The credit card as we have it in the U.S. is really a unique phenomenon:

Source:  Creditcards.com

Only a handful of banks dominate the credit card industry.  The credit card is really built on the premise that the gravy train can go on forever.  At the apex of the credit bubble, and let us face it housing wasn’t the only thing being financed with easy money, credit card companies were offering zero percent offers to lure customers into debt servitude.  Now that banks use the pretext that the “world has changed”, they can up those fees and interest rates and many Americans due to the weak economy are now no longer able to meet their obligations.  Credit card default rates are soaring:

Source: Calculated Risk

Those that can’t pay by definition will not pay and that is why we are seeing high levels of bankruptcy.  A credit card was never intended to be used as a secondary source of income but that is what it has become since wages have been stagnant for over a decade.  The vast majority do not pay their balance off each month.  This is same misguided premise on which option ARM loans were based on.  Given the option 90+ percent of the people went with the minimum payment causing an endgame that we are now dealing with.  Credit card loans outstanding have been contracting at a feverish pitch:

Yet wasn’t the premise of the banking bailouts to increase credit in the market?  Of course the banking system has largely captured the current lawmakers and the policy we are getting is friendly to their needs and desires while using the American taxpayer as their own form of credit card.  The lie that was perpetuated was that debt equals wealth and it absolutely does not.  So people in modest neighborhoods saw friends and family driving foreign cars and wondered how they were doing it with a $40,000 a year income.  They were doing it by extending themselves to the point of financial disaster.  So as the disaster hits, we operate in parallel universes.  The public that did over extend has to realize the marketplace reaction of cutting back, losing homes, or bankruptcy.  Banks on the other hand have actually come out ahead receiving trillions in dollars of taxpayer funded money.  Nothing easier than getting money in a hype of fear with politicians friendly to your cause.

Much of the easy lending environment was given the blessing by the Federal Reserve and U.S. Treasury:

The above is really the story of the housing bubble, credit bubble, and easy money world we had for over a decade.  That is now completely changed and I often wonder if people realize that we won’t be going back to how things were.  We can’t.  The underlying issue is the amount of debt being serviced now.  GDP includes this as a “positive” but we are now transferring this additional wealth to the banking sector on merely servicing preexisting debt.  This is like being happy that banks made billions of dollars in overdraft fees.  How is this good for the economy or most Americans?  The math is so distorted that many Americans are wondering how in a country where 20 percent are underemployed we can have a 73 percent stock market rally.

The too big to fail banks are also at the center of the credit card word:

U.S. general purpose credit card market share in 2008 based on outstandings
(Note: 2007 ranking in parentheses)
1. JPMorgan Chase – 21.22% (17.74%)
2. Bank of America – 19.25% (19.36%)
3. Citi – 12.35% (13.03%)
4. American Express – 10.19% (11.40%)
5. Capital One – 6.95% (6.95%)
6. Discover – 5.75% (5.65%)
7. Wells Fargo – 4.21% (3.07%)
8. HSBC – 3.47% (3.65%)
9. U.S. Bank – 2.14% (1.84%)
10. USAA Savings – 2.02% (2.01%)

Source:  Creditcards.com

It is no accident that they are now putting the vice on average Americans while sucking in trillions of dollars in bailouts.  And what is the big reform?  They now provide a sheet that shows you a breakdown of how you are getting screwed in different formats!  This is the idea of reform right now from the corporatacracy.  Until we get solid reform credit cards will continue to operate in a loan shark environment ripping off the middle class until one day Americans will wake up and realize that there is no longer a middle class.

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If we want to understand the credit card industry we first should take a look at the most popular cards out on the market:

Source:  Creditcards.com

In total there are 631 million credit cards in circulation from Visa, MasterCard, Discover, and American Express.  Now given that we only have 308 million people in the U.S. many under the age of 16, many people have multiple credit cards.  It doesn’t seem odd for people to spend and buy with basically creating debt with each purchase.  The above chart also shows the amount of debit cards out in circulation.  In fact, making debit cards virtually identical to credit cards has created a psychological notion that debit and credit are interchangeable.  They are not.  This is obvious but do anything enough times and you can easily convince yourself of anything including believing the idea that debt equals wealth.  Debit cards access money you have while credit cards mortgage your future for a current item.

Americans are carrying an enormous amount of credit card debt.  The massive spike in credit card debt started 40 years ago when the middle class started losing ground.  You can almost mark the exact date when we started using credit to make up for the lost wage growth:

Since the early 1970s Nixon shock, Americans started losing their manufacturing base but also their ability to maintain competitive wages.  In 1968 Americans carried $1.3 billion in revolving credit.  By 2008 that number was up to $975 billion.  Nonstop growth for nearly 40 years.  Yet for the first time in over a generation this amount has fallen by a large number.  Today, $864 billion in revolving debt is outstanding.  Since the peak in 2008 we have seen consumer credit contract by a stunning $111 billion.  For a consumption driven economy this does not bode well for economic growth since many Americans are finding it harder to spend in such a weak employment market.

As the U.S. Treasury and Federal Reserve they have artificially pushed interest rates to historical lows, but banks have decided to keep credit card rates at extremely high rates:

Source:  Creditcards.com

How is it that the biggest beneficiaries from the Wall Street and banking bailouts are now able to charge such an outrageous margin on credit cards?  These are the banks that received taxpayer assistance supposedly to create more access of credit for middle class Americans.  We certainly are not seeing that.  And who are the biggest credit card issuers?

