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Withdrawal Symptoms

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http://www.economist.com/businessfinance/d...e=hptextfeature

HOW big an influence on spending is housing wealth? Hopes for a consumer revival in countries where house prices have slumped rest, in part, on the answer. A purist view is that the value of homes has no “wealth effect†on consumption. An increase in house prices only raises the future cost of shelter. Those about to trade down or sell out receive a windfall, but first-time buyers and those hoping to buy a bigger home are worse off. The overall effect on wealth is a wash. But even if that is correct, house-price increases may still have an impact as they create housing collateral for consumers who could not otherwise borrow. A study* by Atif Mian and Amir Sufi of the University of Chicago’s Booth School of Business pins down the size of this effect, using the credit records of almost 70,000 American borrowers.

It could be that an unseen influence, such as greater optimism about future earnings, pushed up both house prices and debt. So the authors use their granular data to first establish a link between the two, which is apparent in the aggregate figures up to 2006 (see chart). They found that house prices and household debt increased most where the supply of new housing was limited—in places that are hemmed in by hills, rivers or the ocean. But in cities where housing supply is very “elasticâ€â€”where homes can easily be built to meet demand and prices did not rise—debt barely rose either. This suggests that house-price rises led to more borrowing.

How much of this was simply down to new buyers needing bigger home loans? By limiting their sample to those who were already homeowners in 1997, before the boom in housing and credit, the authors were able to measure how much of the rise in debt was the result of cashing in on higher home values. They reckon almost 60% of increased debt between 2002 and 2006 came from this source. Put another way, every $1 increase in home values led to a rise of 25-30 cents in borrowing. That is far bigger than some long-standing estimates of the wealth effect from rising asset values, which are in the 3-5 cent range (though these include the response of renters, too).

Money released from housing equity was not funnelled into other forms of saving. Homeowners in cities where house prices rose quickly were less, rather than more, likely to invest in other properties. Funds raised against rising home equity were not used to pay down other debts. And fewer households invested in financial assets, such as shares and bonds, when house prices were rising. All this suggests that almost all of the $1.45 trillion the authors estimate was borrowed against rising home equity was used for spending.

Digging deeper into their data, the two Chicago economists discovered that the pattern of home-equity withdrawal was far from uniform. The young were keener to cash out than the old. That is at odds with the life-cycle theory of consumption, which says that the young amass wealth so that they can spend it in old age. Borrowing by the top quartile of homeowners ranked by their creditworthiness scarcely rose in response to rising house prices. That is evidence against a pure wealth effect, says Mr Sufi. The most eager borrowers were those with the lowest credit ratings and whose credit-card borrowing was closest to the agreed limit. That sits well with a model of willing but frustrated consumers given access to credit through the rising value of their homes.

It also fits a more worrying interpretation: that many of the keenest borrowers were myopic or had problems with self-control. More than a third of new defaults in 2006-08 were because of home-equity-based borrowing. Default rates for low credit-quality homeowners rose by more than 12 percentage points in places where housing was scarcest and prices had risen most. In “elastic†cities, by contrast, the increase was less than four percentage points. This suggests huge over-borrowing. Prospects for a sustained recovery look dim if households that are most inclined to spend are mired in negative equity.

Brilliant so the banks lent huge sums to people who had no self control, crap credit histories and where already at the edge financially.

Genius.

I wish I could be paid millions to do risk profiling, unfortunately I couldn't do the equations to make it work so that rules me out.

At least for a time the profits and bonuses where good!!!

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This is why we're going to have a "Ski Jump" shaped "recovery", as someone posted earlier.

If you zoom the graph out a bit it'll resemble a camel's hump on a slight incline.

Normality, followed by massive, baseless boom, followed by bust, followed by normality.

If all goes well that is.

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This is why we're going to have a "Ski Jump" shaped "recovery", as someone posted earlier.

If you zoom the graph out a bit it'll resemble a camel's hump on a slight incline.

Normality, followed by massive, baseless boom, followed by bust, followed by normality.

If all goes well that is.

Doesn't that depend on getting the banks lending again to the masses?

I doubt they can engineer a boom without people borrowing again.

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As that borrowing for spending stops.. so does all the consumption. Hence the massive job loss, reduction of hours, reduction of wages going on now. This job loss could go on for years to get down to the level of actual wages and dividends.. not to mention the cascading effects of job loss and wage loss.

Its why I've been saying the only way to make up for it is collosal state borrowing and spending.

Its why the job loss seems never ending already.

Edited by aa3

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Why the housing market has seized solid. Those holding out for a windfall. The reality is, they have already spent the windfall.

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Why the housing market has seized solid. Those holding out for a windfall. The reality is, they have already spent the windfall.

QE = replaces home equity growth, we have to keep growing, spending, and borrowing and creating money from nothing or the whole financial system could collapse on itself. ;)

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QE = replaces home equity growth, we have to keep growing, spending, and borrowing and creating money from nothing or the whole financial system could collapse on itself. ;)

Perpetual growth is as impossible as perpetual motion, yet the idiots in charge have adopted perpetual growth as the truth.

The power of groupthink.

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Perpetual growth is as impossible as perpetual motion, yet the idiots in charge have adopted perpetual growth as the truth.

The power of groupthink.

Its not just the "idiots." Its all of us really. Our capacity to consume and spend has outstripped our technological and productive abilities for decades. It was masked by easy credit, and HPI. Now the mask has dropped. Its like waking up for work after a big night out.

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I wish I could be paid millions to do risk profiling...

...same wish as everyone who actually works in credit risk. The funny thing is that during the good times many banks couldn´t even see why they still needed a risk department (apart from the remaining regulatory requirement) and starved them of funds.

Oops. :blink:

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Its not just the "idiots." Its all of us really. Our capacity to consume and spend has outstripped our technological and productive abilities for decades. It was masked by easy credit, and HPI. Now the mask has dropped. Its like waking up for work after a big night out.

And finding the stunner you pulled last night was well:

IMG_9797.JPG

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