It's been a while since Congress' mortgage "cramdown" plan has received a lot of publicity. As I write this, I'm looking at a Wall Street Journal piece from the March 14-15 weekend edition entitled, "Mortgage 'Cramdown' Plan Hits Turbulence."
And how.
There is a high level approach to this topic that involves discussing capital markets, the rule of law, contracts, and such. I had originally intended to write that sort of piece.
But there's another level of coverage for this legislation that focuses on the local real estate markets, and that's where this post is now going.
About a week ago, I happened across a good friend and former professional international squash player who is now a local realtor. We began discussing the local market and pending governmental programs to 'help' the situation. She was not happy.
Elaine told me that the $8K credit for first-time home buyers is doing nothing around here, because the house prices are still so high that few, if any, initial buyers can afford them. She said the better solution was to have given anyone buying a home the $8K credit.
Then we turned to the subject of Congressional 'help' for delinquent or about-to-be-foreclosed mortgages.
Elaine concurred with the findings of research into delinquencies which I have read in the press within the past six months. To wit, homes that have mortgages fall into delinquency, then are given temporary relief, have a very high probability of becoming delinquent again and, eventually, entering foreclosure within six months.
Essentially, people typically become delinquent on their mortgage because there has been a job loss. They don't usually decide to take a European or Asian vacation, buy a second home, or a new car, and, thus, skip paying the mortgage on their primary residence for a month or two.
No, such drastic nonpayment events are usually the result of a job loss which exhausts the financial means of the owner of a home. If given a few months respite, the owner isn't magically given a new job, too. Just more time to resolve their delinquency.
All too often, i.e., more than half of the time, the owner re-enters a delinquent state and, then, foreclosure.
This is why cramdowns are a bad idea. It simply allows someone who can no longer afford their home to enjoy a court-ordered, unilateral rescission of the mortgage contract, effectively cutting the price of the home by forgiving some of the principal, and lowering the interest rate, too.
But, as my realtor friend noted, all this does is make taxpayers subsidize the current owner while they enjoy a price cut on their home, while anyone who was waiting to buy the home out of foreclosure at a lower price is denied that opportunity.
When normal housing markets are allowed to function, then people who can no longer afford their home due to having bought what they cannot now afford, the homes are sold out of foreclosure at lower, market-clearing prices, to new buyers who can now afford those homes.
The current foreclosure experiences across the US are not, at root, housing problems, but merely the consequences of employment problems.
You fix the latter with unemployment insurance, not mortgage relief via local court cramdowns.
Because of the looming Congressional mortgage relief, Elaine told me that delinquent homeowners and/or others wishing to sell are maintaining artificially high prices, or simply not listing yet. The result is a clogged and frozen local residential real estate market in which willing, qualified buyers are being denied the opportunity to gain access to homes that should be sold at market-clearing prices.
The mere hint of federal mortgage relief has frozen prices and is keeping the supply of homes tighter than it would be, were normal lending and market forces acting. Banks would be foreclosing, instead of halting those procedures, under TARP-related threats of Congressional penalties.
Since brokers aren't paid until homes sell, Elaine told me that she and her colleagues aren't even participating in workouts of delinquent mortgages anymore, because the owners' expectations of prices are too high to promise a sale anytime soon.
In short, the simple expression of Congressional action and interest in doing other than allowing normal market forces and the legal system operate in the instance of current residential mortgage finance, i.e., allowing lenders to handle delinquencies and foreclosures as usual, has seized up the entire residential housing market and caused existing homeowners to expect a taxpayer-financed price and interest rate reduction on their current homes, while waiting buyers are forced to subsidize this situation, while being denied their chance to finally realize their own dreams of home ownership, albeit on better-funded terms.
Things sure are upside down in the American housing market, thanks to boneheaded federal meddling.
Friday, March 27, 2009
Thursday, March 26, 2009
On Geithner's PPIP Plan
Earlier today I published this post with two video clips of economist James Galbraith opining on Treasury Secretary Geithner's PPIP plan. My business partner noted that the accompanying text with the videos, provided by fallen tech brokerage analyst Henry Blodget, is quite good and concise. These two charts, here and here, are very arresting.
