Tag Archives: subprime

Are Subprime Debt Slaves, a Leading Indicator, Worrying the Fed? by Wolf Richter

The skankier borrowers are running into trouble, and that may portend trouble for the overall economy. From Wolf Richter at wolfstreet.com:

Credit problems always appear first at the margins.

The new Fed remains a somewhat unknown quantity: There are still four vacancies on the Fed’s seven-member Board of Governors that forms the core of the policy-making FOMC. The new Chairman, Jerome Powell, has already shown in his testimony before Congress last week that he may use a little more straight talk than his predecessors, and the markets took notice.

No one knows for sure what this new Fed will look like once the four vacancies are filled. But this new Fed will likely try to push interest rates back to a somewhat more normal level and lighten their balance sheet so that they have some options when the business cycle trips over balled-up credit problems.

With consumers, the credit problems appear first among the most fragile, most at risk, and most strung-out – borrowers with subprime credit ratings, and with lenders that went after these consumers aggressively. And this is happening now.

Small banks pushed with all their might into credit cards, loosening credit standards, lowering credit score requirements, raising credit limits, and offering new cards to people who had already maxed out their existing cards and had limited or no ability to service them from their income, and no way of paying them off – and thus are stuck with usurious interest rates that make these credit card balances impossible to service.

For small banks it was the Holy Grail: to profit from the American debt slave.

There are about 4,888 commercial banks in the US. There are the top 100 banks, and there are the 4,788 smaller banks – those with less than $14 billion in assets. These smaller banks have seen this irresistibly sweet deal. Banks were paying next to nothing in interest to their depositors, but they could charge 25% or 30% interest on outstanding credit card balances. The interest-rate spread between these two products was just too juicy, in this otherwise low-interest rate environment.

To continue reading: Are Subprime Debt Slaves, a Leading Indicator, Worrying the Fed?

This new bubble is even bigger than the subprime fiasco, by Simon Black

There are now more student loans outstanding than there were subprime loans at the height of the housing bubble. And just like those subprime loans, student loan repayment rates are faltering. From Simon Black at internationalman.com:

In 1988, a bank called Guardian Savings and Loan made financial history by issuing the first ever “subprime” mortgage bond.

The idea was revolutionary.

The bank essentially took all the mortgages they had loaned to borrowers with bad credit, and pooled everything together into a giant bond that they could then sell to other banks and investors.

The idea caught on, and pretty soon, everyone was doing it.

As Bethany McLean and Joe Nocera describe in their excellent history of the financial crisis (All the Devils are Here), the first subprime bubble hit in the 1990s.

Early subprime lenders like First Alliance Mortgage Company (FAMCO) had spent years making aggressive loans to people with bad credit, and eventually the consequences caught up with them.

FAMCO declared bankruptcy in 2000, and many of its competitors went bust as well.

Wall Street claimed that it had learned its lesson, and the government gave them all a slap on the wrist.

But it didn’t take very long for the madness to start again.

By 2002, banks were already loaning money to high-risk borrowers. And by 2005, all conservative lending standards had been abandoned.

Borrowers with pitiful credit and no job could borrow vast sums of money to buy a house without putting down a single penny.

It was madness.

By 2007, the total value of these subprime loans hit a whopping $1.3 trillion. Remember that number.

And of course, we know what happened the next year: the entire financial system came crashing down.

Duh. It turned out that making $1.3 trillion worth of idiotic loans wasn’t such a good idea.

By 2009, 50% of those subprime mortgages were “underwater”, meaning that borrowers owed more money on the mortgage than the home was worth.

To continue reading: This new bubble is even bigger than the subprime fiasco

 

Oil Economics, Part 2, by Robert Gore

Monday’s post, “Oil Ushers in the Depression,” was one of the most read, commented on, and controversial posts on SLL. Here is an amplification, and a doubling down on the prediction in that piece:

The sharp drop in oil will support U.S. growth by boosting spending, two top Federal Reserve officials said, playing down the risk that plunging energy costs could push inflation further below the Fed’s goal.