U.S. general purpose credit card market share in 2008 based on outstandings
(Note: 2007 ranking in parentheses)
1. JPMorgan Chase – 21.22% (17.74%)
2. Bank of America – 19.25% (19.36%)
3. Citi – 12.35% (13.03%)
4. American Express – 10.19% (11.40%)
5. Capital One – 6.95% (6.95%)
6. Discover – 5.75% (5.65%)
7. Wells Fargo – 4.21% (3.07%)
8. HSBC – 3.47% (3.65%)
9. U.S. Bank – 2.14% (1.84%)
10. USAA Savings – 2.02% (2.01%)

Source:  Creditcards.com

The top four issuers corner a large portion of the market and are some of the biggest bailout recipients.  The economy for most Americans still hasn’t recovered.  Credit card defaults are simply a reflection of this reality.  The fact that revolving credit has contracted so sharply in the face of $13 trillion in bank bailouts and support is only demonstrating that banks are unable to lend out money to consumers who can actually pay the money back.  Banks also need the money to combat their weaker Swiss Cheese like balance sheet.

Most Americans can’t envision a marketplace with no credit cards.  Many are now having to adjust to the new economic realities in the economy.  Yet the fact that less revolving credit is in the market tells us consumers are pulling back on using their credit cards or banks are simply issuing less credit.  In the end, middle class Americans simply cannot spend like they once did.  Many are now realizing that they will have to save to purchase items and that isn’t necessarily bad.  But with stagnant wages many are finding it hard to save and with no credit card access, dealing with realities that haven’t hit this country for a generation seems as surreal as believing that plastic is money.

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Now with nearly 1 out of 5 Americans eligible for work being unemployed or underemployed the usage of credit cards was trying to spike but credit card insurers have cut back access to debt:

*In billions

Since the peak in September, revolving debt has been on a steady decline.  Since that point, some $50 billion in credit card debt has been removed from the system.  At the same time, the average credit card interest rate has gone up from 12.72 percent in 2004 to a current rate of 13.31 percent.  This is happening in a time when the Federal Reserve is holding rates near their zero bound yet very little of this is making its way to the consumer.  Banks are not lending because they realize that for an entire decade they have been giving too much debt to people highly unlikely to pay it back.  Under the guise of helping the consumer, banks and Wall Street intimidated the U.S. Treasury and Federal Reserve to give them access to cheap and plentiful amounts of debt.  Remember the argument of keeping the life blood of America going linking credit to this premise?  Well as you can see, access to debt is becoming more and more restrictive.

But the game is radically changing.  Credit card companies cannot squeeze more juice out of a turnip so they are now going after borrowers on good terms and playing fast and easy with contracts and terms:

“(MSNBC) When James received a great credit card offer two years ago – a 4.99 percent interest on balance transfers for the life of the card – he jumped at it.  He used the cheap money to remodel the kitchen of his Los Angeles-area home.

He never expected the new kitchen would turn him into a pawn in a chess match playing out among Congress, bank regulators and credit card firms.

The offer, from JP Morgan Chase had only one obvious stipulation: No late payments. Because the rate was far lower than a home equity loan at the time, James used the credit card for the construction project, borrowing around $20,000. His monthly payments were very affordable – just under $300. Paying the minimum 2 percent each month, he’d pay off the loan in about 8 years.

James, who requested anonymity because he’s uncomfortable discussing his personal finances in public -made sure to pay on time each month, jealously guarding the terms of his cut-rate loan. Little did he realize that Chase could find a way to make his life miserable without raising his interest rate.

But Chase recently threw James– and perhaps hundreds of thousands of other consumers – a huge credit card curveball.  The firm sent letters to customers beginning in late June indicating that minimum payments would be raised from 2 percent to 5 percent. In August, his monthly payment will spike to $750.”

Now imagine someone who has lost their job or has had their hours cutback.  For most Americans finding an additional $750 a month is not an easy task.  I can speak from my own experience that credit card companies are doing these kind of tactics.  I had a 4.99 percent balance transfer offer that I went after in 2007 for the life of the entire balance.  During that time, the credit card company continually tried to advertise great deals and how I should use the card to purchase goods.  Of course, doing this would force the new debt onto the higher 20 percent area.  And when you pay back this credit card, your payment would go to the 4.99 percent balance and not the new 20 percent purchase.  These are the kind of gimmicks they use but I never purchased anything beyond the balance transfer.  However, the system they used switched to paperless and they stopped sending a statement to my home recently.  When they sent an e-mail bill it was spam blocked along with Nigerian scams and a few days later I noticed the entire balance was up to 20 percent.

Now I don’t recommend carrying a balance.  This is a bad move.  But I had figured that at 4.99 percent the money was a good deal.  Yet I talked with my attorney and wrote the credit card company a note which brought the promotional rate back.  Either way, credit card companies can do what they want.  They are not in the business of charity.  The U.S. Treasury and Federal Reserve are looking out for banks and Wall Street.  American consumers are on their own.  You need to be vigilant.

