The decline of credit cards

Considering that our economy is based on consumer spending, yesterday should have been a terrible day in the markets.

Sept. 8 (Bloomberg) -- U.S. consumer credit plunged more than five times as much as forecast in July as banks restricted lending terms and job losses made Americans reluctant to borrow.

Consumer credit fell by a record $21.6 billion, or 10 percent at an annual rate.... Credit dropped by $15.5 billion in June, more than previously estimated. Credit fell for a sixth month, the longest series of declines since 1991. (source)

So, the consensus among financial analysts was too optimistic by a factor of five. Mind you, these are the people telling us that the economy is recovering. Ha!

Let's look at this in graph form, courtesy Karl Denninger (click to enlarge):



Every source of money available to the middle class is drying up. One in five workers are unemployed or underemployed. Hours worked per week have fallen. Wages are falling in real terms. Home equity is gone. 401k's and IRA's may have rallied, but most are still far below what they were last summer or in 2007. What we've got left is consumer credit, and this is disappearing at a 10%-per-year rate. [Edit: I didn't make this clear, but consumer credit also includes auto loans and other loans for big-ticket items.] How fast, then, is consumer spending going to decline over the next 12 months?

It's true that some part of the decline in credit is because those who are still well-off are reluctant to take on debts. A credit card they might have signed up for 2 years ago holds far less appeal today, when people fear for their jobs and just want to save some money away, if they're able. But for many, their credit is being cut off. As Mish and Karl Denninger have put it, those who could borrow refuse to; those who would borrow cannot.

Meanwhile, today's buzz was over a YouTube video titled Debtors Revolt Begins Now, featuring a woman telling Bank of America that because they raised her credit card interest rate to 30% for no reason, she was not paying them another red cent. In the comments at Zero Hedge the sentiment was mostly of the "Brava!" sort. Apparently this is called "radical default" in the industry-- people who simply will not pay, no matter what they are threatened with, even if they still have some ability to pay. Part of the attitude is: the banks don't give credit to those who need it anyway, so what the hell do we care about credit ratings? If we should ever desperately need credit, by definition we'll be denied!

The hotels and car rental outfits better be thinking about what to do when half their would-be clients haven't got credit cards anymore. Maybe in ten years we'll be telling kids how you used to be able to buy things using a little plastic rectangle, even if you couldn't cough up the money till months or years later.

Betting on death

The other day a friend mentioned to me that Goldman Sachs was thinking of putting together a fund that would go up in value if people began dying earlier. I didn't completely understand this concept, but I have now run across it several more times, and have some thoughts.

The basic idea is this: Suppose an older person has a dire need for cash, and they happen to have a $1 million life insurance policy. A company might come along and offer them $400,000 today in exchange for the policy. This company (or fund) would continue to make the monthly payments, and upon the person's death the fund would collect the entire payout. If the person keels over almost immediately, the fund would have made $600,000. If they live a long time, the fund may end up losing money because the monthly payments add up to more than their profit at the time of the person's death.

Now, if you know how insurance works you can spot the flaw in this idea. The insurance company, naturally, has worked this all out so that they are likely to make a small profit. Otherwise, this insurance company would not be in business, right? So they've done all the math and worked out all the probabilities so that -- in all likelihood -- they will take in more money from the monthly payments than they'll pay out at the time of death. If you don't take in more money than you're paying out, then you don't have a business.

Now, as an individual who's buying life insurance, you don't really care that you might wind up paying out more money, over a long period of time, than your family would ever receive. What you are actually purchasing, in a given month, is peace of mind. You're paying the bill in order to protect your family. Nobody wants to get gouged, but it's the nature of the insurance business that they're probably going to make a profit from you.

Okay, fine. But why in the hell would a disinterested third party want to assume those monthly payments, knowing that these payments will -- probabilistically speaking -- be more than the eventual return?

This is what certain Germans should be asking themselves. The German newspaper Spiegel recently ran the article Investing in Death: Betting on US Life Expectancy Proves Risky:

Deutsche Bank and other financial institutions manage complex funds that buy up Americans' life insurance policies and pay their premiums in return for their payouts. But angry German investors are finding that Americans aren't dying as quickly as expected -- and that only the bankers are making a buck....

