero-interest loans on cars, access student loan credit at near or below long term inflation rates, get zero-interest short term credit card loans, and allowed the government to reduce the overall tax burden. From 1987 till today, the top bracket on income tax has never been more than 40% and has been as low as 28%. A comparative look at the history of federal income tax in the 1900s shows that for most of this time, top bracket tax rates were much higher than what we’ve seen in the last twenty years (http://en.wikipedia.org/wiki/Income_tax_in_the_United_States). In the last century top tax brackets have been as high as 91% to 94%. The same holds true for capital gains tax rates.

So what does this all mean for our hard-working exploited ant? Whatever he was earning, he got to keep more of it. He had to pay less in taxes, and all of life’s interest expenses were cheaper. A strong saving ethic would have been amply rewarded in this climate. While it might not have been prudent to invest all of one’s excess returns in either housing or stocks, someone who diversified his investments and held money in a savings account has done well. Granted, interest payments on a savings account have been pitiful (in some instances near zero), there hasn’t been any loss of capital, and long-term financial security was never more possible to achieve. The last ten to fifteen years have allowed responsible thrifty consumers and strong savers the potential to grow positive balance sheets by reducing their incidental and financing costs.

“Well that might be true,” states the ant, “I’ve done moderately well these days. But it’s nothing like how the grasshopper has done. I mean he’s completely blown past me in net worth. Look at his house, with the pergraniteel, the Bentleys and Lexuses in his garage, and all the fancy leather furniture he’s got. I myself just rent an apartment and drive an eight year old Pinto.”

“Pssst, hey ant, don’t forget all the MEW-funded bling-bling I bought for the SigO” chimes the grasshopper!

There hasn’t been any contention that the grasshopper has lived a more consumption-conspicuous lifestyle. What really is the issue, currently, does the grasshopper with bailouts, actually have more resources than the ant to survive the onset of winter? The winter I’m referring to is the ongoing credit deleveraging and subsequent contraction in pay, jobs, car/house prices, prices on everything else, etc. A current wonkish paper (The Wealth of the Baby Boom Cohorts After the Collapse of the Housing Bubble) by Rosnick and Baker tries to elucidate on the current state of affairs.

The last accurate measurement of net wealth was completed in 2004. Well it’s currently 2009, how are we doing now. Rosnick and Baker answer unequivocally: “badly.” Net wealth for baby boomers cohorts (ages 45 to 54 and ages 55 to 64) is significantly down, with the younger cohort’s median net wealth down by 45% and the older cohort’s median net wealth down 38%. But what is more surprising, and pertinent to this article, is their finding that over all wealth quintiles and age cohorts, those who were renters in 2004 currently have a greater net worth than those who were owners in 2004. In some cases, the renters have a lot more net worth. Even with the great run-up in home equity after 2004 until 2008, a little over a year of losses has put house-owners into a worse financial position than renters. That’s a somewhat contrarian conclusion. For many years, the real-estate shills have espoused how owners, through owning real estate, are a more capable and financially secure class of people than renters. Presently, this doesn’t seem to be the case for baby-boomers.

While Rosnick’s and Baker’s paper considers only baby boomers net wealth (we’ll have to wait until next year for a more accurate assessment of how everyone is doing) there are a number of inferences that can be made.

First, wealth loss has been greater for those who are younger. Older generations typically have a larger net worth, higher paying jobs, stronger job security, and less financial leverage, while younger generations are saddled with student loans, larger loan balances on their mortgages, and starter careers.

Secondly, as one ages typically the more intransigent one becomes. Baby boomer renters, with their ample time to accumulate wealth, rent for one of two reasons. They could never qualify for home ownership (which seems a historic impossibility given the conflux of option ARMs and Alt-A loans pervasive around 2004) or were accustomed to renting instead of owning. If it’s the former, the renting cohort is represents a less financially stable, creditworthy group; if it’s the latter, the cohort has the same financial strength as a typical homeowner, but chose not to rent for a different reason. That reason most likely was real estate’s inflated price in 2004.

