Consumer Credit: An International Crisis

The global markets are finally catching on. The only thing that matters is the economy. Sure, the markets get excited about a new President or another bailout/stimulus package, but it always comes back to the economy.

Right now, the economy is in bad shape and getting worse. And the markets are just realizing it…again. The worst part is, two of the three sources of consumer spending power, housing and stock market wealth, have dried up.

Housing Wealth

The drop in housing prices is already starting to have an impact on equity extractions as well. The “your house is an ATM period” is over. Equity extractions are when consumers tap home equity lines of credit, second mortgages, or any other type of borrowed money against the equity value a homeowner has built up.

Net equity extractions from U.S. homeowners fell to about $10 billion last quarter. This is down tremendously from 2004 through 2006 when homeowners would extract about $160 billion in equity value each quarter. Moreover, it’s not going to change anytime soon.

If we consider the stock market as a bellwether of expectations, we can see the real estate market won’t be coming back anytime soon. Just look at how rough it has been for over-leveraged REITs over the past year. The housing wealth source has all but dried up.

Stock Market Wealth

The Dow, S&P, Nasdaq, commodities and emerging markets are all way down. Trillions of dollars in wealth have been eliminated. When your average consumer pulls up their brokerage or 401K statement and sees nothing but red, they’re not thinking this is the time to upgrade washing machines, TVs, or get a new car.

Credit Card Wealth

We’ve known all that for a while and the impacts on consumer spending have been expected. Now, the third source of consumer spending power, credit cards, is collapsing as well.

As we warned in mid-October in Why Market Rallies Won’t Last, credit cards are the last great source of consumer spending power. However, they won’t be for long:

The last hope for keeping consumers temporarily afloat is credit cards. All signs point to this source being completely dried up.

Over the past few weeks credit card companies have slashed the amounts they are willing to lend to risky customers. Most of them won’t even open up new accounts for high-risk individuals, and they cut their marketing budgets. According to CBS News, HSBC (HBC) sent out 54% less direct mail advertisements and Citibank (C) has sent out 45% less.

The credit card issuers have become risk averse. They are finally limiting the total credit available and the amount of customers they’re willing to take on. Credit card spending, the third leg of American ‘wealth’ is going away too.

On Wednesday, we got the worst news of all: The private sector is no longer willing to lend to credit card issuers.

For the first time in 14 years, no one has been willing to buy bonds backed by credit card loans. This is huge news that is just one sign of the continuing decline in credit card lending.

You see, credit card issuers like Bank of America (NYSE:BAC), JP Morgan Chase (NYSE:JPM), and American Express (NYSE:AXP) lend money on credit cards. Then they bundle those loans up and sell them off to institutional investors like insurance companies, hedge funds, and mutual funds looking for income. That way they can lend more and more without taking on much of the consumer debt or the risk themselves.

The institutional investors like the debt because they would get a greater rate of interest in exchange for the greater risk. Now, they consider the risk isn’t justifying the reward of a few extra bucks in interest payments.

Now that no one is willing to buy it, the banks and credit card issuers will be forced to curtail lending even more. It’s all part of the downward spiral of credit contractions. This is a just a sign the last great source of American consumer spending power is drying up.

It’s Not Just an American Problem

India is facing similar problems with its formerly debt-loving middle class. Livemint.com reports:

[Indian] Bankers said the trend has intensified in recent months and the portfolio may have shrunk by about 10% this fiscal year so far. This is significant, as the industry has seen growth at an average 30% in each of the past four years.

The percentage of non-performing assets, or NPAs, in banks’ credit card portfolios has almost tripled, going up from 5-8% in fiscal 2008 to 15-20% in the current fiscal. NPAs are the portion of the credit card portfolio where a customer has not paid dues for at least 90 days.

It’s getting pretty bad in India and leading Indian banks like ICICI Bank Ltd. (NYSE:IBN) are also going to have lots of problems to deal with. However, it's not just India, Mexico is also having its own issues with consumer credit.

Wal-Marts (WMT) in Mexico, who extend credit to their customers, are starting to take measures to limit the risks associated with consumer lending. Last week, Mexico’s Wal-Marts upped the interest rate on the credit they extend to customers to 70% per year.

It’s tough to imagine too many consumers willing to pay that kind of interest rate to buy anything other than absolute essentials.

The Impact

Credit cards are the final source of U.S. consumer spending power growth. We both know that is not an option.

This spells even more bad news for an ailing U.S. economy. Nothing will be turned around for good until the employment situation starts to improve. Until then, there are plenty of trading opportunities for a volatile market but cash is still probably the safest place to be for the short term.

Disclosure: None

Comments

[James Wilson:]

NO BAIL OUT FOR SWISS BANK UBS WITH U.S. TAXPAYERS DOLLARS

2008 Nov 07 07:52 AM

[James Wilson:]

C started limiting credit cards and cutting amountsd 2 years ago. They also add and extra 1 % to the credit default account incase.

C has a lot of people fooled wait and see.

2008 Nov 07 07:54 AM

[je:]

Andy,
If you are serious about being a financial writer then you are goin to have to be serious about your subject matter and its content.
For example: the Canadian energy trusts are of overwhelming interest to most of us. What is the politcal climate telling us?
For example: I have been looking at Annaly(NLY). They seem to play on the interest rate differentials in the market. I would like to know exactly what and how they do that.
That is just a couple of items that readers would be grateful for good - GOOD- information.

Stop writing what everyone knows. It looks as though you are auditioning for a job.

2008 Nov 07 01:34 PM

[SwingTimer:]

Andy,
Don't let user 52095's comments influence you adversely. I've read many of his comments - enough to get a measure of his "sophistication" - and I'd say he falls somewhere between an idiot and a moron. Your article was great in that it portrayed the broader picture of the difficulties facing the consumer, the financial industry, and (by inference) the retailers. That's one reason why I have you in My WatchList. Investors with a proper frame of reference can take it from there (excluding 52095, of course).

2008 Nov 07 04:16 PM

[Sharat:]

The India statistics are a red herring. for a start, Indian banking regulation allow for allocation of only a certain amount of capital to be allocated towards unsecured consumer lending, credit card debt and what not, if defaults doubled, Indian banks would survive because by law the have only so much to lend.

What The big domestic banks and their international peers have been doing in their rush to grab market share in an emerging market which has been growing at a clip of 9% for the last 5 years is compromising on the credit quality of their borrowers, and they are starting to see the problems associated with growing a lending portfolio that way. This would have happened in that country regardless of the the larger global crisis. The effects are limited however, International banks, who are the main indian card issuers along with ICICI and HDFC to begin with were thrilled at the rate of growth in their unsecured portfolio, are now chastised because credit quality was obviously low, the unsecured portfolios did not generate profits. Indian retail bankers have been chastened and as a result they are now getting stricter, in their standards, but this trend is a function of India's grwoth and avarice on the part of banks to participate in that growth, like the mortgage meltdown it was always going to happen, unlike the latter no houses are going to be brought down, because of it., There will be no banks that fail in India,

2008 Nov 08 08:20 AM