Do You Believe Borrowing Leads to Prosperity? (Part 2)

|
 |  Includes: AXP, BAC, C, COF, DFS, F, GM, HSBC, JPM, MA, USB, V, WFC
by: James Quinn

<< Return to Part 1

Credit Card With No Limit

I'll need a credit card that's got no limit
And a big black jet with a bedroom in it

Rockstar – Nickleback

We all deserve to live like rock stars. We just need a credit card with no limit. If you can’t get one credit card with no limit, get 20 credit cards with a $10,000 limit on each and the sky’s the limit. According to myfico.com, the average consumer has a total of 13 credit obligations on record at a credit bureau. These include credit cards (such as department store charge cards, gas cards, and bank cards) and installment loans (auto loans, mortgage loans, student loans). Of these 13 credit obligations nine are likely to be credit cards and four are likely to be installment loans. Between 1980 and 2000 13.5% to 15.5% of American’s disposable income went towards debt payments for mortgages, credit cards, auto loans and personal loans. From 2000 until 2008, with the help of the Federal Reserve, the top 10 credit card issuers, the auto financing arms of GM, Ford (NYSE:F) & Chrysler, and President Bush’s defeat of terrorism by buying an SUV cheerleading, consumer debt payments skyrocketed to 18% of disposable income. Disposable personal income in 2008 was $10.6 trillion. Therefore, consumers paid $1.9 trillion towards debt obligations. To achieve normalcy, consumers will need to reduce their obligations to 15% of disposable income. This would require a reduction in debt payments of $300 billion. A massive consumer deleveraging will be required to reach this level.


Click to enlarge

President Obama, Ben Bernanke, and Timmy Geithner need the consumer to keep doing their part in this colossal Ponzi scheme. They want consumers to borrow and spend as if nothing has happened in the last 18 months. Consumer spending has accounted for 70% of our $14 trillion GDP, or close to $10 trillion. In order for the Americans to have a chance at a decent standard of living in their old age, they will need to reduce annual spending by $1 trillion per year and use that money to pay off debt. According to the Nilson Report at the end of 2008, Americans' credit card debt reached $972.73 billion. That number includes both general purpose credit cards and private label credit cards that aren't owned by a bank. The average outstanding credit card debt for households that have a credit card was $10,679 at the end of 2008. To get consumer debt as a percentage of GDP to a manageable level of 13% will require deleveraging in the neighborhood of $700 billion. This doesn’t include mortgage debt. These aren’t the green shoots you’ll hear from Larry Kudlow.


Click to enlarge

You may think all of this credit card debt is spread throughout the banking system. Wrong my friend. According to the Nilson Report, the top 10 U.S. credit card issuers held an 87.6% market share of $972.73 billion in general purpose card outstanding in 2008. That includes Visa (NYSE:V), MasterCard (NYSE:MA), American Express (NYSE:AXP), and Discover (NYSE:DFS). See if you recognize any of these fine institutions.

General purpose credit card outstandings market share 2008

Bank Taxpayer Funding
  1. JPMorgan Chase (NYSE:JPM) - 21.22% $25 bil.
  2. Bank of America (NYSE:BAC) - 19.25% $52.5
  3. Citigroup (NYSE:C) - 12.35% $50
  4. American Express - 10.19% $3.4
  5. Capital One (NYSE:COF) - 6.95% $3.6
  6. Discover - 5.75% $0
  7. Wells Fargo (NYSE:WFC) - 4.21% $25
  8. HSBC (HBC) - 3.47% $0
  9. U.S. Bank (NYSE:USB) - 2.14% $6.6
  10. USAA Savings - 2.02% $0

These 10 banks control virtually the entire credit card market. These 10 banks have taken $166 billion of taxpayer money while continuing to send out 5 billion credit card solicitations per year. The Federal Reserve demands these banks keep the credit flowing. Fitch's Charge-Off Index, which tracks the write-down of uncollectable debt by credit card firms, climbed 101 basis points to a record 8.41% in February. That eclipsed the prior mark of 7.52% reached in November 2005 during the spike in bankruptcy filings. Credit card delinquencies shot to a record high of 4.33% in February.

Meredith Whitney, the outstanding bank analyst, had this to say, "This is the most interesting topic for me out there, which is credit card lines. So, there are about $4.2 trillion in unused credit card lines. And there are about $840 billion of used credit lines. In the fourth quarter alone, half a trillion dollars of lines were cut from the consumer -- half a trillion. As Americans face layoffs and pay cuts, they're turning to their credit cards to make up the difference. These cuts in unused credit lines amount to cuts in compensation.” Her gloomiest forecast is for a 50% cut in unused credit lines. The cutting of credit lines and absolute need for consumers to reduce debt will put a lid on the consumer economy for the next five years.

Hilltop Houses Driving Fifteen Cars

'Cause we all just wanna be big rockstars
And live in hilltop houses driving fifteen cars

Rockstar – Nickleback

Americans love their cars. Americans are their cars. The impression of achievement and elevated social status are conveyed by the car you drive in the minds of many Americans. If you want your neighbors, friends, work colleagues and perfect strangers to think you are a success, just tool around in a $50,000 Mercedes SUV. This damn economy is forcing these socially conscious auto worshipers from following their normal two year trade up cycle. The result is that auto sales have plummeted from an annual rate of 16 million to a current rate of less than 10 million. These short sighted people have allowed the temporary psychological benefits of driving a car they can’t afford to outweigh their long-term financial future. Millions have made this choice. Now that the debt bubble has imploded, the government is pouring billions of taxpayer funds into the auto financing companies like GMAC to try and re-inflate the bubble. Only a fool would buy into it. Luckily, this country has no shortage of fools.

