Monday, September 10, 2007

The Home ATM (a.k.a. Equity Extraction) Is Broken

First up is astute reader Mark A., writing in response to The Big One Just Hit,

I think you're right. The ground indeed quakes.

If the Dollar has nothing to stand on, I imagine a lot (a lot!) of money will move towards anything-but-the-Dollar. gold comes to mind, but so do other things... Swiss Francs anyone?

A kvetch:

I've seen the "Home Equity Loans" graph a number of times in different places. It's very dramatic, but as presented it's completely inscrutable: 40% of WHAT please? -x% of WHAT? I mean really...

(BTW, I got an email today telling me I was pre-approved for a... home equity loan!)

Thanks for your website."

Thoroughly chastened, I set off on a search for accurate data on mortgage equity withdrawal a.k.a. MEW. I soon discovered the subject is a thicket in a bog shrouded by fog: nobody really knows how much has been extracted or how those trillions were spent.

I have spent endless hours researching this and can now share my map of the bog. The sources of confusion are many.

First, MEW have multiple sources: re-finances with cash above the mortgage being paid off, home equity lines of credit, and either new mortgages on free-and-clear properties or second mortgages.

Surveys which ask what homeowners did with the money are pitifully small--less than 500 homeowners in a study co-authored by former Fed Chairman Alan Greenspan Sources and Uses of Equity Extracted from Homes by Alan Greenspan and James Kennedy (March 2007).

Tracking the money from MEW is insanely complex, and so sources just guess: some guess half the money was spent on consumption, others guess two-thirds.

Any data which is self-allocated like this must be taken with a giant grain of salt. Any MEW "allocation" smells strongly of similar studies in which people are asked how many fruits and veggies they ate that week--and in virtually all cases, the actual amounts are far lower than those estimates made by the consumers who sought to "give the appearance of doing the right thing."

My own suspicion is that virtually all the MEW funds ended up being spent.

Consider an example. Say a homeowner borrowed $50,000 in equity off his primary residence to buy an investment property, i.e. used the cash as a down payment on a speculative real estate purchase, a.k.a. a real estate speculator/flipper. He then states that the MEW was used for "investment."

But then when he flipped the investment property, he spent the $100K proceeds on a new truck, a fancy cruise for the family, and various gew-gaws plus a $50K down payment on a condo. Would the $50,000 he spent end up being counted in the MEW statistics? No. Yet fundamentally the money was extracted from the equity of his primary home.

Here are some resources I found in trying to sort out the MEW mess:

Measuring Equity Extraction (Calculated Risk blog, 5/22/07)

(Click on link or chart to go to Calculated Risk and their larger chart)

Home Equity Extraction Still Hot in Q3 (Calculated Risk blog, 1/20/06)

Estimated gross equity extractions rose 10% from the previous quarter to a seasonally adjusted $990.6 billion (for Q3 2005), according to an update provided to Investor's Business Daily of a September Federal Reserve study on mortgage originations.

For the first nine months of last year, equity extraction totaled $2.6 trillion vs. $2.4 trillion for the same period of 2004 and over double withdrawals during all of 2000.
This means at the height of the housing bubble, Americans were pulling out roughly $3.5 trillion a year in equity. Yet other figures sourced below suggest the total "free cash" was on the order of $1.4 trillion--less than half this number. So apparently the rest was used to pay off existing mortgage or consumer debt.

Here's another excellent depiction of the entire equity-extraction cycle:

The Greenspan and Kennedy papers on Equity Extraction from Housing (1990-2006) - A graphic exposition

Greg Ip at the Wall Street Journal filed this report:

Home-Equity Extraction Eases (Wall Street Journal Economics Blog 6/12/2007)

"In the first quarter (of 2007), 'home equity extraction' net of fees fell 8% to $449.6 billion at a seasonally adjusted annual rate from the fourth quarter, the lowest since the fourth quarter of 2003 well below the peak of $863.7 billion in the third quarter of 2005. CHS: note that the data on the Calculated Risk entry from other sources places the peak at $990 billion;' clearly, it is an inexact number.)

Homeowners extract equity from their homes either by selling their home at a capital gain and spending some of the proceeds, taking out a home-equity loan, or refinancing their mortgage and taking cash out in the process.

Such extraction soared with rising home prices and falling mortgage rates earlier this decade, and has since slowed as first mortgage rates edged higher and then home prices stopped rising and home sales fell. The drop in the first quarter was principally due to a sharp, 82% decline in the growth of home equity loans; equity extracted through the sale of existing homes rose 9%, and equity extracted through cash-out mortgage refinancing eased 5%, according to seasonally adjusted data."

Economics prof Greg Mankiw's Blog (8/31/07) offers this chart and data from the Greenspan report:

Free cash generated by equity extraction

2000......553.4 billion dollars

Free cash generated by equity extraction: As percent of disposable income


(CHS note: doesn't it seem that an extraordinarily large percentage of recent income was generated by MEW?)

(Source: Federal Reserve

(source: Sources and Uses of Equity Extracted from Homes Alan Greenspan and James Kennedy (March 2007)

If you're not confused yet, here are some (low-ball) numbers from the New York Times and a detailed, no-punches-pulled report from the Federal Reserve Bank of Dallas:

Economic Letter—Insights from the Federal Reserve Bank of Dallas (11/06)

And for a summary, here is scathing one from the Asia Times, 11/21/06):

In 1999, total outstanding household debt was $6.4 trillion. As of the end of the second quarter of 2006 total outstanding household debt was $12.3 trillion.

Household debt has increased by almost as much since 1999 as the sum total of all debt accumulated by all households across the preceding 220-year history of the US. In 1999, household mortgage debt stood at $4.4 trillion. At the close of the second quarter of 2006 it had more than doubled to $9.33trillion. In 1999, consumer credit outstanding was measured at $1.6 trillion.

The last six years have hosted the most stupendous extraction of inflated household wealth in history. Across the 22 quarters from 2000 through the second quarter of 2006 disposable personal income increased by $2.3 trillion. However, disposable personal income as a percentage of household net worth fell. Rising house values contributed more than personal income increases largely derived from these rising house values."

According to the conservative Greenspan/Kennedy data, $6.6 trillion was extracted as free cash from 2000 -2006. That is 8.4% of the entire U.S. GDP in that time period.

Here are the GDP data (real, not adjusted, in billions)
2000 - - - - - - 9,817.0
2001 - - - - - -10,128.0
2002 - - - - - -10,469.6
2003 - - - - - -10,960.8
2004 - - - - - -11,685.9
2005 - - - - - -12,433.9
2006 - - - - - -13,194.7
total: 78,689.9

source: Bureau of Economic Analysis

Is the Home ATM broken? Well, if home equity loans declined 82% even before the current credit meltdown, how much money do you reckon is being extracted this month? Some number closer to zero than to $100 million is probably a good guess.

Other readers checked in with some excellent comments and links on the weekend entry (The Big One Just Hit) which I highly recommend reading: Readers Journal commentaries 9/10/07.

Please go to to view charts and links.

Thank you, Wayne D., ($100) for your astonishing donation to this humble site. I am greatly honored by your support and readership. All contributors are listed below in acknowledgement of my gratitude.

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