Galbraith and his interviewers make the case that there is, and always has been, a perfectly good alternative to all of these bailout and rescue plans. Simply put, place insolvent non-bank institutions into bankruptcy, take the banks into the FDIC and put insured depositors into new institutions, while allowing other institutions to bid on the loans and other assets of the failed financial firms.
However, Geithner, his boss, and even people like NY insurance czar Eric Dinallo, this morning on CNBC, swear that the only way credit markets can be rehabilitated is through the process that Giethner proposes. Which, by the way, as Blodget notes, is very much the same vehicle that Paulson proposed with the TARP. Government organizes a sale of assets to the private sector. You can quibble about whether the government attaches a guarantee of some sort to it, and how much each shares in loss or profit, but the basic idea is the same.
Galbraith and Blodget demolish these arguments, and more, in their respective critiques of Geithner's DOA plan.
Then we come to the recent furor over the AIG retention payments. Holman Jenkins of the Wall Street Journal wrote on Wednesday of this week, in his column entitled "The Real AIG Disgrace,"
"Yet the AIG bonus episode, the administration's one true disgrace so far, will not soon be forgotten.
Galbraith and his interviewers make the case that there is, and always has been, a perfectly good alternative to all of these bailout and rescue plans. Simply put, place insolvent non-bank institutions into bankruptcy, take the banks into the FDIC and put insured depositors into new institutions, while allowing other institutions to bid on the loans and other assets of the failed financial firms.
However, Geithner, his boss, and even people like NY insurance czar Eric Dinallo, this morning on CNBC, swear that the only way credit markets can be rehabilitated is through the process that Giethner proposes. Which, by the way, as Blodget notes, is very much the same vehicle that Paulson proposed with the TARP. Government organizes a sale of assets to the private sector. You can quibble about whether the government attaches a guarantee of some sort to it, and how much each shares in loss or profit, but the basic idea is the same.
Galbraith and Blodget demolish these arguments, and more, in their respective critiques of Geithner's DOA plan.
Then we come to the recent furor over the AIG retention payments. Holman Jenkins of the Wall Street Journal wrote on Wednesday of this week, in his column entitled "The Real AIG Disgrace,"
"Yet the AIG bonus episode, the administration's one true disgrace so far, will not soon be forgotten.
Tim Geithner is rightly on the hot seat for saying he didn't know about the bonuses until just weeks ago -- because he should have quelled this furor before it ever got started. Instead he played dumb and climbed aboard the outrage bandwagon -- and let Mr. Obama do the same.
Whether Mr. Geithner knew the specifics is unimportant. The retention plan was known to his staff. The details had been disclosed over and over in public filings. As far back as October, New York Attorney General Andrew Cuomo had summoned the Treasury-appointed Mr. Liddy to hammer out a deal on AIG's pay practices. Said Mr. Cuomo in a statement afterward: "These actions are not intended to jeopardize the hard-earned compensation of the vast majority of AIG's employees, including retention and severance arrangements, who are essential to rebuilding AIG and the economy of New York."
The voluble Rep. Elijah Cummings had been railing about AIG retention bonuses almost continually, on air, in the print media, and in publicly released letters to Mr. Liddy, since Dec. 1.
On March 3, Mr. Geithner himself was quizzed during a congressional hearing in detail about the AIGFP retention plan by Democratic Rep. Joe Crowley -- a week before Mr. Geithner now says he heard of the plan.
But the biggest lesson here is the old one that the price of freedom is eternal vigilance -- beginning with insistence on the rule of law. Americans clearly cannot trust their elected officials to defend their rights and interests, or care whether justice is served, when the slightest political risk might attach to doing so.
Which brings us back to Mr. Cuomo, whose office has been implicitly threatening to publish names of AIG employees who don't relinquish pay they were contractually entitled to.
Mr. Cuomo is a thug, but at least he reminds us: It can happen here."
First, I think it bears some consideration of what must have transpired for Jenkins to write that last sentence. I would bet that Rupert Murdoch himself cleared it. You don't call the NY AG a thug without steeling yourself for retribution.
