It May Just Level the US Economy and It's Already Begun

Location: New York
Author: Lenny Broytman
Date: Tuesday, August 28, 2007
 

Welcome to the calm before the storm.

Published reports suggest that the US subprime disaster may be clawing its way into other domestic credit sectors and right now, a drastic rise in credit card borrowing is the first sign.

According to investors.com, the situation over the past year or so has stayed fairly positive, with many consumers (even those foreclosing on their homes) choosing to stay current on their credit card responsibilities. But the picture suddenly turned bleak at the beginning of the summer, with Merrill Lynch reporting an 11 percent jump in consumer credit card balances in the months of May and June. Industry experts often point to the unemployment figures as a sign of escalating consumer debt but as of July, only 4.6 percent of the nation was out of work.   

Many people are saying that although the situation looks manageable at this point, there is in fact a great deal of trouble on the horizon. With the largest hike in credit card borrowing since the 2001-2002 recession, there are mixed feelings about the growingly alarming fiscal problem.

While some industry experts are pointing to the obvious (foreclosure pressure), many feel that the rising numbers may be a sign that consumers are feeling good about the future of the US economy. While this may very well be true for some people, Merrill Lynch insists that the national mortgage woes are the real culprits. It predicts that a sharp increase in credit card delinquencies is imminent over the course of the next six to 12 months.

"Credit card balances are booming," said David Rosenberg, an economist at Merrill Lynch. "On Main Street, the lender of last resort as banks pull in their horns is the credit card. The next shoe to drop from this subprime mortgage fiasco, which has already fed into the asset-backed market, is probably going to be the credit card business."

"Certainly mortgage equity withdrawal has plummeted. So it's no surprise to see credit card lending going in the other direction," said Paul Ashworth, senior economist at Capital Economics.

In recent years, many people living in the US have been utilizing “cash-out” mortgages in an effort to refinance as a way to pay off credit card debt.  

According to Tom Hughes, managing director of credit risk analysis at Moody’s Economy.com, many consumers may also be using their credit cards as a means to refinance their mortgages at lower rates. "It's a plausible short-term strategy — to hold out hope that you can get a near-term re-rating and thus lower interest payments," said Hughes. "But it may not work longer than two or three months."

In addition to all of this, interest payments have also increased over the past three years, mainly due to the Federal Reserve raising rates. Last week, the Federal Reserve did lower the rate it charges financial institutions that are in need of emergency funds but failed to do anything to the federal funds rate, which affects mortgage payments. In the meantime, Wall Street has weakened its interests for mortgage debt and has witnessed many banks raising both subprime and alt-A rates.  

Hughes says that because of the current nature of the subprime disaster, an accurate assessment of credit card borrowing trends is nearly impossible, as many people are acting a lot different than they normally would.  

"We are in uncharted territories," Hughes said. "But the good news is that subprime borrowers haven't lost their jobs yet."

In the first quarter of 2007, credit card delinquencies fell to 4.41 percent, a drop from 4.56 percent at the end of 2006, says the American Bankers Association (ABA).

"The improvement . . . is somewhat remarkable, given that the economy was not operating on all cylinders," ABA chief economist James Chessen said in a statement.

Although many point to the growing use of credit cards as a sign of nationwide economic hope, the UBS/Gallup Index of Investor Optimism says that investor optimism in the US dropped 14 points in August.

A press release on the matter stated: “The Economic Dimension of the Index, which measures  investors’ feelings about the direction of the overall US economy, dropped 11 points to 5 for the month of August, making the lowest level of optimism about the economy since August 2006, when it stood at -1. Yet, investors remain hopeful about their individual investment portfolios, as the Personal Dimension of the Index dipped by just 3 points to 69… Investors fear that the problems in the subprime mortgage market will spread, with 59 percent feeling there will be a spillover into the overall mortgage market, while only 28% feel it will be contained. Investors felt that the credit crunch is squeezing even tighter, with 51 percent saying it is harder for Americans to get credit now than it was three months ago and 42 percent believing the crunch is hurting the investment climate “a lot.”

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