Taking Stock of Bonds

February 4, 2008

Hurting Consumer

Two Sundays ago CBS's 60 Minutes offered a detailed report about the subprime debacle, offering Stockton, Calif., as an example of a market hurt by virulent speculation and aggressive lending.

What was interesting about the news broadcast was the elegant simplicity in how the complex issue was presented to the broader public which, presumably, may not be aware of how securitization works and how Wall Street slices and dices consumer debt payments for a wide range of investors. It was surprising to see this from a news program where the only consumer credit story in recent years may have been Andy Rooney complaining about his mailings from credit card companies in his nasal whine: "You know what I don't like ..."

Some of the CBS broadcast featured thoughts and observations of Jim Grant, editor of "Grant's Interest Rate Observer." In the broadcast Grant recalls 2004 and 2005, when you could barely open your mailbox because "people were pressing on you, if you were not institutionalized, all matters of schemes in which to expand your personal debt and mortgage debt. You could, and people did, borrow more than 100% of the price of a house with the most fragile of financial bonafides."

But mortgage debt -- either first lien or second lien -- was not the only type of debt that has been readily offered to consumers in this gilded age of low cost credit. There were credit card offers, auto loans (zero percent financings that had parallels to the mortgage industry's no down payment programs) and other types of financing for recreational vehicles such as powered watercraft.

Now, it seems the consumer is having trouble making payments for credit card accounts, according to a recent report by Moody's. Specifically, the rating agency warned that its industry outlook for the credit card sector is negative. Economic headwinds, the rating agency says, will most certainly continue to increase charge-off rates relative to the exceptionally low levels reported in 2006 and throughout most of 2007. That same report by Moody's noted that consumers are no longer using home equity loans and lines of credit because the value of their homes has dropped. Also, these loans are tougher to get.

According to Moody's November 2007 credit card index, the most recent data available, credit card chargeoff rates are below 5% -- short of the long-term average of 5.5% -- but charge-off and delinquency rates are "clearly on the rise" and in coming months will continue their upward climb.

How bad can it get? According to Moody's, chargeoff rates after the 2001 recession hit 7.05% in May 2003.