Most of the credit card companies are trying to jack up their rates before new legislation makes it harder in 2010 to pilfer the American public:

“Tens of millions of Chase customers have taken advantage of our promotional low rate financing over the last five years,” she said. “Most of these loans have been paid back in less than 24 months. However, there have been a small percentage of customers that have not made as much progress in paying down these loans. Our desire is to have these balances paid back in a reasonable period of time.”

Bill Hardekopf, who runs LowCards.com, said banks are following through on warnings that credit card expenses for consumers would rise after passage of the Credit Card Accountability, Responsibility, and Disclosure Act.

“From an issuer standpoint, they are looking at their default rates going up, they are in tremendous economic distress and they are trying to minimize their risk as much as possible,” he said. “Issuers feel they need to find ways to make up for revenue they are projecting they are going to lose once the legislation takes effect.”

Chase told msnbc.com that it would work with consumers who are unable to make their new payments, but James said that’s merely an invitation into a lion’s den. The only offer he received was a severe change in terms to his account with a much higher, variable interest rate.

When the new federal regulations take effect next year, they will severely limit banks’ ability to change rates unless cardholders have variable-rate agreements, so banks are trying to steer consumers away from fixed-rate cards.  Bank of America, for example, recently sent notices to cardholders with fixed rates telling them their accounts will be changed to variable rates starting next month.”

So for the moment, they’ll be changing rates at will for the tiniest infractions.  Or because they feel like it.  Also, I have gotten a few letters where you actually have to call to opt-out of a rate increase.  I have a credit card with a fixed 6 percent purchase rate but recently, the issuer sent out a notice stating that they would raise the rate to a variable rate of 15 percent if I didn’t opt-out.  I nearly tossed the letter into the junk mail bin but did a double-take.  Who in the world would sign on to this?  They are betting on many, like I almost did, tossing the letter into the trash and one day waking up seeing the rate skyrocket to 15 percent.  This is the new reality.

The massive amount of debt created by the multi-decade long housing bubble created a cultural psychology and love with debt.  The last generation from the Great Depression knew the slippery slope of debt and many stayed away from it or at the very least, were very skeptical.  That was not the case for the past 20 years.  Credit cards were glorified and even became a designer symbol.  A gold card used to mean something.  Now, everyone has a gold card, platinum card, or some titanium card.  Who really cares?  The real value comes from the terms which have become more onerous.  Yet psychology is a big player here because people “feel” richer with a titanium card in their wallet even though they are flat broke and in massive debt.

If you want a sample look of where things are going, take a look at FDIC insured charge off rates for California:

The charge off rate went from $12 million in 2006, to $17 million in 2007, to $30 million in 2008.  The current rate is tracking over $40 million for the year and keep in mind late payments are shooting up.  This may seem tiny but these are highly leveraged products and banks have these items as assets on their books.  More losses coming down the pipeline and more pressure for banks to squeeze the American public so make sure you stay vigilant.

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The Census Bureau reported on Wednesday that for the month of April retail sales came in at $337 billion, a decrease of 0.4 percent from the month before.  The market reacted to this news and headed lower.  If we pry into the data beyond the headline number, we will see that retail sales are actually down by 10.1 percent from April of 2008.  Now why the market is stunned by this news should be the bigger headline since 24,700,000 Americans are unemployed or underemployed, it would logically follow that more and more Americans are having to tighten up their budgets.  Many Americans are quickly realizing that austerity is now the way of life.

Let us take a look at the retail figures chart since two-thirds of our economy depends on retail sales:

What is interesting for the month is auto sales slightly increased.  Normally, the Census Bureau reports retail sales with and without auto figures.  For April, auto sales actually helped the overall figure.  Let us look at how retail sales measure up to April of 2008:

Taking a look over one year gives us a better sense of the overall trend.  What you will see is that over one year, auto sales are down over 20 percent while retail sales are down by approximately 10 percent.  These are gigantic numbers when you think about it.  If our GDP is slightly over $14 trillion a year, and consumption makes up nearly 70 percent of this, a 10 and 20 percent decline is significant.

A large part of this is many Americans are finding out that their access to credit is being limited.  Over the past few months credit card companies have yanked over 8 million in credit cards from the market.  What is problematic about this is Americans supplemented a decade of stagnant wages with more and more consumer debt.  In fact, the massive rise in debt has occurred for over 3 decades.

I compiled a chart that highlights this new austerity showing personal income and household debt:

This is an incredibly important chart because it strikes at the heart of the matter.  If you look at the 1980s, you’ll see a big explosion in household debt; but when personal income went lower, so did the increase in debt.  Over 40 years, the growth of household debt and personal income flowed in synchronization.  That is, until the year 2000.  At this point it is abundantly clear what occurs.  While personal income started to fall on a year over year basis debt explodes.  This goes on from 2000 to 2005.  After muddling through, both personal income and debt are contracting at the fastest pace in over 40 years.  What this tells us is the perceived health of the economy for the past decade was largely all built on a foundation of debt with no real gains for households.

The recent run up in the stock market is now hitting a wall.  This market volatility that produced a near 40 percent gain in the S&P 500 over 2 months is a sign of an unstable economy, not a healthy one.  What occurred is first, we had manufactured one time profits for banks because of massive bailouts and the market was starting to price in a second half recovery.  After hearing that foreclosures are at all time highs and Americans aren’t spending like they once did, that second half recovery is coming into question.  July 1^st isn’t far away and it is hard to see what is going to occur over the next month that is going to set the American spending machine back on track.

