BofA Slowly Implodes

On Friday I wrote this post concerning banking analyst/fund manager's latest Tom Brown's latest comments praising BofA. Brown has been doing this ever since he put his fund's investors into BofA equity back in the spring of this year. I've written several pieces describing his various appearances on Bloomberg television shilling for his positions.

Yesterday came fresh news regarding Bofa's growth prospects. It announced the sale of its Canadian credit card portfolio, part of the expensive business it acquired from former credit-card segment leader MBNA, to Toronto Dominion Bank.

But that's not all. In the same Wall Street Journal article on this sale, BofA disclosed plans to sell several of its European card portfolios, as well.

Now, I distinctly recall Tom Brown talking last week about how much BofA was going to be growing earnings in the future.

But when a bank sells credit card portfolios, it's a signal that the bank is in serious trouble. Never mind the excuse BofA gave- to focus on other management issues.

Credit card lending is a core bank business. It's a bread-and-butter consumer business. A key component of relationships with consumers.

For BofA to be auctioning off its overseas credit card portfolios is to basically concede the final loss of international business which began with Sam Armacost's initial troubles back in the 1980s. Back then, BofA began dismantling its overseas network, then one of only three among American money center banks.

Since growth in the US, a developed economy, is probably going to be slower than overseas growth, BofA is essentially withdrawing from the sort of growth opportunities which Tom Brown promised would be coming in just a few years.

It's understandable, with similar examples among large US banks now over 20 years old, that many pundits and analysts aren't comprehending the gravity of this latest BofA move. But I vividly recall credit card portfolio sales as a harbinger of the decline of commercial banks. The resignation of a bank's management to balance sheet problems by, in effect, selling the silver to meet the mortgage payment.

That's what BofA is now doing.

Elizabeth Warren's Suspect Research On Personal Bankruptcies

Back at the end of September, Todd Zywicki wrote a lengthy article concerning Consumer Financial Protection Bureau head Elizabeth Warren. He focused on her rather checkered history researching alleged consumer financial bankruptcies. Zywicki teaches contract and bankruptcy law, as well as editing the University of Chicago's Supreme Court Economic Review, so he would seem to be familiar with some of the data Warren used in her studies.

Here are some of the passages from Zywicki's editorial,


"By appointing another White House czar to avoid Senate confirmation, the administration politicized the powerful new bureaucracy from its birth. And by appointing an individual with a track record of using questionable research to advance policy ends, it has jeopardized the second goal as well.



Consider Ms. Warren's much-ballyhooed study on the alleged link among health problems, medical expenses and personal bankruptcy filings. Published in the February 2005 issue of Health Affairs, the report was timed to head off bipartisan bankruptcy legislation that was enacted later that year. Ms. Warren and her co-authors claimed that "at least" 46% of personal bankruptcy filings in 2001 (the year from they collected the data) were the result of "medical causes," and that this represented a 23-fold increase over 20 years.


Both conclusions are extremely suspect. First, the study provided an implausibly broad definition of "medical bankruptcy"—including any filer who reported uncontrolled gambling, drug or alcohol addiction, or the birth or adoption of a child.



Equally dubious, the authors classified a bankruptcy as having a "major medical cause" if the individual had accumulated more than $1,000 in out-of-pocket medical expenses (uncovered by insurance) over the course of two years prior to filing—regardless of income, and even if the debtor did not cite illness or injury among the reasons for bankruptcy.


In 2001, average per capita out-of-pocket medical expenses were $683. During the two-year period Ms. Warren and her co-authors studied, in other words, Americans spent an average of $1,366 on uninsured medical expenses, or 30% more than their threshold definition of a "major medical cause." There was no larger context for their threshold figure: A debtor with $1,001 in uncovered medical expenses and $50,000 on a Saks card would constitute a "medical bankruptcy" in their study.


The claim of a 23-fold increase in medical bankruptcies was based on a comparison of their 2001 data with Ms. Warren's research in a 1981 study—which appears to count only those who self-reported as having filed bankruptcy for medical reasons. This is a completely different and much narrower definition of "medical bankruptcy" than the one she used 20 years later, and obviously inflates the increase.


