Sense on Cents

In the midst of speaking with a wide array of people over the course of the last 6 months, I continue to hear of more and more individuals who fall into the category of “house rich but cash poor.” This phenomena clearly developed over the last 8-10 years given the skyrocketing of home values. As people continued to take equity out of their homes, the home itself was viewed as a provider of wealth rather than a store of wealth. Well, now that the piggy bank that was the home has plummeted in value, many supposed well-to-do Americans are facing bankruptcy.

This unwind has happened so quickly as to leave these ‘successful’ and ‘savvy’ people bewildered. The fact is, a bear market in any segment of the market takes no prisoners.

Bloomberg highlights the explosion in bankruptcies that many high income but overleveraged individuals are facing in writing, Wealthy Families Face Bankruptcy on Real Estate Crash:

Wealthy individuals’ Chapter 11 bankruptcy filings jumped 73 percent in the second quarter from a year earlier, according to the National Bankruptcy Research Center, a research firm in Burlingame, California.

More individuals or families with at least $1,010,650 in secured debt and $336,900 unsecured are using Chapter 11 of the U.S. bankruptcy code typically associated with business reorganizations. Falling U.S. home prices leave them unable to refinance or sell properties when they drop below the value of the mortgage, said Joseph Baldi, a Chicago bankruptcy attorney.

How is this playing out for banks and other credit providers? An ongoing increase in delinquencies, defaults, and foreclosures. Moreover, this segment of the population consumed more high priced items and took more extravagant vacations. The pullback and impact on companies servicing this clientele will continue to be deep and meaningful.

How are banks responding to this development? The banks have ratcheted credit standards significantly higher for potential buyers of high-end homes. Those tighter credit standards also add pressure on this overleveraged crowd.

Bloomberg further adds:

Listings of homes for sale worth $1 million or more increased 27.3 percent in July from October, according to Zillow.com, a Web site that tracks real estate transactions. The number of homes sold with a value between $1 million to $2 million fell 23 percent in July from a year earlier, according to the Chicago-based National Association of Realtors. There was a 21-month supply, up from 16 months last year.

I know that in my corner of the world, the supply of unsold higher priced homes has increased dramatically. Builders are now more inclined to rent than hit down bids. The fact is, though, as much as builders or owners think prices will stabilize, the technicals will keep pressure on prices which will only exacerbate the situation. In fact, as these home values deteriorate further it will push others currently on the edge of bankruptcy over the edge.

Bloomberg addresses why people are utilizing Chapter 11 rather than Chapter 7:

Congress amended the bankruptcy law in 2005, making it harder to file for Chapter 7, which allows debts to be completely discharged. Chapter 11 gives individuals time to make a plan to reorganize their finances.

What’s the lesson here? Borrowing money against a house or any other asset is simply a means of employing leverage. That leverage can appear to be brains when it’s only a bull market, but that leverage is death when the bull becomes a bear.

LD

This entry was posted on Wednesday, September 9th, 2009 at 3:42 PM and is filed under bankruptcies, General. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.