Sunday, 3 August 2008

Still cashing out.....

What would the US economy do without debt. The borrowing bug took off as the US housing market exploded. Home equity loans sustained lifestyles that would have been unattainable if people relied only on their regular incomes.

Mortgage refinancing was another popular source of easy cash. Freddie Mac provides some data that offers an interesting insight into the extent to which refinancing fueled US consumption.

Freddie Mac only buys conformming mortgages - high quality loans under a certain threshold. In theory at least, Freddie Mac doesn't touch anything dodgy like subprime. The chart above indicates what proportion of refinanced loans were used to extract cash. For example, suppose someone has a mortgage for $100,000; the home value increases to $200,000 and the homedebter takes out a refinanced loan for $200,000, pays off the old loan, and has $100,000 in cash.

The data from Freddie mac suggests that back in 2005-6 prime mortgage holders were refinancing and extracting between 25-30 percent of their new loans as cash. That is an extraordinary amount of equity withdrawal, which doubtlessly went on new cars, boats and holidays.

What is even more extraordinary is that people are still at it. The latest data suggests that people are pulling out around 17 percent of their refinanced mortgages as cash. This number is much higher than the historical cash out rate, which tended to fluctuate between 5-10 percent.

Cashing out has become an addiction for the aspirational US consumer. They simply can't stop. Is it any wonder that the US savings rate is basically zero.


Man in a Shed said...

I must get my hands on the IOUSA film sometime !

Anonymous said...

Thanks for this one Alice - it's fascinating.

Maybe another factor here is the high cost of "College Education" for the aspirational US middle class. Anecdotally, I know US friends who have had to swallow hard at the total cost of getting several kids through College and into the workplace - sums like $100,000 for two or three kids are not uncommon, even with some assistance from government loans and College endowments.

I expect "home equity withdrawal" is the most cost-efficient way of takling on debt on that scale, which some people will feel is unavoidable, all for the best in the end, and can be paid back hopefully with ease in the years before retirement when the kids are no longer at home.

When the economy threatens to go down, making entry to the workplace at a high level more competitive, I would expect that kind of borrowing to go up. This kind of borrowing will only feed into luxury consumerism later on and in part, as the money is recycled into the non-educational economy.

B. in C.

Anonymous said...


How much of the spike is total loans down rather than MEW up?