February 2008 Archives

I wonder when this credit card action by Citigroup crosses the pond to the U.S.? From today's Wall Street Journal:

"In a sign of more consumers losing access to loans, Citigroup Inc. has told some 161,000 credit-card customers in the U.K. that they can use their cards until the first week of March and then they'll no longer be able to tap the New York bank for credit."

Mortgage credit is tight. So are auto loans and student loans. Credit cards are next....

You've heard President Truman's famous quip that he wanted a one-handed economist after getting so many briefings on the econonmy that started with "On the one hand"... and then went into "on the other hand".

Jim Paulson, the chief investment officer at Wells Capital Management, (managing almost $220 billion in assets) took a look into the recent dismal employment report and came up with his own version of the two-handed economist. He had some fun with the idea, and came up with an intriguing final message or conclusion. I'm not sure if I buy into his conclusion, but his analysis is well worth reading. Download file

Enjoy. (And hopefully you can read the file. I'm still learning how to use this software. Let me know if you have any problems. Thanks.)

Last week, Tess and I talked about my theme that a half-century of borrow-as-much-as-possible and spend-as-much-as-possible may be coming to an end. More and more people will embrace a New Frugality where the phrase "can I afford it" replaces the mantra "I want it now."

The reason for the change goes beyond current household pressures of falling home prices, soaring energy bills, and big debt payments. The main factor behind the New Frugality is that lenders have suddenly realized that consumers with lots of debt are risky borrowers.

Today's Wall Street Journal had a news piece that supports the thesis that lenders will force consumers to embrace thrift.

Credit Cards Are Playing Harder to Get
Amid Rising Delinquencies,
Banks Get Pickier, Raise Fees;
Direct-Mail Pitches Decline
By JANE J. KIM
February 5, 2008; Page D1

The stricter lending standards come as many banks recently reported earnings and disclosed surprisingly large losses from their consumer businesses. Among the problems: higher credit-card delinquencies and losses. The banks expect the problems to get worse as the economy slows.

Imagine, the average consumer could find not only their mailbox free of credit card solicitations---but that their credit limit has been cut.

Here is some background on the idea of what I'm calling the New Frugality. It's a theme that explains much of what is going on with the economy.

First, a cover story by Mike Mandel for Business Week laid out the basic idea:

The Consumer Crunch
Recession or not, American families will be forced to tighten their belts

The long-awaited, long-feared consumer crunch may finally be here. That might not mean an economywide recession, but the pain for American households will be deep.

What comes next could be scary--the largest pullback in consumer spending in decades, perhaps as much as $200 billion to $300 billion, or 2%-3% of personal income. Reduced access to credit will combine with falling real estate values to hit poor and rich alike. "We're in uncharted territory," says David Rosenberg, chief North American economist at Merrill Lynch (MER ), who's forecasting a mild drop in consumer spending in the first half of 2008. "It's pretty rare we go through such a pronounced tightening in credit standards."

You can read the full story here.

I followed up with a story looking into the personal finance implications of thrift:

How to Survive the Credit Crunch
by Chris Farrell

Driving along the Interstate on the outskirts of Minnesota's Twin Cities, you can't miss the nation's largest mall. A massive citadel of consumerism, the Mall of America boasts some 520 stores in a space big enough to hold 32 Boeing 747s. Spend a few hours there and big numbers stop fazing you--numbers like the record $2.5 trillion in U.S. household debt, which rises to $13.6 trillion with mortgages tossed in. Bigger is better, you say, with a wink, charging that 52-inch flat-screen TV. Yet the credit crunch could mark a major turning point for the U.S. consumer economy. Half a century of spend-with-abandon attitude may be winding down. The shift won't come about because consumers embrace a new frugality. What's happening is that the average consumer now looks like a towering risk to the folks who extended all the debt--credit-card companies, mortgage lenders, and, most recently, student loan outfits. And those lenders are pulling back, making it harder to borrow.

