If this rally is real (and despite today’s performance, I still think that the market will close higher on Thursday), how long will it last? Setting aside whether the next leg down will establish a new low or not, there will be an end to the rally. I read Naked Capitalism (‘cause it tastes good). Yesterday, Yves posted this insightful piece, Spreads for Credit Cards and Auto Loans Widen Sharply. There’s a chart showing the spreads on some of the 2-5 year loans. Now, most people are expecting the spreads to ease over the next week or so, but it does beg the question: are these spreads optimistic? I found this link from Naked Capitalism today, titled simply “We have successfully transformed credit risk into solvency risk.” An interesting snippet:
We knew that credit cards pose as much risk to the financial system as subprime mortgage, as the respective securitised products markets are roughly of equal size. More recently, the spreads on credit card securitised products widen dramatically, and this suggests that the Fat Lady about to sing in this market as well – as credit-cruched Americans have been loading up with only source of credit that has been freely available (though free is perhaps the wrong word). Naked Capitalism has an interesting entry on the latest spreads between various types of credit cards and the respective Swap/Libor rates. The spreads for credit card debt, both fixed and variable rate, and autoloans went up by 50bp in one weak, and this is unlikely to reverse as money market rates improve. Naked Capitalism remarks that the “consumer borrowing party is coming to an abrupt close”.
That first line is the most interesting to me. The securitized credit card market is roughly the same size as the securitized subprime mortgage market. Fortunately, if I am reading that correctly, it is not the “subprime credit card market” that is of equal size, but the total market. To me, this indicates that the problem area may be roughly two orders of magnitude less. Unfortunately, the losses for each default are likely to be more severe, since the debt is not backed by assets. I know nothing about this market, but I do know the sensitivity of the US economy to consumer buying power. Already, the US auto industry is expecting the weakest auto sales in decades. PepsiCo lowered their expectations today. Home equity withdrawals have gone from hundreds of billions of dollars (around 9% of disposable income) to near zero. These are not good signs for a consumer-focused economy.
The consumer has shown surprising resiliency over the last couple decades. The consumer has been weakened in this downturn. If the weakening continues, that may be the driving force behind the next leg down.
UPDATE
I’d like to clarify something: I don’t think the focus on consumption is a good thing for the US. A slow shift from spending to saving would be great in the long run for the nation as a whole. It would be good if the US was a net lender to the rest of the world. But, that’s not the case. We are heavily focused on domestic consumption. A sudden shift away from consumption is going to have dramatic consequences.
US workers, at least in good times, are some of the most flexible workers in the world. Our community college system, technical schools, and other adult-friendly training programs are unmatched on a global scale. People can be trained to switch industries with incredible efficiency. Think about how many people were able to quickly become real estate agents, brokers, homebuilders, etc. during the housing boom. Think of the number of web programmers and designers that erupted during the dot-com boom. After the booms go bust, people who were on the fast track for easy money take a while to swallow their pride and find alternative employment opportunities. The US transition to a consumer economy has been the biggest boom and can potentially be a devastating bust. However, I believe that opportunities will be created and the workforce will find a new distribution of labor.
