The Only Certain Bet in this Market is paying Down Debt. Credit Card Rates Rise as Other Interest Rates Drop. $866 Billion in Revolving Debt Still Remains.
The global economy remains on unstable footing as we see debt problems slam the European markets with Greece in the current spotlight. Yet the problem of debt is not unique to Greece itself and it is fascinating that the world is only focusing on one country. The average American over the past four decades has taken on so much debt that household debt outstanding is now equivalent to the U.S. annual GDP. The biggest amount of debt is with mortgage debt. Yet with mortgage debt you are securing the mortgage to ideally a property that will reflect the amount of debt linked to the home. Part of the housing bubble problem stems from the hyper inflated values of homes and now we are seeing the ramifications of this with millions of homes being foreclosed on. But another large part of this bubble was around the usage of credit cards that hit their apex during this crisis:
For nearly four decades Americans’ love affair with credit cards grew unabated. The amount of credit card debt outstanding hit an apex in 2007 at the height of the bubble reaching $975 billion in debt (to put this in perspective Greece’s GDP is $367 billion and their current deficit is 12.7 percent of economic output). Unlike mortgage debt or even auto debt, there is nothing securing credit card debt. This can be someone going to a club and buying $300 in drinks for friends or taking a trip to Antigua and spending thousands and charging it up on easy plastic. It can also be in the form of consumer goods consumption like buying a new television set or additional appliances. Yet for the first time since data on revolving debt has been kept we have now seen it contract on a yearly basis. And part of this contraction stems from the Great Recession but also more people are paying down extremely expensive debt:
The above data comes from an interesting article from the St. Louis Federal Reserve. The author William T. Gavin examines the low interest rate and its impact on consumers. As his chart above highlights, even with the Federal Reserve lowering funds to record lows the average interest rate on credit cards has crept up even higher than in 2000 when the Fed funds rate was at 6.5 percent. With interest rates on savings accounts so low, it is definitely appealing for many consumers to pay down high interest rate credit cards down since this is a guaranteed return of 13, 15, 20, and even 79 percent on some credit cards. This low interest rate environment is creating some asymmetrical dynamics in the market. While the above shows interest rates on credit cards as being high, rates on savings accounts are extremely low:
A 90 day certificate of deposit is currently yielding 0.19 percent, or slightly above the rate you would get by sticking your paycheck in the mattress of your bedroom. So even as we see the amount of revolving debt outstanding decline, there is still $866 billion in credit card debt outstanding. Credit card companies are losing money on charging off accounts as bankruptcies across the country rise. Many times credit card companies are hiking up the fees whether they are annual payments or jacking up interest rates on even good paying customers. In this environment it is rather clear that if you have high interest credit card debt, forget about the stock market and focus all your energy on paying down that high debt.
This interest rate spread on debt and savings is enormous. And as average Americans move their money to safer deposits as the stock market now reflects a speculative casino, many are wondering how they will do with such low rates:
In this current environment it would seem that the best course of action is paying down high interest debt and more importantly, not spending beyond what you can reasonably afford. Unfortunately many Americans are now realizing that they do not have access to the same lending window banks have with their central bank. The bailouts were largely a method of shoring up the troubled assets within banks, not a bailout to help the balance sheet of average Americans. If banks had any faith in their customers you would see lending pick up once again. But this Great Recession has created a smaller number of quality borrowers. Or to be more accurate, there weren’t many quality borrowers to begin with over the past decade but that didn’t stop banks from making loans earlier in the decade. Once banks gained consciousness they slammed shut the door and they went into survival mode primarily by focusing on government support to keep them solvent.
Banks have very little desire to loan money when they are dealing with large imbalances on their internal accounts:
You don’t need the above chart to tell you that credit has contracted massively during this grand economic calamity. Just look at the amount of credit card solicitation you now receive in the mail. Long gone are those zero percent offers for 12 months. You might get a six month balance transfer offer at zero percent but you will find out in the small print the enormous 5 percent fee for moving any amount over. Or you might soon come to realize that your annual fee free card now has a service fee. These are the ways banks are trying to go after additional revenue streams from their customers (or if you like, taxpayers that saved them from extinction).
Until our system is reformed, these are the rules we have been given. If you have outstanding credit card debt ($866 billion tells us many do) start paying it down. Forget about the stock market for the moment. The stock market is highly volatile and with no real reforms yet, we are in for another crisis in the short-term since the same games that got us here are once again being played out. By paying down your credit card debt you are assured a fixed return for a defined set of time. In this current market, that is as close as you will get to any sort of guarantee.
If you enjoyed this post click here to subscribe to a complete feed and stay up to date with today’s challenging market!Commercial Real Estate Collapse Bigger than Subprime Implosion – Why is the Market Ignoring the $3.5 Trillion Commercial Real Estate Market Implosion? Pricing in Another Bailout.