Lastly, Rosnick’s and Baker’s estimated the average price loss on houses from 2008 till the end of 2009. They initially estimated that real estate prices would decrease between 10% and 28% (depending upon market severity), but had to revise their estimates for a loss between 21% and 33% to reflect current trends. This brings up an interesting situation. At the end of this year, irrespective of the wealth quintile, cohort, financial situation, or house loss estimate, baby boomers who owned properties are less wealthy than those who rented. This also includes all prior bailouts to date. Maybe the grasshopper’s banker buddies aren’t so friendly after all? If the present downturn in housing doesn’t end this year, what does the current situation portend for Americans’ future balance sheets?

To date, the ant’s lifestyle choices haven’t actually impaired him, while the grasshopper’s has, but what about the future? What happens when the grasshoppers start to foment rebellion and earnestly petition their representatives in Congress to strong-arm help from the ant? After all, they are the voting majority and wield much more political muscle than the lowly ants.

In the near future there will be a lot of policies and laws that will help coerce a large majority of house owners into recourse loans that will destroy this cohorts long term wealth. Housing represents the largest line item on the majority of Americans’ balance sheets and to have such a large negative interest rate and loan amount will have profound effects on Americans thirty years from now. While the data just two years into the housing crash already shows renters wealthier than owners, twenty years from now the difference in wealth will be even larger. This will mostly be due to the large amount of positive equity that renters have accumulated and will subsequently loan to owners for an increased risk premium (interest rate).

Commentary from IrvineRenter

I agree that renters also benefited in as much as everyone benefited
from the economic prosperity of the bubble. I don’t think people really
dispute that. The question is one of degree. Owners received huge
financial benefits and lifestyle benefits by owning and borrowing and
spending their equity. This benefit was many orders of magnitude higher
than the benefits renters received from the economic expansion caused
by all the homedebtor spending.

Now that the crash is on, the losses
are not typically being borne by homeowners because they are walking
away from the bills and leaving it for lenders and taxpayers to pick up
the tab. In the end, the benefit to renters during the bubble will be
wiped out by the increased tax burden caused by the collapse, whereas
the benefits of the homedebtors will not be fully erased by the same
collapse. Homedebtors may look worse on paper because many will be
penniless, but they will have years of memories of rampant consumerism
that cannot be taken away.

In the end, renters will come out ahead
financially because they were never given free money to spend, so they
never got used to the spending, and they did not have to endure
foreclosure and bankruptcy; however, former owners will have the
memories of the trips, big houses, fancy cars and other perks of free
money that renters never got to enjoy. Personally, I am glad I am in
the renter camp, but sometimes I wonder if the party would have been
worth it; so do many other renters.

Asking Price: $654,000

Income Requirement: $163,500

Downpayment Needed: $130,800

Purchase Price: $740,000

Purchase Date: 3/16/2004

Address: 34 Blazing Star, Irvine, CA 92604

informaiton?

• This property was purchased on 3/16/2004 for $740,000. The owner used a $592,000 first mortgage and a $148,000 downpayment.
• On 10/26/2004 he opened a HELOC for $87,000.
• On 6/23/2005 he opened a HELOC for $125,700.
• On 8/23/2005 he refinanced for $735,000 with an Option ARM with a 1.9% teaser rate.
• On 10/28/2005 he opened a HELOC for $140,000.
• Total property debt is $875,000 assuming he maxed out the HELOC.
• Total mortgage equity withdrawal is $283,000 including his downpayment.

The property went into default, and IndyMAC bought it at auction for $619,742.

Foreclosure Record
Recording Date: 11/07/2008
Document Type: Notice of Sale (aka Notice of Trustee’s Sale)
Document #: 2008000524952

Foreclosure Record
Recording Date: 07/07/2008
Document Type: Notice of Default
Document #: 2008000323207

Foreclosure Record
Recording Date: 05/22/2008
Document Type: Notice of Default
Document #: 2008000244983

If this sells for its asking price, and if a 6% commission is paid, the total loss to IndyMAC/FDIC/US Taxpayer will be $260,240.

How do you feel about paying for that? Is the fact that we may have extracted some benefit from this behavior enough to make you feel better about it?

The Santa Claus Bailout Hearings