Lenders retreat as housing market plummets

Credit crunch leads to drop in equity lending. Chronicle Graphic Credit crunch leads to drop in equity lending. Chronicle Graphic Image 1 of / 3 Caption Close Lenders retreat as housing market plummets 1 / 3 Back to Gallery

As the nation's housing market swoons, lenders are tightening their grip on their money. Last month, that credit crunch reached Brent Meyers.

To all appearances, he's an unlikely victim. A well-paid chief executive of a small consulting firm, he owns a substantial investment portfolio and a million-dollar house in Moraga. He pays his bills on time and has no credit card debt. His credit score, he says, is around 800, a rating more or less in the stratosphere.

But in mid-March, Bank of America cut off his home equity credit line of a little more than $180,000, citing a decline in the value of his property. Meyers, 40, is now scrambling to come up with $75,000 to pay for a major landscaping project and is canceling other big spending plans.

"My wife would like a new car, but that's going to have to wait," he said. "We're taking a $75,000 cash-flow hit, and I want to boost savings."

The credit crunch made big news last month when brokerage giant Bear Stearns Cos. was forced to sell itself on the cheap after it was unable to borrow money to cover losses in its portfolio of mortgage securities. But the chill in the credit markets is not something that's hitting just big banks and securities firms.

In thousands of ways big and small, across the Bay Area and the nation, lenders are retreating after booking losses in the mortgage market. Households and businesses are suffering the consequences as money becomes tougher to get and more expensive to borrow.

That in turn spells bad news for the economy. Credit is the grease that lubricates the economic engine by giving individuals and businesses the means to spend.

Borrowed money pays for everything from new outfits at the clothing store to house purchases and major home improvement projects. When individuals and entrepreneurs can't get loans at interest rates they can afford, they spend and hire less. Tight credit ripples through the economy. The result is a slowdown, and, if severe enough, a contraction of economic activity, in other words, a recession.

Households, which gorged themselves on easy credit for most of the past decade, are bearing the brunt of lender caution. In a wide variety of consumer loan categories, particularly those backed by real estate, lenders are cutting back on loan amounts, charging higher interest and stiffening qualifications.

Take home equity loans. In the past decade, borrowing against the value of their homes became the money source of choice for homeowners who wanted large sums to pay for such items as home improvements, college tuition or luxury spending.

By 2004, Americans were taking out $180.5 billion in home equity loans, according to the Federal Reserve. Much of that cash was pumped right back into the economy, buying cars and furniture, renovated bathrooms and kitchens, airline tickets and hotel rooms.

'Unprecedented' conditions

But as home prices started to sink, homeowners had less equity to draw on. Lenders including Bank of America, Washington Mutual and Countrywide Financial cut back on home equity loans to reduce their exposure to the housing market.

"These are unprecedented market conditions," said Bank of America spokesman Terry Francisco.

By the last three months of 2007, home equity borrowing dropped to an annual rate of $26 billion, the Fed calculates. And home equity borrowing has undoubtedly fallen further in 2008.

Cutbacks in home equity loans and other forms of consumer credit are one of the factors behind a stall in retail spending.

Total retail sales fell 0.6 percent in February, according to the U.S. Commerce Department, led by slumping car and truck purchases. Forecasters predict consumers will barely boost spending above the rate of inflation this year, the worst performance in more than a decade.

Consumer spending represents about 70 percent of all economic activity in the United States. "For the economy to expand, it will have to come from the other 30 percent," said Carl Steidtmann, chief economist at the consulting firm Deloitte Research.

Warren Leiber, Brent Meyers' landscaping contractor, sees the spending slowdown every day. Leiber Landscape Services, his Walnut Creek business, serves an affluent corridor from Benicia to San Ramon. A typical job comes in at $30,000 to $40,000.

He estimates that 80 percent of his clients used home equity loans or mortgage refinancings to pay for his services. Now, with that tap choked off, his strapped clients are backing off, knocking $10,000 or $20,000 off their work orders, if they go ahead at all.