That doesn't mean the Mall of America is going to empty out like New York City in the new Will Smith movie I Am Legend. But the fallout from tougher lending standards should be making you think about adjusting your financial strategy, from plotting your portfolio to figuring how you'll finance home purchases and college educations. Says Ross Levin, a certified financial planner and president of Accredited Investors in Edina, Minn.: "The implications are gigantic when it comes to personal finance."

You can read about those implications for home ownership, stocks, bonds, credit cards and student loans here.

The New York Times caught up with the idea earlier this week:

Economy Fitful, Americans Start to Pay as They Go
By PETER S. GOODMAN
For more than half a century, Americans have proved staggeringly resourceful at finding new ways to spend money.

"The long collapse in the United States savings rate is over," said Ethan S. Harris, chief United States economist for Lehman Brothers. "People are going to start saving the old-fashioned way, rather than letting the stock market and rising home values do it for them."

You can check out the rest of the story here.

I'll keep an eye out for further evidence of a sea-change in consumer borrowing behavior and signs of increased savings. Send me any evidence you have that consumers are embracing the New Frugality--or perhaps I should call it the forced embrace of the New Frugality.

The opening paragraphs from today's Wall Street Journal:

Credit-Card Pinch
Leads Consumers
To Rein In Spending
By ROBIN SIDEL, SUDEEP REDDY AND JANE J. KIM
February 8, 2008; Page A1

Such a pullback may already be taking shape. Yesterday, the Federal Reserve reported an abrupt slowdown in consumers' credit-card borrowings. In December, Americans had $944 billion in total revolving debt, most of it on credit cards, a seasonally adjusted annualized increase of 2.7%. That was off sharply from seasonally adjusted growth rates of 13.7% in November and 11.1% in October. And it reflects the volatility in consumers' spending habits as economic growth sputters.

The signs were there that this was going to happen. I think this is more than just reverberations from the credit crunch. When it comes to student loans, the long boom is over.

Here are the opening paragraphs of today's story in the Wall Street Journal:

Student-Loan Issues Under Stress
By LIZ RAPPAPORT and KAREN RICHARDSON
February 11, 2008; Page C1

"Investors are seeking safety right now," says Joe Lynagh, portfolio manager at T. Rowe Price who runs tax-exempt money-market and other short-term investments....

Okay, oil breaks the $100 barrier. That hurts. That said, (and this could be a strange way to look at the price action), but I wonder if the oil market is telling us the economy isn't doing as bad as it seems. Or, to put it somewhat differently, that the worst is behind us?

My take on the latest economic numbers. I talked about this yesterday with Kerri Miller on mid-morning (you can listen to it here). I also wrote this story for Business Week online.

Looks a Lot Like Stagflation...

Dismal reports on producer prices and consumer sentiment are just the latest signs that the 1970s scourge could be making a comeback
by Chris Farrell

A dark memory still haunts the U.S. economy: The Great Stagflation of 1973-80, a time defined by an uncomfortable mix of high inflation and stagnant growth. Well, everything old is new again, as they say: A number of recent economic reports point to an early 21st century return of the two-headed beast. While nostalgia can be nice--1973 brought delights including the Academy Award-winning best picture American Graffiti and Roberta Flack's classic ballad Killing Me Softly--this is one relic of the not-so-distant past that's best left to the history books.

Unfortunately, the stars may be aligning for stagflation's return. The big implication of the government's recent round of price reports is that inflation is starting to accelerate. The producer price index over the past 12 months has risen 7.4%, according to a government report released Feb. 26--the biggest advance since October, 1981. The consumer price index over the same period is up 4.3% (and in the past three months it has been running at a 6.8% pace). Import prices have risen 13.7% since January, 2007, representing the largest year-over-year increase since the index was first published in September, 1982.

Price Hikes Go Mainstream

Even more disturbing, energy and food are no longer solely responsible for the sharp headline price hikes. The inflation figures increasingly reflect broad-based changes in the economy, affecting the prices of a wide variety of goods, including over-the-counter and prescription medicines, soap and detergents, and platinum and gold jewelry. So much for price stability.

