American Homeowners Borrowed Too Much, Economist Concludes

A Fullerton university professor says the housing market collapse was caused less by people who bought homes but could not afford them than homeowners who relied on second mortgages to get into their homes, it was reported today.

And Cal State Fullerton finance professor Michael LaCour-Little said tax- free second mortgages, used by longtime homeowners to tap equity, may be unwise policy, the Orange County Register reported today.

LaCour-Little's theory is that the real culprit for the housing value death spiral is the preceding upward spiral. And that might mean Americans need to rethink the economic shibboleth that rising house prices are a good thing.

"The conventional view is that housing appreciation is good because it reduces (default) risk," he told the Register. "Not according to my theory, which is housing appreciation is bad.

"It encourages junior-lien borrowing," he said. "When appreciation stops, somebody is going to be left in a bad position."

The professor tracked all houses and condos set for foreclosure auctions in the first two weeks of each November for thelast three years in Orange, Los Angeles, Riverside, and San Bernardino and San Diego counties. He found that, during the housing heyday, many people bought homes with a first loan and a simultaneous second mortgage to finance 100 percent of the purchase, LaCour-Little said.

For the early November 2008 data sample, he tracked 2,358 properties and found that 79 percent of borrowers had at least a second mortgage. More than half of those houses were purchased before the housing value peak in 2005 and 2006.

Total debt on the 2008 properties averaged $551,000 at time of foreclosure, or roughly 170 percent of their average value at the time based on a computer model. That value was double the average price the bank later received from buyers.

LaCour-Little told the Register that finding suggests owners borrowed against all the gains in their property's value by refinancing, and when prices dropped, they owed much more than the houses were worth.

Federal law makes the cost of buying those home equity loans tax deductible, a policy that encouraged borrowing against home equity gains that turned out to be a mirage, he said. That might make recent decisions by the Obama administration to bail out persons who tapped to much home equity a bad idea, some economists told the paper.

Although foreclosures have a terrible social cost and can drive the overall economy down, "one beauty of foreclosure--if you can find beauty in it--is it does clean up title to a property," he told the Register.

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