"Things started to really go south back in October," Leiber said. "We would get to the point of reviewing proposals, and people would say, 'That's great. Looks terrific. But it's more than we can spend right now.'

"It wasn't like it used to be when people weren't worried. People just don't feel wealthy and secure, like they used to."

Meyers began his landscaping project in January, expecting to draw on his home equity loan to pay Leiber.

When Meyers took out the credit line in November 2006, his home was valued at $1.475 million. With less than $1 million in principal outstanding on his first mortgage, he had a comfortable equity cushion to cover the line.

A few weeks ago, Meyers got a letter from Bank of America informing him that the line had been suspended in its entirety. When he called to ask why, he was told that his house had dropped to an estimated $1.09 million in value, which left insufficient equity to cover the line.

He insists his house has not lost that much value. He's asked the bank to reconsider. His appeal is pending.

For its part, Bank of America is reducing home equity lines for some customers "in areas of the country that are experiencing consistent and significant home value declines," Francisco said.

The bank is acting when customers "have used home equity lines beyond newly updated home values," he added.

Deferring expenditures

Meyers isn't exactly a hardship case. Unlike some who have had their credit cut off, he has other resources to fall back on. He intends to complete his landscaping project and will sell stock to pay for it.

"If I weren't able to pay cash, I would toss (Leiber) and his five-man crew out on the curb," he said.

Still, losing the credit line is prompting him and his wife, Deborah, to retrench.

"I'm going to change my spending behavior because I lost access to $180,000," he said. "We're going to be deferring other expenditures to build a pot of money to replace what Bank of America took away."

For example, the couple had planned to remodel the master bathroom once the landscaping work was finished. Now that's out the window. And any vacation this year for Meyers, his wife and their kids, Julia, 7, and Justin, 3, will be within driving distance of the Bay Area to save on airfare.

Economists stress that there are other factors besides tight credit behind the slump in consumer spending. Ordinary Americans have been slammed by a series of blows to their pocketbooks.

Wages are growing too slowly to keep up with rapidly rising prices, particularly those for necessities such as food and fuel. Homes and stock portfolios are dropping in value. Many people feel they're falling behind. And they can't borrow easily to fill the gap.

That witch's brew - stagnant incomes, rising prices, evaporating wealth and reduced access to credit - is fostering a fundamental change in attitude and behavior, economists say.

"We've seen a significant shift over the last year," said Richard Curtin, director of the Reuters/University of Michigan Surveys of Consumers. "People are more cautionary minded. They want to increase their reserve funds and decrease the amount of money they spend."

In essence, the borrow-and-spend game that sustained American households - and boosted economic growth - reached its limit. By the fourth quarter of 2007, households devoted a record 14.2 percent of their incomes just to service debt, according to the Federal Reserve.

That "record debt servicing burden ... is affecting people's ability to feed their families, make their utility bills and to discharge their health and education responsibilities," Merrill Lynch economist David Rosenberg wrote in a recent report.

Hence, the newfound reluctance of lenders to lend coincides with growing consumer disinclination to borrow.

"We are seeing signs of a major sea change taking place," Rosenberg wrote. "Debt is now being viewed as a four-letter word at best, a ball and chain at worst."

Watching labor costs closely

Meanwhile, Leiber is starting to worry about his business and his seven full-time employees. Spring is the busy time in the landscaping business, and Leiber has enough work to keep his crew fully employed. But he's nervous about what will happen when the seasonal surge is over.

"I'm going to be watching our labor costs very closely," he said. "If things slow down, the very first thing that will go will be labor costs."

So far, no clients have shut down a project because they ran out of money. But there are straws in the wind.

"Some of our clients have not been paying on time," he said. "I have quite a few clients who owe me various amounts of money. There were just a few at first, but it's growing.

"People have their pride," he added. "They won't say they're having a hard time. That's started to concern me."