I’ve been musing a lot lately on our financial situation, and everyone else’s, and I thought I’d write about it without a licence. No, no economics degree, no MBA, not even bookkeeping in secondary school. Whooee! I’m living dangerously.
I don’t think Rudd’s “fiscal stimulus” is going to do much to save us all from a recession. Why? Because although we’ve had the resources boom, I think a lot of our economic “growth” has been due to demand created by people spending more than they earn, and doing it for a long, long time. I think it’s unsustainable and will inevitably have to stop, and I’m no Robinson Crusoe there. We’ve heard a lot about people who have credit cards stacked on top of other credit cards and who end up declaring bankruptcy. I think that from now on we’ll hear a lot more about the other story, people pulling money out of their houses for consumption spending.
Like me, you might be watching the price collapses and home defaults in the US and thinking “is it going to be just as bad here?” Many well-informed people think it won’t. It’s scary, though, to see so many people lose their homes there.
Of course, the flip side is that houses might become more affordable. If, that is, people still have jobs and credit to buy them with.
In the last few months I’ve been following this blog, which tracks house sales in the Irvine district of Orange County (yes, that’s “the OC”), California. Unlike the stratospherically rich suburb in the TV series, this is a place roughly similar to - I’d say - Malvern or Brighton in Melbourne. So, much more upmarket than where I live. It may not sound like fascinating reading, but in California, it’s somehow possible to obtain and publish details of the house’s financial history as well as the number of granite counter tops. The lessons to be learned are salutary.
I like the Irvine Renter’s blog concept, in which he ties each post to a song with a Youtube link, although I don’t always agree with his song picks!
One of the central themes of the Irvine Housing blog is HELOC abuse. A HELOC is a Housing equity Line of Credit. Long story short, it is borrowing money against the equity in your house, supposedly for improvements to that house which then increase the value. But in the last few years homebuyers, thinking house prices would rise forever, have been taking out one HELOC after another to support their consumer spending - cars, holidays, boats, that sort of thing. Some people are even using it as income. IR calls it the “Home ATM”, because they’re treating their house like an ATM that gives out free money.
We do this too here in Australia, we just call it a home equity loan or refinancing, and there’s a scary looking thing called a Viridian Line of Credit, which seems very much like a HELOC to me. Sometimes, financial advisers encourage people to roll their credit card debt into their house loan, because of the lower rate of interest. It seems to me that that’s not an easy way out, because unless you cut up your card after that (or become the perfectly responsible pay-off-every-month customer, which probably wasn’t happening before) you’ll just keep on increasing your mortgage faster than you pay it.
As Irvine Renter points out, this was all fine when everyone thought house prices would never fall. But now that they are, some people end up owing more than the house is worth. “Negative equity”, they call it here. Irvine Renter calls it being “underwater”. He calls the desire to spend your house “the Kool-Aid”, because it seems so simple and tempting.
We were tempted to sip from the Kool-Aid in 2001, when the presence of a second child (one more than available bedrooms), plus wiring and plumbing that had reached its use-by date, coupled with a loan that was laughably titchy in today’s terms (55,000) made us decide to get the place in order. I don’t regret that, because if I do the maths I can tell we’re unlikely to end up underwater. And I really don’t want to live with wiring that’s going to kill us.
But we’ve survived that because we’ve paid it down since then. The people featured in the IR blog have been increasing their house debt year by year. Back when we borrowed to renovate, everyone was madly sanguine about what a massive price we’d get for the house if we ever sold, but we like living here. We didn’t renovate it to flip it - we did it to live in ourselves. Thank the FSM we didn’t get a taste for the Kool-aid and start using the home equity to pay for a big shiny SUV, holidays, furniture and consumer gadgets.
An important difference between Australia and the US is that over there the homebuyers can choose to walk away from the whole mess and the bad debt is taken over by the bank. The homebuyers’ credit rating is up the creek, but they don’t get chased for the balance of the loan. In Australia, we do.
It’s going to take more than the injection of a couple of thousand per selected household to kickstart an economy if that economy is dependent on people spending more than they earn. Once the homeowners have to stop using the home ATM, the music really will stop for some. That’s going to mean a lot of pain for people who make stuff and sell stuff and provide services. More thoughts on that later.