The "db Kompass Life" fund buys up life insurance policies of Americans and assumes responsibility for paying their future premiums. When a policyholder dies, the entire payout from the policy goes to the fund. And since everybody dies, it would seem to be a fairly crisis-proof investment.

Actually, it would seem to be not so much crisis-proof as profit-proof, at least during normal times. The only way such a fund would make money is if people started dying, en masse, earlier than predicted. Such a fund would only soar during pandemic, massive warfare, or an economic catastrophe dire enough to kill thousands from cold, heat, and hunger. Meanwhile, a new category of cancer drugs or a new heart medication could cause the fund to tank.

(These funds, by the way, will cause life insurance premiums to rise for everyone. This is because people often cancel a life insurance policy once their kids are grown or the house is paid off or whatever. But once a policy has been bought by a fund, it will not be canceled. The cancellations are a financial boon to the insurance industry, since it never has to make a payout. Without those helpful cancellations, higher premiums will have to be charged in order to make up the difference.)

Wall Street makes a ton of money just packaging things and charging fees and commissions, which is risk-free. They made a slew of money off bundling up risky mortgages and passing them off to the big money and the dumb money. And they'll make huge profits bundling up life insurance policies and securitizing those, too. As reported in the New York Times:

Undeterred, Wall Street is racing ahead for a simple reason: With $26 trillion of life insurance policies in force in the United States, the market could be huge....

But even if a small fraction of policy holders do sell them, some in the industry predict the market could reach $500 billion. That would help Wall Street offset the loss of revenue from the collapse of the United States residential mortgage securities market, to $169 billion so far this year from a peak of $941 billion in 2005, according to Dealogic, a firm that tracks financial data.

The key thing to understand here is that Wall Street doesn't have to fleece the sheep itself. It's more like Wall Street collects a finder's fee for delivering sheep to the shearer; the finder's fee is otherwise known as "fees and commissions." They earn a steady income just by creatively shuffling paper, right up until their Next Big Idea blows up and leaves pension plans, 401k's, and European banks in smithereens. Wall Street's problem, at the moment, is that they're in dire need of a new way to shuffle paper.

Our old friends at Goldman Sachs have gone one better than merely packaging "life funds" (how's that for Orwellian?). Goldman has created a way to gamble on US life expectancies, without the gambler even having to join one of these funds:

Goldman Sachs has developed a tradable index of life settlements, enabling investors to bet on whether people will live longer than expected or die sooner than planned. The index is similar to tradable stock market indices that allow investors to bet on the overall direction of the market without buying stocks.

Boy, that should be an interesting thing to watch. Considering the insider trading that went on just before 9/11, the Goldman Death Index could foretell a very nasty event. Some big player might get wind of a widespread, mutated H1N1 in China and go long the Death Index before the news hits the Western press, which we would see as an inexplicable price spike. Or someone might know about a terrorist event about to occur in a major city, and might buy a slew of call options on the Death Index. As my friend pointed out, a speculator could take a "pro-Reaper" position or short the Reaper. Major pro-Reaper moves would signal something very bad coming down the pike.

I'll leave you with an excerpt from Wall Street Vultures Betting on Death:

The rating agency involved in the ” early death investments,” DBRS, employs a “mathematics whiz” who has created computer models to manage the risk of investing in life-insurance securitizations. The risk being, of course, people living longer than expected.

The math whiz, Jan Buckler, also has a PH.D. in nuclear engineering and she has devised a scheme of packaging the bond instruments based on the type of disease to lower the risk. She recommends bundling policies with a mix of certain diseases such as leukemia, lung cancer, heart disease, breast cancer, diabetes and Alzheimer’s. The theory is, if too many people with breast cancer are in the securitization bundle and a cure is developed, the value of the bond would drop.

Wall Street is betting against a cure for cancer.

Sarah Palin was looking for her death panels in the wrong place.

