Housing: "What Killed the Home ATM in 2006?"

Comparing 2006 to the current market and to the 1978-to-1982 period

A reader (ht SV) asked an interesting question: What killed the Home ATM in 2006?

First, the “Home ATM” is a joking reference to mortgage equity withdrawal (MEW), where homeowners extract equity from their homes - like a cash-out refinance or with a Home Equity Line of Credit (HELOC).

In this post, I’ll compare MEW for the current period to both the housing bubble and the 1978 to 1982 period. In Housing: Don't Compare the Current Housing Boom to the Bubble and Bust, I pointed out that demographics, lending standards, and the Fed fighting inflation are similar to the 1978 to 1982 period, and dissimilar to the housing bubble - and I suggested that we look to the 1980 period for parallels to the current boom and coming housing slowdown.

Estimate of MEW as a Percent of Disposable Personal Income

In March 2007, former Fed Chair Alan Greenspan and Fed economist James Kennedy wrote Sources and Uses of Equity Extracted from Homes and released a quarterly estimate of MEW for the years 1991 through 2008. I had previously developed a simple model of MEW and it tracked the estimates from Kennedy and Greenspan very closely.

The following graph shows the net equity extraction, or mortgage equity withdrawal (MEW), results, using the Flow of Funds (and BEA data) compared to the Kennedy-Greenspan method.

Note that MEW (as a percent of DPI) was at about the same level in 1980 as today and is well below the peak bubble years.

During the housing bubble, many homeowners borrowed heavily against their perceived home equity, and this contributed to the subsequent housing bust, since so many homeowners had negative equity in their homes when house prices declined. In 1980, households had about 70% equity (almost 1/3 of households had no mortgage). That is about the same percentage equity as today, however in 2006 it was closer to 60% - meaning households with mortgages had taken on more debt.

What Killed the Home ATM?

Following the bubble, MEW declined sharply in 2006 and 2007, and went negative during the bust since this calculation includes debt cancellation and foreclosures. There were several factors led to the sharp decline in MEW in that period:

• Mortgage rates increased slightly from about 5.9% in 2005 to 6.4% in 2006, but that was a minor factor.

• Regulators tightened standards in 2006 (for example, see: Nontraditional Mortgage Guidance).

• And, as house prices declined in 2006 and 2007, people had less equity to borrow against.

Now compare to 1980 and today. Homeowners have plenty of equity, and lending standards are not being tightened, from the Fed’s January 2022 Senior Loan Officer Opinion Survey on Bank Lending Practices

For loans to households, banks eased standards across most categories of residential real estate (RRE) loans and home equity lines of credit (HELOCs) over the fourth quarter while also reporting weaker demand for most types of RRE loans on net. emphasis added

The key reason for the decline in MEW in 1980 (and in 2022) is the increase in mortgage rates. Very few will do a cash-out refinance and replace their 3% mortgage with a 5%+ mortgage rate. Some borrowers will use HELOCs.

Here is a graph of 30-year mortgage rates from Freddie Mac. Although rates are much lower today than in 1980, It is the Change in Monthly Payment that Matters, and we are seeing a sharp increase in monthly payments now.

So, this is another reason - along with similar demographics, lending standards, and concerns about inflation - to compare the current housing market to the 1978 to 1982 period, and not to the housing bubble. (Of course, there are differences too).