341 Meetings: Easy Cash

Byron King responds to and disagrees with a Wall Street Journal article describing home equity loans as “easy cash,” telling us what he’s learned while sitting in on and observing Federal Bankruptcy Court 341 Meetings.

A RECENT ARTICLE in The Wall Street Journal, “Home Equity Loans Hit Record Levels,” began by stating, “Taking advantage of rising property values, record numbers of homeowners are turning to home equity loans as a source of easy cash.”

The WSJ article discussed the massive, and growing, business of lenders convincing homeowners to borrow funds that are secured by the value of their real estate. The WSJ states that “home equity originations climbed 35% last year to a record $431.3 billion” and that “lenders are looking for new ways to boost this market.”

Four hundred thirty-one billion dollars? Of “easy cash”? That is more than the entire U.S. defense budget. That is more than two-thirds of the U.S. merchandise trade deficit for last year. And the lending industry wants to increase that very big number to an even bigger number?

Some of the techniques that lenders are offering to “boost this market” include the lender providing the borrower maid or lawn service for six months after signing up for a line of credit. One major lender calls this “creativity in the types of offers being made.” In a cautionary aside, the WSJ noted that “there are also fears that some homeowners may become overextended.”

But still, the WSJ called it “easy cash.” Having spent some time in the U.S. Bankruptcy Court in Pittsburgh, I beg to differ.

Every now and then, on behalf of a client, I attend what is called a “341 meeting” in the office of the U.S. Trustee of the bankruptcy court. These meetings are required by law (under Section 341 of the U.S. Bankruptcy Code, hence the name) after a debtor files for bankruptcy protection in federal court. At the 341 meeting, the debtor is subject to examination under oath by the U.S. Trustee.

Any creditor who cares to do so may appear and ask questions about the circumstances of the bankruptcy filing. Usually, but not always, the debtors and creditors are accompanied by their respective attorneys. These 341 meetings are open to the public. Due to court delays, I often have to wait awhile in the hearing room before my client’s case is called. It is just part of practicing law. So I sit back and listen to the discussions between the trustee and the debtors, creditors, and attorneys.

341 Meetings: Not Easy at All

“Easy cash?” I remember an elderly couple. They both worked all their adult lives and then retired. They said that they owned their home outright. Because the value of real estate in their neighborhood was rising, their tax assessment increased. With the rising tax assessment, their municipal, school, and county property taxes also increased. The couple needed funds to pay the increased taxes. They took out a home equity line of credit. They said they thought that they would “pay it back over time.” But the wife developed some medical problems. They paid the medical bills and fell behind on the payments to the lender. The lender sued in an action of mortgage foreclosure. Now these nice people are in bankruptcy court, trying to save their home.

“Easy cash?” There was a little old lady. Her husband had died a few years ago. Her house needed some repairs. She took out a home equity line of credit to fund the repairs. After awhile, her “introductory low interest rate” expired, and the lender increased the rate to what the lender’s attorney characterized as “the market level of interest.” (“What market?” I wondered.)

The borrower’s monthly payment went up to the point that she could not make the payments on a regular basis. The woman said she was late on two payments over a period of four months. Under the terms of the loan, the lender accelerated the loan to become due and payable immediately, “in its entirety,” as the loan contract stated. The borrower could not repay the funds. The bank sued. The little old lady filed for bankruptcy.

“Easy cash?” There was a middle-aged man whose father had given a house to him and his wife. The middle-aged man was “downsized” out of his job, which went to Mexico, if not China. Then his wife had her hours cut back at her place of work. With their joint incomes reduced, they decided to “tap into the equity” in their home to start a business. The business failed. But not surprisingly, the lender still wanted to be paid. This couple missed some payments. Then the county sheriff served them with the lender’s lawsuit papers. They filed for bankruptcy. Now they are explaining it all to the U.S. Trustee.