Fed Vice Chairman Stanley Fischer and New York Fed President William C. Dudley, speaking at separate events today in New York, both stressed the positive impact on the U.S. economy from the steepest decline in oil prices for five years.(Bloomberg, “Fed’s Dudley Says Oil Price Decline Will Strengthen U.S. Economic Recovery,” 12/1/14)

If that sounds eerily like Benjamin Bernanke’s infamous assurance that “…the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained,” it should (testimony before the Joint Economic Committee, U.S. Congress, 3/28/07). However, Fischer and Dudley go Bernanke one better. Bernanke at least acknowledged a problem, although he woefully underestimated its impact. The dynamic duo sees nothing but blue skies after oil’s precipitous fall. Their Panglossian visions reveal the rotten-to-the-core premise of Keynesian economics and complete ignorance of the towering debt skyscraper of cards their policies have helped erect.

In their Keynesian world, demand and consumption are the center of the solar system around which all other economic factors revolve. Reality, on the other hand, dictates that something must be produced before it is consumed, so we’ll stick with reality-based economics. Fischer and Dudley don’t even acknowledge that the falling price of oil might harm producers.

The Saudis are the world’s low cost producer. It is much cheaper to pump oil out of the desert than it is to frack it, extract it from tar sands or shale, or pump it from under the ocean, which is how oil is produced in much of the rest of the world. The Saudis amortized the costs of their petroleum industry long ago; the relevant cost to them is their marginal cost.They have decided to pump sufficient oil to drive its price low enough to make it uneconomic for many higher-cost producers to produce.

Their decision has political and economic motivations. The Saudis have been mightily displeased by the course of events in Syria. The Sunni Saudis don’t like Shiite Bashar Assad, Syria’s despot. They thought President Obama would fight their war for them when Assad crossed his red line. They were furious when Vladimir Putin gave Obama a face-saving out, not just because of Obama’s inconstancy, but also because Putin had thwarted a potential US attack against his ally, Assad. The U.S.’s half-hearted response to the Islamic State—its reluctance to put those all important boots on the ground—has further inflamed the Saudis, who view the campaign against the Islamic State as the perfect pretext for getting rid of Assad.

What better way to punish both the US and Russia (and perpetual enemy Shiite Iran), and reestablish dominance in oil, than by glutting the market? As a business plan, taking on debt at junk bond rates to fund oil production, as many US and Canadian producers have done, or basing government budgets and economic projections on a high price of oil, as Russia and many other oil-producing nations’ governments have done, leaves something to be desired when the lowest-cost producer can lay waste to your plan at any time.

The subprime fiasco offers the perfect analogy. Just as everything “worked” as long as house prices kept going up, the dreams in the oil patch seemed plausible when its price was high. As soon as oil’s price headed in the undesired direction in this highly leveraged market, the dreams evaporated, just as they did in the highly leveraged housing market. The debt of the most indebted producers, now losing money, is worth less than face value. Their creditors will eventually recognize losses. As previously noted, the one wrinkle is that so many producers are governments. They have not, in most cases, explicitly backed their debt with oil revenues, but they had assumed those revenues and based their future spending plans on them. Call it “soft” debt.

The dilemma is the same for both private and government producers. They can go on producing at an economic loss, for the cash flow, adding to the glut and the downward pressure on prices, or they can curtail production and their own revenues. The former is a short-term palliative only; the latter means immediate pain. Either way, total revenues accruing to uneconomic oil producers decline. Those producers will consume less—just as homeowners significantly curtailed their spending when house prices crashed, which is contractive and deflationary.

As the oil price drop leads to losses for producers, their suppliers, and creditors, assets will be sold, production curtailed, orders cancelled, and workers laid off. Eventually the price of oil will stabilize, but producers, especially government producers, may well continue to add to the glut due to short-term cash flow needs—it’s better than people taking to the streets. Even the House of Saud has committed much of its huge revenues to bribing their disaffected off the streets and keeping itself on the most kleptocratic and lucrative throne on the planet.

Dudley and Fischer refuse to acknowledge the debt daisy chain for which they and their fellow central bankers around the world are largely responsible, just as Greenspan and Bernanke have never fessed up to their mortgage-debt-and-securitization daisy chains. When oil-based debt implodes, it will stay as “contained” as the subprime implosion; daisy chains are daisy chains. However, given the much higher level of world debt now, the fallout from this conflagration compared to last time will be akin to the difference in fallout between hydrogen and atomic bombs.

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