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The Great Consumer Crash of 2009
posted
on: August 14, 2008
“It is easy to ignore the storm if
you look at the opposite horizon. When the storm reaches your location
there can be no more ignorance.”
I
hate to tell you, but the storm has reached your location and it is a Category
5 hurricane. The levees are leaking. Ignore it at your own peril. The 6,000 sq
ft McMansion buying, BMW leasing, $5 Starbucks latte
drinking, granite countertop upgrading, home equity borrowing days are coming
to an end. The American consumer will not go without a fight.
For the last seven years the American consumer has carried the weight of the world on its shoulders. This has been a heavy burden, but when you take steroids it doesn’t seem so heavy. The steroid of choice for the American consumer has been debt. We have utilized home equity loans, cash out refinancing, credit card debt, and auto loans to live above our means. It has been a fun ride, but the ride is over. We can’t get steroids from our dealer (banks) anymore.
After
examining these charts, it is clear to me that the tremendous prosperity that
began during the Reagan years of the early 1980’s has been a false prosperity
built upon easy credit. Household debt reached $13.8 trillion in 2007, with
$10.5 trillion of that mortgage debt. The leading edge of the baby boomers
turned 30 years of age in the late 1970’s, just as the usage of debt began to accelerate.
Debt took off like a rocket ship after 9/11 with the President urging Americans
to spend and Alan Greenspan lowering interest rates to 1%. Only in the bizzaro world of
How Did I Get Here
And you may find
yourself behind the wheel of a large automobile
And you may find yourself in a beautiful
house, with a beautiful wife
And you may ask yourself-Well...How did I get here?
And you may ask
yourself
Where is that large automobile?
And you may tell yourself
This is not my beautiful house!
And you may tell yourself
This is not my beautiful wife!
-Talking
Heads, David Byrne lyrics to Once in a Lifetime
By 2005 practically everyone had a large automobile and a beautiful house. By 2010 many of these people will be asking where is that large automobile and will realize as the sheriff escorts them out of their house that this is not my beautiful house. There is plenty of blame to go round for this predicament. According to Northern Trust economist Paul Kasriel, “We’re a what’s my monthly payment nation. The idea is to have my monthly payments as high as I can take. If you cut interest rates, I’ll get a bigger car.” Major banks offer credit cards using your home equity as a way to pay everyday expenses like groceries, gas and clothes. Eating your house was never so easy.
I
have been accused by many of my friends and family as someone who sees the
glass as half empty. I disagree with their assessment. I see the glass as it
is. I find myself scratching my head trying to figure out why a society that
always saved for a rainy day, consistently saving between 8% and 11% of their
disposable income, now has a negative savings rate. I believe that keeping up
with the Jones’ is the primary reason that Americans have taken on so much
debt.
The
authors of the book, Why Middle Class Mothers and Fathers Are Going
Broke, contend that the costs of housing and a good education for
their children are killing them. It now takes two incomes to provide what one
income provided 30 years ago: a middle-class house in a safe neighborhood with a decent public school. Bidding wars
erupted for homes in what are thought to be good school districts, making homes
in those areas ever more expensive.
A
phenomenon called “expenditure cascade” has occurred in the
The
click to enlarge images
We
have outsourced our savings to the emerging economies, along with our
manufacturing jobs. The Chinese are saving the money we’ve paid them for flat
screen TVs and the Middle Eastern countries are saving the money we’ve paid
them for oil. You need savings in order to increase investment. The emerging
markets are making the vast majority of the investments in the world. While the
U.S. endlessly debates drilling and construction of nuclear plants (none built
in U.S. since 1987) and oil refineries (none built in U.S. since 1977), China
brought four oil refineries online in 2008 and plans to build 30 nuclear
reactors in the next twelve years. The Asian Century has begun, but the
Source: Creditwritedowns.com
Positive Feedback Loop
The
last thing that anyone thought would result while watching the
“I have nothing to offer but blood, toil, tears, and sweat. We have
before us an ordeal of the most grievous kind. We have before us many, many
months of struggle and suffering.”