In contrast to Ms. Warren's studies, a battery of analysis, including research done by the Department of Justice's Executive Office of the United States Trustee (which oversees the administration of bankruptcy cases), and by David Dranove and Michael Millenson of Northwestern University, concluded that fewer than 20% of bankruptcies are caused by health problems or medical expenses."

This is pretty troubling, isn't it? Just what is Warren's claim to expertise in this area, if her research is demonstrably flawed, poorly designed, and seemingly deliberately misleading. Warren comes across as having her conclusion in mind, and jamming the data into whatever classifications were required to support those a priori conclusions.

Zywicki further wrote,


"Last year Ms. Warren and her co-authors were back with an even more dramatic study, in the American Journal of Medicine, timed to promote President Obama's health-care reform law. Drawing on 2007 filings, the authors concluded that 62% of bankruptcy filings were the result of medical issues and that the odds that a bankruptcy had a medical cause had doubled between just 2001 and 2007. This study was also flawed.



After Congress made it harder for people to skip out on their debts in 2005, the number of bankruptcy filings plummeted. In 2001, the year Ms. Warren used for the first study, there were 1,452,030 personal bankruptcy filings; in 2007 there were 822,590. Even if we are to accept the methodologies of the two studies for the sake of argument, there were 670,838 "medical bankruptcies" in 2001 and 510,828 medical bankruptcies in 2007—a drop of 160,000 per year. Yet Ms. Warren's article nowhere acknowledges that the absolute number of bankruptcies and purported medical bankruptcies declined.


Concerns about Ms. Warren's presentation and interpretation of data have been longstanding. As I wrote in these pages in August 2007, her book "The Two-Income Trap" willfully ignores the obvious in her own data: that spiraling taxes—and not living expenses—were a major cause of middle class financial woes.


Similarly, reports of the Congressional Oversight Panel of the Troubled Asset Relief Program (TARP)—a panel of which she was chair—uniformly treated home foreclosures as the result of bank fraud and the bullying of helpless homeowners. Fraud and bullying there was, but her panel consistently ignored the many foreclosures that have resulted from a homeowner's strategic decision to walk away from a house whose value has fallen below the amount still owed on the mortgage. Economists and housing analysts widely agree that a substantial number of defaults occur for this reason. That reality is largely absent from the TARP panel's reports."

It's quite distressing to learn that Warren, a darling of Washington's liberals, has basically twisted facts and done shoddy research, published just in time to affect some key legislation which will continue to cause unintended consequences for years to come.

The Emerging Congressional Credit Score Fiasco

While watching CNBC this morning, I was shocked to see/hear a debate involving, I believe, a House member, and another guest, concerning a bill to shield consumer credit scores from the effects of mortgage modification.

We saw, in 2007 & 2008, what happened when credit rating agencies dumbed-down their ratings for CDOs and various mortgage-backed instruments. It resulted in a catastrophe as many investors, overly reliant on ratings from S&P, Fitch or Moodys, simply took AAA ratings on faith and bought instruments which later were found to perform far below the expectations of their credit ratings.

Now we have Congress trying to whitewash consumer credit scores.

The argument put forward by the Congresswoman on CNBC was that mortgage modifications are simply contracts between two consenting parties, and, therefore, involve no forgiveness nor default or delinquency on any loan.

The argument against allowing this hiding of true consumer credit history is that any modification is, in fact, the failure of the consumer to honor the terms of the original contract and, thus, be in default or delinquency on an instrument to which they were a party. Additionally, it's very disingenuous to say that banks are doing modifications out of their own free will, when, in fact, the current administration coerced banks into suspending foreclosures and offering modifications, instead.

So we have yet another situation in which the federal government is attempting to alter useful private industry measures and practices, distort reality and rewrite history.

Combined with the recent FINREG bill, this should add impetus to financial institutions to back away from lending to all but the best-collateralized, least-risky consumers.

