What the Fed can't do

As expected, the Federal Reserve lowered interest rates again today, which in a normal recession-fighting cycle is a simple story: "The Federal Reserve today lowered interest rates, hoping to spur new borrowing by businesses and consumers."

That's not the story this time around. While the Fed is cutting rates, banks in many cases are making it harder to borrow. They have no choice — they've made so many bad loans that they can't afford any more boneheaded moves. The Fed isn't trying to help consumers; it's trying to save the banks.

Lou Barnes, my favorite Fed-watcher: "... the financial system is still too busted to function properly, credit is extremely scarce and expensive, the system is terribly vulnerable to recession-cycle credit loss ahead. ... How can loans be scarce with the Fed hosing loans into banks? Because system capital is impaired. There isn’t enough capital to support current loans outstanding, let alone new ones."

Cutting rates may be the Fed's best option, but that doesn't mean it's working. There is a cost, too, to the rate-cutting: a weaker dollar, rising import prices (oil and gas), the threat of more inflation, the kick in the pants to savers.

If you don't think credit is getting tighter, ask someone with a home equity line of credit. I continue to hear from homeowners who have had their HELOCs frozen or reduced.

This today from a recent L.A. home buyer whose credit line was frozen two days ago: "We bought our house last February right in downtown Culver City, got a good price and went for one of the fixer-uppers on the street (due to the state of the house aesthetically we were able to get a good house on the low end of the spectrum of prices for houses in our neighborhood). We put 20% down too which you would think would have prevented any of this from happening in the first place. We were planning on having that HELOC liquid there in case we needed it with the renovation we are planning for our kitchen this year...which will of course only ADD equity to the house. According to their 'reduced' value of the house we still actually have over $80,000 in equity (calculated by taking their low-ball estimate and subtracting from that the outstanding principal on the mortgage). ... I tried talking to the bank over several conversations over the phone and basically they do not look at, nor care to hear about, the actual equity on the house."

Your thoughts? Comments? E-mail story tips to peter.viles@latimes.com.

Comments

[tbgpalisades]

The Culver city anecdote is especially telling, 'with the renovation we are planning for our kitchen this year...which will of course only ADD equity to the house'

The point being - a kitchen remodel *might* return $.65 - $.80 for every $1.00 spent. It will only 'add equity' if the owner pays in cash, not debt. The banks are wise to this, too many present-day owners are not.

[IToldu2CashOut]

Thats because the economist at the bank are projecting that in a few years that equity won't be there anymore and this person will be underwater. They are right to be worried as many of these people will walk away. Houses are not ATM machines, the bank owns a lot more of it than this person does and they are finally using their heads. Think about it would you loan money to one of your friends if you already knew they had so much debt that they couldn't pay it off for 30 years if ever? This womans thinking is exactly why the whole system is a shakey three legged chair right now. Here is a radical idea, save your money to pay for the purchases you would like to make instead of asking other people to pay for it and writing I.O.U.'s.

[Cal]

Pushing on a string. People (and Banks) have so much debt it is difficult to get them to take on more debt (which is what the Fed is trying to do).

As for the HELOC issue.. the banks are taking an absolute bath on HELOCs. They are in secondary position and many were given at insanely high LTVs (anything over 80% is extremely risky, normal lending standards it is 70-75% max). They are in a junior position so they get wiped out during foreclosure because the houses are worth less than what is got in sale. And the banks paradigm for HELOCs was such that many were given out as stated income because the Banks figured they were less risky because the homeowner had a track record of payments.

So the banks really don't know what they have as far as borrowers and the collateral value which is their cushion is falling extremely fast.

[E]

Pete...please.

No more sob emails from people who can't remodel their kitchen with borrowed money. What was in there when they purchased the house? A cooler and a camp stove?

My father was born in 1928. He always told me a saying that they had while growing up during the depression.

"Use it up, wear it out. Make it do, or do without."

[arroyogrande]

This is a little bewildering...

"the renovation we are planning for our kitchen this year...which will of course only ADD equity to the house."

The problem (for the lender) of letting you use a loan to "add equity" is that in normal times, remodeling only immediately gives you something like 50 to 80 cents return on the dollar spent. It wasn't until recently, when prices were going up by crazy amounts *anyways*, did people expect to immediately and completely recoup the cost of remodeling through increased home valuation.

Look at it this way. Suppose you were deciding to sell your house with a kitchen that needed a remodel. Should you spend $50,000 on a remodel, or just price the house for $50,000 less and let the new owner remodel? Well, from the buyer's perspective, paying an extra $50,000 means that they don't have to make any decisions, and don't have to live through the dust of a remodel. However, it also means that for $50,000, they are stuck with *your* choices in counter tops, appliances, kitchen flow, lighting, etc., where, had the house not been remodeled, and had been offered for $50,000 less, they could have chosen their own counter tops, appliances, lighting, etc.

The point is that a $50,000 remodel isn't always worth $50,000 to the buyer, especially if they need to tear it out for what they really want.

