Memories are short, and 2008 is ancient history. Consumers can’t suppress their urge to consume. Lenders can’t suppress their urge to lend. We’ve learned nothing from the last boom-bust. We are repeating it, piling error upon error.
“People will spend more of their equity,” Chris Christopher, an economist at IHS Global Insight in Lexington, Mass., tells Bloomberg. “It won’t be as much as they spent when prices were gaining at a rapid pace in 2005 and 2006, but it should have a positive impact on consumer spending.”
As you may have detected in Mr. Christopher’s statement, bankers (speaking of short memories) are back in the business of making home equity lines of credit — HELOCs — and consumers are ready to ramp up the good life again.
“After six years of declines, lending for so-called HELOCs will rise 30%, to $79.6 billion, in 2012, the highest level since the start of the financial crisis in 2008, according to the economics research unit of Moody’s Corp. Originations next year will jump another 31%, to $104 billion, it projected.”
This borrowing will spur consumer spending, which, according to Bloomberg, is the largest party of the economy. The Mortgage Bankers Association’s crystal ball predicts home prices will gain 8% this year, and, in turn, Bloomberg reports, “The amount of equity homeowners had in the second quarter rose by $406 billion, to $7.3 trillion, the highest level since 2007.”
Of course, this increase in home prices is a temporary mirage, as empty homes and those occupied by strategic squatters are held off the market by legal kinks in the foreclosure hose. ZeroHedge estimates that an additional 2.5 million homes should be for sale. For now, millions are living in homes mortgage-free “just to perpetuate the illusion that ‘housing has rebounded,’” writes ZeroHedge.
The problem with this consumer debt is that while analysts cheer on the consumer purchases, the debt is what market analyst Robert Prechter calls unproductive. Three years ago, Prechter pointed out in his Elliott Wave Theorist newsletter that banks had been lending to consumers at the expense of businesses.
The nominal numbers are striking. At year-end 1999, according to FDIC figures, commercial and industrial (C&I) loans stood at $971 billion. On June 30 of this year, C&I loan totals stood at $1.4 trillion, an increase of only 44% over more than a dozen years. Again, these numbers are not adjusted for inflation.
Meanwhile, loans secured by real estate totaled $4 trillion on June 30, 2012, a 167% increase from $1.5 trillion on Dec. 31, 1999.
Only business loans are self-liquidating. Healthy businesses generate cash flow that can pay off debt, while consumer loans “have no basis for repayment except the borrower’s prospects for employment and, ultimately, collateral sales,” Prechter wrote.
Lines of credit to businesses are provided with the understanding that the business borrowers will “revolve the debt,” borrow to pay vendors and employees and then pay down the debt as their customers pay them for product. Thus, the debt is directly tied to the business firm’s production. The funds tend to be borrowed only for short periods of time. Credit, in this case, aids a business in potentially earning entrepreneurial profits, which build capital, which ultimately fuels economic expansion.
Conversely, consumer debts are not self-liquidating, but instead stay on the banks’ books for long periods of time, with payments being made only to service the interest and pay down very small portions of the loan principal balance.
Economists think HELOC loans will spur consumer spending and, in turn, GDP. After all, household purchases account for 70% of GDP, according to Bloomberg. However, phony GDP numbers are not a good gauge of the economy’s health. Besides, burying yourself in debt and consumer toys is not the way to individual prosperity.
Austrian economist Hans Sennholz has made a sharp distinction between “productive” and “unproductive” debt:
“A debt incurred for productive purposes, e.g., a commercial or industrial investment designed to earn future incomes, may cover its interest costs and even yield entrepreneurial profits.“In contrast, new debt in the form of a second mortgage on a home may finance the purchase of a vacation home, new furniture or another automobile, or even a luxury cruise around the world. The debtor may call it ‘productive,’ but it surely does not create capital, i.e., build shops or factories or manufacture tools and dies that enhance the productivity of human labor.”
“A debt incurred for productive purposes, e.g., a commercial or industrial investment designed to earn future incomes, may cover its interest costs and even yield entrepreneurial profits.
“In contrast, new debt in the form of a second mortgage on a home may finance the purchase of a vacation home, new furniture or another automobile, or even a luxury cruise around the world. The debtor may call it ‘productive,’ but it surely does not create capital, i.e., build shops or factories or manufacture tools and dies that enhance the productivity of human labor.”
Capital and wealth are created by saving, not by borrowing and spending.
At the same time, banks are still licking their wounds from the real estate crash. It’s hard to fathom that they would be piling into HELOCs again when they are not ever done writing down these type of loans made in ’06 and ’07. ZeroHedge points out:
“What is shocking is that this is all happening just as the last batch of HELOCs has hit record default rates, and have yet to be cleared off the banks’ nonperforming books. But who cares: Uncle Ben will fix it all.“That this will all end in another epic housing and credit bubble collapse is by now perfectly clear to everyone. And yet nobody is doing anything to stop it. Surely, once the system collapses for good next time, as at this point the central banks too are all in on rekindling the bubble and there will be nobody left holding the bag, ‘nobody will have been able to foresee any of this happening.’ But for now, the music plays, and one must dance.”
“What is shocking is that this is all happening just as the last batch of HELOCs has hit record default rates, and have yet to be cleared off the banks’ nonperforming books. But who cares: Uncle Ben will fix it all.
“That this will all end in another epic housing and credit bubble collapse is by now perfectly clear to everyone. And yet nobody is doing anything to stop it. Surely, once the system collapses for good next time, as at this point the central banks too are all in on rekindling the bubble and there will be nobody left holding the bag, ‘nobody will have been able to foresee any of this happening.’ But for now, the music plays, and one must dance.”
The housing market has not fully corrected, and now banks are looking to kick-start their loan books by lending on collateral that will again plunge in value when the foreclosure tsunami gets under way.
But while bankers must dance and their memories are short, one thing they always remember is that Washington is their friend and its checkbook is big. For HELOC customers, on the other hand, there will be no bailout, just more debt and despair.
Original article posted on Laissez-Faire Today
Douglas French is a Senior Editor for Agora Financial. He received his master's degree under the direction of Murray N. Rothbard at the University of Nevada, Las Vegas, after many years in the business of banking. He is the author of two books, Early Speculative Bubbles & Increases in the Money Supply, the first major empirical study of the relationship between early bubbles and the money supply, and Walk Away, a monograph assessing the philosophy and morality of strategic default. He is founder and editor of LibertyWatch magazine.
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