Wednesday, April 16, 2008

The accelerating down

I love america. The path we are taking is not one of correction, but to go down faster in flames. One of these days there will be a reckoning.

Not Looking Down
by Stephen Pizzo

In a time when almost daily I read stories that terrify me, this one terrified me more than any of late. It was a story on the front page of the second section of yesterday's Wall Street Journal. I scanned it in and want to share some excerpts. Because I don't want to terrified AND alone:

Habit - Forming: Borrowers Keep Piling On Debt
By Jane Kim

As Lenders' Tighter Standards Cut Off Some Avenues, People Tap Credit Cards, Equity Lines

The credit crunch has made it harder for Americans to indulge in their love affair with debt. So what are they doing? Borrowing more. While tighter lending standards have cut off all but the most credit-worthy borrowers from auto loans and home loans, many people are turning to credit cards and tapping more of their home-equity lines of credit to dig themselves in deeper. And lenders, once eager to lend to those with even spotty credit records, are trying to rein in borrowing by cutting consumers' available credit lines.

Average balances on credit cards and home-equity lines of credit are growing rapidly, rising....

Borrowing is climbing quickest in the regions where house prices plunged most sharply, making it tougher for people to extract money in cashout refinancings. Credit-card balances rose nearly 15% during the first quarter from a year earlier in California and Florida and more than 20% in Nevada-all states caught up in the housing bust, according to Equifax and

The rise in borrowing shows just how addicted the U.S. consumer has become to credit. Even as borrowers are cut off in one area, they promptly look for new sources. Workers have increasingly been raiding their 401(k) plans to take out loans over the past year, according to plan administrators.

Oh boy, where do I begin? When the housing bubble finally burst and credit tightened, I figured folks would realize that borrow & spend was not a sustainable economic model. It seemed inevitable that they would start cutting back. Of course I figured there would always be those ten-percenters out there who would prefer to go down in flames than adjust to a more frugal reality.

But it now appears the real ten-percenters are those doing just that -- cutting back and paying down debt. The rest have just ratcheted up their borrowing ways. Like crack addicts who've lost their usual pusher, they've hit the street and found new sources of crack. Clearly, most are not ready to take the cure.

Deborah McNaughton, president of Legacy Financial Services Inc., a mortgage lender in Placentia, Calif., says several of her clients have recently borrowed more from their home-equity lines of credit and stashed the money in bank savings accounts. Theresa Leick of San Juan Capistrano, Calif.' a loan processor who works with Ms. McNaughton, pulled $21,000 from her available home-equity line of credit in February to park in a certificate of deposit.

"I'm fattening my reserves in case I have to go look for more work," says the 40-year-old Ms. Leick, who says she is concerned about losing her income because she works in the mortgage business. She says she would have preferred not to have tapped her home-equity line, "but if the bank takes away my comfort zone, that will make me lose sleep at night."

That's the "another-shot-of-the-hair-of-the-dog-that-bit-ya," cure for a hangover theory, and its kept many an alcoholic on the juice until their livers called the game over.

Fearful that her bank might cut her off from borrowed money, her solution was to borrow money she currently doesn't need. Now she's got a bigger monthly payment on that unneeded cash, including interest. All because she wanted a "stash," just incase.

Now, if that's not the description of clinical addiction, I don't know what is.

Across the country, consumers are increasingly relying on credit cards to stay afloat. This week, the Fed reported consumers are boosting their use of credit cards. In February, Americans had $951.7 billion in total revolving debt... Credit counselors say they have started seeing more people turn to their credit cards to cover everyday items.

"Food, fuel and medicine-people are charging their day care, even their tithes to church, and any incidental items," says Gail Cunningham, a spokeswoman for the National Foundation for Credit Counseling in Silver Spring, Md.

This is particularly disturbing. I was raised by parents who ran their own business. They taught me that credit was a business tool, not an income source. If there was no way to make money on borrowed (rented) money, then it was stupid to borrow the money. Even the family car was bought with money, not credit. And a home mortgage was something to be paid off as part of the family's retirement planning.