Most people that follow real estate even at a cursory level have heard of the problems in commercial real estate. The enormous $3.5 trillion market in commercial real estate (CRE) has deep and profound problems. At the peak CRE was estimated to be valued at $6.5 trillion. Today the value is closer to $3.5 trillion or closer to the loan amount outstanding. This market is now sitting in a zero equity position. In fact from market trends it is very likely that much of CRE bought during the last few years is significantly underwater. This trend is a few years behind the residential housing bust that shocked the markets into record declines. Why is the market not reacting as negatively to the bust in CRE as it did to residential housing?
Commercial and construction loans combined are bigger than the entire subprime market and CRE values have now fallen by 43 percent from their peak across multi-family units, hotels, and retail space. And with the CRE collapse there is a harder time selling off this space if there is no economic demand for certain spaces. You also have a smaller pool of borrowers looking for retail space. Take for example retail space near empty suburban housing divisions. With the busted homes if you lower prices enough, there will be a market created at a certain point. Yet this takes time. But with commercial real estate you may have no market at any price. Much of the CRE space is used as a business. With no business there is no need for CRE. So we have a giant $3.5 trillion market of loans that are largely toxic but the market seems to be ignoring this. Take a look at the combined CRE collapse from data collected by MIT:
And the worst isn’t behind us. It is still to come:
“(Moody’s) The delinquency rate on CMBS conduit and fusion loans increased by more than 50 basis points in January, bringing the total rate to 5.42%. The total delinquent balance is now more than $36 billion, a $3 billion increase over the month before. By dollar and basis points, this is the largest increase in the delinquency rate thus far in the downturn, as measured by the Moody’s Delinquency Tracker (DQT).”
Source: Calculated Risk
So the speed of value declines in CRE is still deep and troublesome. Why is it then that the market is ignoring this data? Part of it has to do with the banking system bailouts. It is now assumed that any large and significant problems are going to be handled by the U.S. Treasury and Federal Reserve. In 2008 when the market was pricing in reality based risk and valuing companies on their own ability to succeed, countless firms were going to zero because that was their actual value. Today, with the entire banking sector bailed out the market is now pricing in no failure and subsequently even companies with enormous amounts of commercial real estate seem to be doing well. Take a look at one of the larger holders of commercial real estate in Simon Property Group (SPG):
This institution is now up by 159 percent since the March lows. Has CRE really changed that dramatically in the last year? And this is one of those areas being hit extremely hard:
“(Reuters) Simon’s Mills properties portfolio is comprised of two types of assets: regional malls and Mills properties, totaling over 45 million square feet of gross leasable area. A Mills property typically comprises over one million square feet of gross leasable area and has a combination of traditional mall, outlet center and big box retailers and entertainment uses, all focused on delivering value for the consumer. These assets are located in major metropolitan markets. The Mills is Simon’s fifth retail real estate platform.
Simon’s Community / Lifestyle Center Division consist of more than 70 centers comprising over 20 million square feet in size. These properties range in size from 30,000 square feet to over 900,000 square feet. All of the properties in the Community Lifestyle Center Division are an open-air format and offer a range of merchandise opportunities in a well located and convenient setting. These daily-need centers operate with the who’s who of big box anchor stores and many national, regional and local small store operators.”
Giant holding of retail space in a time when retail spending is collapsing. We have seen consumers pulling back usage of credit cards and discretionary spending. The only reason for this enormous price increase is the market is now highly mispricing risk because of the enormous moral hazard embedded in the entire system. We went from having a bank failing causing the market to react to now, we need an entire country to reach collapse like in Greece to yield any reaction to the markets. And this notion that companies are no longer at risk is naïve and at worst, problematic for our entire system. We took systemic risk and digested it to the entire network of our economy. The risk is now directly linked to taxpayers through various bailouts and Federal Reserve programs aiding banks. Yet the problems are still there. Unemployment is still at its peak and we’ve been losing jobs for 25 straight months. Prices on residential real estate and CRE have yet to come back because people no longer have access to loans that don’t verify their income or ability to pay the loans back. The market is mispricing risk yet again believing that these trillions in loans at risk will simply be back stopped by the entire country.
Japan gives us an example of what happens when a country turns their banking system into a zombie like nation. The big banks like hungry alligators demand more and more money and this sucks away from the productive economy. You also have a rise in part-time employment (Japan has one-third of their workers on part-time status). We now have seen a massive rise in this part of our underemployed economy, the largest ever. And Japan spent trillions in trying to stimulate their economy and here they are two decades later with little to show for their massive financial bailout. Instead of facing the music at once it was spread throughout the Japanese citizens to pay over decades. The outcome is the same, someone has to pay for the bad bets. Will it be the institutions or the people? The United States with their bailout policy has decided that it will be the people who pay for this mess.
So when you look at the CRE market, don’t be deceived that things are suddenly better. In fact, they are as bad as they ever were. The market is simply assuming that the taxpayer will make all these bad loans whole like Goldman getting protected via AIG and taxpayer funding. In the end someone will pay and true values will eventually have to be reflected.
