Life after the bubble: From American dream to American nightmare By Jeff Manning, The Oregonian October 10, 2009, 7:49PM

Kevin and Annette Martin celebrated their 15th anniversary by getting foreclosed out of their Newberg house.

Kevin's homebuilding business collapsed in the recession, and they couldn't pay the mortgage. Their bank, JPMorgan Chase, rejected the Martins' request for a mortgage modification and took legal possession of the house Aug. 19.

On their anniversary two days later, the Martins and their two young children moved in with Kevin's aunt in her small condominium in Charbonneau. They're broke, unemployed and visibly stunned at their rapid plunge from the middle class to the newly poor.

A bomb of debt vaporized the Martins' once-comfortable life. The heavy load of leverage they had assumed in hopes of grabbing their piece of the pie proved their undoing.

"I believe in the American dream, the white picket fence and the whole thing," said Kevin, 38. "But now, we're just in survival mode. For 14 months, it's been survival mode."

Beth Nakamura/The OregonianKevin Martin, second from left, borrowed heavily to build his construction business and was vulnerable when the housing market crashed. He and his wife, Annette, and their two young children squeezed into his aunt's condo in Charbonneau after losing their Newberg house to foreclosure in August. A year has passed since the peak of the great financial panic of 2008. Regulators and analysts alike spent much of September pontificating about the economy's regained stability.

Thanks to a multitrillion-dollar bailout, much of the financial sector has regained an uneasy equilibrium. Some banks that seemed on death's door less than a year ago earned record profits this past spring.

But for many individual Americans, 2009 feels a lot like the depression that we supposedly averted. The unprecedented transfer of wealth from taxpayers to the financial industry has done little to improve the prospects of millions of people who have lost their jobs, their homes and much of their wealth. Even their sense of security is gone.

View full sizeSteve Cowden/The Oregonian
The nation is now living through a vast deleveraging. A huge bubble of borrowing, enabled by the financial industry's "don't ask, don't tell" lending policies, is a thing of the past.

The end of the bubble has enormous ramifications for individuals and families struggling with job losses, salary cuts and restive creditors. But it may have even greater significance for the U.S. economy, which some economists argue had come to rely on an artificial and unsustainable surge in consumer debt for much of its growth.

A new era of forced austerity arrived almost overnight last year when lower consumer spending pushed dozens of retailers into crisis. That led to further problems for the commercial real estate sector and banking industry, which in turn led to greater job losses and more mortgage defaults.

So if much of the economic growth of the past 15 years was illusory, fueled by injections of high-octane debt, what happens now that the tank is empty? We could be entering a wrenching adjustment period of lower spending, slower growth, perhaps a lesser standard of living.

"We're not going back to those growth rates; that was a dream world," said Kevin Lansing, an economist with the Federal Reserve Bank of San Francisco who for years has tracked consumer debt. "There could be 10 years where you're going to have this drag on the economy. ... People's living standards are not going to be improving the way they were. It will place a new strain on government as their tax revenue falters."

Household debt doubles

The current economic wreckage has its roots in a sweeping change in American behavior dating to the late 1980s.

Between 1965 and 1985, household leverage -- measured by the ratio of debt to personal disposable income -- hovered between 55 to 65 percent. It more than doubled in the ensuing years, reaching a zenith of 133 percent in 2007, according to a paper issued in May by Lansing and Reuven Glick, economists at the Federal Reserve Bank in San Francisco.

For people who wondered how their friends and neighbors afforded their McMansions, BMWs and high-end club memberships, it may well have been courtesy of their always-obliging debt merchant.

Much of the debt was mortgage-related, the loans backed by escalating home prices. In 1995, Americans took out $3.3 trillion in mortgage and home equity loans. Ten years later, the total topped $10.4 trillion.

The surge in debt is attributable, in part, to what Lansing politely calls "credit industry innovation and product development."

Translated, that means that some lenders dropped any pretense of cautious loan underwriting. In an era when most lenders simply bundled their loans and peddled them to the secondary market, a buyer's ability to make mortgage payments seemed of minor importance. No one could lose, as long as home values were going up every year by double digits.

Many borrowers eagerly joined the free-ride parade, fabricating loan transactions and working with unscrupulous brokers to extract the easy money from lenders.

As Americans borrowed and spent more, they saved less, culminating in the infamous "negative" savings rates of 2005 and 2006.

Some went on buying binges, but millions needed the money just to get by. The huge increase in debt stemmed in part from years of flat incomes and the simple fact that life got more expensive. Even people who took the historically intelligent steps of buying a home or getting a college degree had little choice but to take on increasing debt.

Some examples: Median Portland-area home prices soared to a peak of $302,000 in August 2007, more than six times the median household income. Historically, Americans spent 2 1/2 to three times their annual income for a house.

Tuition at Oregon state colleges have increased 40 percent just since 2001, far exceeding inflation. The typical Oregon college grad now leaves school owing more than $20,000 in college debt and about $5,000 in credit card debt.

Whether the debt was fiscally cautious or the worst kind of payday loan, the increase was huge and unsustainable in countless households.

"We lived for seven, eight years well beyond our means," said Christian Weller, a professor of public policy at the University of Massachusetts who has studied consumer borrowing and the financial industry. "Now we have to pay for the party. Ultimately, that debt has to disappear."

Mountain of foreclosures

It's no surprise that with so many homeowners overleveraged when the housing bubble burst, mortgage defaults and foreclosures have taken a corresponding jump.

In Portland's tri-county area, lenders foreclosed on 517 homes in 2006 and 769 in 2007.

But as the economy began to wither in 2008, the number of foreclosures tripled, to 2,361. The momentum continued to build, with lenders completing 2,489 foreclosures just through August of this year.