The Other America

A couple of years ago I was listening to a podcast with Max and Stacy, and she mentioned that a friend had recently gone to the States as a tourist. This friend had intended to start in New York City (I think it was NYC) and travel down the entire East Coast. She only made it as far as -- if I remember rightly -- Virginia, then caught a plane back to Europe because she was so horrified at the poverty. That tale has always stuck in my mind... say, when I'm driving past a tiny rural home with junk in the yard and a sheet tacked over the window.

If you haven't heard of photographer Harvey Finkle, he does some excellent photo journalism on the subject of homelessness, poverty, and advocacy for the poor. The photos in this post are from his gallery on child poverty.

While current national data are not available, the number of schoolchildren in homeless families appears to have risen by 75 percent to 100 percent in many districts over the last two years, according to Barbara Duffield, policy director of the National Association for the Education of Homeless Children and Youth, an advocacy group.

There were 679,000 homeless students reported in 2006-7, a total that surpassed one million by last spring, Ms. Duffield said.

With schools just returning to session, initial reports point to further rises. In San Antonio, for example, the district has enrolled 1,000 homeless students in the first two weeks of school, twice as many as at the same point last year. (source)

So, maybe 2 million homeless students this year. The last time we went to the library, one of the books my daughter checked out was called "How to Steal a Dog." The protagonist is a girl whose family is living out of their car (she wants to steal a dog to return it for the reward money). I guess this is becoming a mainstream reality.

The number of working Americans turning to free government food stamps has surged as their hours and wages erode, in a stark sign that the recession is inflicting pain on the employed as well as the newly jobless.

While the increase in take-up is often attributed to the sharp rise in unemployment... the Financial Times has learnt that some 40 per cent of the families now on food stamps have “earned income”, up from 25 per cent two years ago.

The agriculture department, which runs the programme, attributes this rise to workers having their hours cut back.

“I’m sort of stunned, it seems like a dire warning . . . that even the jobs people are retaining in this recession aren’t at the wage level and hours level that they need to provide for their families,” said Heidi Shierholz, economist at the Economic Policy Institute. (source)

Jobs and wages must increase or there is no economic recovery. Furthermore, those jobs must come from extraction (things like mining, fishing, and forestry) and from production (manufacturing, textiles, refineries, new infrastructure). Put another way: the recovery must come from well-paid blue collar work. A "jobless" recovery is no recovery at all, but merely a sick joke told by the media.

The poverty rate among older Americans could be nearly twice as high as the traditional 10 percent level, according to a revision of a half-century-old formula for calculating medical costs and geographic variations in the cost of living.

The National Academy of Science's formula, which is gaining credibility with public officials including some in the Obama administration, would put the poverty rate for Americans 65 and over at 18.6 percent, or 6.8 million people....

The overall official poverty rate would increase... to 15.3 percent, for a total of 45.7 million people [emphasis mine], according to rough calculations by the Census Bureau.

(source)

In other words, the real number of poor people in the US is approaching 1 in 6.

The National Alliance to End Homelessness (NAEH) estimates that this recession will create 1.5 million new homeless – nearly double the current number. Half of those people will exist outside the shelter system – in cars, tents, campers, or sleeping bags under highway overpasses....

The rise in long-term tenting and camping is a sign that people’s options are running out, says Nan Roman, president of NAEH. (source)

I think these people are invisible to most of those in charge. In their meetings about interest rates and banking liquidity and GDP and SDR's, nobody is talking, say, jobs projects to build rudimentary cottages in areas with high numbers of homeless families. Nobody is talking about the re-opening of textile mills and foundries. Sure, we'll use stimulus money to re-pave some roads, but where do the new blue collar jobs come from? And how do we make sure they are well-paid jobs when workers get slave wages in so much of the world? The only thing I can think of is so taboo, one dare not whisper it in mixed company: tariffs and protectionism.

The pretense of honesty

I had mentioned that the government tells lies about the unemployment rate, "adjusting" the numbers according to this theory or that theory. Mish quotes from an article that addresses some of these jobs numbers [all emphasis is mine]:

What was really key were the details of the Household Survey, which provide a rather alarming picture of what is happening in the labour market.

First, employment in this survey showed a plunge of 392,000, but that number was flattered by a surge in self-employment (whether these newly minted consultants were making any money is another story) as wage & salary workers (the ones that work at companies, big and small) plunged 637,000 — the largest decline since March (when the stock market was testing its lows for the cycle).

