December 31, 2024

The Good News About Retail Sales

December 8, 2008 by Leave a Comment

If you only read the headlines, you are probably under the impression that the economy is totally collapsing.

The economy is weak and many are paying the price for being over leveraged, but when you see  hysterical headlines, it makes sense to examine the data.  For example, consider the following headline which seems to imply that retail sales are collapsing.

Retail Sales Notch Biggest Drop in 39 Years

Further in the article we learn that:

Overall, same-store sales for November fell by 2.7% from last year, according to the International Council of Shopping Centers Inc.’s index of 37 stores, the biggest drop since 1969, the first year that the council began collecting data. Same-store sales are closely tracked because they provide a snapshot of a retailer’s results, unaffected by new store openings.

“It’s an awful start to the holiday season,” said Michael Niemira, the council’s chief economist and director of research, who lowered his combined November and December sales forecast to flat to a 1% drop. “It looks to us as if it will be the weakest holiday season in our record,” he said.

Despite the gloomy retail news, many retail stocks rose Thursday, suggesting some investors believe retail sales have bottomed. Despite a 2.5% drop Thursday in the Dow Jones Industrial Average, shares of Nordstrom Inc. rose 10.2%, Abercrombie & Fitch Co. 7.8% and Tiffany & Co. 10.8%.

Should this headline have been “Retail Sales Show Modest Decline“?  A drop in sales of less than 3% given the lack of confidence by the American consumer (spurred no doubt by the headlines) does not really seem that catastrophic.  In addition, the rise in the stock price of many retailers on this news also implies that many investors believe that the worst has been seen.

The same retail news is examined by Ken Fisher who arrives at a more optimistic conclusion.

The bearish headlines have gotten bolder, and the panic has gotten worse (notwithstanding the late-November rebound). So I’m even more bullish now.

On Nov. 14 the headlines screamed, “October Retail Sales Down–Worst Ever Recorded.” Stocks buckled. But virtually no one noticed that the “recording” had started only in 1992. Since then we’ve had just one recession. The same reporting failed to mention anywhere that October sales, excluding autos, gasoline and building materials, which everyone already knew about, were down only 0.5%, which was hardly remarkable.

Simply nowhere in the mass media have I seen it reported how strong third-quarter earnings were. Roughly two-thirds of firms reported higher earnings through Nov. 25. Also, two-thirds reported earnings stronger than analysts’ latest expectations. Yet we only heard about the laggards. Excluding financials, 67% of companies reported earnings better than the year before, and 68% exceeded expectations.

On Oct. 13 the s&p 500’s dividend yield was 3.74%. That means it exceeded the yield on the ten-year Treasury note for the first time since 1958. Did you see a headline about that?

Business inventories are at record lows for the start of a recession, and that fact should make the recession milder.

I have previously observed that now may be a time to go long, based on the the incredibly negative headlines (Breathless Hysteria Overdone?).

The bad news headlines are really good news if you consider the following:

– lower spending may imply that the personal savings rate is increasing as the consumer rebuilds his balance sheet and becomes more frugal.  If the consumer wisely chooses to spend less and save more, retail sales will of course decline somewhat – you can’t have it both ways.

– much concern has been expressed that credit card debt will be the next crisis for lenders.  To the extent that credit card companies are reducing credit lines and consumers are spending less, this should help to mitigate this potential problem.

– lower retail spending may imply a reversal in attitude towards the use of debt to finance every purchase, which would be a positive development.

-a new found frugality by the consumer and a reluctance to take on more credit, although a negative factor for the retail industry, will in the long run be a positive factor for the country’s financial system and the consumer.

Filed Under: Economy, Stocks Tagged With:

Refinancing Jumps By Record Pace?

December 4, 2008 by Leave a Comment

Old story – if you just read the headlines, you don’t get the full story.

Applications to refinance home-mortgages jumped by a record amount, as borrowers flocked to take advantage of falling mortgage rates — which were driven down by the government’s announcement that it would step in to stabilize the mortgage market.

Later on in the same Journal story we learn more facts.

How many applications will wind up as actual mortgages remains to be seen. In southeastern Florida, about one-third or less of refinancing applications are leading to loans, says W.D. Acosta, executive vice president for residential lending at Seacoast National Bank, down from as much as 80% two years ago.

