Into The Red - The Growing Us Housing Crisis

The Age

Saturday June 28, 2008

Ian Munro in Detroit - Ian Munro is New York correspondent

The subprime meltdown is taking a heavy toll on many Americans, even in Detroit, a city long used to financial strife.

MOTOWN Records and the US automotive industry: those are Michigan's motifs. Now add another: the preoccupied, half-focused stare into nothingness of the debt-burdened home owner. Detroit has been doing it hard for a long time. That inner-city residents have targeted abandoned homes, which stand barricaded or fire-bombed to prevent reoccupation by drug-dealing squatters, is testimony to that. Now the stalling state and national economies are threatening to bring down another generation of home owners.

Steve Kovach should be secure. One of the first to settle in the forested lakeside gullies of West Bloomfield, on Detroit's outermost reach, he paid $US25,500 for his home almost four decades ago. He did this in Oakland County, Michigan's most affluent county and one of the richest in the country thanks to the fact it was home to the car industry's highly paid executives.

As a landscape gardener whose partnership once grossed $US1 million a year, he has seen the state shrink by degrees. "I have done jobs for $US100,000, $US125,000, and all those people were associated with Ford and General Motors. Paved driveways, brick patios - these were status symbols for these people," he says. "Every time the economy shifted, my business went down. I sold equipment and then I had to buy it back. I financed and refinanced to rebuild the business and put the kids through college. Short story long, I owe $US144,000 ($A150,000) on a $US25,000 house."

He is a robust looking 66-year-old, but his knees are shot. Landscaping is beyond him, so he works for a hardware store for as many hours as he can get, at $US10 an hour. It beats Michigan's minimum wage of $US7.40 an hour, but it won't save him.

Housing prices are falling across America - 15% in 12 months - but in Michigan they have been falling for longer. Four years ago, Kovach's house was valued at $US225,000. Now, it would not fetch $US180,000. If he could sell at all. His neighbour has tried for a year to sell, even dropping his asking price by $US50,000. No go.

Instead, Kovach's bank has issued a foreclosure notice, and 38 years after he bought it, he stands to lose his home. Cue the half-focused stare into nothingness.

For the US, Michigan is a grim consolation. It has been failing for decades. The collapse in the housing market, which has been powered by the subprime mortgage crisis, is bringing other parts of the country to the place Michigan has occupied before. Consumer confidence is shredded and the economy is confronting recession. Maybe nowhere else will this latest slump bite as hard, but it will bite. The slowing US economy will drag down other Western economies as well, although its impact on Australia may be cushioned by the commodities boom sustained by growth in China and India.

A half-hour drive east of West Bloomfield and in the town of Pontiac, is the Oakland Livingston Human Service Agency, which, in a sign of the times, occupies a building once home to car makers. From here, counsellor Tamara Orza-Ramos tries to help people rearrange their financing so they can keep their homes. A month ago the office was overrun with calls for help. "At one point we received 200 calls in a week. It was scary," she says. "We had no rescue funds. I did not know where to start. We had people in here crying, depressed. They are about to lose the most important thing in their lives."

It fell to her to tell most of them there was nothing that could be done for them. She is currently working with 20 families. Maybe four of them will be able to successfully refinance, she says. It is likely the rest will lose their homes.

It is a harsh truth that Michigan's troubles are less of a concern to the rest of the country than the national downturn is to Michigan. The state partly recovered from a series of "one-state recessions" beginning in the early 1980s, but it will be a long time waiting this time, as the signs are bad all over.

The jump in the US unemployment rate from April to May, a full half of a percentage point to 5.5%, was the biggest monthly increase in 22 years. Nationally, 301,000 jobs have been lost this calendar year in a slide that has been biggest in manufacturing and construction but is also hitting retail and business services. This week the Citigroup bank shed 6000 jobs, representing about 10% of those lost across the financial sector.

Wall Street has seen thousands of jobs go and even its famously generous annual bonuses have been trimmed by several per cent, although the sacrifice seems modest when the average bonus remains close to $A200,000.

Otherwise, one in five American workers relies on commissions or tips to make up a substantial part of their income, and those incomes are shrinking. The number of underemployed - part-time workers wanting full-time jobs - has increased 17% in a year.

The flow-on is hurting Michigan, with demand for its four-wheel-drive vehicles and trucks collapsing. Sales for General Motors and Chrysler plummeted in May by 25%, and for Ford by 15%, as motorists panicked over soaring fuel prices.

General Motors last month announced it would close four factories in the US, Canada and Mexico as it shifts production away from SUVs. Ford last month said it would open a new small-car plant in Mexico, despite concessions from US car workers hoping to lure the $A3.2 billion operation to American soil.

Tumbling house prices, no novelty in Michigan, are also a big concern in Florida and California, which have experienced real estate booms. The price collapse in real terms is 18% in the past year, and sales are stagnant. And the mortgage crisis may have more bite to come.

The number of fixed-interest home loans resetting to adjustable rates is still peaking, meaning there could be a rise in foreclosures in the second half of the year as people find they cannot cope with higher interest charges. In March, 235,000 home owners were served with foreclosure notices nationally.

Rental evictions are rising too, but it is the loss of confidence and the tightening of credit from the home price slump that has done most harm.

"As far as the toxicity of those mortgages is concerned, it will mean there will be a lot of houses on the market, and houses will sell cheaply and some people will lose, but that's life," says Yale University economics professor William Goetzmann. "The fear to me would be that American financial institutions will never entirely recover their quality.