But, beyond that, Jenkins' careful recounting of who knew what, when, demonstrates another, more human behavior-based reason why Geithner's PPIP program will fail.
No matter what Geithner swears will be acceptable, including massive private investor profits on these toxic assets, he can't actually guarantee that Congress will not react in the future the same way they reacted to the very reasonable and already known AIG retention payments, i.e., abrogate contracts, pass bills of attainder, and otherwise behave unconstitutionally.
Why will any private investor believe an administration's promises? Remember when Hank Paulson swore that TARP funds would not entail any active interest whatsoever by the federal government in the institutions which agreed, upon request, to accept the money?
Now they have their entire compensation systems subjected to Congressional mandate.
The truth is, nobody knows how today's buyer of a PPIP-offered asset will be treated next quarter, or next year, by Congress, when, in a fit of pique, that branch of government decides that the profits earned by those private buyers are, in fact, unacceptable. That the deal offered by the PPIP was not fair to taxpayers. Or whatever other ex post facto reason Congress may choose to use to unfairly appropriate gains after the fact.
The banks selling the toxic assets at low prices will risk insolvency. The buyers will risk some loss, and, worse, taking of their profits by the government, if they do profit.
On many bases, Geithner's overly-complex, ambitious and naive plan for relieving financial institutions of bad loans and securities won't work. It would be simpler to just force realistic valuations, close the insolvent institutions, transfer any insured deposits, and sell off the assets, thus providing real, market-determined prices. As well as removing inept management and providing room for better managers to provide fresh financing, when and as needed, to the economy.
James Galbraith on Geithner's PPIP Plan
I'm not a big fan of James Galbraith. The Texas-based academic PhD in economics is the son of none-other than America's major water-carrier for John Keynes, the late John K. Galbraith.
However, these two video clips are worthy of your viewing time.
http://finance.yahoo.com/tech-ticker/article/216311/Part-I-Geithner
http://finance.yahoo.com/tech-ticker/article/216480/Part-II-Geithner
I agree with pretty much everything Galbraith says. The banks won't lend more because of this program. They simply want to avoid insolvency. Yes, they may even bid on each other's assets, in order to prop up prices.
Remember when Drexel's high yield debt maven Michael Milken did this with his clients? Each beneficiary of Milken's funding skills was required to buy some of the same paper from another of his clients, thus providing a floor for valuation.
In any case, I think these two videos lay bare some- but only some- of the problems with Geithner's program, which will ultimately lead to its failure to reach its objectives of healing the US economy's financial sector.
However, these two video clips are worthy of your viewing time.
http://finance.yahoo.com/tech-ticker/article/216311/Part-I-Geithner
http://finance.yahoo.com/tech-ticker/article/216480/Part-II-Geithner
I agree with pretty much everything Galbraith says. The banks won't lend more because of this program. They simply want to avoid insolvency. Yes, they may even bid on each other's assets, in order to prop up prices.
Remember when Drexel's high yield debt maven Michael Milken did this with his clients? Each beneficiary of Milken's funding skills was required to buy some of the same paper from another of his clients, thus providing a floor for valuation.
In any case, I think these two videos lay bare some- but only some- of the problems with Geithner's program, which will ultimately lead to its failure to reach its objectives of healing the US economy's financial sector.
Wednesday, March 25, 2009
Jim Chanos On Mark-To-Market
Hedge fund manager James Chanos wrote a wonderful piece in yesterday's Wall Street Journal entitled "We Need Honest Accounting."
The piece dissects, in greater detail than I have been personally aware, the mess that has become commercial bank accounting for CDOs, CMOs and other structured instruments.
Since mid-2007, I have believed that, either by Presidential Executive Order, FASB ruling, or Congressional action, existing mark-to-market rules should have been, and be, modified to allow cash-flow-based expected value to be used for non-trading structured financial instruments, especially those composed of mortgages or mortgage-backed securities. This belief is rooted in the fact that underlying performance, in terms of cash flows, may not necessarily be reflected in the prices of the securities into which such mortgages have been bundled.