“Many of the people who need refinances don’t have the equity in their home or … their job situation isn’t what it was when the loan was originated,” he says. Nationwide, the “pull through” rate is about 55% for purchase applications and 65% for refinance applications submitted in the first half of this year, according to the Mortgage Bankers Association.

This isn’t 2005 again when everyone got approved and easy cash out refinances financed the good life.  Talking to various mortgage lenders, it seems that few of their previous customers can be refinanced due to high debt ratios, lack of equity, restrictions on amount of cash out (non FHA loans usually limited to 80-85% loan to value), very expensive and hard to obtain mortgage insurance for over 80% loan to value, minimum credit score requirements, absence of stated income, absence of “no doc” loans, and  numerous fees (adders) for anything but the best customer.

If you are self employed you probably need a “hard money” loan at crazy high rates.  Many underwriting guidelines are more strict than they were 10 years ago before the easy mortgage money era started.

So the good news headline isn’t really good news but the real news is really good since this is a small step on the path to sanity in the mortgage industry.

Filed Under: Mortgages Tagged With:

Breathless Hysteria Overdone?

December 3, 2008 by 1 Comment

The stock market has suffered one of the worst declines in history as we all know.

At this point, however, the breathless hysteria over how much worse things will get has become overdone.  Markets discount bad news and this market has discounted everything except the end of civilization.  The talking head predictions of doom dominate the headlines.   Today is probably psychologically equivalent  to when oil was peaking at $150 and predictions of $300 dominated the headlines.

Without bothering to consider what the future will bring, at this point there is money to be made on the long side.   The market is extremely oversold.  Nothing does in a straight line.  High quality Dow stocks have 5-7% dividends.  The Fed’s zero interest rate policy will force money into higher risk investments.  There is optimism building about a new Administration.

Besides some of the Dow stocks I am increasing my positions (on down days) in DIA and SSO.

Let’s all have a Merry Christmas!

Filed Under: Stocks Tagged With: ,

Loan Mods Just A Warmup For The Real Thing-A Mortgage Holiday

December 3, 2008 by 1 Comment

It has become increasingly obvious that the central banks of the world will engage in whatever desperate actions are necessary in order to sustain and increase our already unsustainable levels of debt.  The ridiculous idea of providing more credit to a financial system already imploding from oceans of debt seems to be the only solution that makes sense to our policy makers.

The alternative to keeping the credit engine going is to accept the economic pain necessary to restore sound finances.  Since the short term financial pain  would include very high unemployment, lower stock prices, frugal living standards, more credit write downs and  more asset destruction, it is a certainty which path the political and monetary authorities will chose.  Quantitative easing, bailouts and government borrowings are all certain to see immense increases.  The risk of inflation and debasement of the currency brought on by these techniques is apparently viewed as preferable to the pain of deleveraging.

The false prosperity of the past 25 years has come from a parabolic increase in the national debt.  One credit bubble after another in various asset classes have now burst leaving us with destroyed asset values and mountains of debt that can never be repaid.

Real national income has been stagnant for the last decade; attempting to address this problem by borrowing money to maintain living standards does not work long term since the interest costs eventually overwhelm a static income level as shown on the chart below.  With interests rate essentially at zero the Federal Reserve is now forced to employ the unconventional methods that Fed Chairman Bernanke has spoken about in the past.  The deflation we are now facing makes debt payments ever more onerous to the borrower.  Debts too large to be repaid by definition will not be repaid – the only two options are to default or attempt to reduce the debt through inflation of the currency.  The Fed has obviously chosen the later option.


Since the consumer represents roughly 80% of the economy,  there will be massive efforts to put cash into the American consumer’s pocket.   Additional income will not come from wage increases with the present high level of unemployment.   Additional cash  will not come from borrowing  since the banks have thus far largely refused to lend to poor credit risk consumers.   Additional cash will not come from lower rates since the Fed is out of bullets on rate decreases.   Those who are financially responsible do not want to borrow or spend since they are trying to save to make up for the huge wealth destruction they have sustained over the past two years.

What is the solution on how to put more money in the pockets of those consumers most likely to spend whatever cash they receive?  The proposed stimulus rebate program is presently the government’s only and preferred “solution” to over leverage and static incomes.   The next move beyond this point will be to simply provide a way for the consumer to simply stop paying his bills without technically defaulting on the debt.

Since the largest monthly payment most consumers have is the mortgage payment, it is increasing likely that as the economy continues its downward spiral, the government will allow a mortgage holiday, as I have previously predicted. This once unthinkable action was actually proposed today by Gordon Brown in Britain, where consumers have distinguished themselves by becoming the most indebted citizens of the world.

