Can the Economy Recover in the Midst of a Consumer Confidence Crisis?

Citigroup (C) announced plans to use $36.5bn of the $45bn in TARP funds it received for the purpose of lending in the following areas: $25bn in mortgages; $5.8bn for credit card loans; $2.5bn for consumer loans; $1.5bn for corporate loans; and $1bn for student loans.

CEO, Vikram Pandit, issued this statement: "Our responsibility is to put these funds to work quickly, prudently and transparently to increase available lending and liquidity." Furthermore, Pandit stated, "The government, on behalf of the American taxpayer, has invested in Citigroup…. We have an obligation to repay in ways that go well beyond the $3.41bn Citigroup will repay the government each year in dividends associated with its TARP investment, and a separate loss-sharing agreement."

It is reported that none of these TARP funds would be used for compensation, bonuses, dividend payments, lobbying, marketing, advertising, and corporate sponsorship.

On the surface, this seems appears to be a positive development. Could it be that other banks will follow Schitty Group’s lead? Most likely, the answer is yes. Banks make money when they lend it and these loans are resold or repaid and right now the financial markets are struggling to re-establish a healthy equilibrium of cash flows.

The TedSpread has come down considerably to suggest that the trust level amongst banks has improved. Actually, banks still do not trust each other, but they do trust the U.S. Treasury which is willing to insure almost $400bn of illiquid assets on banks’ balance sheets with OPM (other people’s money), e.g. taxpayers. To a certain degree, some of these perceived and real risks have been mitigated.

The lender of last resort has stepped up and right now no one seems concerned about the fact that there is no back-up plan for the back-up. Actually, there is a back-up plan. If you examine any form of U.S. currency, it clearly states "In God we trust" and apparently this is the real secret to operating and managing a fiat currency. God help us all, should this system ever collapse.

Now just about every criminal act of any great magnitude has its accomplice(s), intended or unwitting, unless you are Bernie Madoff (of course). In this instance, irresponsible greedy bankers have the immediate-gratification seeking American consumer as its accomplice in the current financial crisis.

However, the word on the street from the man on the street (latest Gallup polls) is that consumers are currently enrolled in a twelve step program and it may be premature to expect them to fall off the wagon anytime soon. Consumers are still too painfully aware of hitting rock-bottom and not enough progress has been made or enough time has passed to induce a false sense of self-control over their addiction to credit.

Monday’s Personal Income and Outlays economic report shows that consumers are holding on to their precious dollars. December 2008 spending declined for its sixth consecutive month, falling -1% after the previous month’s -0.8% reading. Faced with shrinking income and the prospects of rising unemployment trends, borrowing money without certainty of the means to repay it may curb the cravings for more debt. The American consumer has learned a hard lesson and the tuition for this education has been expensive, i.e. depleted home equity, foreclosures, bankruptcies, and ruined credit.

Therefore, one must ask if it is realistic for an economy that derives 3/4 of its GDP from consumer activity to recover in the midst of a such a consumer confidence crisis just because banks may be willing to lend again. Not!

This crisis in confidence will come to an end, but there needs to be a different catalyst. Perhaps the catalyst will come in the form of a stimulus package that creates sustainable new employment opportunities. This will take time and so will any other positive forces driving a recovery.

Furthermore, the global economy will need to recover as well, as it is clearly evident that the American consumer is vulnerable to another overdose of credit if other economies are not willing to indulge in a "moderately" excessive consumption habit.

Sources: Bloomberg, Reuters, Gallup and AP news

Disclosures: Hillbent.com, Inc. or its affiliates may own positions in the equities mentioned in our reports. We do not receive any compensation from any of the companies covered in our reports.

Comments

[AssetReset:]

Who is C going to lend $36.5B to? Although I understand Wall Street's propensity for not learning from past mistakes but one has to think that lending standards have been tightened.

$25B in mortgages? What if home prices drop another 20%? (there are NO reports I have seen the housing market has slowed is plummet). If they do fall another 20%, an 80%loan/20% equity mortgage would all ready be taking on water. 20% equity requirement is a conservative approach to lending.

I think these plans are just a PR move. Citi will continue to loan to well qualified debtors - 45B in TARP money did not change its business model, just its lending practices (hopefully). I think a majority of its planned "loan money" is going to sit on the sidelines, gaining interest.

"We want to loan this money, there are no qualified debtors..."