Let us examine where Americans are pulling back:

For the most part, Americans are cutting back on nearly every segment of retail goods.  The only 2 areas that seem to be neutral or slightly positive are food purchases and health spending, which shouldn’t be surprising.  Americans are cutting back to the necessities.  One of the biggest hits is in auto sales which are down 25 percent on a year over year basis.  This is a primary reason why one of the three large U.S. automakers has filed for bankruptcy and another, GM is on the verge.  The disconcerting part about the U.S. automakers is that they were failing in large part to the high cost of energy.  Remember that oil bubble?  Well as you can see above, gasoline stations have seen a drop in retail sales by 35 percent over the year largely to the oil bubble popping.  Yet you would logically think that with cheaper fuel, Americans would be back to buying big cars.  That is not the case.  It isn’t that people don’t want new cars, its just that they can’t afford them without easy access to credit.

Going back to the chart above, we see that electronic spending is down by 6.9 percent.  That is why electronic giant Circuit City went under.  People are pulling back on discretionary spending.  Building material and home spending is down as well by 11.2 percent.  People are finding it hard to adorn their home in HGTV fashion when money is tight.  Clothing spending is down by 6.1 percent over the year.  You will also see sporting goods, hobby, and book spending down.  The bottom line is most Americans are shifting their spending priorities to things they need and away from things they want.

This decade saw something that we haven’t seen in nearly 100 years.  Americans even with declining personal incomes were given unlimited access to credit to continue to spend.  That is unheard of.  The chart above demonstrates this.  Right now we are facing the brunt of spending more than we were earning as a country.  The chart showing personal income and household debt should tell you a lot about what occurred over the past 40 years.  Debt would always increase but was closely aligned to growth or declines in personal income.  This decade saw a large disconnect.  We are now dealing with the recalibration of this poor alignment.

The Federal Reserve and U.S. Treasury would like to go back to the debt spending ways of the past but that isn’t in the cards.  Currently, they are trying to sacrifice the U.S. dollar to get Americans back on their spending treadmills.  They have done this through a variety of ways including, making it extremely unattractive to save.  With the Fed rate touching zero, many people see bank savings rates of 0.2 to 1.2 percent and wonder why should they even save a penny?  Yet with the markets off their peaks by 40 percent, many people don’t mind saving their money in a secure vehicle instead of it losing value.  Plus, with the employment situation so fragile, people are saving because they have too.  The new austerity is on us and people need to adjust to the new reality because we are not going back to the way things were in 2000 through 2005.

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In addition, the amount of credit limits has also fallen.  From the peak, credit lines have fallen by $320 billion.  That is, American consumers no longer have access to that credit.  And as a company, this is a smart move since many American families have been over spending for years but this couldn’t occur at a worse time.  The irony here of course is while American households are getting their credit yanked, the government is extending various credit programs to banks and Wall Street.  This double standard is infuriating to a public that is witnessing their money paying for massive bailouts while their access to funds is dwindling given that we now have 24 million Americans that are unemployed or underemployed.

Mortgage delinquencies are also rising at the same time.  39.8 percent of subprime borrowers are now 30 days behind their mortgage payment.  This is up from 23.7 percent last year.  Close to 1 out of 2 subprime borrowers are now late with their payment.  This is an astonishing figure.  A more disturbing number is now 7 percent of all homeowners with a mortgage are now 30 days late, a jump of 50 percent from a year ago.

The growth of revolving credit has been exponential since the early 1980s:

In the most recent data $961 billion in outstanding revolving debt is out on the market.  The credit limit out on the market is $3.27 trillion.  So with the $320 billion drop in credit limits, many people are now at risk of getting slapped with a worse FICO score!  How?  Well one component of FICO is your debt to limit ratios.  So if you had $800 on a $2,000 card, your ratio is 40 percent.  But say your line got cut to $1,000, your ratio is now pushed up to 80 percent and you didn’t spend anymore.  Such are the unintended consequences of our current debt crisis.

And you can expect many more people to start defaulting on loans as credit card companies try to squeeze even good card buyers for every penny they got.  Many recent stories are popping up where a borrower with a good credit score took out $5,000 fixed for the life of the loan at 5% only to see that rate jump up to 19% because of some random reason.  It is outrageous what these companies are doing especially when many are benefitting (in fact, owe their life) to the taxpayer.  No wonder why there is so much anger floating out in the public.

Again looking at the chart, this is another ominous sign of the times.  This explosion in debt is symptomatic of the problems in our economy.  Stagnant wages have been here for a decade yet the expansion in the housing bubble and consumer debt gave the façade of an actual booming economy.  The only thing that was booming was debt and now that it is crashing, the system is morphing into something utterly different.

Lenders are doing what they should have always done.  Be more careful with lending money out.  But consumers realizing the government is not going to help them are now saving more to protect their financial vitality.  In the mind of the government, all we need to do is inject enough credit and we’ll be back to the good old days.  That isn’t the case.  This recession is deep enough and will be painful enough that you will have a generation that doesn’t view debt the same way.  This is already the longest recession since the Great Depression.  So many Americans from this point on, will never view debt in the same way.  When do you think we’ll hear people say, “real estate never goes down” again in a steady chorus?  Those are days long gone.