As reported by the Financial Times, “Gordon Brown on Wednesday granted homeowners in financial difficulty the right to demand a two-year mortgage holiday, guaranteed by taxpayers, in a dramatic bid to underpin the housing market.”    You can be certain that this program will eventually be applied to all mortgage holders in many countries.

According to the Federal Reserve, total home mortgage debt as of the second quarter of 2008 was $10.6 trillion, roughly equivalent to 80% of the GDP.    Assuming an average interest rate of 6.5% on this mortgage debt, the cost to the government (who would pick up the tab) would only be $700 billion per year, oddly enough the same size of the presently proposed rebate program.  Since we have already partly institutionalized the repudiation of debt through loan modification programs, this step is only a natural progression but applied to a wider number of people.

This program would no doubt be eagerly embraced and wildly popular with cash poor consumers. It would put cash into the pockets of those most likely to spend it, thereby helping the economy.  The minority of those without mortgages may be upset until they accept the wisdom of “wealth redistribution” now being preached as a method of helping those in need.

My view is that we will all end up equally poor.

Filed Under: Bailout, Economy, loan modification, Mortgage Holiday, Mortgages Tagged With:

US Bancorp Takes Fed’s Advice To Lend Aggressively

December 2, 2008 by Leave a Comment

US Bancorp (USB) is still profitably while other banks can’t find enough zeros to put after their losses.  In the latest quarter ending September 30, 2008, USB’s net earnings declined by 48% to $576 million due mainly to an increase in provision for credit losses of $549 million in the quarter.  The increase in the provision for credit losses for the 9 months ending 9/30/2008 increased dramatically also, by $1.3 billion.  Nonetheless, even after these large increases for bad debts USB was still able to show a very respectable 9 month net income of $2.6 billion (down 23%).  A large reduction in their interest expense of $1.1 billion due to lower funding costs helped results considerably.

USB is a highly regarded well run institution still profitable and well capitalized despite horrendous losses by the banking industry in general.   Warren Buffet through Berkshire Hathaway owns over 4% of the company and other institutional investors own approximately 60% of the shares outstanding.  Of 22 analysts covering USB, there are 4 strong buys, 1 sell and the rest mainly hold.

USB pays a generous dividend of $1.70 yielding almost 8% at the current price although this is unlikely to be maintained since the payout is 100% of earnings.   If earnings continue to drop the dividend would probably be cut.   USB is borrowing $6.6 billion under the TARP program via a preferred stock sale.  USB is a non agency lender, retaining many of its mortgages.

USB’s portfolio is not heavily weighted to any particular lending sector, being spread geographically and across a broad spectrum of borrowers.  The short position on the stock is only 2% of the float.  In the last 12 months, of 71 insider trades there were 51 sells and 20 buys.

Level 2 assets as of 9/30/2008 totaled $41 billion and Level 3 assets totaled $3.7 billion, for a combined 214% of total equity, a potential source of earnings trouble depending on what mark to market rules ultimately apply and whether the credit quality of these assets deteriorate.   (Level 2 assets are not actively traded but priced on what similar securities are valued at; Level 3 assets are “model derived” using best guess estimates to determine value.)  As of 9/30/2008, USB had a derivatives position of total notional amount of $52 billion; the company states that it does not use derivatives for speculative purposes.

USB apparently is in a very strong position to lend and gain market share while its competitor banks struggle to stay alive.   With other banks reportedly reluctant to lend, it would seem that USB could cherry pick its customers, lending only to the best credits at a properly risk adjusted rate.  With this in mind, I spoke recently to some mortgage companies that broker loans to USB and reviewed some wholesale rate sheets that USB distributes to its broker network.  The following items are noted:

USB has a wholesale operation that aggressively recruits mortgage companies.  Many other banks have terminated their wholesale side of the business due to volume declines industry wide and also due to the questionable quality of brokered loans.   This gives USB the opportunity to pick up a lot of new business if they can effectively monitor the various brokers that they deal with.  The word on the street as I hear it is that USB is the most aggressive lender out there and if you have a deal you can’t get done, you  try USB.