Feb 03 06:16 PM

[James Wilson:]

Fannie Mae had to resort to renting to slow the drop in home prices and keep people in their homes. A few homes on the Government Auction site were sold for $32k - inagine getting a $180k home in a Florida Subdivision for only $32k.

Why would consumers even think of buying a home when the oil refiners will not back off. Stories of the 5 oil refiners turning away oil shipment so they can keep a preceived shortage going and price high.

Consumers can't get a break !

IS THIS THE FACE OF ECONOMIC SLAVERY ??????

Feb 03 06:46 PM

[Timmothy Posey:]

Economic Slavery? Poor term, it's already been coined as indentured servitude.

Feb 03 06:50 PM

[Jolly_Rancher:]

Doesn't recession always bottom when consumer sentiment is in the tank? Why would consumers be merry at when things are at the their worst? I think the consumer being in the tank is more than just a debt issue. Sure consumer debt is high, but there's more to it. The fact is that more consumers are reaching retirement age at which time retirees typically reign in spending as they adjust to fixed income. The increase in savings rate also logically fits into this scenario. Therefore, I suspect that deflationary trends will continue into the next 10 years or so. Of course, the economy will have ups and downs during that time. But the trend in prices should be down. Also, in three or so years, as a large number of people enter retirement, these retirees will exit the labor force, which will put downward pressure on the unemployment rate. So things get better but only very slowy. Many people are looking for a V-shaped recovery; however, the picture I've painted is more of a roller coaster that has already seen its too highest peaks but still has a a lot of fun left in it.

Feb 03 06:52 PM

[RJMoran:]

Jolly Rancher/ the wealth 'hit' these retirees have recently taken also means they won't be skipping into retirement a 'la bon temps roulez'! (sic). That coaster may have less roll to it than you think...

Feb 03 07:32 PM

[fatcat:]

Citi is under pressure from the government...this is just more lies from the opaque banking sector..

Feb 03 07:34 PM

[Mr. Ed, Jr.:]

Not too long ago, Citi announced that they would be happy to help out their fellow Americans by renegotiating some mortgages. After all, we are all in this together, are we not ?
Now, more good deeds from the good-deed-doing bank.
If I was a suspicious or cynical person, I might suggest that this was, indeed, yet another PR move from a broke bank that knows they will soon be back asking for even more bailout cash.

Feb 03 08:22 PM

[Moon Kil Woong:]

Citibank, don't believe a lie they say. I'm sure they will loan the money out, to their existing customer base, not you and me. They need the money to pay off their trillion dollar derivative boo boos every quarter. Don't you want to cry for them. Poor Citibank.

If they want to do us a favor declare bankruptcy and open the books so we can get rid of the toxic stuff before it drops in value even further.

Regarding consumer confidence, it is a right response to pare spending in a downturn, especially since wages are falling and unemployment is a real possibility for many people. When the consumer wants to be thrifty we say its bad. But their actions are the same as businesses and financial institutions. It's self preservation. Until you can show a jobs and wage increase that isn't offset by immigration and inflation consumers should be wary. Too bad we didn't start cutting back a decade ago because that's about the time the average citizen started treading economic waters. The "lost decade" started in 2000. If we have another it will have to be named "lost decades".

Feb 03 08:56 PM

[PacificGate...:]

Consumers should ignore the commentary admonishing them of spreading “weakness,” and “lacking confidence.”

pacificgatepost.blogsp...

Stay the course.

Feb 03 08:57 PM

[Steven Hansen:]

"Therefore, one must ask if it is realistic for an economy that derives 3/4 of its GDP from consumer activity to recover in the midst of a such a consumer confidence crisis just because banks may be willing to lend again. Not!"

I do not think consumer confidence plays such a major role as the past. what i am trying to say is that the confidence is based more on reality than bar room talk. the confidence IOM will change rapidly if economic conditions change.

Feb 03 09:15 PM

[fatcat:]

The blame for the crash in consumer confidence can be placed squarely on the rise of gasoline to $4 per gallon.That was the beginning of the end for Joe Sixpack.

Like 9/11 without the planes...

Feb 03 10:59 PM

[Briggsy:]

You get it fatcat. How short our memories are. We could have continued to cling to that fragile leveraged branch indefinitely. But $140 oil was too strong a breeze. And when the bough broke, down came baby cradle and all.