Many policies are under the impression that we’ll somehow be back to peak credit.  I’m not sure we will be there.  Just take a look at what the credit card companies are doing.  The last thing they are doing is extending more lines of credit.  So we are seeing an actual contraction in the availability of credit to borrowers.  Many consumers now have to rely on saved money, a concept that is now taking hold on a wider scale.

It is impossible to spend yourself out of a recession especially if a large part of the recession was based on over spending.  Cutting credit cards to consumers is smart.  Cutting credit cards to banks and Wall Street is genius.

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The irony of what is going on is that many items are now reverting back to the inflation adjusted mean now that credit is being sectioned off from the current economy.  What this also implicitly tells us is much of the rise in the price of homes, cars, and other debt items was largely inflated by the access to credit.  Let us for example look at the price of a Los Angeles home over the past decade:

What this chart shows us is that the median home price in Los Angeles is now back to 2003 price levels and the trend is still moving lower.  It is highly likely that once we reach bottom, we will be back to 2000 price levels.  This has much to do with the intricacies of the California housing situation but also the fact that over time many systems including those economic, revert back to the historical mean.

In December of 1999, the median home price in Los Angeles was $192,000.  It reached a peak of $550,000 in August of 2007.  Currently, the median price is $300,000.  Just for the sake of reference, I went to the BLS inflation calculator and put in $192,000 in 1999 and wanted to see what it would by 10 years later:

It is interesting to note that simply by using the data from the BLS, we already see that Los Angeles home prices for example are quickly reverting to the mean.  In fact, all this would mean is a further reduction of 19% or allowing inflation to erode the price further.  My guess is we will have a combination of both.  Currently we are facing massive debt destruction so we are dealing with prices actually decreasing as the money supply contracts.  In an economy where debt equals money, debt being destroyed through writedowns or defaults is the actual destruction of money.

I have discussed this in the menace of deflation since the supply of money is currently being destroyed at a quicker pace than all the debt we are creating.  How can this be?  Well look at the U.S. equity markets.  $11 trillion has evaporated since the crisis started and we have used up $2.1 trillion in multiple bailout programs (although we have allocated nearly $9 trillion).  Globally, $50 trillion has been wiped off.  So more money (debt) is being destroyed than is being created.

The prospect of what is happening is somewhat stunning and shocking to many.  In fact, if we look at the S&P 500 over the past 12 years, you would might want to consider stuffing money into your mattress!

You would have done better by simply sticking your money into an inflation adjusted account like savings bonds or a CD.  This is how bad the stock market is performing.  But yet again, we see things reverting back to the mean.  And the mean we are reverting to is a mean that focuses on stable amounts of debt.  Let us take a look at how much debt is floating in the system:

As you can see from the above chart, household debt has topped off.  We can expect this to continue to decline especially with all the foreclosures coming online and also, all the revolving debt that is unable to be paid because of the unemployment situation.

So what is happening is more and more Americans are working harder and harder just to stay in the same spot.  A story hit the wires about a janitor position in Ohio with 700 applicants.  This tells you a lot more of the story than the headline 8% unemployment rate.  Many are coming to the realization that the stock market was really a big gamble even though countless advisors kept stating that it was the only game in town.

Just imagine if you had all your money in the S&P 500.  Even if you dollar cost average on your way up to 2007, the market has tanked by 57% from that point.  So let us assume you had approximately $500,000 at the peak in 2007.  You are now looking at sub-$250,000.  This on top of your home price falling.  That is why many are feeling they are running in the same spot and going nowhere fast.  You need to be prepared and ready for tough times.  There is no reason to believe the economy will rebound in 2009.  Earnings are still pointing lower and until job losses abate, there is very little reason to think that we have hit bottom.  The Red Queen knows that the faster you run, the more you will remain in the same place.

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And the rates are misleading for this reason because someone may say that a 1 percent rate is tiny but when you are talking about trillions of dollars, this is a big deal.  Let us first look at the rising charge off rate for all commercial bank loans:

It is rather clear to see 3 major episodes in the data provided.  We can see the S & L Crisis, the technology bubble, and now our current credit bubble.  Of course our current bubble is epic in size and dwarfs any of these and that is why the U.S. Treasury and Fed are trying to throw everything to stop this from getting worse.  And by the way, the data above is only available for the third quarter of 2008 which doesn’t even have the fourth quarter which will surely put us near record territory.

Yet let us look at the peak for the S & L Crisis which hit in 1991.  The bottom wasn’t hit until Q1 of 1994 nearly 3 years later.  Now remember, this is a much deeper and profound credit crisis and our trajectory is still moving to an apex, so we haven’t even topped out.  And as you can see from the S & L Crisis, there was a head fake in 1989 but then resumed upward again for 2 more years before hitting a peak.  For the tech bust, it took 4 years to hit the bottom in charge-offs.  We are spiking up at a near perpendicular angle and have yet to hit the peak.  With $49 trillion in assorted debt out there, this number is going to be growing.

Let us now look at charge offs in different asset classes:

First let us take a few minutes to walk through these assets on the books of commercial banks.  Clearly residential loan charge-offs have been spiking since Q3 of 2006 because of the epic housing bubble.  Given that there is $10.5 trillion in home mortgages outstanding, you can understand why even a 1% spike is damaging.  In terms of consumer credit, there is $2.6 trillion outstanding and credit card companies are now putting on the vice to consumers after a decade of zero down offers and teaser rates.  Now, you’ll be lucky to even get a card with a decent rate with good credit.

