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January 19, 2001

Equity Shrivels as Homeowners Borrow and Buy
By Louis Uchitelle, The New York Times

Deep Debt Threatens to Drown Homeowners and Sink the Economy ... Weiss comments

NEW YORK - For most American families, their home is their biggest investment, and after years of prosperity in which home prices rose substantially, family wealth has increased as well. But millions of households borrowed heavily against their homes, often to help support greater spending.

The borrowing has been so extensive, in fact, that homeowners, after building up equity through much of the 1960's and 1970's, have let their ownership shares deteriorate over the last two decades to the lowest level on record, the Federal Reserve reports. The borrowing even accelerated in the 1990's, helping to explain how Americans managed to easily outspend their incomes through two long economic expansions.

Now a slowing economy catches the average household owning less of a stake in its home than in any economic slowdown since the advent of the modern mortgage in the 1930's. If a recession develops and people start worrying that they have too little equity left to continue borrowing safely against their homes, the blow to spending could turn a mild recession into a prolonged one. That would certainly happen, economists say, if a downturn causes home prices to fall, shrinking even more the equity stake that households still have in their homes.

"When you make borrowing dependent on your home, then you erode the fire wall that protects your standard of living and we are going into this slowdown with the fire wall clearly eroded," said Nicolas Retsinas, director of the Joint Center on Housing Studies at Harvard. "The home is not just a financial transaction, it defines who you are and what kind of community you live in. When all of a sudden you get into trouble, you can't just rip it up like a credit card."

The big concern among economists is not a relatively short recession, but a longer one, lasting a year or so. "In a brief recession, the extra borrowing and spending would even soften the downturn," Mark Zandi, chief economist at in West Chester, Pa., said. Indeed, a new surge in mortgage refinancing as interest rates fall - the fourth surge since 1993 - is likely to give a lift to spending as some people go further into debt, pocketing the extra mortgage money without increasing their monthly payments.

"But in a longer recession," Mr. Zandi said, "housing prices would weaken and many homeowners could easily find themselves owing more on their homes than the homes were worth."

If that happened, the abrupt pullback in spending as these families tried to work down their debts and preserve their homes would exacerbate a recession. Many Japanese behaved in just this way after the collapse in real estate prices in that country a decade ago.

Or, with monthly mortgage and home equity payments in the United States at a record level as a percentage of disposable income, trouble on the job - layoffs, for example, or cutbacks in overtime pay - could quickly restrict spending, also deepening a recession.

Throughout the last bull market, Americans were caught up in a borrowing and spending frenzy. Homeowners amassed $4.9 trillion in outstanding mortgage debt as of the third quarter of 2000, according to the Federal Reserve. That's nearly double the level it was in 1991. In that same time, consumer credit debt piled up to $1.5 trillion, and the savings rate crashed to a negative 0.8% -- the worst on record.

But now, the party's over...the bull market has ended, but consumers are still wallowing in debt. They can no longer count on stock market gains as a "sure thing" to improve their incomes and offset spending. Plus, increasing lay-offs and cutbacks in overtime will choke off spending power. Consumers will be forced to cut way back -- even halt spending altogether -- to pay enormous mortgages and credit card bills from the past decade.

The slowdown that we've experienced in the last few months is just the beginning. As the bills become harder and harder to pay, the economy could very well sink into a deep recession.

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