"According to their 'reduced' value of the house we still actually have over $80,000 in equity"

Look at it from the lender's perspective...is it a prudent move for them to give you additional loans such that your loans equal your (current) house value? Why would they do that, in this era of price declines in California? If you were lending out your own money, wouldn't you want, nay, REQUIRE that there be a 10%, 20%, 30% equity cushion to protect your loaned-out money should prices fall further? If you have 20% equity in the house (due to your 20% down payment), wouldn't you expect the bank to maintain that cushion, so that if things go bad and they have to foreclose, they will at least get back the amount you owe them, even if prices fall another 10%-15%?

It might help to remember that the recent practice of lenders lending out 100% (or more!) of the value of the house is one of the dubious practices that got us in this mess in the first place. I would assume that most of us would applaud lender for finally using the same prudent lending practices that they used just 5 years ago.

It's interesting that people think that crazy things like lending out 100% of the value of a home is somehow normal. That is how far out of whack people's perceptions and expectations have become due to this housing bubble.

- arroyogrande

[dutchtrader]

Thats because YOU DON'T HAVE ANY EQUITY IN THE HOUSE!

[Wilson]

Culver City buyer, you have to be kidding right?

Your 20 percent down payment means nothing...at a bear minimum, you are still 30 percent underwater...you just don't know it yet and the comps don't yet show this.

Man, watching your equity crumble over the next three years is going to be painful...I almost want to film your plight.

I wish you the best, but like all LA buyers in 2005 and 2006, it's going to be tough to never see your home value recover...

[bondinvestor]

these types of "sob" stories in the press are getting out of hand. here are a few thoughts

1. renovations do not "add" equity to a house in a down market. it's not even clear to me they add equity in a flat market. this is one of the biggest myths that has been created by the bubble, and it's amazing that here, in 2008, people are still promulgating this BS.

2. just because you have $80,000 of equity in the house today, it doesn't mean you'll have $80,000 tomorrow. the banks are looking at where the puck is going, so to speak. the big lenders expect another 20% downside on the westside of LA in the next 18 months. the futures market thinks that could be too optimistic. so while you *think* you have all this equity in the house, the reality is that in two years time it very well could be the case that the only equity you have left is that which you've amortized via the principal repayments.

3. you do not have an inalienable "right" to a home equity line of credit. you signed a contract, and included in that contract were terms which gave the bank the explicit right to revoke or change the terms of credit with a written notice. had you read the contract fully, perhaps you would have appreciated that point and been in a position to anticipate what might happen in the event that home prices dropped 25-30% - which, by the way, many people were saying could happen at the peak of the bubble.

4. did you ever think that perhaps the kitchen remodel can wait 5 years? if you don't have the financial resources to finance the remodeling with equity, perhaps the market is trying to tell you something. namely, that you should do what your grandparents did and save before you consume.

[Fourth Generation]

I always thought that equity was build by paying into the principal. Silly me you only have to get a bank to finance 100% and voila instant equity by next week.

[Laker]

IToldu2CashOut, ARE YOU CRAZY???
I think Peter should ban you from adding comments here....
You are saying that people should save money to pay for their projects and not use other's money or writing I.O.U.'s.
That is nuts, wild, and against the US constitution where it says our homes are ATM machines.
LOL.......

The FED lowered the rate another 0.25%. Look what the CEB is doing in Europe, they fight inflation. This is something we need to do, and we better do it early.
You see, if the fed had kept rates at 5.25%, there would be no inflation but some banks failure, thus tax money would have been used to save them directly. But people would still able to buy food and gas. Now the fed has created this inflation directly because of his rate cutting below 0% real rate, so now people are strapped with no money since they need to pay much more for everything, yes everything including food and gas but not only food and gas. This way, the banks are saved, and we the tax payers still pay for it, albeit indirectly...so it is easier to hide that fact...
The problem is this with this scheme, the lower and middle class are killed because they consume a lot more than the rich in proportion to their income...
Want it or not, FED will raise rates but this time, go higher than 5.25% to as high as 8-9% because inflation would be double digit.

And lastly, to the happy buyer in culver city that think they have $80,000 equity...you don't. The banks now are actually following the cold facts, and know that values are dropping to the norm. That is you are indeed 30-40% underwater. Your 20% down payment is history to tell to your kids. In two years, your house will be worth 20-30% less than what you owe today.
Deal with it, or walk a way once you can buy same house next street for 30% less.

[JohnnyB]

The Fed keeps filling the trough for these glutinous, greedy hogs at our expense.

What the Fed HAS done is be the key stone in the arch of this bubble. They were a supporting force in it's rise and are a supporting force in it's decline.

Their mortgage debt promotion effectively ruined the RE market for millions of people, triggered a global financial system seizure (like an epileptic insulin OD), effected a new worldwide commodity bubble and sent the dollar on a Quadrophenia-esque schizophrenic suicide dive off the cliff – singing “why should I care…”.