That is the true problem now that credit card companies were playing into the Ponzi scheme that had become our economy.  The game was good since everything was going up in tandem in a bubble like symphony.  Now that the bubble has burst these highly leverage institutions now have to be more cautious about their loans and their capital reserve ratios are getting hammered.  Let us take a look at Capital One for Example:

Capital One has been punished during this credit contraction.  And of course this is obvious because charge-offs are going sky high and also, consumers are actually pulling back on spending and trying to repair their balance sheet.  This is one of the paradoxes of credit/deflation induced economies.  First, during the good times easy money was everywhere yet the need for easy money wasn’t necessary per se.  Now, with the unemployment rate spiking and now having our 3^rd consecutive month of 500,000+ job losses, people are actually in need of credit yet at the same time, the easy access to credit is now gone.  Talk about poor planning but that is the reason why states like California are facing $42 billion budget short-falls.

It is amazing that in the third quarter of 2008, the household sector actually borrowed $117 billion less than the previous quarter.  This has not been seen for multiple decades:

This is a stunning given that the household sector in 2007 alone, was borrowing approximately $900 billion a quarter!  That is the insanity that we were living through.  So just imagine going from nearly $1 trillion in borrowing to negative in a few quarters.  That is why this recession will be the worst since World War II and frankly, since the Great Depression.  We have over built an economy to accommodate a bubble world were consumers were yanking out $900 billion in debt each quarter and now, that money has stopped.  Sure, we’ll be kicking down additional funds through stimulus but let us have a few more quarter like Q3 of 2008 (which is assured) and you can see how much of what the government is doing is small relative to the destruction occurring in the markets.  As I highlighted in detail before, since the crisis started $40 trillion in wealth has evaporated from only 3 areas.

The problem in solving something like current crisis is that we have to go through the pain since we lived for a decade in a debt induced bubble.  Trying to return to those days is not an option.  The belief system has been shattered and rightfully so.  We tend to blame Bernard Madoff and Art Nadel as the financial minds that broke this system.  Yes, they will be tried for what they did but the true crime is what is occurring through our Federal Reserve and U.S. Treasury.  If they could destroy the U.S. dollar today they would do it.  They want nothing more than high profits for the financial sector and could care very little about how average Americans are coping with this crisis.  Have you seen any piece of the trillions in debt, capital injections, TARP, and other forms of programs put into the system?  Of course not.  You aren’t part of the inner circle and all these charge-offs are going to continue to happen because the money is simply going to a select few while nearly 600,000 are laid off in one month.  That is a pace of approximately 20,000 job losses a day!

The fact that the market is rallying today is another sign that horrible markets show signs of massively volatility.  In fact, this should tell you everything you need to know.  The fact that we just saw 598,000 people get the axe and the market is soaring is indicative have Wall Street views the average American.  The market is rallying on the prospect of a bad bank or some aggregator bank where banks can start trashing these charge-offs but push them on to the American taxpayer for a nice little rally like today.  So what that we’ve lost 1.5+ million jobs in 3 months so long as we can kick down a few bucks to insolvent banks.

These charge-offs aren’t going away anytime.  But remember, before you get to excited about this rally ask yourself how a market can rally on the announcement of 598,000 job losses?  Sure, we know the warn out mantras of buy the rumor and sell on the news.  Yet there is no rumor here and people are buying on the news of massive job cuts.  This is how deeply flawed our system is.  It is time we get serious about this before we wake up one day and the U.S. dollar isn’t worth the paper it is printed on.  Those Federal Reserve Notes aren’t what they used to be.

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Capacity meant you had the means to pay the loan back.  Character meant a lender usually vouched for your habits and economic lifestyle as a good credit risk.  Finally, collateral meant that whatever the loan was secured to would ideally hold its value should you default on the loan.  Yet in our current crisis, all these 3 areas were completely ignored.  First, capacity was never examined.  Just think of the no-doc no-income loans made to borrowers who never had a chance of paying a mortgage back.  Character was never really examined as well.  In fact, think of all those multiple credit card offers you get in the mail.  Do you really think American Express, Chase, Citi, or any other major credit issuer really knows your character?  And collateral was essentially made up.  Just think of the global housing bubble and you’ll realize that creditors now have collateral that isn’t worth the loan amount.

In this article, we are going to focus on consumer debt.  We won’t focus on mortgage debt since we have already discussed that at great length in a couple of articles.  It is also the case that much of the focus has been on the housing market and the credit markets that relate to that area.  But not much has been devoted to the credit card and installment loan markets.  First, let us look at the size of this market:

The massive growth in consumer credit is astounding.  Since 1992, consumer credit has grown by $1.7 trillion.  This stunning number is even more breathtaking when you realize that most of this current decade, Americans have seen stagnant wage growth.  This chart really highlights the reliance on credit via credit cards and loans to keep our economy humming.  Let us be more precise with the numbers:

American Households:            112,377,977

Credit Card Debt:                   $973 billion

Non-revolving loans:               $1.59 trillion

Credit Card debt average per household:       $8,658

Total consumer debt per household:               $14,148

Of course, not all households have credit card debt or installment debt so keep that in mind.  Even if you have zero credit card debt and no installment loans, this is the average if all the debt was disbursed evenly across American households.  Installment loans include auto loans, mobile home notes, and education loans and that is partly why the amount is larger.  Yet the amount of credit card debt is staggering.  However, it is interesting to note that actual credit card debt has contracted in recent months:

The contraction is rather significant and shows that households are simply reaching a peak in their borrowing capabilities.  Remember the 3 C’s above?  Now credit issuers are being more diligent and actually using these criteria and as it turns out, the balance sheet of many Americans is deeply in debt.  To a certain extent, this was encouraged by a government channeled by the Fed and U.S. Treasury who have been for decades trying to discourage Americans from saving.  The game is quickly coming to a stop here.