(Winston Churchill – May 13, 1940)
In
the true spirit of Winston Churchill, President Bush could have paraphrased
Churchill by saying: I have nothing to offer but tax cuts, tax rebates, 0% auto
financing, and no-doc mortgages. Americans grieved for a few weeks and then did
their patriotic part by buying everything they could get their hands on. As
Alan Greenspan denies causing the housing crisis today, his words from November
2002 come back to haunt him, “our extraordinary housing boom…financed by very
large increases in mortgage debt, cannot continue indefinitely into the
future.” After making this statement, he proceeded to slash the discount rate
to 1% in June 2003 and left it at that level for a year. This began the
positive feedback loop:
1. The Federal government cut
taxes and sent rebates to all Americans.
2. The Federal
Reserve cut interest rates to 1%.
3. Government
officials urged Americans to spend in order to defeat terrorism.
4. Alan Greenspan
told people that adjustable rate mortgages were a good thing.
5. Congress and
President Bush believed that everyone should own a home and pressured lenders
to provide mortgages to low income people.
6. GM, Ford, and
Chrysler offered 0% financing on their cars through their finance arms, while
also encouraging low rate leases. Credit card companies sent out 5.3 billion
offers in
7. Wall Street
created new investment vehicles that allowed mortgages to be packaged and sold
to investors throughout the world with investment grade ratings provided by
Moody’s and S&P, for a price.
8. Mortgage companies and
lenders developed ARMs, Option ARMs,
teaser rate loans, no-doc loans, negative amortization loans and 100% financing
loans.
9. Low income people started
buying homes, with these exotic mortgage products, from middle income people.
Middle income people started to buy larger houses from rich people, boosting
demand for new homes. Rich people bought mansions and second homes. Bidding
wars for houses were common.
10. The demand
caused by this influx of new home buyers drove prices skyward, with home prices
doubling in five years. This price rise brought in the speculators/flippers, who began to buy multiple houses with nothing down,
pre-construction, with plans to sell them for a profit without ever moving into
them.
11. Average Americans
who saw their paper wealth growing rapidly, as their home value increased, took
advantage of this by refinancing their mortgages and extracting the equity from
their homes and spending it. The chart below shows that in 2004 and 2005,
Americans sucked $800 billion from their homes in each year.
Source: Calculated Risk.com
12. Homebuilders throughout
the
13. The massive number of
excess home sales and equity withdrawal led to huge demand for home
furnishings, remodeling services, appliances,
electronic gadgets, BMWs, and exotic vacations. This led to massive expansion
by retail and restaurant chains based on extrapolation of this demand.
14. Retailers,
homebuilders, restaurants, and car makers extrapolated the false demand far
into the future. There are now over 7,000 Wal-Marts,
6,000 CVSs, and 30,000 McDonalds. Any company that
built their business on false assumptions and excess debt will be meeting their
maker, shortly.
15. Because the
originators of virtually all loans to consumers were immediately selling the
loans off, they had no incentive to follow any guidelines or due diligence when
issuing the loans. Anyone with a pulse could get a mortgage, car loan, or
credit card. Unscrupulous mortgage brokers popped up everywhere, luring
uneducated and willing people to join the party. Greedy appraisers went along
with the scam by overvaluing houses to whatever the banks desired.
16. The debt induced spending
that occurred from 2001 until 2007 accounted for virtually all the GDP growth
over this time. Without the mortgage equity withdrawal, the
Source: John Mauldin
Negative Feedback Loop – Underway
The
pseudo-wealth that has been created in the last seven years has begun to
unwind, but will increase in speed in 2009. You only know how you’ve lived your
life over the last seven years. Your neighbor who has
been getting their house upgraded, sending their kids to private school,
driving a BMW, and taking exotic vacations may have been living the high life
on debt. As usual, Warren Buffet’s wisdom comes in handy.
“Only
when the tide goes out do you discover who’s been swimming naked.”
The
tide is on its way out, and the naked swimmers are numbered in the millions.
Mohamed El-Erian, the number two man at PIMCO, fears
a negative feedback loop consuming the country. I believe we have begun the
negative feedback loop and it is starting to accelerate. The stages are as
follows:
1.
Home prices reached an unsustainable level in 2006. Prices had gone parabolic
between 2001 and 2006, with the average price reaching above $225,000. In 2001,
prices were just above $125,000. As the pundits keep looking for a bottom in
housing, the chart below clearly shows there is a long way to go.
2.
The massive overbuilding based on false demand has led to 3.5 million excess
homes in the
3. With the tremendous price
increases in houses over the last decade, you would think that equity would be
at all-time highs. But no, owner equity as a percentage of house value has
reached an all-time low of 45%. People have sucked the equity out of their
homes and spent it faster than the prices were rising. The problem is that
house prices can and will fall, debt remains like an anchor around your neck
until paid off or it drags you down into bankruptcy.
