Warning: The Coming Credit Dislocation

I have reason to suspect that the "monetary transmission mechanism" is full of rocks (again), and we are about to have another instance of what could colloquially be called "fun." (Yes, that's sarcasm.)

Here's what we know and what I can deduce from it:

• JP Morgan's "cash position" was analyzed by a writer who published on SCRIBD, which showed that actual cash held has deteriorated radically. By more than half in the last year. The deterioration is continuing, not slowing.
  
• I am hearing repeated anecdotes from multiple areas that foreclosed property held by banks with multiple full-price offers that include a financing requirement are being sold instead to people with actual cash at radical reductions from that price. This implies that these financing contingencies are regarded as not only potentially no good but factually no good, as if the banks know for a fact that the credit pipeline will (not might), within weeks or months (in the time required to close), disappear. There is no other rational explanation for this behavior.
  
  
• Citibank's credit-card terms change implies a willingness to accept and even provoke a complete and intentional destruction of their credit card business as a very high probability outcome, given that nobody in their right mind will accept a 30% interest rate who has an alternative. The obvious implication is that only those who can't transfer balances out will remain and if your credit is that impaired there's a good chance you will default - either intentionally or otherwise. This too implies foreknowledge of a near-complete impending freeze in the credit markets.
  
  
• The change in terms on credit accounts is NOT confined to Citibank. I have received a fax from a customer of Infibank with substantially identical terms, in which both the standard and penalty rate was adjusted to 29.99%. This strongly implies that whatever Citibank smells the problem is not confined to them.
  
  
• Both of these credit card "adjustment" letters are of course marginal rate changes. That is, they are both based off the PRIME rate. The importance of that is missed by many. Don't be one of them (more on that below.)
  
• I recently received a back channel communication indicating that The Fed is aware that this has been and still is a solvency problem and has so briefed certain members of Congress. This from a source believed reliable, but which cannot be independently confirmed.

This data is not conclusive. But - if you are dependent on credit access and these anecdotes are in fact indicative of actual knowledge of an impending lock-up you are at grave financial risk.

Note that "margin" type rates that are based on the PRIME rate could hurt you far worse than you believe. With PRIME at historic lows should any such dislocation spike the prime rate your interest rate could go much higher with little or no notice or ability to do anything about it.

IF this is going to manifest as a dislocation of some sort it will probably occur within the normal closing window for real estate transactions, since the anecdotes related to that have the best-defined "reach", and the discounts being accepted to avoid this risk are massive to the point of denoting near-certainty of this event in the minds of the market participants who are electing to accept these cash-discounted offers.

Therefore, if you are dependent on such credit access I would take immediate action to do whatever is necessary to mitigate, to the extent you are able, the consequences of such a dislocation.

Consider how you survive returning to what essentially amounts to a cash economic posture in your business and personal life.

Note that the indications above are far stronger than what we saw going into last fall before the wheels came off. As a consequence if these actions are those of people with real knowledge (and this is not a guess on their part) I would expect the outcome to be worse than what we saw last fall in terms of economic impact.

Those who are short dollars (synthetically or in the actual market) need to beware - if I am reading this correctly you're about to get a really ugly surprise.

If you want to speculate on this outcome levered bets on radical dollar appreciation look like one of the best choices out there, followed closely by bearish levered bets on commodities. I would not consider such a speculative play that is not characterized by defined risk, as this analysis is based on nothing more than observation of behavior by market participants that all point toward their foreknowledge of an event that might happen in the reasonably-near future and is not, at present, backed up with actual significant credit-spread widening or other objective criteria.

Disclosure: Initiated a small speculative, defined-risk play LONG the US Dollar (UUP CALL options for March 2010)

Comments

[Michael Clark:]

Jesus, Karl. I do believe you are one of the angels blowing a trumpet. I expect there will be more.

Oct 23 12:48 PM

[ebworthen:]

Karl,

Thanks for the information, I believe it.

The other side of this coin is the moral hazard engaged by the FED and Politicians bailing out the banks, insurance companies, automakers, etc.

Implicit in the bailouts was the moral equivalent of sanctioning indebtedness, bankruptcy, insolvency, and default as a means to acquire more capital or speculate with the capital defaulted on.

This signal was not lost on the average person. If the banks and the government can do it, why not them? I am not condoning this, simply pointing out that the word on the street is that you can default on your home mortgage or credit card and it will be forgiven, reduced, or delayed. Word of mouth has spread that your $25,000 credit card bill will be forgiven for $5,000 or less and that the bank will let you stay in your house to maintain it and not have the foreclosure show on their books. Or, refinance via Fannie/Freddie at 3% down.