Some of the average debt amounts are astounding.  Take a look at the terms for the average car loan:

Interest rate:                          6.43%

Maturity in months:              63.2 months

Loan-to-value ratio:              88

Amount financed:                 $25,041

Interestingly enough, in 2003 the interest rate was 3.81% and the loan-to-value was 95 percent.  What this means is we had an automobile bubble as well.  With low rates, little down, and massive demand the cost of cars went through the roof spurred by easy access to installment loans.  Now, with automakers suffering the price of cars will be falling just like that of homes.  All of this was fueled by easy credit and without access to credit, prices will have to come down to more stable levels that reflect the balance sheet of the average American family.

The average interest rate on credit cards is 13.36%.  If you are looking for a guaranteed investment let me tell you what to do.  Pay off your credit cards if you can!  Even Ponzi expert Bernard Madoff was pumping a steady rate of 11% so 13% is should be obvious.  If you are worried about the stock market and have credit card debt, just pay off your debt.  It’ll give you a much bigger assured return.  In addition, now that we are facing the menace of deflation debt is your worst enemy.

The major holders of credit card debt are commercial banks.  They hold $376 billion of credit card debt on their books.  But you’ll be surprised that $449 billion is in pools that are securitized assets.  So once again, with the rise of bankruptcies we are going to see the same issues with mortgages.  That is, it is hard to tell who is the ultimate holder of the note since it has been sliced and diced so many times it is difficult to distinguish true ownership.  Yet the thing with credit card debt is that it is easier to get rid of in bankruptcy:

Bankruptcy cases filed in federal courts totaled 1,042,993 for the 1-year period ending on September 30, 2008.  This is a 30 percent increase from the last fiscal year ending in 2007 where only 801,269 cases were filed.  What is more troubling is the rise of Chapter 7 bankruptcies which are liquidations (instead of Chapter 13 reorganizations):

Expect this number to explode in 2009 with the amount of debt outstanding and the housing market continuing to deteriorate.  The reason the number has been lower is possibly that consumers have been relying on installment and credit card debt to stay afloat for the last few years.  Now, that is ending and with that, more bankruptcies will inevitably occur.

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It is hard to utter the following phrase because we haven’t heard it in so long.  Americans are abruptly spending less than they earn.  As I’ve talked about before with U.S. Savings Bonds the U.S. government is purposely trying to keep you from saving.  This is simply one piece of the puzzle but in the middle of 2008, the U.S. Treasury suddenly lowered the ceiling of how much money could be invested in U.S. Savings I-Bonds for each calendar year from $30,000 to $5,000.  That is incredibly steep.  It isn’t like I-Bonds were garnering 11 percent year over year returns like Bernard Madoff but they were simply keeping pace with inflation.  In fact, with the current CPI readings, I-Bonds will probably be yielding 1 to 2 percent on the next readjustment since they adjust bi-annually.  My point is, our government is really trying to encourage people to spend beyond their means.

Just think about the entire concept of the Troubled Asset Relief Program (TARP).  The first tranche of $350 billion was funneled to banks to help their capital ratios to encourage lending.  None of this happened.  In fact, banks merely hoarded the money:

So what is happening is banks are simply not lending money.  This is the doublethink world we live in now.  We are expected to believe that giving money to banks, banks who are part of the reasons for this economic crisis, is going to actually help us in the long run.  The problem with TARP is there is no clear objective.  First, it was slated as a method of purchasing bad assets from the housing collapse.  Next, it morphed into the U.S. taking a stake in many large banks.  The last morsel was given to the U.S. auto industry.  Now, we are back to square one with the TARP.  Another $350 billion but no clear idea of how we are going to spend it since the first tranche was squandered and as you can see above, is simply sitting idly in excess reserves.

The savings rate for November spiked 2.8 percent.  This is up from the amazing zero at the start of 2008.  Here is a chart of the savings rate:

This decade we actually went negative for the first time since data started being gathered in 1959.  This is a reason why this recession is already giving us signs that it will be the most prolonged recession since World War II.  Many Americans have no buffer of savings to protect them from a job loss.  That is why many states are seeing their unemployment insurance funds being depleted at astronomical rates.  But let us show this chart with the expansion of debt over this same time:

This also coincides with my analysis that the roots of the housing bubble started way back 30 years ago.  It started back then because this is the tipping point where Americans not only became comfortable with debt, but they started confusing debt with wealth.  Unfortunately our Federal Reserve and U.S. Treasury are making this same mistake spending money we don’t have on bailing out banks and other projects that will simply harm our country in the long run.

