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Home Equity Shoe Dropping

posted by John Pottow

Something that I had been wondering about re: the mortgage meltdown has been home equity loans.  We've all been focusing on home mortgages (starting with sub-prime, but slipping up to Alt-A and conventionals), but what I was curious about was home equity lines: are those going into default too?  The answer, it seems, is yes.  In just today's Wall Street Journal, Robin Sidel reports that charge-offs on home equity lines are doubling.  J.P. Morgan Chase predicts first-quarter write-offs of $450 million (up from $248 million prior period) on its $95 billion portfolio.  Delinquency rates are also up too, to over 4%.

The rub with these loans will be on under-water mortgage homes.  The home equity lines, I suspect, are second liens to the PMSI mortgagee, so for the many homes where the superior-lien mortgage gobbles up most of the value of the home, will this result in foreclosures, or just losses?  Either way, more bad news I guess.


Is it bad news?

Every circuit that has considered the issue has allowed second/third/fourth mortgages that don't attach to any equity to be stripped and treated as unsecured debt in Chapter 13 bankruptcy cases. And, it should be noted, this practice of stripping wholly unsecured mortgages has been going on for years.

See, In re Bartee, 212 F.3d 277 (5th Cir. 2000); In re McDonald, 205 F.3d 606 (3rd Cir. 2000); In re Zimmer, 313 F.3d 1220 (9th Cir. 2002); In re Lane, 280 F.3d 663 (6th Cir. 2002); In re Pond, 252 F.3d 122 (2nd Cir.2001); In re Tanner, 217 F.3d 1357 (11th Cir. 2000).

Following the logic the mortgage companies have been peddling of late in opposing the new bankruptcy mortgage bill - allowing these home equity mortgages (that attached to no equity) to be treated as unsecured must have resulted in people not being able to get home equity loans.

So, there should be no losses on these Loch Ness loans, because they must have been incredibily rare. After all, the dictates of the credit markets ensure that no one could get a home equity loan because the bankruptcy laws made them so risky banks were unwilling to make such loans.


The following question has been bugging me for a while. Maybe this is not the correct place to ask it, but here goes:

In the universe of CDOs and SIVs that are behind the whole "subprime" phenomenon, what kind of premium were the players getting who invested in the various classes of these securities, as compared to other conventional rates, such as Treasuries, corporate bonds etc?

Was all this mayhem caused by a chase after DOUBLE or TRIPLE the Treasury rate? Or was it all just for a few tenths of a percent extra yield? And if the answer is "Both", then what was the approximate distribution across that spectrum?


Equity Loans as Next Round in Credit Crisis

Published: March 27, 2008

Little by little, millions of Americans surrendered equity in their homes in recent years. Lulled by good times, they borrowed — sometimes heavily — against the roofs over their heads.

Now the bill is coming due. As the housing market spirals downward, home equity loans, which turn home sweet home into cash sweet cash, are becoming the next flash point in the mortgage crisis.

Americans owe a staggering $1.1 trillion on home equity loans — and banks are increasingly worried they may not get some of that money back.

To get it, many lenders are taking the extraordinary step of preventing some people from selling their homes or refinancing their mortgages unless they pay off all or part of their home equity loans first. In the past, when home prices were not falling, lenders did not resort to these measures.

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