The unintended consequence of the bailouts is many people are following the example set. "Do as I say, not as I do" doesn't work for leaders anymore than it does for Parents.

Oct 23 01:09 PM

[Bronze pencil:]

Hell will freeze over before the credit-markets will.

If this was a matter of national security and it was dependant only on US asset leverage, then yes, the rulebook would have to be rewritten. But this is a Too Big to See Their Feet problem- they'll tap Quantitative Supplies from other currency blocks for Trading purposes.
What you're observing is the not lack of liquidity- instead it's a trend which has finally matured: there is little interest in Consumer-side Banking amongst the Ugly Sisters.
As for insolvency fears at the Fed, that remains the Golden Goose.

Oct 23 01:18 PM

[socrateaz:]

I think you need to avoid needing credit for the near future. The basic terms can usually be acceptable but the just incase crap tied to it will move you from in some trouble to serious trouble quite quickly. If the credit givers have control they will take it and take advantage of it!

Oct 23 01:32 PM

[ryanclarke:]

If the Fed doesn't do something about dollar weakness some time between November 2009-March 2010 ... so U.S. oil and gasoline stockpiles can be increased this winter ... hopefully filled to the brim just like last year ... there will be shortages of gasoline in the U.S. sometime in the summer of 2010. Look at the historical EIA data. For the past five years U.S. oil products (diesel) exports have increased and U.S. oil product (gasoline) imports have DECREASED .... very much so in the past two months ... which is why gasoline is being withdrawn from U.S. stockpiles at a rapid rate ... a repeat of the fall of 2007.

Oct 23 02:16 PM

[Iconoclast421:]

Oh my gods!! Another "so it begins..." thread from Karl! Looks like it is once again time to buy Citi $5 calls!

Oct 23 02:26 PM

[Jasper M:]

I think Karl slightly overstates the case - but only slightly.
The banksters in question have looked into the Abyss, recently, and many of their number probably awaken screaming from dreams of armageddon. That's plenty of reason for them to over-prepare for the next 'event'. Which is coming. Oh, yes, it's coming.

Come to think of it, the whole thing might be a top-down issue: If the Administration is clever enough to se that Fannie and Freddie need to be put down, they know there will be trouble attendant to that, so they might warn their pet zombies to brace for impact.

Oct 23 05:31 PM

[Andrew Butter:]

So do you reckon the long term Treasury rates are going to go up?

Oct 23 06:02 PM

[lower98th:]

>Consider how you survive returning to what essentially amounts to a cash economic posture in your business and personal life.<

Why have only participated in the market with a 1/3 asset allocation? Because as small business owners, the actual and perceived need for cash makes us keep a lot more than we would like on the sidelines. Any day our LOC could vanish, and we would have to self-finance or be out of business.

Oct 24 08:55 AM

[Soldalma:]

I think there is a solvency problem with US banks. But even in the ugly scenario painted by Mr. Denninger, why would the US dollar go up? Common sense suggests the opposite. My guess is he thinks people will go "into cash" and that will create demand for dollars. If that is the reasoning, it is an elementary mistake.

Oct 24 09:14 AM

[fwi:]

Excellent article Mr. Denninger. It was the observant native in Sri Lanka that noticed the animals were going up into high land that warned and saved his family. The tourists, sadly, were not watching, or did not understand the signs.

I believe that you are right, that the infinitely expandable Fed balance sheet is about to burst, and the banks already know this. And I suspect (at the risk of sounding like a conspiracy theorist) that the large option player who started the Bear Stearns tsunami is about to strike again.

Oct 24 11:11 AM

[TeresaE:]

The government is a bankrupt entity at nearly every level.

The only way to go forward into next year and continue the fallacy to those still stupid enough to buy T-Bills, is to have a whopping good year end where many end up paying taxes on "gains."

Gains which will evaporate before you can cash any out and cut the tax checks.

The banks started upping rates in '06 when Congress decided to shoot us in the foot (head actually) with "help."

This is just continuing the process AND thanks again to Congressional "help" Citi knows it won't be able to spread the increases after February thanks to the new "protections." Which once again equate to more money from our pockets flooding directly into the bankster's pockets.

I am still amazed at how those that stand to lose the most (the upper middle-class - not filthy rich, just rich) will NOT open their farkin' eyes.

