Money Sage (archive)

Well folks, we have been doing some thinking in recent days about the credit card securitization "situation." In view of the reports that late payments on credit card obligations are mounting, and defaults rising, we are wondering if this may prove to be the precursor of something far more serious. It is as clear as day that credit card "problems' will be mounting in the days, weeks, and months to come. As the delayed impact of the burst of the house price bubble moves into real time for more and more credit card borrowers -- unable to refinance their houses, extract "equity" from shrinking housing values, hardpressed to pay reset mortgages, faced with the domino effects of the credit contraction in the form of downward pressure on wages and a rising risk of job loss -- the lenders will be forced to write down rising losses. This will further impact negatively on the lendable capital of the banking system, intensifying the risk of a general financial and economic implosion.

The rise in bad loans to credit card holders will also impact negatively on the retail sector, and on consumer spending. It is a truism that you can't spend what you don't have, or what your friendly bank won't -- or is unable to -- lend you. As retail and consumer spending generally suffer, there is a ripple effect to other economic factors: employment, business investment, production.

What possesses the potential for changing the arithmetical negative of a credit card contraction to a GEOMETRICAL negative impact on the economy via an outsized blow to the creditors is, you guessed it, the "securitization" of credit card debt. This securitization, another creation of Wall Street financial wizards, is the country cousin to the the securitization of mortgages via the creation of complex mortgage-backed securities and tranches. We are already all-too-familiar with the EVOLVING EARLY CONSEQUENCES of the mortgage-backed meltdown. What we do not yet know is how serious an analogous credit-card backed securities crunch might prove to be, especially coming ON TOP OF AND EXACERBATING THE NEGATIVE IMPACT of the mortgage-backed collapse on the capital position, if not the solvency, of the American banking system. This, we would reiterate for the umpteenth time, is hardly a TRIFLE.

At present, we are almost completely in the dark about the credit card securitization situation and what it might imply. This is much the same situation we were in last summer vis-a-vis the mortgage-backeds. Once the truth starts to seep out, it gains traction, increasing its velocity, both in informational terms and in terms of its RAMIFYING CONSEQUENCES upon both the banking system and, with normal time lags, upon the economy. For the present, we do not know WHO has the pleasure of owning these securities, what their true market value -- in contradistinction to the "value" at which they are carried on institutional books -- is. Nor do we know how widespread these holdings are, who owns them, or how fast their value might descend as the underlying SOURCE of their value -- the reliability of the income stream generated by credit card borrowers duly making their monthly interest rate payments at the...ahem...shall we see somewhat elevated interest rates they are charged deteriorates. (A multiple of the reported rate of inflation about which our FED is so frantic). Of course, this mountain of credit card debt, made by banks and other issuers at what some might consider to be usurious rates of interest, have been a very lucrative cash cow. And why not? If a bank borrows from lenders (read: depositor Joe Sixpack) at 1 or 2%, or even at 3 or 4%, and LENDS to Joe Sixpack's brother at 12, 15, 18, 21% -- why, the profit is ENORMOUS. "Securitize" these loans and sell them for a huge profit and you have not only churned out an immense gain at no risk (since you have quickly laid off the risk on the greed-driven buyer), but you can now re-use the capital to lend more to borrowers and to hawk more cards to more potential credit card users. Kind of like a used car dealer selling a junker to a buyer he guesses will not be able to pay: collect the up-front deposit, a few juicy payments, and then, when the inevitable occurs, re-possess the car. And then, guess what? You "sell" the same car to the next victim.
All of which, by the way, raises another interesting point: car loans too -- you guessed it -- have been SECURITIZED.

As with the mortgage-backeds, securitizing credit card balances and car loans is immensely lucrative, boosting lender bottom lines, stock prices, and multi-zillion dollar bonuses to the brilliant executives who have marketed the stuff and have piled that which they are unable to unload on the unwary investor onto their bank's own balance sheet. As in the case of the mortgage-backeds, of course, it is all a question of grabbing a chair BEFORE THE MUSIC STOPS, AS IT INELUCTABLY DOES. Where will your bank be when the music has stopped?? Where will the banking system be?? The music has not yet stopped, but we would venture that IT WILL STOP IN 2008. The consequences will hardly be pleasent. Some lender stocks now selling in the double digits or even single digits may look, retrosectively, like a good short 9 months from now. Who can say?

One final point we do wish to make before closing. While the major question is HOW SERIOUS A MELTDOWN will we see, and how much damage will it do, a second important question is: who is responsible for the soon-to-unfold debacle?
Well folks, believe it or not, prime responsibility, in our humble judgment, rests with the good old FEDERAL RESERVE. Their eager abdication of their major responsibility of regulating the banking system with regard to the creation, packaging, and dissemination of sub-prime junk mortgages was not LIMITED to sub-primes, but encompassed the ENTIRE UNIVERSE OF SECURITIZED LOANS -- car loans, credit card loans, appliance loans (?), God knows what. And now, having punctured the balloon whose creation they were instrumental in allowing to occur, they are sanguine about the non-consequences they aver will transpire.

The Greenspan-Bernanke FED has not distinguished itself for its responsibility, its aptitude, its analytical capability, or its policy. And that, folks, may be the understatement of the year.