Chanos, however, casts a very different light on the matter. In his opinion, banks have long-used market values on these instruments when they were rising, thus abrogating their ability to now declare them to be held for investment purposes,
"Financial institutions had no problem in using MTM to benefit from the drop in prices of their own notes and bonds, since the rule also applies to liabilities. And when the value of the securitized loans they held was soaring, they eagerly embraced MTM. Once committed to that accounting discipline, though, they were obligated to continue doing so for the duration of their holding of securities they've marked to market. And one wonders if they are as equally willing to forego MTM for valuing the same illiquid securities in client accounts for margin loans as they are for their proprietary trading accounts?"
Further, Chanos notes that, in the current environment, you don't really want to trust the executives who mistakenly bought and held these instruments with telling you that their intrinsic economic value is actually much higher than the market thinks they are. He continues by observing,
In this, he echoes Anna Schwartz' views from her interview in the Wall Street Journal last October. That is, the crisis has never been about liquidity, but, rather, solvency and trust that banks are actually solvent, on a market-based valuation.
Until this is accomplished and enforced, once and for all, private capital will not flow to suspect financial institutions holding assets marked by fundamentally dishonest means.
The piece dissects, in greater detail than I have been personally aware, the mess that has become commercial bank accounting for CDOs, CMOs and other structured instruments.
Since mid-2007, I have believed that, either by Presidential Executive Order, FASB ruling, or Congressional action, existing mark-to-market rules should have been, and be, modified to allow cash-flow-based expected value to be used for non-trading structured financial instruments, especially those composed of mortgages or mortgage-backed securities. This belief is rooted in the fact that underlying performance, in terms of cash flows, may not necessarily be reflected in the prices of the securities into which such mortgages have been bundled.
Chanos, however, casts a very different light on the matter. In his opinion, banks have long-used market values on these instruments when they were rising, thus abrogating their ability to now declare them to be held for investment purposes,
"Financial institutions had no problem in using MTM to benefit from the drop in prices of their own notes and bonds, since the rule also applies to liabilities. And when the value of the securitized loans they held was soaring, they eagerly embraced MTM. Once committed to that accounting discipline, though, they were obligated to continue doing so for the duration of their holding of securities they've marked to market. And one wonders if they are as equally willing to forego MTM for valuing the same illiquid securities in client accounts for margin loans as they are for their proprietary trading accounts?"
Further, Chanos notes that, in the current environment, you don't really want to trust the executives who mistakenly bought and held these instruments with telling you that their intrinsic economic value is actually much higher than the market thinks they are. He continues by observing,
"According to J.P. Morgan, approximately $450 billion of collateralized debt obligations (CDOs) of asset-backed securities were issued from late 2005 to mid-2007. Of that amount, roughly $305 billion is now in a formal state of default and $102 billion of this amount has already been liquidated. The latest monthly mortgage reports from investment banks are equally sobering. It is no surprise, then, that the largest underwriters of mortgages and CDOs have been decimated.
Commercial banking regulations generally do not require banks to sell assets to meet capital requirements just because market values decline. But if "impairment" charges under MTM do push banks below regulatory capital requirements and limit their ability to lend when they can't raise more capital, then the solution is to grant temporary regulatory capital "relief," which is itself an arbitrary number.
There is a connection between efforts over the past 12 years to reduce regulatory oversight, weaken capital requirements, and silence the financial detectives who uncovered such scandals as Lehman and Enron. The assault against MTM is just the latest chapter.
Instead of acknowledging mistakes, we are told this is a "once in 100 years" anomaly with the market not functioning correctly. It isn't lost on investors that the MTM criticisms come, too, as private equity firms must now report the value of their investments. The truth is the market is functioning correctly. It's just that MTM critics don't like the prices that investors are willing to pay."
In effect, Chanos contends, correctly, I now think, that the banking executives who mistakenly created, bought and/or held these instruments, and were happy to take advantage of their rising market values, now want to call the whole thing off and claim that they really meant to hold them long term as investments.