“Easy cash?” There was this tall, well-dressed, muscular woman. She did not have an attorney. She was representing herself. She sat upright and spoke very clearly and respectfully, answering “Yes, sir; no, sir” to the trustee’s questions. She had prepared her own bankruptcy petition. The trustee was impressed, and told her so. She had a small tattoo on her left arm, a globe and anchor emblem of the U.S. Marine Corps. The woman said that she had served in the Iraq war in 2003, returned to the United States, and was honorably discharged from the Marines. She took the savings she had accumulated during her time overseas (“There was no place to spend it in Iraq,” she said) and put the funds toward a down payment on a house for herself and her mother.

This newly minted veteran of the Iraq war filed for bankruptcy protection. She told the trustee that she is still in the Marine Corps Reserve and has applied to be mobilized to return to Iraq as a Marine because her pay in a war zone is tax free. She wants to use her Marine Corps pay to work things out with her lenders, the ones who provided her with that “easy cash.” The U.S. trustee looked at her, shook his head slowly and said “God bless you, Marine.” 

341 Meetings: Lax Standards

The WSJ article about the “easy cash” noted that “the sharp rise in home equity lending has brought heightened concern from bank regulators,” and warnings of “lax home equity [lending] standards.” According to the WSJ, the U.S. Office of the Comptroller of the Currency “plans to issue guidance for lenders on how to manage the risk in home equity lending.”

The Comptroller of the Currency “plans to issue guidelines”? Translation: A $431.3 billion secured lending business (equivalent to about 4% of U.S. gross domestic product) is rife with “lax…standards” and requires federal “guidance…on how to manage the risk” of what it does. The comptroller can plan away, but this is not to say that the home equity lending industry does not know exactly what it is doing.

The home equity lenders, in the aggregate, have their own guidelines and know exactly what they are doing. These are lending businesses. Their expansion plans require aggressive lending practices. Growth in their business is premised upon bringing the halter of secured indebtedness to as many people as they can possibly lasso into the corral. The lenders use the sweet bait of what the WSJ calls “easy cash.”

The business plan for expansion of the home equity credit industry also rests on an inherent appeal to the basic human flaw of greed.

They offer a person the tantalizing prospect of getting something for nothing, or at least something for very little. It all seems so painless, what with real estate values rising. More secured debt against a person’s home? Especially when the real estate values are rising all around? Well…what is another slice off of a cut loaf, anyhow? After all, it is “easy money.”

Thus, unsophisticated home equity borrowers are lured into the trap of secured debt by the marketing efforts of lenders that are themselves desperate to increase their loan portfolios. You recall the “military-industrial complex?” This is the lending-litigation complex. Same thing, really. Lawsuits for collection and foreclosure, and trips to bankruptcy court for 341 meetings, are just part of the cost of doing business. Let the Comptroller of the Currency issue guidelines for that.

The moral of this story is that, contrary to the characterization of the WSJ, there is no such thing as “easy cash.” There never has been such a thing as “easy cash” outside of ancient fantasies of smiling leprechauns and pots of gold at the end of the rainbow.

“Easy cash” from a home equity line of credit is just a disingenuous way for a lender to induce a borrower to incur a secured debt. It might work out well, if the borrower repays the loan. That is, if the borrower maintains cash flow from a job or other source of income and does not have an illness, injury or other setback.

341 Meetings: Nothing to Brag About

But what if something bad happens and the secured debt is not repaid? Or what if the borrower somehow breaches the repayment terms of the agreement with the lender? As night follows day, the lender will be filing a lawsuit for the house. All of the home equity lenders’ “creativity” in marketing, all of it in the whole world — including “free” gardening and maid service — will not change this basic fact of economic life.

According to the WSJ, home equity loans have hit “record levels.” Maybe so, but I would not brag about it. This is not a sign of good economic health in the land, because much of the borrowing is being used to fund consumption, or even worse, speculation. It is no coincidence that bankruptcy filings have been hitting unprecedented levels in recent years.

Look at it this way: If the ability of some people to borrow some funds is a good thing, having more people borrow more funds is not necessarily better.

The key question is how much home equity debt can any given household afford? In the aggregate, how much can an economy afford? Whatever that exact number or debt ratio might be, I am sure that the U.S. economy currently is carrying too much of it. Why do I say that? Because the casualty list is, as often as not, posted on the case docket sheet next to the door of the hearing room of the U.S. Trustee.

And until another time…
Byron W. King
January 31, 2005