Tuesday, March 16, 2010

Give Credit Where Credit is Due


Without an increase in consumer spending, the “recovery” remains nothing more than a misused word to most Americans. Even the devious derelict denizens of Wall Street understand that continued “growth” (even under their definition) requires a fundamental change in this consumer trend, but since there are no clear signs that this reality is likely anytime soon – and the underlying negative job numbers are unlikely to change for the significant good for a very long time – the big financial institutions make money the old fashioned way: they continue to create derivatives that bet against success (like the credit default swaps on national debt in struggling economies overseas, which only makes those countries pay more interest and suffer more) and press for greater increases in productivity (read: more layoffs).

The factors underlying consumer spending, mostly related to consumer confidence and available consumer money to spend, suggest that breaking this consumer trend is going to be anything but easy. First, even Americans with money are spending their cash very, very carefully, and the big crash may have reset spending patterns for decades. Caution has replaced lifestyle as a motivator, and the fact that there may be a recession, part 2, as commercial real estate defaults take down an increasing number of local and regional banks, doesn’t help. Second, since the over-use of credit (leveraging) got us into this mess, lending institutions – feeling pressure from their shareholders and government regulators – have seriously tightened their credit requirements; most people and companies simply cannot qualify, even if money for this purpose were available.

There’s another huge credit elephant in the room, and a definite Catch-22 in the lending markets. Securitization. The old credit bundle (definitely a derivative!) – where financial institutions aggregated one form of debt or another (mortgages, credit card debt, car loans – you name it, they bundled them) into financial instruments and then sold them in the open “securitization” market (the so-called “asset-backed securities” – or ABS – market; “mortgage-backed securities” – or MBS – is a subcategory) to willing investors… like Bear Stearns, Lehman Bros and more than a few pension funds. This process allowed banks to move the debts off their books and free up loan money to lend again. And so the process rolled along. According to the March 8th The Deal.com: “ [B]y the markets’ height in 2006, U.S. new issuance in mortgage-backed and asset-backed securities totaled $2.172 trillion, according to Dealogic… According to the Federal Reserve Bank of Dallas, ABS markets funded almost 66% of all residential U.S. mortgages by mid-2008 and about 25% of non-mortgage consumer credit.”

Well with federal regulators breathing down their necks, notwithstanding President Obama’s mandate that recipients of TARP money were bailed out to restart the consumer and small/mid-sized business credit market, and the inability to sell off any loans they make (they literally have to keep the risk and have vastly less money to lend) into the derivatives marketplace, local lenders are clearly not likely to change the their unwillingness to lend absent some very big indications to the contrary. Defaults are not longer the problems of those who purchased the debt bundles; they now remain the lending banks’ risk. And with commercial real estate loans about to tank the balance sheets of many banks, the prospects of opening up their lending coffers appear to be bleak. 2009 may have represented the greatest lending contraction in decades, but 2010 doesn’t shine even the faintest light of change in this process. Fundamentally, the ABS and MBS markets are pretty much dead in the water. “The federal government recognized early in the crisis that reviving securitization was key to stabilizing the financial system. That's why the Federal Reserve created the Term Asset-Backed Securities Loan Facility, or TALF…” The Deal.com But that program was only a modest success, insufficient to solve a very, very big problem… and it expires sequentially over the next few months.

So you’re the government, and lending – in a society that is now based on available credit – has never fallen so severely. We have pressure from the international community, particularly China (our largest creditor nation), to stop borrowing so much, especially the U.S. government which has incurred game-changing deficits to cope with this economic collapse. The collapsed economy has also taken companies and individuals that might have been good credit risks a few years ago and put them in a much riskier category, if they would qualify on any basis at all. The unregulated ABS and MBS marketplace help accelerate our financial demise like good ice under a speed-skater’s skates, but without ABS and MBS markets, there are exceptionally limited resources to restart the credit markets again.

So we want more available credit, but we don’t want banks to make risky loans. We want more money to flow to consumers and small and mid-sized businesses, but they are either in the process of getting out of debt or simply don’t qualify anymore. We want strict regulation of the derivatives marketplace, but we want “never again” regulation of these markets to prevent a recurrence of past failures. What you are seeing here is obvious: a pendulum of inconsistencies. We’re seeking balance. All this takes time. Congress, for example, is considering rules that would require banks to retain some risk in bundled lending derivatives so that they cannot escape responsibility for their lending decisions.

And right now, the little guy is getting screwed where credit is absolutely needed. The March 9th DailyFinance.com: “Millions of Americans today are facing the worst money problems imaginable, but these same conditions are creating flush times for pawn shops and so-called payday lenders. As banks slashed their lending and jacked up fees on overdrafts and bounced checks and as credit card issuers made credit harder and more expensive to get, the number of people walking into a pawnshop or a payday-loan store has skyrocketed.” Payday loan fees, literally charging an effective annual interest rate of 400-500%, and pawn brokers, whose practices aren’t fundamentally different, used to be the place for those at the bottom of the economic spectrum – the poor get poorer – but today, D ailyFinance.com points out, big payday companies are finding half their borrowers have annual incomes of at least $50,000, and 20% make more than $75,000. Last month, a bi-partisan Congressional effort scaled back proposed consumer protection legislation to create and enforce rules against payday lenders; it seems their lobbying efforts and campaign contributions were simply “too big to refuse.” Somehow, the marketplace needs to find middle ground, but when will that occur?

Nevertheless, trend lines are clear; there will be a securitization marketplace in the future, but the rules of necessity will make it much smaller than in the past: “Not everyone thinks this is a terrible idea. Anders Maxwell, a managing director at investment bank Peter J. Solomon Co., says that the re-emergence of securitization in any strong form would be ‘really shocking.’ He argues that over the years securitization created a system where actual lenders to many credit card users, home-buyers and even corporate high-yield borrowers were not banks themselves but investors in the securities, including insurance companies, foreign banks, pension funds and, in increasing numbers, hedge funds. This is the much-­derided ‘shadow banking system’ that until recently existed largely out side regulators' purview. ‘It's a completely unregulated market,’ says Maxwell. ‘And it's proven to be a disaster.’” The Deal.com (March 8th)

As the government literally works at cross-purposes against itself, there will be movement in that pendulum, from way-overleveraged unrealistic “too big to fail” assumptions to a shriveling up of the entire lending structure. We will wind up in the middle… until Wall Street finds another bubble cow to milk!

I’m Peter Dekom, and this is really complicated stuff!

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