The fact that over two-thirds of our economy is based on consumption does not bode well.  In fact, we are now in a debt unraveling spiral.  Take a look at the bankruptcy of Circuit City:

“NEW YORK (CNNMoney.com) — Bankrupt electronics retailer Circuit City Inc. said Friday it will close its remaining 567 U.S. stores and sell all its merchandise.

The company said it has 34,000 employees.

The company said the sale would begin Saturday and run until March 31, pending court approval.

The retailer’s Web site and call center will cease to operate after Jan. 18.

Circuit City said employees will receive 60 days notice of the termination.

Employees who are laid off earlier will get pay and benefits for the 60-day period beginning Friday, the retailer said.”

So here is the 1984 scenario at hand.  Fundamentally saving money is good for you individually.  But the fact that you are not blowing money on plasma TVs or new surround sound systems will cost 34,000 employees their jobs.  These people will not be able to spend at local restaurants, will have a harder time making their bills, and ultimately have a hard time coping in this environment.  This isn’t to say you should go out and spend but this shows the tragedy which our government has set us up with when they proclaimed 30 years ago that deficits don’t matter.

They do because now, we are big borrowers from Japan and China and they will not be content keeping our gig going when their countries are accumulating savings with a growing middle class that wants to see their homegrown currency appreciate.  If you don’t think this 30 year debt mindset is correct, let us look at our federal surplus or deficit:

This is why history is so important.  What we’ve been living in is a debt induced hyper charged economy that has saddled our nation with $49 trillion in various forms of debt.  And this debt will be growing with more TARP spending, further bailouts, and major fiscal stimulus.  This is money we do not have.  We are now relying much too heavily on foreign nations to keep our spending going.  In this case however, Americans are being forced to save and this is the only way to correct our damaged balance sheet.  The government looks to be spending more than we have for the foreseeable future.  If our foreign borrowers get tired with low rates, there will be economic havoc and a run on the U.S. dollar isn’t completely out of the question.

On an individual level, you should save.  We can’t speak for everyone but it is time to get our budget in order and protect what has made this country strong.  I doubt that any of us believes that one of our inalienable rights is to spend beyond our means.

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The retail sales numbers came out today and once again they have declined for the 5^th straight month.  People are simply not spending as much.  That is why when I talked about 10 reasons we will have a minor depression, I noted that retail sales will play a big factor in determining a point where we may hit a bottom to our current economic problems.  Until we get employment and retail sales back up, we will not be out of the slump.

Take a look at this chart showing consumer debt topping out:

*Source:  CNN.com

Even though the drop of 0.8% is tiny, it does signify a shift in what is going on but more importantly it is another factor showing us that we are clearly in a deflationary environment.  The Federal Reserve and U.S. Treasury are doing all they can to avoid deflation because deflation unlike inflation, causes people to pull back on their spending more furiously.  Think of the Great Depression.  Why would you purchase a home today when you know it will be cheaper tomorrow?  Why would you go out and buy a car today when next year it may be significantly cheaper?  That is the consumer psychology making the rounds right now.

With inflation, there may be an incentive to purchase now.  As perverse as the housing bubble was, if you were to believe housing prices always went up you had an incentive to buy today.  If you felt the home would be more expensive next year, you’d go out and spend today.  As bad as inflation is, it is more manageable at least from a monetary perspective.  If inflation gets out of control, they can simply raise rates.  With deflation?  They have very little in their arsenal to combat it.  That is why the effective rate on the market is near zero already.  That is why the government is not only the lender of last resort now, but it will also be the spender of first resort.  The data in this recent report tells us people are not spending and actually paying down current debts.

Part of this also comes from U.S. households losing $2.8 trillion in the third quarter in their net worth:

That is a painful decline.  This is a drop of 4.7% and the largest decline in the 57-year history of the report.  It also marks the fourth straight quarter of declines.  You also have to keep in mind that this report does not include October, November, and December which have been even tougher months.  Where did the markets end on September?:

Dow:               10,850
Nasdaq:           2,091

S & P 500:       1,166

What you can expect is the net worth of many Americans will show significant declines again for the fourth quarter of 2008.  I would also suspect that given the debt destruction by people defaulting on mortgages and credit cards, that you will see debt decline once again.

So what can you do in this climate?  If we are to remain in deflation for a short period, the best thing you can do is pay down any debts you may have.  This should be a primary target.  In fact, you should go after credit card debt first.  Why carry a balance of 15 percent or higher when a savings account is only yielding 2 percent?  Pay down that 15 percent and you’ll at least know that you are “earning” a 15 percent return right now in this market which is practically unheard of.

The balance sheet of many Americans may look weaker but there are things you can do.  If you are planning on buying a home or a car, don’t.  These two sectors are deflating at incredible rates and all economic fundamental data is pointing to further declines.  What do you think automakers are going to do next year?  They are going to have inventory overload and will look at ways to moving the items.  In economics the best way to move something is through price.  Lowering the price.

I wish I could say the same about the U.S. government but we are going to be in debt for some time.  It doesn’t look like in the short term we are going to do anything to address our massive debt.  Given the current employment situation and fragility of the credit markets, I just don’t see anyone advocating a balanced budget approach.  But that doesn’t mean you shouldn’t try to get your house in order.  You should.  Even people that make $46,000 for their household can find ways to save.  It takes flexibility and adaptation but it can be done.  Hopefully this gives you a few ideas on how you can prepare.

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