Everybody else, especially those with anything approaching a middling, sanitized credit score, will probably be denied credit.

I guess this proves that Congress has learned nothing from the recent financial sector meltdown and its own role in the mess, via Fannie, Freddie and too-complex regulatory processes.

Can we say "unintended consequences?"

Meredith Whitney On Financial "Reform," Small Businesses & State&Local Governments

Meredith Whitney wrote a simple, elegant editorial yesterday in the Wall Street Journal entitled The Small Business Credit Crunch.

In it, she drew a fairly short, straight line from the current Senate financial sector regulation bill to higher-cost or even unavailable consumer credit for use by small businesses. Added to that, Whitney noted how lower housing values have wiped out their use as a traditional small business financing source.

Thus, in her opinion, small business-based job creation, a traditional source of US economic expansion, will be crippled, as the small businesses face financing difficulties, as and should they desire to expand or be created.

To this already dark picture, Whitney added her prior views on municipal and state government budget shortfalls and, eventually, job cuts.

Whitney and former Merrill economist David Rosenberg each shared these views last winter on CNBC, from which I wrote the two linked posts.

Now, it seems that at least Whitney sees evidence of her predictions coming true and having meaningful consequences.

The punchline of her article is that the government job cuts will result in up to two million newly-unemployed at a time when Congressional legislative action will help dampen small business formation and/or growth.

Whitney believes it unlikely that large US businesses will turn around and hire nearly the same number of workers- three million- they just got finished laying off in the past three years.

Missing from the picture will be small businesses growing to take up the five million jobs they have cut in the recent recession.

Putting the pieces of the picture together, Whitney sees continuing jobless 'recovery,' with large businesses continuing to enjoy jobless productivity gains, small businesses crippled by consumer credit contraction, while municipal and state governments finally shed workers larded on in earlier expansions.

Hardly cause for optimism for a robust, high-employment recovery, is it?

Congress Plans To Ration Consumer Credit

This morning and afternoon, CNBC has had fairly extensive coverage of the new and expanded consumer finance regulations making their way through the Senate and headed for the House.

Among other features, the bill cuts debit card usage fees. The general effects of the bill are for Congress to exercise price controls over consumer credit providers. This will, of course, result in the rationing of credit to consumers.

Imagine lower-income consumers finally getting to the point of affording credit or debit cards, only to discover that they are no longer available to them, on prior terms, due to increased costs of regulation.

Yesterday's Wall Street Journal carried an editorial co-authored by Cliff Asness, founder of hedge fund AQR. His piece called attention to the very many vague and unspecified instances of language in the horribly-written Dodd financial 'reform' bill. Language making it unclear what is illegal and how penalties will be assessed.

Bill Isaacs, the former FDIC head, was on CNBC expressing his hope that more insane and unworkable concepts get added to the bill, thus making it completely incapable of being passed during this session of Congress.

Between the badly-written, so-called 'reforms,' public and legal attacks on investment banks, and, now, new attempts to curtail, proscribe and limit profitability of consumer lending, the recent federal government actions aimed at the financial sector point to less available capital or credit, higher costs of capital, and the effective rationing of credit and capital on non-price bases.

None of which are good things for our nation or its future economic growth.

The Myth of Consumer Over-Spending

Last week, I caught a few minutes of CNBC's morning program, Squawkbox, when a market strategist for, I believe, Citibank, Tobias Levkovich, made a clear and succinct statement regarding US consumer debt and spending.

Levkovich unequivocally stated that he had studied data over some longish period, perhaps the past 7-8 years, and concluded that the wealth created among consumers over that time vastly outweighed what had been borrowed against housing equity and on credit cards.

David Malpas, once the chief economist of Bear Stearns, is the only other prominent analyst to have noticed this.

Levkovich then addressed the many who consistently claim that US consumers simply 'used their houses as piggybanks,' and said they are wrong. That this is a myth and it's simply, clearly, wrong.

Counting On A Consumer-Led Recovery?

Yesterday's Wall Street Journal presented a chilling chart pertaining to consumer debt.

