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Credit Card Debt Soars as House Prices Plunge
By Dean Baker
The Center for Economic and Policy Research
Wednesday 09 January 2008
"The current rate of house price decline will destroy $2.2 trillion of wealth
this year."
The Federal Reserve Board reported yesterday that credit card debt rose at
an 11.3 percent annual rate in November after rising at an 8.5 percent rate
in October. By comparison, credit card debt rose at a rate between 2 percent
and 4 percent from 2003 to 2005.
The explanation for this surge in credit card debt is that millions of homeowners
are losing the ability to borrow against their home. In the last Flow of Funds
release, the Fed reported that the ratio of homeowners' equity to value stood
at just 50.4 percent, down from 54.2 percent at the end of 2005, and 57.3 percent
at the end of 2001. The ratio will almost certainly cross below 50 percent for
the first time in history when the fourth quarter data is reported. This is
a remarkably rapid decline, especially since the soaring home prices of recent
years translated dollar for dollar into additional equity.
This aggregate number conceals vast differences among homeowners. More than
one-third of homeowners have completely paid off their mortgages and many others
are close to having them paid off. This means that a large number of homeowners
have little or no equity in their home. These people are now running up credit
card debt at near record rates. Of course, credit card debt cannot offset the
ability to borrow against home equity for long. Total outstanding credit debt
is less than $940 billion; mortgage debt was increasing at a $730 billion annual
rate in the third quarter. Millions of households will soon have little choice
but to sharply curtail their consumption.
The latest Case-Shiller indexes, which received little attention because they
were released on December 26th, showed that house prices in the aggregate index
were dropping at an annual rate of 11.7 percent in the three months from July
to October. At this pace, households will lose more than $2.2 trillion in housing
wealth over the next year. Some of the really big losers in the latest data
were Las Vegas, where house prices were falling at an 18.9 percent annual rate
over the last three months, San Diego, where they declined at a 20.3 percent
rate, and Miami where they dropped at a 22.0 percent rate.
Many homeowners in these formerly hot markets put little or nothing down when
they purchased homes in the last two or three years. As a result, a large percentage
of recent homebuyers will soon find themselves with negative equity. This is
the reason that the foreclosure crisis is spreading from the subprime segment
of the mortgage market to the Alt-A and prime segment. Homeowners who find themselves
owing more than the value of their home have enormous incentive to default.
The pending home sales data for November are somewhat better than most analysts
had expected. While they are down slightly from the October levels, the latter
were revised up to show a gain of 3.7 percent from September instead of 0.6
percent. The improvement from the August-September trough is concentrated in
the West, where sales have risen by almost 8 percent from the lows hit in the
summer. This probably is due more to the extraordinary weakness of the summer
sales levels (down almost 40 percent from 2005) than to any real upturn in the
market.
The mortgage applications index continues to give erratic readings, jumping
32 percent from last week's seasonally adjusted measure. The recent mortgage
application data is hard to interpret for two reasons. First, the subprime segment
of the mortgage market is underrepresented in the Mortgage Bankers Association
(MBA), which constructs the index. This means that the index will not fully
capture some of the falloff in subprime loans. Also, as borrowers switch from
defunct subprime lenders to MBA members, it will appear in the index as an increase
in lending. The other problem with this data is that a far higher portion of
applications are turned down now that a year ago. Even with these factors inflating
the index, the four-week average for the purchase index was just 397.9. It had
been over 500 at its peaks in 2005.
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