USB allows debt ratios of up to 50% on a first position fixed rate loan and 45% on a first/second purchase with a FICO score over 680, subject to disposable income limits.   For a score of 650-679 a more reasonable debt ratio cap of 35% is imposed.  A debt ratio over 35% is neither “affordable nor sustainable” as I have detailed in past discussions.  The FDIC has recently proposed that mortgage borrowers in default have their loans modified so that the debt ratios of the mortgage payments do not exceed 31% of income.  There is a big difference between front end and back end debt ratios, but USB’s allowed debt ratios are aggressive lending standards under any circumstances.

No reserves are required for many of the USB loans.  This means you can have a borrower purchase or refinance a home with zero in savings to fall back on should unexpected expenses occur.  With a high debt ratio on top of no savings, this is a recipe for disaster for many homeowners.

USB has a very aggressive jumbo (over agency loan limits) loan program.  Some features as highlighted in their wholesale rate sheets are quoted, as follows:

-interest only to 80% loan to value; competition offers only 65% loan to value limit

-full 80% for cash out -competition allows only 70%

-no hits for cash out refinance – competition does not allow this or charges a rate adder or fee

-revolving debt (credit cards, etc) can be paid with cash out proceeds to qualify-competition does not allow.  (Credit card debt paid off with a refinance can be easily run up again causing payments to become unmanageable.)

-only 36 months out of bankruptcy allowed – competition requires 5 – 7 years.

The Wall Street Journal reports that USB had the greatest increase in loan volume, a whopping 35%, among midsized lenders, beating out BB&T and Flagstar Bank.  The reasons given by the Journal for the very large loan increase are different from mine as noted above.  Typically, the most aggressive lenders fund the most loans.

USB recently acquired failed $13 billion asset Downey Savings Bank in an FDIC arranged takeover.  Downey had a significant presence in California and Arizona.  USB agreed to accept the first $1.5 billion in losses on Downey’s portfolio; losses in excess of this amount are subject to a loss sharing agreement.

Downey was one of the biggest pay option arm lenders, which allowed borrowers to pay only a small portion of the interest actually accruing on a mortgage, thus resulting in negative amortization.  With the severe property declines in CA and AZ, many of these loans now greatly exceed the value of the mortgaged property.  In addition, many of the pay option arms allowed “stated income”.  80% of pay option arm holders pay the minimum payment each monthly and took out this type of loan because it was the only way they could afford the loan payments.  USB may find that the lossses on the Downey pay option arm portfolio vastly exceed any estimates they might have made, once they establish the borrowers’ true income and property value.

USB’s aggressive lending and acquisition of Downey may put them in an exceptionally profitable position if the economy turns around quickly,  companies start hiring again and the residential property markets quickly recover.  If you believe in regression to the means, however, and that bubbles that burst wind up either at the level where they first started or lower, consider the chart on US home prices below.  Home values may still have much further to fall which would cause great distress to USB’s mortgage portfolio and ultimately their income statement.

Filed Under: Bailout, Banking Industry, Economy, Mortgages Tagged With:

Gold, Cheap at $5000?

December 1, 2008 by 2 Comments

Although I have been following the gold market for many years, I can’t seem to remember the last time that I have seen so many unanimously bullish articles on the price future of the yellow metal.  Typically in the past, I would note that a bullish article in a major publication or a cover story on a major magazine would coincide with a price peak, rather than a buying opportunity.

Is this time different?  Most of the bullish opinions on gold are based on the actions being taken by the  world’s governments to reflate the economy with oceans of cash and credit.  Let’s take a look at a sampling of some of the recent bullish articles on gold that appeared after the gold shares and the bullion recently rebounded sharply, after a nasty sell off from the price peaks of early 2008.

Will gold protect us from bailout inflation?

As the amount of bailouts and guarantees by the Federal Reserve grow exponentially, worries are mounting over the future inflationary impact of these actions.  Is buying FSAGX the best way to protect your purchasing power?

The role of gold in the world’s monetary history

For those who dismiss the idea of gold as having a continuing role in the world’s monetary system, consider that central banks and the IMF hold 80% of the world’s gold reserves.

Gold could gap up by hundreds of dollars in one day

Gold’s price is artificially low at this point, but fundamental market forces will prevail with huge and sudden price gains.

Low gold lease rates foretell of higher prices

The gold carry trade is now unprofitable resulting in less gold being supplied to the market place at a time of huge physical gold demand.

“gold itself is now free to rise in deflation given its true role as money”

Based on the technical breakouts on the gold stock charts and monetary fundamentals, it looks like a bottom is in for gold here.