Of course, back in those days (the 50s & 60s) credit card companies weren't shoving plastic into the hands of anyone with a pulse. Not that there's anything wrong with credit cards. They are convenient little buggers, safer than carrying a lot of cash and quicker to use than checks. (Don't you just hate it when someone at the grocery store keeps you waiting in line while they write a check?)

So the cards are fine. Just pay them off in full at the end of every month. Is that so hard?

Apparently it is:

Major credit bureaus ... say their own analyses of credit files show that more consumers are turning to credit cards. TransUnion last week said total credit-card balances increased 4.8% in the fourth quarter to $1,694 per user from the third quarter- more than double the growth it has typically seen in prior years over the same period-with the steepest increases in states that have been hit hard by the mortgage crisis, such as Florida, Nevada and California.

In a separate survey released last week, Discover said 52% of consumers it surveyed in March expected to spend more in April on household basics by cutting back on discretionary expenses, such as vacations, or by setting aside less money for savings and investing. That is an increase of 12 percentage points from its February survey and close to the highs seen last November, when gas prices spiked.

Now don't get me wrong. I understand that a lot of working Americans are having trouble making ends meet these days. But the average household credit card debt is now over $8000, and they didn't get there last week. They piled that debt on during the relatively normal years, buying things they wanted (as opposed to needed) but did not have the cash to buy at the time. Now that the nation (and the world) is in a recession, heading towards something worse, these credit junkies are responding by piling on more debt. (I just had an image of them as Dicksonian little Oliver Twists facing their bankers with the hands out, "You want MOOOOORE credit?")

Let's look at it another way. Imagine that these folks were in a boat that was filling with water. Would the correct solution be bailing water out, or adding more water to the boat? These folks have decided to add more water to their already sinking boats.

Rather than bite the bullet, everyone from Washington to Main Street, seem determined to emulate Wile E. Coyote. You know, like when Wile E. chases the Road Runner right off a cliff, running on thin air as long as he doesn't look down. No one wants to look down.

Veteran Washington Post reporter, David Ingnatius, took a look down that abyss and didn't like what he saw. Washington's solution to the credit crisis is to make credit even easier and cheaper by having the Federal Reserve bolster lender's balance sheets by assuming their bad debts.

The Fed has pledged itself to a rescue package whose ultimate scope is unknown but that will put at risk the nation's most precious asset, which is the Fed's credibility. How much bad debt will the Fed have to assume? Nobody knows. Estimates of the subprime portion range up to $400 billion, but that's just the beginning. The consensus among analysts is that losses in credit markets will total at least $600 billion, but suppose it proves to be double that, or triple?

"It's not a liquidity crisis, but a solvency crisis," says my banker friend. "Can the Fed really take on $1 trillion of impaired securities? $2 trillion? More?" (Full)

Another very smart man, billionaire investor, George Soros, told investors during a conference call last week that the credit crisis was far from over, and urged regulators to move faster to contain the damage from the collapse of the housing finance markets.

"I think the situation is more serious than the authorities admit or recognize," Soros said. "He pointed to the potential for huge losses from complex investments linked to the U.S. subprime mortgage market, like credit default swaps, which allow investors to put bets on the likelihood that companies will default on bond payments. He described the market in credit swaps as a sword of Damocles.

"This $45 trillion market is totally unregulated. That's more than five times the entire government bond market of the United States. It's almost equal to the entire household wealth of the United States."

In another column David Ignatious concluded, "The public, fortunately, doesn't understand how bad the situation is. If it did, we might have a real panic on our hands.

Panic has not yet set in. Credit cards and home equity lines of credit are allowing Americans to hold on, if only by their fingernails, to their cherished yet unsustainable lifestyles.

But the day is near when they will have no choice but to look down, and we all know what happens then.

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