4. The millions of exotic mortgages
(subprime, alt-A, ARMs,
no-doc, and negative amortization), which have started to blow up, has led to a
tsunami of foreclosures. In 2005 there were less than 600,000 foreclosures in
the
Source: MBA
5.
The combination of oversupply, over-leverage, and foreclosure tsunami has now
taken on a life of its own. Home prices have been spiraling
downward for two years to the point where 29% of all households that purchased
in the last five years owe more than their house is worth according to Zillow, the home valuation company. For those who bought in
2006, 45% have negative equity. It is now making economic sense for people to
just walk away from their house and send the keys to the lender. This is
referred to as ‘jingle mail’.
6.
The ongoing housing price decreases are now affecting prime mortgages,
home equity loans, and home equity lines of credit. Prime mortgages for less
than $417,000 had a delinquency rate of 2.44% in May, up 77% from last year.
Prime jumbo loans over $417,000 had a 4.03% delinquency rate in May, up 263%
from last year. According to the
7.
Consumers have dramatically increased the use of credit cards, now that the
housing ATM has run out of cash. The average American household has credit card
debt of $9,840 versus $2,966 in 1990, at an average interest rate of 19%.
Credit card delinquencies have increased to 4.51% in the 1st
quarter. Amex just announced a major unexpected write-off because its prime
customers have hit the wall and are defaulting. Consumers used their credit and
debit cards to buy $51 billion of fast food in 2006 according to Carddata. According to the Federal Reserve, 40% of American
families spend more than they earn. This has led to the result in the chart
below. The reversal of this trend will be necessary but traumatic. It has
already begun, with the savings rate increasing to 2.6% in early 2008. David
Rosenberg, the brilliant economist from Merrill Lynch, describes what has
happened and what is to come:
"This is an epic event; we're talking about the end of a 20-year
secular credit expansion that went absolutely parabolic from 2001-2007.
"Before the US
economy can truly begin to expand again, the savings rate must rise to
pre-bubble levels of 8pc, that the US housing stocks must fall to below eight
months' supply, and that the household interest coverage ratio must fall from
14pc to 10.5pc.
"It's important to note what sort of surgery that is going to require.
We will probably have to eliminate $2 trillion of household debt to get
there," he predicts, saying this will happen either through debt being
written off, as major financial institutions continue to do, or for consumers
themselves to shrink their own "balance sheets".
The
elimination of $2 trillion of household debt will lead to the closing of
thousands of retail stores, strip malls, restaurants, and bank branches. There
should be a lot of vacant buildings available in the next few years, and a few
suspicious fires.
Source: Creditwritedowns.com
8. Banks are doing what they usually do. They are closing the barn door after the pigs have escaped. As their losses have crossed the $500 billion mark, it is getting tougher for them to convince more suckers to buy their stock. They have so much toxic waste “assets” on and off their books at inflated values that they can not or will not lend. The Federal Reserve reported that banks have tightened standards for all loans in record numbers. After giving loans to anyone with a pulse for the last five years, this information is refreshing. But based on the well qualified assessments of Bridgewater Associates and NYU economist Nouriel Roubini, there is still $1.0 to $1.5 trillion in losses to go. Bank lending to consumers will be subdued for years.
Source: Mike Shedlock
9. Government unemployment figures have begun to skyrocket, while the true unadjusted unemployment figures point to a major recession. If the number of people who have given up looking for a job were included, the official 5.7% unemployment rate would jump to 14%. People without jobs can’t spend money or make mortgage payments. With the deep recession that I anticipate, the official figures will reach 7%. This will result in lower consumption.
Source: Haver Analytics
10.
Car sales have plummeted. The major car manufacturers have stopped leasing cars
to consumers. J.D. Power and Associates forecasts car sales of 14.2 million
units in
Source:
J.D. Power
11.
Retail store closings and retail bankruptcies have begun to accelerate. This
will lead to hundreds of thousands in job losses. Barry Ritholtz
recently documented the fate of many retailers so far:
Ann Taylor closing 117 stores nationwide
Bombay
Company:
to close all 384 U.S.-based
Cache,
a women’s
retailer is closing 20 to 23 stores this year
CompUSA (CLOSED).
Disney
Store
owner has the right to close 98 stores.