In the time since I originally reflected on mark-to-market pricing and its modification, several investment and commercial banks have failed, no publicly-held investment banks of any size now remain, and several hundred billion dollars of financial service company writedowns have occurred, mostly related to the ever-falling values of mortgage-backed assets which were structured from now-suspect subprime home loans.
Chanos' major focus is really the need for those who initially benefited from the first blush of rising values from structured instruments to now be forced to take the pain of their falling values.
Up until a few months ago, I think I would have disagreed with him. Now, I don't.
The recent failures of WaMu and Wachovia have proven that Chapter 11, FDIC seizures, and orderly closures of banks can occur without undue damage to the economic or banking system. Since depositors are protected, and assets will be sold at market prices anyway, I no longer see a downside to Chanos' insistence that financial service firms mark to the tradeable values of instruments which they originally treated as, well, tradeable assets. Not investments.
The piece goes on to detail some of the more hilarious ways in which FASB is about to allow bank CFOs to 'value' assets such that nobody in their right mind will believe balance sheet values anymore.
Chanos ends his persuasive editorial by stating,
In this, he echoes Anna Schwartz' views from her interview in the Wall Street Journal last October. That is, the crisis has never been about liquidity, but, rather, solvency and trust that banks are actually solvent, on a market-based valuation.
Until this is accomplished and enforced, once and for all, private capital will not flow to suspect financial institutions holding assets marked by fundamentally dishonest means.
Tuesday, March 24, 2009
Yesterday's S&P Gains
7.1%! More than 54 points!
That's how much the S&P500 Index rose yesterday, allegedly in response to the Treasury's newly-unveiled TALF plan.
The knee-jerk interpretation has been that equity investors are all better now, just based on the terms of the new plan.
How else to interpret such an impressive and surely near-record S&P single-day gain?
Well, one way is to not interpret it at all, since it's just another one-day S&P performance. Since mid-February of 2008, here are the 10 best and worst single-day percentage performances of the S&P.
The total return of these 10 best days is +70.7%
Worst 10 days since February of 2008-
Total return for these 10 worst days is -69.6%
The total S&P500 return for the days included since last February is -39.4%.
Rather like my findings in this post from September of 2997, you can see that quite a bit of recent S&P return could be accounted for in these 20 days. I wouldn't be surprised if that post receives a lot of hits today.
My point is that there are plenty of examples, even in just the last 13 months, of similarly-extreme daily S&P percentage returns, either positive or negative. Yesterday's was only the third-best daily S&P500 return of the past thirteen months. The two best were both in excess of +10%. And the totals of the 10 best and 10 worst return days for the period were nearly identical.
Why would yesterday represent the end of a bear market and the start of a new bull market, whereas the two higher daily S&P return days in October of last year did not?
Our proprietary volatility measure went up- a lot- yesterday. It's now firmly above 3% for the first time this year.
Granted, the S&P rise since early March has resulted in the month's having roughly an 11% return thus far. But even that does not move our equity-market re-entry signal to anything remotely near indicating a switch from short to long allocations.
The past twelve months of S&P returns have, in total, been so massively negative, in such a dismal pattern, that it would take a lot more than just a good March, in our opinion, to indicate that equities are now poised for a monotonic upward move.
Consider my post yesterday. The Treasury plan for toxic assets has no impact on real economic issues such as consumer credit. Or corporate earnings, for that matter.
While many people are understandably happy about the S&P's dramatic gains yesterday, I don't see it as particularly noteworthy at this time.
Quite a few other performance measures would have to look different than they do now before we will buy calls, instead of puts, and see a long, rather than a short equity allocation.
That's how much the S&P500 Index rose yesterday, allegedly in response to the Treasury's newly-unveiled TALF plan.
The knee-jerk interpretation has been that equity investors are all better now, just based on the terms of the new plan.
How else to interpret such an impressive and surely near-record S&P single-day gain?