On the other hand, most indications are that the economy is teetering on the edge of a downturn. For instance, the housing market continues to deteriorate with both lower home prices and lower home sales while foreclosures and short sales are rising. The manufacturing sector appears to be stalling out, and corporate payrolls are weak. The Conference Board's consumer confidence index is at its lowest level in 15 years (not counting the impact of the 2003 Iraq war). The dollar is flirting with record lows against the euro.

Add it all up, and it starts to look like the "S" word. "I would call it mild stagflation compared to the 1970s," says Allen Sinai, chief economist at Decision Economics, an economic and financial advisory firm. "But it is probably the same animal."

Stagflation Skeptics

Of course, not everyone buys the stagflation scenario. Take Richard Berner, chief U.S. economist for Morgan Stanley (MS). He's relatively optimistic on the inflation side. He believes price pressures will abate as economic growth slows sharply. "In my view, the time-honored forces of increased slack brought about by recession will cause inflation to slowly move lower," Berner wrote in a Feb. 26 report. "In that context, I expect that rising costs will soon have an impact on profit margins instead of prices, as companies are less able to pass them through to consumers."

Richard Yamarone, chief economist at Argus Research, thinks the underlying economy is doing better than the consensus believes. Consumers are still spending, business is still investing, exports have never been stronger, and "you can't call the U.S. agricultural industry in 2008 anything other than blistering." Indeed, he argues that a broadly defined agricultural sector is behind everything from increases in employment to gains in investment--and the much of the rise in inflation. Agricultural companies have been raising prices, and the price hikes are sticking. For instance, in the latest producer price index report, finished consumer foods are up 9.2% over the past 12 months, eggs 60.1%, pasta products 30.4%, and agricultural machinery 2%. "I think inflation is the biggest risk to the economy," says Yamarone. ""There is a propensity for inflation to run away," he says.

Navigating Dangerous Waters

However you slice the economic data, Federal Reserve Board Chairman Ben Bernanke's job got a lot tougher after the Feb. 26 releases. The central banker is forced to sail between the rock of inflation and the hard place of recession. When the Bernanke Fed was fighting the gathering forces of recession it used the time-honored remedy of cutting its benchmark interest rate. But now that inflationary pressures are mounting, the classic Fed response should be raising its benchmark interest rate, or at least staying the course.

So, what will it be when the Fed assembles at its next Federal Open Market Committee in March? Battle recession and gamble on inflation, or focus on combating inflation and risk recession?

The bottom line: There is no easy way out of this mess. The economic discomfort index just got a bit worse. A modern-day songwriter who wants to pen a tune about the return of stagflation could paraphrase Flack's long-ago hit: Killing Us Softly.

For years the banking system has argued for deregulation. The message from the banking industry to government was "leave us alone" and "let the free market work." But now that losses are running in the billions and billions of dollars all of a sudden the industry is receptive to various kinds of bailouts. Congress and the White House, "just say no."

However, there is one thing that Washington can do that would benefit the financially strapped homeowner and the economy. It's also a remedy opposed by the financial services industry. Let bankruptcy judges modify the terms of a mortgage loan.

Despite the massive rewriting of bankruptcy law in 2005, the legislation left alone the rule barring bankruptcy courts from modifying home mortgages. That rule was written in the early 1970s, an era when the securitization of mortgages was in its infancy and 20% down payments routine. In the past, extending that protection to home lenders wasn't a big deal. But the securitization of mortgages over the past decade allowed lenders to encourage consumers to transfer high interest rate consumer debt into low-rate consolidated mortgage debt. Making the shift even more attractive to well-heeled families was the tax deductibility of home equity loans while consumer loans aren't. Those onerous mortgage debts are now weighing down on many households, and there's nothing bankruptcy judges can do about it. That should change.

Bankruptcy law is about getting a second chance.