Dillard's
Inc. will close
another six stores this year.
Eddie
Bauer to
close more stores after closing 27 stores in the first quarter
Ethan
Allen Interiors: plans to close 12 of 300 stores to cut costs.
Foot
Locker to
close 140 stores
Gap
Inc.
closing 85 stores
Home
Depot store
closings 15 of them amid a slumping
J.
C. Penney, Lowe's and Office Depot are all scaling back
Lane
Bryant, Fashion Bug, Catherines closing 150 stores nationwide
Levitz
- the
furniture retailer, announced it was going out of business and closing all 76
of its stores in December. The retailer dates back to 1910.
Macy's - 9 stores closed
Movie Gallery – video rental company plans to
close 400 of 3,500 Movie Gallery and
Pacific Sunwear - 153 Demo stores closing
Pep Boys - 33 stores of auto parts supplier closing
Sprint Nextel - 125 retail locations to close
with 4,000 employees following 5,000 layoffs last year
Talbots, J. Jill closing stores. Talbots
will close all 78 of its kids and men's stores plus another 22 underperforming
stores. The 22 stores will be a mix of Talbots
women's and J. Jill
Wickes Furniture is going out of business and
closing all of its stores. The 37-year-old retailer that targets middle-income
customers, filed for bankruptcy protection last month.
Zales, Piercing Pagoda plans to close 82 stores by July 31
followed by closing another 23 underperforming stores.
I know Linens & Things just went belly up, and Steve & Barrys recently filed for bankruptcy
protection and sale.
12.
Mall owners and commercial developers are on the brink of bankruptcy.
Commercial developer CB Richard Ellis didn’t sound too optimistic in their
recent 10Q filing:
We are highly leveraged and have significant debt service obligations.
Although our management believes that the incurrence of long-term indebtedness
has been important in the development of our business, including facilitating
our acquisitions of Insignia and Trammell Crow Company, the cash flow necessary
to service this debt is not available for other general corporate purposes,
which may limit our flexibility in planning for, or reacting to, changes in our
business and in the commercial real estate services industry. Notwithstanding
the actions described above, however, our level of indebtedness and the
operating and financial restrictions in our debt agreements both place constraints
on the operation of our business.
General
Growth, a mall developer, looks like a prime candidate for bankruptcy based on
their recent 10Q info. Mike Shedlock assesses their situation:
Interest expense for 3
months ending June 30, 2008 was $312,943,000.Net Income for 3 months ending
June 30, 2008 was $34,082,000 Earnings per share from continuing operations was
$.01 Earnings per share from discontinued operations was $.12 If the cost to
refinance $18 billion were to rise to 8.0%, interest expense would rise by 50%
to a whopping $469,414,000 per quarter. Even 7% would be a killer based on the
numbers presented above.
Given that the Shopping Center Economic Model Is
History and credit is tightening everywhere, General Growth Properties is going
to be in deep trouble if credit conditions remain as they are, or even if they improve slightly. I
expect credit conditions to worsen.
13.
Consumer and business confidence is shot. Consumer confidence is at
multi-decade low levels. Small business confidence is also at historic lows.
Small businesses do most of the hiring in the U.S. Consumers and businesses are
correct in their assessment of the situation. It is our political and corporate
“leaders” that are in denial.
In
conclusion, the gathering storm has arrived. It will be long, painful and
destructive. Those who prepared for the storm by not taking on excessive debt
and living above their means, will ride it out unscathed. Those who built their
house on sand by leveraging up and living the “good” life,
will see their house swept out to sea. The storm will pass and we will rebuild.
Our country is resilient. The purging of this massive debt will result in the
creative destruction that is the hallmark of American capitalism. New
opportunities, new technologies and a new attitude will put us back on course.
There has been and will be resistance to the inevitable deep recession that is coming. The American consumer is not cutting back willingly. They are being dragged kicking and screaming towards the joys of frugality. The “material generation” needs to dematerialize. My biggest concern is that our politician leaders and their cronies running our government will continue to try and reverse the normal capitalistic course of recession and expansion. Companies need to fail, housing needs to find its bottom based on supply, demand and price. Those who gambled must be allowed to lose and suffer the consequences. If the government attempts to shift the losses to those who lived lifestyles of thrift, an angry uprising will ensue. Government intervention in this natural process could lead to a decade long depression. Let’s hope that reasonable heads prevail.