Well, one way is to not interpret it at all, since it's just another one-day S&P performance. Since mid-February of 2008, here are the 10 best and worst single-day percentage performances of the S&P.
| 10/13/2008 | 0.116 |
| 10/28/2008 | 0.108 |
| 3/23/2009 | 0.071 |
| 11/13/2008 | 0.069 |
| 11/24/2008 | 0.065 |
| 3/10/2009 | 0.064 |
| 11/21/2008 | 0.063 |
| 9/30/2008 | 0.053 |
| 12/16/2008 | 0.051 |
| 10/20/2008 | 0.048 |
The total return of these 10 best days is +70.7%
Worst 10 days since February of 2008-
| 11/5/2008 | -0.053 |
| 1/20/2009 | -0.053 |
| 10/7/2008 | -0.057 |
| 10/22/2008 | -0.061 |
| 11/19/2008 | -0.061 |
| 11/20/2008 | -0.067 |
| 10/9/2008 | -0.076 |
| 9/29/2008 | -0.088 |
| 12/1/2008 | -0.089 |
| 10/15/2008 | -0.090 |
Total return for these 10 worst days is -69.6%
The total S&P500 return for the days included since last February is -39.4%.
Rather like my findings in this post from September of 2997, you can see that quite a bit of recent S&P return could be accounted for in these 20 days. I wouldn't be surprised if that post receives a lot of hits today.
My point is that there are plenty of examples, even in just the last 13 months, of similarly-extreme daily S&P percentage returns, either positive or negative. Yesterday's was only the third-best daily S&P500 return of the past thirteen months. The two best were both in excess of +10%. And the totals of the 10 best and 10 worst return days for the period were nearly identical.
Why would yesterday represent the end of a bear market and the start of a new bull market, whereas the two higher daily S&P return days in October of last year did not?
Our proprietary volatility measure went up- a lot- yesterday. It's now firmly above 3% for the first time this year.
Granted, the S&P rise since early March has resulted in the month's having roughly an 11% return thus far. But even that does not move our equity-market re-entry signal to anything remotely near indicating a switch from short to long allocations.
The past twelve months of S&P returns have, in total, been so massively negative, in such a dismal pattern, that it would take a lot more than just a good March, in our opinion, to indicate that equities are now poised for a monotonic upward move.
Consider my post yesterday. The Treasury plan for toxic assets has no impact on real economic issues such as consumer credit. Or corporate earnings, for that matter.
While many people are understandably happy about the S&P's dramatic gains yesterday, I don't see it as particularly noteworthy at this time.
Quite a few other performance measures would have to look different than they do now before we will buy calls, instead of puts, and see a long, rather than a short equity allocation.
Monday, March 23, 2009
Meredith Whitney, Credit Card Lending & The Fed's Rumored Solution
Meredith Whitney, once of Oppenheimer, now on her own, wrote an insightful and thought-provoking piece on March 11th in the Wall Street Journal regarding consumer installment credit, i.e., credit card loan limits. She appeared that week on CNBC in support of her article.
As I write this, the S&P500 is up about 3.8% this morning, causing all matter of pundits to declare victory over recession and equity market doldrums. With this as a background, consider Whitney's contentions.
Whitney, who is regarded as a capable and generally accurate sell-side banking analyst, originally forecast credit card loan limit reductions of something like $2T. In her recent Journal piece, she wrote,
"Just six months ago, I estimated that at least $2 trillion of available credit-card lines would be expunged from the system by the end of 2010. However, today, that estimate now looks optimistic, as available lines were reduced by nearly $500 billion in the fourth quarter of 2008 alone. My revised estimates are that over $2 trillion of credit-card lines will be cut inside of 2009, and $2.7 trillion by the end of 2010."
This isn't just an isolated event. And it does seem to be a rather under-reported credit contraction story. But Whitney continues by explaining the implication of her forecast,
"Inevitably, credit lines will continue to be reduced across the system, but the velocity at which it is already occurring and will continue to occur will result in unintended consequences for consumer confidence, spending and the overall economy. Lenders, regulators and politicians need to show thoughtful leadership now on this issue in order to derail what I believe will be at least a 57% contraction in credit-card lines.
As I write this, the S&P500 is up about 3.8% this morning, causing all matter of pundits to declare victory over recession and equity market doldrums. With this as a background, consider Whitney's contentions.