Citi anaylst predicts $2000 gold price

As the huge government stimulus efforts work their magic, over time, inflation is expected to rise significantly causing large increases in the gold price

All of the above posts are written by exceptional ananylsts; over time I believe that they will be correct in their bullish assessment of gold – the exact timing of the price increase is not important.   I have been adding to my gold stock and bullion positions over the last fifteen years and will not sell until gold reaches $5,000 or Time Magazine runs a cover story on why everyone should own gold.

Gold investors have been laughed at for years and there have been long periods of declines and/or under performance in price versus other asset classes.  Gold, however, is the only monetary asset where the ultimate value of your investment is not sujbect to someone’s else’s promise or ability to pay.  I view gold as the ultimate insurance hedge against a government’s propensity to spend itself into insolvency and, accordingly, I believe that gold should constitute 10 to 20% of one’s core investment assets.   Historically, governments  have regularly and repeatedly defaulted on their sovereign debts.  In every such case of default, the citizens of those nations would have been far better off holding gold rather than government paper.

Filed Under: Economy, Gold Tagged With:

Obama Pledges Fiscal Discipline – Huh, What Was That?

December 1, 2008 by Leave a Comment

As reported on by the Wall Street Journal,

President-elect Barack Obama on Tuesday emphasized his commitment to fiscal responsibility, promising that his team would strip the federal budget of all unnecessary spending to help offset large outlays expected for his planned stimulus package.

But Mr. Obama didn’t provide many specifics, and he gave little sense of how he would tackle entitlement programs like Medicare and Social Security. Few experts believe the budget deficit can be brought under control without trimming spending on these programs.

These words sound to me like the obligatory hat tip to the concept of fiscal discipline and budgetary restraint by the government.  Except for a few years under the Clinton administration, the country has seen ever more massive deficit spending at every level of government, especially since the early 1980’s.  John Q Public has not been bashful about borrowing every dime that he could as well, encouraged by government agencies and banks all too eager to make every citizen a homeowner regardless of his credit rating or ability to service the debt taken on.  For good measure, the purveyors of credit cards and second mortgages did their best to extend credit lines in massive amounts so that John Q Public could live the life style he was entitled to.

Many good minds have argued with persuasive logic and statistics that the over extension of credit has in no small part contributed to the financial debacle that is now impoverishing us all as a nation.  Regardless of whether or not one decided to participate in the credit bubble, we are now all paying a very dear price.  Our children and their children will pay a heavy price as well since we have already spent their future, leaving them little but IOU’s in return.

Some of the many obstacles blocking President-elect Obama’s road to fiscal discipline include the following:

– calls for a $700 billion stimulus package (will probably wind up being more)

-the coming bailout of GM and Ford which will be open ended

-the country’s inability to deal with or even discuss the unfunded liabilities of $90 trillion for medicare and social security (the country’s entire wealth is estimated at $56 trillion but dwindling rapidly)

-a bailout of various state and local governments; starting tab at least $100 billion

– continued bailout of our insolvent banking system; final cost indeterminable

-upcoming bailout of the insurance industry will make the $150 billion “investment” in AIG look small

-calls for energy independence have virtually disappeared, coinciding with the drop in oil prices.  To truly implement energy independence will cost trillions today; to ignore the situation risks our future economic fate

– reducing unnecessary government spending is seriously doubtful; reducing any government program means taking on the entrenched political and economic interests of the recipients of such spending.

The above list of bailout needs/new programs will no doubt grow considerably larger and this list does not include the $7 trillion (to date) in guarantees and bailouts by the Fed and Treasury.  I would expect next years budget deficit to be approaching the $3 trillion dollar range and it will be exceptional to observe how it will be funded.  “Quantitative easing” by the Fed will grow by ever larger amounts.

My best wishes to the President-elect on his commitment to fiscal responsibility but I am not fooled by such talk.   Since many observers have compared Mr Obama to President Lincoln, I am reminded of one of Lincoln’s more memorable lines; “You can fool some of the people all of the time, and all of the people some of the time, but you can not fool all of the people all of the time.”

Filed Under: Bailout, Economy Tagged With:

The Invisible Meltdown Of The Insurance Industry

November 24, 2008 by 1 Comment

As discussed previously, Next Bailout – Insurance Industry?, the insurance stocks have continued their disastrous sell off.  Yet, I have seen virtually nothing in the mainstream press about the dangers of an imploding insurance industry – this invisible crash has reached the point where the Treasury and the Federal Reserve need to address this prior to the point of policy holder and public panic.   The insurance industry is in many ways more important to our economy than the banks and their problems need to be addressed soon.

