Borrowing and Selling

When the Wall Street Journal compared the tech bubble with the housing bubble, they offered one comparison that was a stunner. It had that same home-as-piggy-bank notion that appeared in Money magazine. Comparing owning stock with owning a home, the WSJ concludes: “Families are also better able to tap into the value of their homes to finance the purchase of new homes and other items.”

You can sell stock in a recognized market one share at a time, but if you need cash you can’t sell off a bedroom or chop ten feet off the back yard. A second mortgage doesn’t “tap” the value of a home. It is just plain old borrowing.

Borrowing and selling are very different. If you sell your shares of tech stock today, you are out of that game. If the market collapses tomorrow, you can laugh knowingly and pat yourself on the back for your prescience. But if you borrow against your home today (“tapping” in WSJ parlance), and the market collapses tomorrow, you are in deep trouble. The loan has to be repaid, and even if you sell the house, you may not make enough to cover it. You have a lot more to lose than your initial investment. The debt can tear away everything else you own.

In the 1920s, the stock market crashed when people leveraged their purchases (borrowing money to buy stock, then using the stock as collateral to borrow more money to buy more stock). Aggressive borrowing had the effect of inflating the stock market and then accelerating a dizzying crash when it all came down. When banks failed and businesses were shuttered, people who never went into the stock market were crushed by the economic fallout.

Could the same thing happen in the housing market? WSJ gives some scary stats: “Homes are collateral for about $7.7 trillion in mortgage and home-equity debt, whereas total margin debt in investors’ stock brokerage accounts is only $194 billion. For the same reason, a decline in housing prices would put more bank loans at risk; mortgages make up 40% of the assets of U.S. commercial banks, mortgage-backed securities another 16% and stocks less than 1%.”

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When we hit the tech bubble, regulations dating back to the Great Depression restricted over-leveraging. The downward spiral was steep, but the disaster remained fairly confined. Home mortgage lenders have repeatedly loosened lending standards, increasing the leverage of millions of marginal homeowners across the country. If those homeowners start to fail, the effects will be felt everywhere.

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