"If this crisis leads to a series of class-action law suits that attack financial institutions and undermine the long-term viability of US investment banks, that could really hurt the competitiveness of the US."

So where is the US heading? "I am surprised we are not already in a recession."

Foreclosures look the same all over the country, but their causes are different.

In the rust belt - the traditional manufacturing base of Ohio, Illinois, Michigan and Pennsylvania - they are part of a decades-long decline. In California and Florida, they are the result of a speculative gamble that as recently as four years ago appeared to be not a bad bet, Goetzmann says. Speculators bought homes by carrying substantial levels of debt, punting on rising prices to enable them to resell at a profit. For a time, it worked. But when the momentum shifted, all the profit projections went out the window.

Profit projections never were part of the plan for Ingeburg Prince, soon to turn 74 and another of those staring into the dark maw of homelessness. Her lenders have begun foreclosure proceedings on the property she shares with her daughter, Eveline, and 20-year-old grandson, Adam. She migrated from Germany as a 29-year-old. After her marriage broke down she became a skilled machine operator for an aeronautical manufacturer, and later with wheel and brake builder Kelsey-Hayes.

After Kelsey-Hayes, a leader in its field, was taken over by an English company, the lay-offs began. Next, she worked in an auto industry quality control firm, but when it became too much for her she got Adam a job there. Lay-offs have reduced staff to a handful, and Adam was among those shown the door. Eveline, who suffers a degenerative joint condition, is now unable to work and has lodged a disability claim.

Unlike the worst-hit in the housing crisis, who have found themselves with no equity in their homes, Ingeburg Prince owes about $US110,000 on a property valued at $US200,000. The trouble is that right now a valuer has told her she will be lucky to sell for $US160,000. It is not enough to make a new start. Illness and stress have reduced her from 75 kilograms to a state where a bony frame forms ridge lines through her shirt. "If I could sell the house and gain anything, I would do it, but it's still not going to get me out from under," she says as tears well. "I am a proud person. I don't want handouts. I want to pay for it, but give me a chance . . . I phone the (finance) company, but I just keep hitting a brick wall."

Prince has continued sending part-payments hoping to trigger a renegotiation of her loan, but is falling ever further behind. At the end of a proud working life she is left hoping for something to turn up: a judgement for Eveline's disability claim, a job for Adam.

But it is not a strong market for working-class Americans. A strike at parts supplier American Axle recently ended with skilled workers taking a 21% pay cut.

Prince has considered declaring herself bankrupt, but that would leave her with nothing. Personal bankruptcies in 2007 increased by 38% over the previous year, to more than 820,000.

Bankruptcy expert and Harvard law professor Elizabeth Warren told The Washington Post recently that the figures exposed a long-running undercurrent.

"It's about the fundamentals. It's about declining wages, rising costs, inadequate health insurance, job instability. More hard-working middle-class families simply can't make it in this economy, and it's only getting worse."

Harvard economist Kenneth Rogoff says this is payback time for a country that rode an artificial boom largely based on housing prices. Growth was exaggerated, and now a sustained slowdown is almost unavoidable.

Consumption in the US comprises more than 70% of the economy, and consumers are rattled. Whether the country slides into a technical recession - two consecutive quarters of negative growth - is a 50:50 prospect, Rogoff says. Just as likely is that it could rumble along on growth of 1% or 2%.

Former Federal Reserve chairman Alan Greenspan is marginally gloomier than Rogoff. This week Greenspan said the US was "on the brink" of recession, and the odds of confirming a recession were better than 50%.

In any event, not yet fully understood - or felt - is the impact on the economy of the invasion and occupation of Iraq.

"The costs of the war have been pushed into the future," Rogoff says. "There are costs like paying the health care of the soldiers for 50 years. There are estimates that the true cost is $US600 billion a year. That may be a touch too high, but we just have not seen those costs come in yet . . . I just think that's a huge wild card with only downside risk."

He says that so far only a fraction of home owners trapped with loans exceeding their home equity have abandoned their properties, but if prices continue to fall, which is very likely, "more and more will find the best option is to walk away".

Last week the FBI made a series of arrests over bogus mortgage schemes and misleading statements to investors. Most prominent among those arrested were two former executives with the failed Bear Stearns investment bank. While that was no great salve to struggling mortgage holders, this week the US Congress was trying to finalise a rescue package for home owners. Key to the plan is a federally underwritten refinancing package to enable them to convert to 30-year fixed-interest loans.

Michigan, which appears to be in terminal decline, is not helping itself. It lacks college graduates and an "education culture", says demographer Kurt Metzger. People still seem to want to believe that the production-line jobs might some day come back, Metzger says.

"We are not going to lead the recovery. There was more hope when we were in a one-state recession. Now the rest of the country has joined in, it's going to make it a lot harder to turn it around."

NONE of this would bring any cheer to Steve Kovach or Ingeburg Prince, who are united in uncertainty and frustration. Prince was 69 when financiers allowed her to borrow to add a bedroom for Eveline, but, she says, at the time she was working and in good health. Despite a recent illness, this near 74-year-old insists she would work if she could find a job she could physically do. "I never got fired," she says. "If I applied for a job, I got it. If they offered overtime, I did it. I am a doer."

Kovach also reinvented himself several times in his career, studying creative design and acquiring an associate degree in landscaping. The executive successors to his old clients in the auto industry are still in Oakland County, in a rich belt of sculpted gardens and sweeping lawns several kilometres from Detroit's urban wreckage. Theirs is an ostentatious display of affluence. But there are no longer enough of them to make a difference.

Ian Munro is New York correspondent.

© 2008 The Age

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