The individual State guarantee funds backing the insurance industry are woefully under capitalized and were designed to address one failure, not an industry wide meltdown.  The State funds rely on assessments of healthy surviving insurance companies when one fails; unfortunately this does not provide much comfort when the entire industry is starved for capital.

The price declines from my October 1, 2008 price summary (updated below) has been catastrophic to the industry’s ability to maintain confidence of their investors and policy holders as well as their ability to raise capital.

STOCK  PRICE OCT 1’08    PRICE NOV 21’08    %DECLINE

MET      48.15                     18.48                      -62

GNW       7.36                          .90                     -88

ALL       44.00                     21.52                      -51

CB         51.55                     42.76                      -17

PRU       64.80                     16.30                      -75

HIG        38.11                       4.95                      -87

The insurance stocks went into a tailspin once it became obvious that commercial real estate values are declining rapidly as the economy continues its deleveraging.  Commercial real estate had not been subject to the massive overbuilding and speculation that occurred in residential real estate and until recently had been considered relatively immune to the credit crisis.  Since early November, however, the cost of buying default protection on AAA commercial debt via credit default swaps (CDS) has tripled from 200 to 550 basis points (down from a recent high of 847).   Financing for new deals or maturing debt on many commercial loans has become almost impossible to obtain with AAA commercial securities trading at junk bond levels.

At Markit.com, the situation was summarized in their Credit Wrap as follows:

“The commercial mortgage market, often in the shadow of its residential sibling, made its presence known this week. The CMBS sector has been under pressure since the government changed the focus of TARP away from buying distressed and illiquid assets and helped push spreads wider. But the real impetus behind the widening this week came from two CMBS deals. The securities, backed by hotels and a retail centre, are reported to be close to default… The CMBS meltdown was felt in the broader market. The Markit CDX IG widened to record levels, driven by the insurance sector. Life insurers such as Hartford Financial and Lincoln National have significant exposure to CMBS, and losses could well force them to raise more capital.”

The insurance industry companies have always been major investors in commercial real estate as they seek to match long term assets with long term liabilities.   The problem is the overallocation of capital to this one sector as reported by Smart Money.

“Should commercial real-estate turn out to be next focus of the financial crisis, life insurers will be among the companies feeling the most heat.

Life insurers on average have the equivalent of about 41% of their equity invested in commercial mortgage-backed securities, or CMBS, compared with 23% on average for property/casualty insurers, according to a Thursday analysis of 10 large public insurers by Fox-Pitt Kelton analyst Adam Klauber. He said Hartford Financial Services Group Inc. (HIG), Protective Life Corp. (PL) and MetLife Inc. (MET) had the highest exposures.

Investment banks, by contrast, hold about 18% of their equity in CMBS.

While the financial crisis has come late to the life insurance industry, it has hit them hard. Shares of life insurers are down nearly 72% so far this year, a bigger drop than for other types of insurers. The pressure on life insurers, some of which may become bank holding companies to get access to investments from the Treasury, makes government efforts to contain the financial crisis yet more complicated.

The latest blow is coming from commercial mortgages, which are beginning to look like they may follow the dismal example of home mortgages, with a few big defaults hitting the news in recent days. Life insurers, big investors in mortgage-backed securities of all types, are taking another big hit.

UBS analyst Andrew Kligerman calls the concerns about commercial real estate the “leading factor” in insurance stocks‘ poor performance this week. Lincoln National Corp. (LNC) was the big loser Thursday, closing down 30.6% to 5.07. Shares of Hartford closed down 19% to $5.57 and Principal Financial Group (PFG) closed down 19.2% to $9.43.”

Although some of these companies have applied for bank holding status so that they can access the Fed for borrowings, these six companies (representing only part of the insurance industry) have assets of over $1.7 trillion.  Assuming significant losses as implied by CDS pricing, recapitalizing the insurance industry could easily consume the second half of the $700 billion bailout fund,  while the demands on the treasury grow ever larger, as discussed in The Line at the Treasury Grows Longer.