Click to enlarge

The great American consumer has changed their car buying habits over the decades. In the 1970’s they saved up the 20% down payment and then financed the remaining balance over 3 or 4 years. With an average loan of $4,000 to $8,000, the burden was not great. After 4 years, they owned the car free and clear. They would then drive their American built car until it fell apart, usually around 90,000 miles. In 2008, the average new car loan topped out near $30,000. In comparison, the median home price was $17,000 in 1970.


Click to enlarge

The $30,000 average car loan was made manageable by the “creative” auto financing arms of the Big 3 extending loans to 6 or 7 years. This worked fine for the trader uppers in our society. They wouldn’t be caught dead driving a 7 year old car. It was a beautiful deception. Car buyers deluded themselves that the debt didn’t matter and the car companies deluded themselves that the loans would be repaid. A perfect combination to sell 16 million cars per year for all eternity. When the return customer came into the dealership to trade up after two years, the dealers were perfectly willing to roll the unpaid loan balance into the new deal. Presto!!! We’ve got millions driving cars with a Loan-To-Value of 140%. How could this possibly fail? According to JD Power, there are now 6 million people who are underwater on their car loan. When this Ponzi scheme collapsed, car sales plummeted 40% and GM and Chrysler have been revealed as bankrupt disasters.


Click to enlarge

This brings us to the most irrational financial move anyone can make, leasing a car. Estimates are that 25% to 30% of all car sales have been leases. This is 4 to 5 million per year. The most leased cars in 2008 according to LeaseTrader.com were:

MSRP
  1. BMW 3 Series $40,000
  2. Mini Cooper $25,000
  3. Mercedes C Class $35,000
  4. Toyota (NYSE:TM) Camry $25,000
  5. Cadillac CTS $40,000
  6. Mercedes SL Class $50,000
  7. Land Rover LR3 $50,000
  8. Lexus IS 250 $35,000
  9. BMW X Series $40,000
  10. Mercedes GL Class $60,000

This list substantiates that most people’s need to appear more successful outweighs the benefits of living within their means and saving for the future. Personally, I want to be financially secure rather than appear to be financially secure. I’m evidently in the minority. A car loan payment over four years that would normally be $399 a month can be $249 a month with a lease, which is very appealing to those who insist on driving a new car. The difference is that you own the car after four years with a loan. With a lease you become an indentured servant, forever indebted to the car company master. The financial reasons for not leasing are numerous:

  1. A lease starts a trend of perpetually paying a car payment. If you never paid a car payment and the average car payment in America was $350 a month, putting that $350 a month in a mutual fund that made 10% would become $791,171 in 30 years.
  2. If you get in an accident and the vehicle is totaled, you’ll still be responsible to pay back the full lease contract amount. Even if the insurance company gives you back less than what you owe to the dealership, you’ll be responsible for the full amount.
  3. Many times, the lease agreement will be for 5 years/60,000 miles. So, if you go over that 60,000 and keep it until the 5 years is up, you’ll pay a penalty for every mile over 60,000 miles. Most people use well over 12,000 per year.
  4. If you lose a job or experience a heavy time of financial hardship and cannot afford the payment anymore, the dealership will recover the car, sell it an auction, and if they sell it for less than you owe for the lease agreement, you will be legally responsible to pay the difference.
  5. The car is not yours, yet they still make you pay for the maintenance of it. Again, you can’t claim the car as an asset. It is technically still an asset of the dealership that leased it to you.
  6. If you decide to take the option to buy the car at the end of the lease term, you’ll have paid much more than the cost of the car even if you had financed it.

In order to get ahead in life you need to invest in assets that appreciate, not depreciate. Does the appearance of wealth and success really outweigh actually being wealthy and successful? Driving a $50,000 car doesn’t guarantee happiness. If it did, we’d be the happiest country on earth. Looking marvelous is a shallow, shortsighted way to go through life. That is fine for those who choose that route, but I’m tired of picking up the pieces of their shattered lives with my tax dollars.

Illusions

The biggest and most dangerous illusion for Americans today is that everyone deserves to be a winner. Everyone does not deserve a trophy just for playing. If you screwed up, didn’t work hard, didn’t save for a rainy day, and didn’t save for your retirement, then you lose. The winners studied, worked hard, lived within their means, and saved for the future. The winners have the option to help the losers through charitable means. If the government forces the winners to pay for the bad choices of the losers, our economic system is worthless. This is the reason that anger is building in the country. The Tea Parties were not about taxes. They were about anger towards our government for rewarding the profligate at the expense of the frugal.

Comedian Andy Kaufman died in 1984 at the age of 35 from lung cancer, even though he never smoked a day in his life. Did he really die? Did we really put a man on the moon? Andy was the master of illusion. Audiences never knew whether he was serious or joking. Next time you are at a truck stop take a look around. Andy might be there with Elvis. The American government and its citizens have to get over their illusion that they can spend their way to prosperity. According to Zillow.com 33% of all homeowners with a mortgage owe more than the home is worth. At least 67% of all homeowners with a mortgage have 15% equity or less in their homes. The average household has $23,000 of consumer debt. Six million car “owners” owe more than the car is worth. The median 401k balance is less than $15,000. Any economic recovery that is dependent on consumers to borrow and spend will just be a fool’s errand. The illusion of prosperity is coming to a tragic end.

Hey Andy, did you hear about this one?