Since 70% of US economic spending comes from the consumer, that segment's ability to finance further spending would seem to have a lot to do with any imminent, sustainable recovery, would it not?

According to the chart, sourced from the Fed, consumer household debt as a percentage of disposable income has remained above 120% since roughly 2005.

Whatever increased savings have occurred in the past six months has had little impact on overall consumer indebtedness.

The visual in the chart makes clear how the rate of increase in this measure moved up from a clear inflection point in about 1999. Thus, we've had nearly a decade of pretty much monotonic growth in this debt/income measure.

That's not going to go away very quickly.

Since federal stimulus spending does not lead to the same quality of jobs as those in the private sector, recent jobless increases are only going to exacerbate this picture. Either spending will slow due to joblessness, or debt will be paid off, and savings will effectively rise. Both will hamstring consumer spending.

Don't expect a sudden lift to the US economy from domestic consumer spending anytime soon.

The Credit Card Business' New Inefficiencies

With the recent, hurriedly-passed legislation involving credit cards now law, it's reasonable to expect some major changes in the way that the providers of revolving, installment credit will do business.

Of course, the biggest change is going to be the rationing of credit at the high-risk end of the spectrum. Since the legislation limits the degree to which installment credit providers can recoup losses and offset risk with fees and interest rate changes, many lower-income or poor credit-risk consumers will simply be denied this source of credit at any price.

To those who would argue that this 'protects' such low-end consumers, let me remind them that nobody put a gun to anyone's head and forced them to accept and use installment credit. Charge-offs by banks of balances on excessively-risky accounts were the banks fault. But the incurring of the debt, and related fees for delinquency, etc., were the responsibility of adult consumers.

As an aside, this would seem to be an odd governmental policy in the midst of a recession, since consumer spending will, as usual, be a major engine of growth at some point. With less credit, there'll be less spending sooner.

At the other end of the spectrum, lower-risk credit customers now may see the return of annual fees on bank cards, as well as the disappearance of the 'grace' period. In return for harsher regulation of riskier credit consumers, the issuers were given leeway to eliminate that free 30 days in which a card user may carry a balance that is paid off in full by the required statement date.

I discussed this with a colleague recently, comparing thoughts about how this will cause unintended, currently-unforeseen consequences, as legislation like this typically does.

For example, in the last few years, probably like many of my readers, I've agreed to let some vendors apply a monthly charge to my credit card. Services such as a fitness club, TiVo, an online service provider, and Netflix, to name a few, use this business model.

Consequently, I would have an average monthly balance of over $200, which is currently paid in full, since I'd just as gladly write checks for these recurring expenses. In a world with no grace period, and a 20% annual interest rate, these charges will result in roughly $40 of additional financial fees. Add a $50+ annual fee, times two cards, and I might be looking at an additional $150/year of installment credit-related fees, with no change in my own financial behavior.

Multiply my experience by a few million consumers, and there'll be impetus for change.

My colleague thinks that several of these monthly services will quickly move to an annual, check-paid discounted fee option. The larger vendors, such as the fitness club, will probably offer a private-label credit card on which to charge their own service, at no annual fee.

Either way, though, there will be inefficiencies. In the case of the discounted annual fee, the funding is simply being moved back to me, with a small interest rate paid, via discount, for me funding the vendor for an extra eleven months.

In the case of the fitness club and any other vendor large enough to offer a private credit card, there's the added time and expense of writing another monthly check, plus stamps, which are no longer trivial.

Having worked at Chase Manhattan Bank for many years, I've always been leery of allowing direct access to my DDA account by vendors. If there is any problem whatsoever, the bank employees have zero motivation to make sure it is resolved. Any resulting damage to my credit rating will be borne by me, not the bank, nor its employees, and I'll have to spend my time to clear that up.

Thus, the net effect of this new installment credit legislation is likely to be substantially less credit extended, at any price, and a much more inefficient use of, and payment for credit by those still possessing revolving charge cards.

Hardly economic progress, is it?

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.

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.