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Sunday, May 23, 2010

The Homeowner’s Dilemma: To Amputate or To Suck-it-Up and Take One for the Team

It can be challenging to find comfort, peace, and tranquility, as a homeowner, when the big bad financial wolf is outside huffing and puffing on our doorsteps. This situation is even more disconcerting when the behemoth house next door (that looks just like ours) is renting for several hundred dollars a month less than our own monthly mortgage payment and we are struggling to put food on our tables.

Some may ask, “If a home is just a home (a roof over our heads), what does it matter if one is underwater $30,000 to $300,000 or more on their mortgage?” It doesn’t matter to those who don’t need employment income and to those with the financial wherewithal to remain in their homes until they die. It does, on the other hand, most certainly matter to those who are currently experiencing unemployment or underemployment, death of a spouse, divorce, or those dealing with serious illness. There are those life events that arise from time to time that can change our perspective on what is truly important. In such situations homeownership can quickly assume a lesser importance as we pick up the broken pieces and begin the process of restructuring and reordering our lives.

In many sectors of the economy, jobs are vanishing fast and in order to remain employed many are faced with the choice of a long and expensive commute or relocation to a distant city. An underwater homeowner, in a declining real estate market, will be faced with the equally disturbing choice of either selling their home, at a serious loss, or renting their home out for much less than their current mortgage payments in the event they decide to accept employment outside their commuting area. Some of these same people who previously postulated on whether a home is just a home (a roof over their heads) and whether it really matters if one is underwater $30,000 to $300,000 or more on their mortgage may have defended the original purchase of their own homes by declaring, “We don’t want to rent and just throw our money away.” If a home is truly a roof over our heads, what is wrong with renting? If we pay money for the roof over our heads or pay money for the food we put in our stomachs, how is that throwing money away? Did we not receive value-4-value? Obviously, to some, throwing money away is not now the exclusive domain of those who choose to rent but also the domain of those who became homeowners in the last 10 years or so. The cost of homeownership has recently come with a very high premium attached to it especially in those hard hit areas of California, Arizona, Nevada, Michigan, and Florida where there have been drops in home value of 50 percent or more. In Detroit, Michigan, the average sales price of a home in 2009 was $7,000.

Homeownership has, traditionally, offered many who’ve been disinclined to save money, the perceived opportunity to save in a more disciplined fashion. The illusion of "forced" savings, however, has quickly vanished in our declining real estate market. Many have found that the “home” piggy bank that they thought was made of more sturdy material is, in reality, fashioned with materials resembling straw. The big bad financial wolf has been huffing and puffing on these straw houses and we've experienced severe asset deflation (collapsing home values) as a result. Exacerbating this situation is the fact that these “home” piggy banks have had their very foundations structurally compromised, by the owners themselves, with Home Equity Lines of Credit (HELOC). These homeowners mistakenly thought that their home’s value would increase in perpetuity and serve as unlimited funding for present and future consumption. Their homes miraculously became ATMs. They either forgot or were totally oblivious to the market axiom that says, "If something seems too good to be true, it probably is."

What must be clearly understood, in our current economic environment, is that our current asset deflation phenomenon is global in nature. It is not just the U.S. market that is impacting home values but also the larger global markets of the Western world. How so? The bubble in the U.S. housing market was facilitated not only by the promotion of easy money policies consisting of artificially low interest rates, liar’s loans, no money down, and cash back upon closing schemes, but also by those financial weapons of mass destruction called derivatives. Derivatives, at their inception, were marketed simply as hedges, or insurance, against a larger market position much in the same fashion a homeowner used home insurance as a hedge to protect their homes against fire loss. That sounds innocent enough, doesn’t it? It was innocent until the misuse of leverage was thrown into the mix. The inherent danger of artificially low interest rates is that it attracts all sorts of creative individuals who are not held in abeyance to natural market forces until the misallocation of resources becomes magnified to the point of inviting global disaster. Artificially low interest rates, derivatives, and the fact the U.S. dollar has been the reserve currency of the world has globalized a disaster that would have otherwise been contained locally. It may take decades for the hundreds of trillions of dollars of derivative borne toxic assets to be safely absorbed into the financial bloodstream of the global economy.

Many of the financial mavericks who predicted the original downturn in real estate are now looking for one more hard down before there is a final capitulation in which many more homeowners, previously in denial, will be looking to head for the exits, in mass, via selling or by exercising their contract option of simply walking away and leaving the lender(s) to buck up and take their medicine for making under-collateralized loans.

The overhang in the U.S. housing market could also last for decades and those latecomers to the real estate boom party, attempting to wait it out, are likely to pay a tremendous price for doing so as there cannot be a meaningful recovery in housing without a meaningful recovery in jobs and livable wages. Many homeowners are in serious denial of this fact and, sadly, most will be too paralyzed to take the necessary action to save their financial lives. The choice of financial amputation is always a difficult and painful choice much like the decision to amputate a seriously infected limb is a disturbing but sometimes necessary choice. More importantly, the choice to amputate is an individual choice. We each have to decide what is in our own best interest and shouldn’t begrudge others for doing the same.

The quicker one decides to sever their losses, the quicker they will rebound. Such a move takes courage because it transcends the conventional wisdom of the day. Conventional wisdom is what got us into this mess and history suggests that conventional wisdom will have little or nothing to do with the remedy that gets us out of it. Conventional wisdom said we could spend ourselves into prosperity by purchasing things we didn’t really need with money we really didn’t have. Conventional wisdom now says that walking away from our homes hurts everyone else and that underwater homeowners should just suck it up and take one for the team. Do you believe this conventional wisdom or do you see through it as a desperate and fearful attempt by others to preserve their own self interest and greedy ambitions...at your expense?


Len Penzo said...

Steven and Debra,

I think you are overlooking one important point.

The Fed and US government are intentionally working very hard to unleash something down the road that will save everyone who is currently upside down on their mortgages (much to the chagrin of fiscally responsible folks like you and me) - massive inflation.

You and I both know that a sustained period of high inflation will greatly reduce the value of everyone's debt. If it happens, underwater homeowners will be able to pay off their mortgage very easily - assuming they can stay employed during the inflation cycle, of course.

I could be wrong, but I think the Fed knows the only way out of the crazy debt trap we are getting into is via a massive devaluation of the dollar courtesy courtesy of high inflation.

The only question, in my opinion, is when it will happen. My $0.02.


Len Penzo dot Com

~ said...

You make an interesting point in regards to a hyperinflationary scenario and one which we've certainly considered.

We've already seen some price inflation, in certain sectors (housing excluded), but expect much more in the coming years with the massive printing or digitizing of money that has already taken place. And, there will no doubt be much more as the crisis in Europe spreads to the UK and US.

Real estate, however, is currently experiencing asset deflation. No matter how much hyperinflation we may see on the horizon, we expect the babyboomer overhang in primary housing and vacation homes to remain with us for quite some time and will probably serve to keep the market extremely soft.

Additionally, and you touched on it in your response, is the built in assumption those staying the course (not walking away) will continue to have jobs. It is our view that there can't be a recovery in housing without there first being a recovery in the employment sector. Therefore, we see the real estate market bucking a very strong headwind even after taking into consideration hyperinflation.

Thanks for your comment.

Steven and Debra

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