On Feb 03 10:59 PM fatcat wrote:

> The blame for the crash in consumer confidence can be placed squarely
> on the rise of gasoline to $4 per gallon.That was the beginning of
> the end for Joe Sixpack.
>
> Like 9/11 without the planes...

Feb 03 11:39 PM

[John Lounsbury:]

I agree with Jolly_Rancher and The hand. I don't think I need to research the data and draw a graph to say that consumer confidence is either a coincident or trailing indicator in the economic cycle, especially with respect to the bottom of a recession.

Feb 04 12:33 PM

[derryl:]

Author Hill wrote,
"Actually, there is a back-up plan. If you examine any form of U.S. currency, it clearly states "In God we trust" and apparently this is the real secret to operating and managing a fiat currency. God help us all, should this system ever collapse."

The truth in a nutshell! Nicely put!

Consumers feel confident when they feel their income is secure. Consumers feel downright giddy when their income is steady AND the value of their houses, mutual funds and other assets seems to be reaching for the sky. So they feel comfortable taking on debt to increase their standard of living because everybody feels rich.

For most people their base income comes from employment (either self-employment or a job). For others it is rental income, dividends or other kinds of investment revenue. Right now none of these incomes looks very secure so people and businesses are retrenching; paying down debt and increasing cash savings. This is a perfectly rational response to income uncertainty and is what used to be called 'conservative' or 'prudent' personal financial management.

I think the Chinese savings rate is about 25% which they feel is prudent in a country with no social security backstop. On the downside, China will not be able to create the much hyped domestic consumer economy when the people save 25% of their income rather than spend 110% of it by borrowing like Americans and other G8 citizens have been doing. China will not be able to decouple from the US.

In a Jan.27 Financial Post column titled, 'Geithner is wrong on China trade', Bret Swanson makes a highly credible argument that, contrary to the idea that China has manipulated the yuan to keep it low, in fact China pegged the yuan to the US$ in 1994 to create an 'East Asian Dollar Standard'. This was an act of opening China to the Western market, not protecting itself. I quote, 'The dollar-yuan link allowed a real price system to arise in China and created a single economic fabric stretching across the Pacific.'

Swanson argues, 'The opposite of 'currency manipulation', this dollar standard was a victory for free trade and global growth. But US economists missed its portent. The Fed and Treasury of the late 1990s did not supply sufficient dollars to match rapidly growing global demand. A scarce dollar shot higher and hard assets fell. Oil plummeted to $10 a barrel, gold fell to $250 from $400, credit shriveled and dollar debtors across Asia went bankrupt. With an appreciating dollar and a world in turmoil, capital flooded into the US and especially our soft, intellectual assets--Cisco, Microsoft and dot-coms. The technology boom and bust was not a function of easy money but a scarce dollar.'

After 2005 when the US coerced China to raise the yuan in an attempt to close the trade gap, 'All these 'more competitive' dollars had to go somewhere, and with amazing efficiency found their way into oil and subprime mortgages.'

(when I finish this post I'll try to do another post with a link to the column; it's an illuminating perspective)

The upshot is that the world in general and China in particular needs a strong dollar and it needs sufficient quantities of those dollars to grease the global economy. Nixon notwithstanding, the dollar still is the world's 'gold'. The US can create those dollars for free and use them to pay trade deficits ad infinitum, unless and until the world decides to engineer a new currency regime like Bretton Woods II.

But in the meantime any move by the US to devalue the dollar in order to ameliorate the trade deficit only weakens the global economy and makes the trade deficit worse. Western economies will not revive until this function of the US$ is recognized and accepted by the Fed and Treasury; or until an alternate global currency anchor is established. The US does not and can no longer exist in 'splendid isolation'.

I quote, 'Robert Mundell--Nobel laureate, China expert, father of the euro and supply-side economics--continued to warn that the trade deficit was perfectly natural. Worry about currency instability instead.'

I think Swanson is right.

Feb 04 01:18 PM

[derryl:]

www.nationalpost.com/s...

That's a link to the article I quoted above. If it doesn't work go to financialpost.com and search >geithner is wrong on china trade<.

Feb 04 01:23 PM

[Larrysyr:]

"If you examine any form of U.S. currency, it clearly states "In God we trust" and apparently this is the real secret to operating and managing a fiat currency. God help us all, should this system ever collapse."

This is an especially unappealing backup plan...
Consider that God's "recessions" usually take the form of ice ages, bubonic plagues or World Wars. I think we can do better ourselves.

Feb 04 02:29 PM