The number of people in jeopardy of losing their homes is much larger. The number of mortgage default notices -- filed by the loan servicer when a homeowner stops paying the mortgage -- soared from 3,309 in 2006 to 8,761 through the first eight months of 2009.

The human toll of the foreclosure wave is immense.

The Oregon Education Department reported in September that the number of homeless students in the state surpassed 18,000, a 14 percent increase from the previous year. Nationwide, 13 million homeowners have defaulted or fear they will default.

The flood of foreclosed homes on the market has helped push down real estate values to the point that nearly a third of American homeowners find themselves in a limbo known as "negative equity." In common parlance, they are underwater -- they owe more on the house than it is worth.

In the Portland area, more than $30 billion worth of residential property -- about a quarter of the market -- is underwater or close to it, First American CoreLogic reported in August.

Negative equity doesn't by itself result in foreclosure. But an underwater borrower has much less to protect than does a homeowner still in the money, and may be much more likely to walk away from the debt.

The Martins now number among the grim statistics of the painful financial realignment.

Maximum leverage was the norm in the high-stakes residential construction business when Kevin Martin started his company early this decade. He and Annette first borrowed $120,000 in 2003 to buy land north of Newberg and build their own 2,600-square-foot house. Kevin went to work remodeling a historic home in Tigard and building spec houses in Yamhill and Washington counties.

But building the business required money. As their house gained in value, they refinanced their home loan multiple times. Kevin's grandmother and father co-signed on loans he took out to build homes in Tigard and McMinnville.

In the most recent home refinancing, the Martins took out a so-called negatively amortizing loan from Washington Mutual, one of those lending industry "innovations" that Lansing wrote of. The loan was structured so that the amount they owed actually increased each month.

By 2008, the Martins owed $512,000 on their house. They also owed $563,000 on a construction loan from Liberty Bank.

They put their house on the market in January 2008. It sat for a year with no takers as the residential market began to tank.

The houses in McMinnville and Tigard didn't move either, costing the Martins thousands of dollars in carrying costs every month.

Kevin folded his company in 2008. In November of that year, the Martins could no longer make their house payment. JPMorgan Chase, which bought the failed Washington Mutual last September, rejected their repeated pleas for a loan modification.

Without a regular income, they didn't qualify, they were told.

OnPoint Community Credit Union repossessed their three cars after the Martins stopped making payments on Kevin's 2008 Dodge truck. They didn't realize until afterward that their car loans were cross-collateralized: If they defaulted on one, the lender could seize all three.

The couple are now without a permanent home, they're on food stamps, they've dropped their health insurance and have enrolled their two young children in the Oregon Health Plan.

"We tried for the American dream, and it's become a nightmare," Annette Martin said.

Surviving on savings

There's new hope for homeowners living in fear of foreclosure: loan modification.

But it's a thin reed.

The financial industry, whose greed and irresponsibility helped steer the economy into the trash bin, the same industry that then needed an unprecedented rescue package courtesy of the American taxpayer, is now suddenly the picture of prudence when it comes to modifying a hard-pressed homeowner's mortgage.

The Obama administration, after providing trillions to banks, insurance companies and investment banks, in February pushed through Congress a program to help strapped homeowners. The Homes Affordable Modification Program (HAMP) is intended to help homeowners stay in their homes by paying loan-servicing companies to lower their customers' interest rates, extend the terms or reduce the principal owed by the homeowner.

Those taxpayer-funded incentives could add up to $75 billion. But it's strictly a voluntary program, and it gives the loan servicers discretion on which loans to modify.

As the lenders exercise their newfound caution, the financial time bomb keeps ticking for desperate families.

Justin Melonuk is a well driller whose income nose-dived with the housing crash. He and his wife, Megan, and their three young children live in a modest 1,600-square-foot ranch in Oregon City.

The Melonuks are scrambling desperately to stay current on their mortgage. They haven't defaulted yet, but only because they've emptied the $12,000 out of their 401(k) retirement savings account.

Wells Fargo refinanced their home loan last March and collected all the associated fees, despite the Melonuks' faltering income. But Wells Fargo is decidedly less eager to modify their loan now.

One Wells Fargo official told the Melonuks they didn't qualify for a modification because their income is too low. Another said the bank wouldn't consider them for a modification until they defaulted. Housing counselors who work with homeowners say the conflicting messages sent to the Melonuks are typical of the loan modification program.

"We're struggling so hard to make our payments," Megan Melonuk said. "But they say they won't do anything to help us because we're current."

Wells Fargo spokeswoman Teri Schrettenbrunner conceded that the bank and the rest of the industry have struggled to provide adequate customer service. But that's primarily because of the overwhelming number of customers seeking help; the bank is making progress in staffing up, she said.

Schrettenbrunner said the bank has to be careful because plenty of homeowners who don't need or deserve modifications are applying.

Collectively, the servicers claim they have extended offers on more than 570,000 trial loan modifications under the program.

Those are impressive numbers. But the nation's struggling homeowners can only hope that the success stories trumpeted by the industry don't resemble the deal offered to Tim Young and his wife, Asheley Biesemeyer-Young, of Beaverton.

Tim lost his job last September, and Asheley got a 20 percent pay cut the same month, making the family's $2,800 monthly mortgage a difficult strain. After nine months of battling the bank's bureaucracy, the Youngs in July were offered a six-month loan forbearance that lowered their payment to less than $1,500 a month.

But after January, their monthly payment will return to $2,800, and their bank also expects a one-time payment of $17,000 to cover late payments, fees and penalties.

For Asheley, a normally mild-mannered escrow officer at a title company, her dealings with her bank have left her shaken and infuriated.

"I just think this loan modification thing is a big scam," she said, "a way for the banks to get more money out of the government."

- Jeff Manning