My father-in-law is dying of cancer, his wife will only have investment income once he goes. I was trying to speak with her about starting now to protect herself. She told me that I was just a "cynic" and that America is recovering and government debt and debased currency won't effect her at all.

My bro-in-laws concur with her. My husband too. Wish I had the blind faith that currently being "rich" or well-off brings.

Meanwhile, I continue to take any extra funds I have to buy necessities, clothes for the upcoming years for my growing daughter and non-perishable foodstuffs, oh yeah silver too.

Most of us have no idea how truly bad things were in the 30s, or in the run-up in Germany until Hitler "saved" the country.

Bad times are coming and yes, I fully expect at least one more strengthening of our currency as soon as the stock market is exposed as the casino it is. One more chance to save ourselves by trading our soon-to-be-worthless dollars into something else.

Heed the warnings of those that see reality - like Karl - or start figuring out how to eat non-food items and still survive.

Oct 24 12:10 PM

[KirbyJF1:]

Karl

Do you still go down to your bomb Shelter every night?

Kirby

Oct 24 01:29 PM

[bluesky123:]

what Karl is saying jives perfectly with what Tyler Duerden is saying at Zero Hedge about the explosion of excess capital reserves at the banks. Banks are not lending. They are tightening the screws mightly on credit. Bank excess reserves went from $2billion to over $1trillion in the last 12 months. Frankly the banks might just as well close up shop. If they're not lending, I don't know what they're actually doing.

www.zerohedge.com/arti...

It is exactly the same data being published by St. Louis Fed
research.stlouisfed.or...

Oct 25 06:43 AM

[surgcare:]

I agree and understand what you're saying , but I can't understand how the dollar will "melt up" , as what you describe would surely cause a flight from the USAD . Unless the feds raise interest rates suddenly which will cause the stock market to "melt down ". All this in opposition to what the feds and government have been doing , devaluing the dollar . Please explain.

Oct 25 03:38 PM

[obewon:]

@Teresa:

Nice supplement to Karl's thought-provoking commentary; from my experience, your "assessment" of the US economy is "on target." There is no "real" recovery, as the venerable John Mauldin (www.2000wave.com/gatew...) has often written; instead, our "new normal" will be a jobless recovery, with continuing recessions over the next 10 years.

While I always read Karl Denninger's daily commentaries (market-ticker.denninge.../); I don't always agree with him, but his website is a "must read" for at least two important reasons:
1. His analysis and commentary are based on factual data, not myths or "hopes", and
2. Most of the time, he provides very useful info that forces us to think of all the various alternatives ahead.


On Oct 24 12:10 PM TeresaE wrote:

> The government is a bankrupt entity at nearly every level.
>
> The only way to go forward into next year and continue the fallacy
> to those still stupid enough to buy T-Bills, is to have a whopping
> good year end where many end up paying taxes on "gains."
>
> Gains which will evaporate before you can cash any out and cut the
> tax checks.
>
> The banks started upping rates in '06 when Congress decided to shoot
> us in the foot (head actually) with "help."
>
> This is just continuing the process AND thanks again to Congressional
> "help" Citi knows it won't be able to spread the increases after
> February thanks to the new "protections." Which once again equate
> to more money from our pockets flooding directly into the bankster's
> pockets.
>
> I am still amazed at how those that stand to lose the most (the upper
> middle-class - not filthy rich, just rich) will NOT open their farkin'
> eyes.
>
> My father-in-law is dying of cancer, his wife will only have investment
> income once he goes. I was trying to speak with her about starting
> now to protect herself. She told me that I was just a "cynic" and
> that America is recovering and government debt and debased currency
> won't effect her at all.
>
> My bro-in-laws concur with her. My husband too. Wish I had the
> blind faith that currently being "rich" or well-off brings.
>
> Meanwhile, I continue to take any extra funds I have to buy necessities,
> clothes for the upcoming years for my growing daughter and non-perishable
> foodstuffs, oh yeah silver too.
>
> Most of us have no idea how truly bad things were in the 30s, or
> in the run-up in Germany until Hitler "saved" the country.
>
> Bad times are coming and yes, I fully expect at least one more strengthening
> of our currency as soon as the stock market is exposed as the casino
> it is. One more chance to save ourselves by trading our soon-to-be-worthless
> dollars into something else.
>
> Heed the warnings of those that see reality - like Karl - or start
> figuring out how to eat non-food items and still survive.

Oct 25 04:38 PM

[morph366:]

Until last week the solution was to buy Australian dollars.
Now (as per Borat) not so much!

Oct 28 03:51 PM