Right, so they call people up and they say "Well, I'm self-employed... I'm setting up my own consulting business." And maybe their income from that business, for this month, was negative $500. Doesn't matter. They still count as employed.

As an aside, the Bureau of Labor Statistics also publishes a number from the Household survey that is comparable to the nonfarm survey (dubbed the population and payroll-adjusted Household number), and on this basis, employment sank — brace yourself — by over 1 million, which is unprecedented. We shall see if the nattering nabobs of positivity discuss that particular statistic in their post-payroll assessments; we are not exactly holding our breath.

Wow-- a million jobs lost last month. Seems like that would make the news, no?

In the Dmitry Orlov presentation called Closing the Collapse Gap, in which he talks about the fall of the USSR and its similarity to the coming denouement of the US, he says that the Soviet collapse was harder to predict because of government secrecy. Well, I'm not so sure about that. Everyone acknowledged that the Soviets, having a command economy and an opaque, secretive government, would be dishonest about their fiscal situation. The US government pretends to be transparent, but they sure do play with the numbers. Some of the people watching CNBC don't seem to understand that this is cheerleading and lies, or that the jawboning coming from the Fed and Treasury are more of the same. Most people probably don't believe that the Fed has found ways to buy our own Treasuries without admitting to it (first using Cayman Islands accounts, and then using "swap accounts" or "swaps" with other central banks-- I can't claim to understand all the details). Which is more dangerous-- flat out stonewalling, or the illusion of honesty and transparency while they're lying through their teeth?

All news media outlets reported August job losses of 298,000 216,000, the official number the government likes to use. [Edit: 298,000 was the ADP estimate.] Meanwhile other estimates put the real figure at over 1 million, but few news articles, if any, will mention such a horrifying figure. I think green shoots might prove worse for the average person in the US than secrecy. Secrecy makes citizens suspicious, and rightly so; green shoots give them the warm fuzzies. As it grows harder to maintain confidence in the US dollar, in US stocks, and in Treasuries, the incentive for government to lie becomes stronger and stronger. Before it's all over they might be making up numbers out of whole cloth, yet some folks will still believe they are honest.

So I think Mr. Orlov might be wrong; it might be harder to predict the timing of the demise of the United States.

By the pricking in my thumbs

This summer felt like a waiting period, a hiatus during which everything slowly got a little worse but nothing major happened. Now, however, it's September, and things feel foreboding.

I'm hearing rumors again about banks and hedge funds that are in trouble (Morgan Stanley, Wells Fargo, and Cerberus). This reminds me of last fall, when a slew of banks were teetering. Sub-prime may be old news, but the commercial real estate implosion is just getting going. Mish writes that 1 in 6 construction loans is in trouble.

Unemployment is still ticking up. Officially it's 9.7%, except that doesn't include the long-term unemployed or those who need full-time work but can only find part-time jobs. Including those folks the unemployment rate is 16.8%, but even this is seen as a low-ball estimate because the government plays with the numbers and makes a lot of ridiculous assumptions. Economist John Williams has the real unemployment rate at 21.1%.

Meanwhile, in at least 18 states the money has run out for unemployment benefits, and they are borrowing from the federal government to make payments. California pays out $80 million per day to the unemployed. As Ilargi writes in States of Shock:

At state level, a mountain of trouble is brewing in America....

There are lots of political fights ongoing.... In some cases, parties are rolling over the floor for budget cuts of 2-3-4 percentage points. Whoever is involved in any of those fights is up for a rude sunrise, since in many cases, tax revenues are already off by 10-20%. I haven't seen one state that doesn't admit to at least a few hundred million in budget deficits, with losses predicted to grow rapidly in years to come....

There is no doubt that all states, with perhaps 1 or 2 exceptions, will go into the next fiscal year with a budget that is far too optimistic. This is how politics works. Whatever can be made tomorrow's problem will be. And tomorrow's problems are set to be huge....

We are about to see a huge increase in the issuance of state bonds and other forms of borrowing. Kicking all your cans down all the roads that you can find. Many states are in the process of opening some kind of gambling den or another.