Whitney, who is regarded as a capable and generally accurate sell-side banking analyst, originally forecast credit card loan limit reductions of something like $2T. In her recent Journal piece, she wrote,
"Just six months ago, I estimated that at least $2 trillion of available credit-card lines would be expunged from the system by the end of 2010. However, today, that estimate now looks optimistic, as available lines were reduced by nearly $500 billion in the fourth quarter of 2008 alone. My revised estimates are that over $2 trillion of credit-card lines will be cut inside of 2009, and $2.7 trillion by the end of 2010."
This isn't just an isolated event. And it does seem to be a rather under-reported credit contraction story. But Whitney continues by explaining the implication of her forecast,
"Inevitably, credit lines will continue to be reduced across the system, but the velocity at which it is already occurring and will continue to occur will result in unintended consequences for consumer confidence, spending and the overall economy. Lenders, regulators and politicians need to show thoughtful leadership now on this issue in order to derail what I believe will be at least a 57% contraction in credit-card lines.
There are several factors that are playing into this swift contraction in credit well beyond the scope of the current credit market disruption. First, the very foundation of credit-card lending over the past 15 years has been misguided. In order to facilitate national expansion and vast pools of consumer loans, lenders became overly reliant on FICO scores that have borne out to be simply unreliable. Further, the bulk of credit lines were extended during a time when unemployment averaged well below 6%. Overly optimistic underwriting standards made more borrowers appear creditworthy. As we return to more realistic underwriting standards, certain borrowers will no longer appear worth the risk, and therefore lines will continue to be pulled from those borrowers."
Clearly, this sort of consumer-lending risk management on the part of card issuers will have a dramatic effect on any economic recovery in the years ahead. According to Whitney, the use of credit card loan availability by US consumers is not uniform. She concludes her piece by noting,
"Over the past 20 years, Americans have also grown to use their credit card as a cash-flow management tool. For example, 90% of credit-card users revolve a balance (i.e., don't pay it off in full) at least once a year, and over 45% of credit-card users revolve every month. Undeniably, consumers look at their unused credit balances as a "what if" reserve. "What if" my kid needs braces? "What if" my dog gets sick? "What if" I lose one of my jobs? This unused credit portion has grown to be relied on as a source of liquidity and a liquidity management tool for many U.S. consumers. In fact, a relatively small portion of U.S. consumers have actually maxed out their credit cards, and most currently have ample room to spare on their unused credit lines. For example, the industry credit line utilization rate (or percentage of total credit lines outstanding drawn upon) was just 17% at the end of 2008. However, this is in the process of changing dramatically.
Without doubt, credit was extended too freely over the past 15 years, and a rationalization of lending is unavoidable. What is avoidable, however, is taking credit away from people who have the ability to pay their bills. If credit is taken away from what otherwise is an able borrower, that borrower's financial position weakens considerably. With two-thirds of the U.S. economy dependent upon consumer spending, we should tread carefully and act collectively."
I haven't read or heard of analysis similar to Whitney's elsewhere recently. I suspect it means that governmental economists are going to be seriously blindsided by this aspect of the banking system's reaction to recent events.
Of course, given Washington's actions and reactions over the past twelve months, beginning with the handling of Bear, Stearns' collapse, you can probably count on the following solution to this forecasted dramatic contraction of consumer credit card lending capacity.
Look for the current administration to step into frozen, shrunken consumer installment lending with Fed-issued credit cards.
I understand that, even now, prototypical card designs are being circulated, much like a Capital One card customization package. Available designs from which a Fed credit card holder could choose would include: the current President, Fed Chairman Ben Bernanke, and Treasury Secretary Tim Geithner behind a motif of jail bars.
It wouldn't surprise anyone, would it? A Fed-backed credit card for otherwise-cardless consumers would seem to be the last, logical extension of Federal credit guarantees which began with Bear Stearns, led to AIG, the TARP, GM and Chrysler/Cerebrus bailouts, mortgage forgiveness, cramdowns, and, now, this week, the TALF.
Everyone, it appears, will receive their bailout, including ordinary consumers whose credit lines have been cancelled by prudent private lenders.
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