Page 2 of 2 Paid-up card-carriers feel the pain
By Julian Delasantellis
reserves, in the case of lending, no longer carried sufficient value to support
the loan and money creation it was being used for.
First, two of Bear Stearns highly leveraged hedge funds based on subprime
mortgages went belly up, then so did Bear Stearns itself. The entire world of
finance has been completely transformed, and we now see that all the
media-acclaimed geniuses and money savants who were doing such fancy and
incredible deals, making themselves and their investors fabulously wealthy in
the process, don't look half so clever now, when it’s hard to impossible to do
the leverage, to borrow the money, for another deal.
The Wall Street Journal's Dealblog now lists 17 private equity
leveraged buyout deals announced between January and September of last year,
with a total nominal value of over $70 billion, that have since fallen apart
because the prospective buyer could not obtain financing. These days the
leveraged deals are few and far between on Wall Street, a prime reason for the
now over 20% rollback in US equity prices we have seen since the top in early
October.
It's the same with credit cards, even with blue-blooded American Express. When
a bank hands you a credit card with a $5,000 credit limit, what you are really
receiving is a highly easy means to draw on a $5,000 line of credit; in its
simplest terms, the banks are making you a $5,000 loan. If you immediately max
out the card and then take your own sweet time paying it back, sending in only
the minimum payment every month, then you've made the bank happy as a clamz.
With credit card interest rates in the 15-30% range (as opposed to three-month
US Treasury securities now paying under 2%), you are a very valuable customer.
The bank may even send you a birthday card wishing you continued good health in
your next year; they sure want to keep someone like you around.
But the bank must carry a percentage of the $5,000 as a reserve, either as cash
(doubtful - nobody keeps their cash just sitting in a bank vault these days,
especially banks), or by claiming the value of some other security, like a
subprime mortgage, as the reserve.
If the value of that security declines, then to maintain a stable asset to
capital ratio, the bank must pull some of that $5,000 back. With recent
statistics indicating that Americans are now turning to their credit-card
plastic, that is to debt, in order to make up the difference between the amount
of their paychecks and the cost these days of the necessities of life,
particularly food and fuel, and with credit card delinquencies now approaching
the level of the recession of the early part of this decade, this is an
especially inopportune time for the banks to be forced into triage decisions as
to what families will either survive or perish in the current credit maelstrom.
That's undoubtedly what happened to my colleague. Maybe she was too incautious
with other credit cards and borrowing, and the great omniscient American
Express credit-scoring computer in the sky reached out with its mighty hand to
smite her. (Actually, the computer is more likely in South Dakota, the state
which in 1978 repealed its usury laws against exorbitant loan interest rates as
a quid pro quo to then Citicorp chairman Walter Wriston's promise to move the
stated company headquarters to that state. The US Supreme Court had ruled that
credit card companies, by virtue of the US Constitution’s contracts clause,
could charge nationwide the rates allowed in their purported "home" state - Voila!
Nationwide 30% interest rates on outstanding credit card balances.)
Maybe it was the opposite; banks also don't like it when you carry too small a
balance, when you pay your bill in its entirety every month. You're no fun to
them then.
What effect is this credit card deleveraging going to have? Simple, it's going
to further curtail US retail spending at a time when the consumer is already
reeling under high gasoline prices. Forget about my colleague plunking down the
Amex card for the $2,000 down payment for her new Toyota Prius hybrid.
The same effect will undoubtedly be seen across the economy. For those who
carried a revolving balance near their credit limit, letters like the one my
colleague received will mean that their free-spending ways will come to an
abrupt halt. Their new lower, credit limits mean that they will be essentially
living in the cash economy until their balances are paid way down. If you're in
a situation where you have to wait for the US government's next fiscal stimulus
check to eat or heat your house you better get used to being hungry and cold,
for there's just so many times the government is going to be able to tack on
another $160 billion on the deficit before foreign lenders pull the plug.
What if you used credit more responsibly, say, carried a $3,000 balance on a
card with a $10,000 limit? Your probity and virtue are no guarantee of being
spared the fate of a credit limit reduction, of deleveraging. Maybe you were
late, even if it was only a few hours late, with a payment or two, maybe your
employer's financial difficulties have led to a reduction in your hours that
the credit-scoring computers have found about (they always do), maybe the
computer has gone over all your purchases and activities, finds that it just
doesn't like you very much.
You may wake up one day to find that the extra $7,000 in unused financial
firepower that you had been keeping in reserve in case of a big car repair
expense or family medical emergency just isn't there any more.
An omnipresent feature of American life recently has been that, middle-class
status meant that you always had access to money (even if you didn't use it),
whether through using your house as an automated teller machine (ATM) through
home equity borrowing, or through credit cards. With home prices declining and
credit tight, the home ATM is flashing "out of order"; now we see that even the
credit-card plastic has melted under the wilting heat of constant use.
When will it end? Well, it all started with the decline in housing prices, and,
in contrast to the chipper chiming colloquies of all the TV real estate
"experts" now desperately hoping that they will not soon be forced to get their
previous professional attire, their ketchup-stained luncheonette aprons, out of
the closet, the real estate crash continues unabated.
The shares of Fannie Mae and Freddie Mac, the government sponsored mortgage
guarantor enterprises, are now regularly losing over 20% of their value in a
day. At a high-level financial conference in Arlington, Virginia last Monday,
Morgan Stanley CEO Jamie Dimon, the suitor in the shotgun marriage the US
Federal Reserve arranged with Bear Stearns last March, responded to a question
as to when US real estate prices would stop falling with a simple, carefree
shrug of his broad shoulders.
"This is all just the patriarchy in action, stupid old men exercising unlimited
gender privilege to make stupid decisions, isn’t it?" my colleague exclaimed
after I elaborated on what was going on here.
I don't know about that. You don’t have to be a man to make boneheaded
financial decisions. Bankers of either gender do that just fine.
Julian Delasantellis is a management consultant, private investor and
educator in international business in the US state of Washington. He can be
reached at juliandelasantellis@yahoo.com.
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