There would seem to be a finite limit to the amount of losses/guarantees that can be assumed by the US Treasury (taxpayers).  Bloomberg is reporting that the total Fed credit pledges and loans now exceed a staggering $7.4 trillion.  Let us all hope that we do not find out what the limits of the Fed are.   Obviously at some point, the  US Government’s credit and ability to fund never ending losses will be questioned.
Filed Under: Bailout, Economy, Insurance Industry Tagged With:

Debt Collection M&A Is Booming As Collections Collapse

November 24, 2008 by Leave a Comment

Business Week reports that amid a general collapse in the mergers and acquisitions (M&A) field, one area that is still booming is in acquisitions of companies that buy and collect on defaulted consumer debt.  Acquisitions of $1.8 billion this year already exceed last years total of $1.65 billion.

The apparent lure of the hot money M&A crowd is that with a collapsing economy, there is an ocean of debt that is defaulting giving the debt collectors an opportunity to cash in on chasing delinquent customers.  Every company in the country from small businesses to the S&P 500 list are finding out to their surprise that when you extend credit to already heavily leveraged and/or poor credit risks, it doesn’t take much before your customer is unable to pay.

My forecast is that the buyers of debt collection firms that the hot money deal makers are selling will not be sailing on their yachts next summer.

Borrowers of all credit levels suddenly have a new mentality:

-there is no job security and layoffs in the thousands are announced daily; even if I have the money, it is better to keep it in my pocket than to pay off overdue bills.  The choice between being able to buy groceries or pay off a delinquent bill is an easy one.

-the massive bailout of of the banking industry has caused much resentment among working people who justifiably perceive this to be a handout to those who caused the problem to begin with and in addition, made multi millions of dollars in the process.

-the idea that debts really don’t have to be paid back is being encouraged by the government’s bailout mania, especially with the institution of mortgage modifications for delinquent borrowers.  If I don’t have to pay my mortgage back, I am certainly not going to worry much about defaulted credit card debt.  The repudiation of debts is being encouraged by the very actions that the government is taking to contain the economic crisis.

-lending to many consumers, especially the weaker credits, has been drastically curtailed.  If I won’t be able to get new credit, why would I worry about the credit implications of not paying off old debts?

-I know many people who are not using bank accounts anymore, but cashing their paychecks and paying their bills in cash to forestall the seizure of their money by creditors who have judgments against them.

-the change of power in Washington along with the current job losses and declining economy will lead to a revision of the bankruptcy laws, essentially reversing the changes made in the recent past which made it much harder to file a Chapter 7 liquidation bankruptcy.  The debt collectors who think they can obtain a judgement and wage garnishment may soon find that their claims are now worthless.

-the most obvious reason that debts will not be collected easily or at all is the fact that the American consumer simply does not have the money; squeeze as hard as you want to – there is nothing left so nothing will be paid.   As reported in The Wall Street Journal,

“This should be the best of times for America’s debt collectors, since never has a society been so in hock. But ironically, much of the debt-collection industry is struggling because there’s little cash left to squeeze from strapped consumers.

Encore Capital Group Inc., a San Diego debt buyer, said third-quarter profit fell 30% to $3.8 million after its impairment provision for debt — an accounting term for debt it doesn’t think it can collect — rose to $7.3 million from $2.4 million. And Debt Resolve Inc. of White Plains, N.Y., said big losses at its debt-collection unit led to a second-quarter loss of $4.2 million.

“More and more accounts are going out to debt collectors, but it’s harder than ever to collect,” said John Nemo, a spokesman for ACA International, a Minneapolis-based trade group that includes 3,500 of the country’s estimated 4,500 collection agencies.

“There may be no other industry that has such immediate knowledge of consumer liquidity,” said Paul Legrady of Kaulkin Ginsberg Co., a Rockville, Md., consulting firm that advises collectors and others who manage accounts-receivable. The company publishes the Kaulkin Ginsberg Index of indicators such as corporate charge-offs of unpaid debt. “There’s been a clear downward trend for the past year,” Mr. Legrady said.

The slump also hurts businesses that supply equipment and services to debt collectors. Soundbite Communications Inc., a Bedford, Mass., company that makes automated robo-callers for debt collectors, told investors recently that it expects sales to agencies to decline in the second half of this year.

“Their ability to actually collect payment is significantly reduced because more and more debtors are simply unable to pay,” said Soundbite’s chief executive, Peter Shields. he said. As a result, debt-collection agencies are “becoming more selective in their spending.”

Good luck to the new owners of the debt collection agencies – I would say that the other side of this trade got the better deal.

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