From a middle class perspective, their assumptions were wrong, their strategies were flawed, their implementations were corrupted and their executions were lethal. Like a big, self aware parasite.

From a big-bank, big-business, mega wealthy, top 2% perspective, they were a finely tuned, over-leveraging, derivative-promoting, profit and wealth re-distribution machine and a godsend.

Seems short sighted and self defeating that they cannot craft some middle class America friendly policies and structures. I mean… what the f*ck.

[puckhead]

"And lastly, to the happy buyer in culver city that think they have $80,000 equity...you don't. The banks now are actually following the cold facts, and know that values are dropping to the norm. That is you are indeed 30-40% underwater. Your 20% down payment is history to tell to your kids. In two years, your house will be worth 20-30% less than what you owe today.
Deal with it, or walk a way once you can buy same house next street for 30% less"

Laker,

Dude, you really must be the life of the party. LOL's.

[sheila]

nothing like pairing an anecdote with a real story to bury the lede. the point of this post is that all you "responsible renters" are watching your down payments circle the drain while your 401(k) shrinks, the dollar devalues, inflation creeps up, jobs and govt. services are cut, and prices skyrocket for everything from bread to healthcare, thanks to lousy govt. policies.

save your outrage which you are misdirecting at the culver city buyer and target your stupid government, which has grotesquely mismanaged your money, and continues to service only Big Banks, Big Energy, Big Pharma, Big Arms and Big Insurance while screwing us silly!

didn't anyone read the money quote?

The Fed isn't trying to help consumers; it's trying to save the banks.

If we don't know by now that "trickle down economics" is the biggest ponzi scheme ever, then i guess we deserve the government we have, but i like to pretend we still have a say. shouldn't we be objecting to devaluing OUR spending power to bail out people who earned hundreds of millions of dollars perpetrating these frauds on us? this is way worse than the foreclosure bailout...

[E]

Ummmmm Sheila...

the story wasn't about big pharma, big arms, big energy or any of that stuff.

It was about a "loan owner" that was miffed because he/she couldn't have the kitchen of their dreams on borrowed money.

We're not "outraged"

We're laughing at the person and their whiny sense of entitlement.

[William Jones]

I am in the commercial side of real estate, and I deal with the "cost basis fallacy" all the time. Property owners assume that if they pay $X for a property, and do $Y in repairs and upgrades, then their property has to be worth $X + $Y, or close to it.

In income producing properties, its the income that counts. If after all your work your income has gone up in proportion to your costs, then your property really is worth more...but if it hasn't, then the value has not gone up.

[E]

On second thought...you are right Sheila.

The Whiny Culver City homedebtors should show their outrage by writing letters to the government about Pharma, Banks, Energy and Insurance, rather than writing to Pete about the kitchen that they can't have.

[the problemwithcaring]

shouldn't we be objecting to devaluing OUR spending power to bail out people who earned hundreds of millions of dollars perpetrating these frauds on us?
Posted by: sheila

Pwned this entire blog, she! No one here EVER talks about that...

[Arti]

To the Culver City owner:

Wait a minute, you bought this thing in Feb 2007 at the absolute peak of the biggest housing bubble in US history, yet you think the bank's appraisal was "lowball" and that you have $80,000 "equity" in the house? They're not giving you a HELOC because they don't think you *have* any equity in the house because you could never sell at anywhere near what you bought for. Worse, the bubble has only begun deflating in these areas and the banks know that there is a lot worse coming. You simply cannot expect them to take such a risky bet that you're not wiped out already, when you can simply hand in your keys once you figure out the downpayment's gone and they are left with huge losses. Thank god this bank has some sense, this is the kind of risky loans the banks made that got us into this mess in the first place...

[HELOC Basics]

Putting money down doesn't mean that the value of the home won't decrease. One of the risks of taking out a HELOC is that lenders have the power to reduce or cancel the line. Unfortunately, many borrowers have no idea that this is possible.

[sheila]

Reading comprehension issue here. i see the "point" of the post as being "what the Fed can't do," as in, can't help individuals, can't actually increase the availability of credit, or save us from these institutions that are completely ripping us off, but what they CAN do is devalue our dollar to enrich banks, which were already unfairly enriched in the "boom."

The Culver City anecdote was a sort of quasi-related story about how all the rate-cutting in the world won't make credit more available to consumers, even though it has greatly increased the profit margin on credit (for the banks). Just an illustration, not actually the POINT, but everyone got so pissed off at the person for remodeling their kitchen, that they ignored the first 2/3 of the article, which was the real story.

So, the whole point of this article was that the Fed is FURTHER RIPPING US OFF because they aren't helping us with the rate cuts, but ARE helping banks, all while grossly devaluing our dollar, which makes us all poorer.

My point was that this is systemic in our government, but they rely on people attacking each other so we don't look upwards and see the real cause of our distress - the reverse Robin Hood philosophy of our government. The ridiculous attacks on this CC homeowner prove that we would rather attack a homeowner than scream with rage at a government which is literally printing money and handing it to banks TO KEEP, which is impoverishing us all.