And then down the line will come the tax increases, stealthily at first, more openly later. But raising taxes on a population that is getting poorer fast is a stillborn idea, especially at the lower levels of government, where people know where you live.

To understand the underlying justification for budget cuts that are way too meagre, for not properly tackling problems and for issuing even more debt, you only need to look at the White House and its message of recovery and 3.5%-4% economic growth right around the corner. That message undermines the need for more unpopular measures at the state level, even as revenues are falling much faster than that.

On another note, as I've written about recently, the stock market looks set to have another major fall in the next month or two, which will cause further havoc with pension plans, university endowment funds, and 401k's. Insider buying & selling activity (e.g. if the CEO of a company wants to sell some of his stock in that company) must be reported to the authorities. For most of August the insiders were selling 31 times more than they were buying. In the last week in August this shot up to 62 times. For every $10 worth of stocks they purchased, they sold $620. This is important because major market moves happen in three steps:

1. The smart money buys (sells).
2. The big money buys (sells).
3. The dumb money buys (sells).

The dumb money is the public. We're just here to buy at the top, sell at the bottom, and generally get fleeced by the big boys.

Currently, the "smart" money (insiders) and some of the "big" money (funds, money managers) are getting out. When stock prices are going up it's usually on slow, low-volume days. When they go down, though, they go down on busy, high-volume days. This is indicative of the big guys starting their exodus.

I do think the dollar will be okay for the next little while, because most people don't know about gold and silver, and when stocks fall and they panic, they run straight back into Treasuries and dollars in the bank. That makes dollars and Treasuries in hot demand and supports their value. But somewhere out there, and quite possibly just a few months away, we could see one of these "black swan" events and the dollar could tank. Most dollars in existence are not in the United States. Once the rest of the world decides they don't want our dollars, there is nothing the Fed or the government can do to keep the dollar from losing much of its value.

I increasingly find that people are very cynical and tired of the government / Goldman manipulation of markets, commodities, and currencies. People still trade in the markets, but it's partly based on their understanding of what the government / Goldman gang will do, e.g. "They always shove stocks up starting at 3:30 on Fridays" or "They always smash gold when the market opens in New York." Wall Street is becoming a bit of a joke. Too much more corruption and our foreign friends will pack up and go home, taking their investment money with them.

Should be an interesting fall.

Wages must increase

I was over at Karl Denninger's Market Ticker yesterday, and saw this amazing graph:


This graph shows the growth in the US population since 1970 (about a 50% rise), as well as the growth in consumer credit (close to a 20-fold increase). As Denninger points out, this doesn't even include mortgage debt. Or corporate debt. Or government debt.

Why this gigantic increase in debt?

In real terms, if you properly adjust for inflation, wages have been falling during the entirety of the above graph. Note that government statistics about inflation, particularly after about 1980, are lies. The government understates inflation in order to reduce Social Security payments, which increase along with inflation.

The American standard of living doesn't seem to have fallen much, though. Particularly not if you watch a lot of TV, where fictional characters are mostly wealthy and the mainstream news pretends that everyone is upper middle class at minimum. But even here in the real world, considering that wages have been falling for 40 years, it's amazing that we've kept this standard of living. (Again, I'm saying they're falling in real terms, in terms of what you could actually buy with your paycheck.)

Partly this is explained by the prevalence of two-income households, which are now usual. But clearly, much of the gap left by falling wages has been made up by credit cards, home equity loans, student loans, and so on.

However, that credit is now drying up and going away. Home equity lines have been canceled, credit card limits have been slashed. And yet 70% of the economy is based on consumer spending, so if you take away Americans' credit cards, their reduced spending also reduces the whole GDP.

Meanwhile, income disparity has been rising. We all know about the bonuses given to bankers who are complete failures, bankers making many hundreds of times what the bottom quartile of Americans earns.

The solution here really ought to be obvious: wages must rise. That hasn't happened, perhaps, because of globalization, but thankfully that is now coming to an end. Protectionism, tariffs, wars, and expensive crude oil will spell doom for the globalized economy. As this happens, workers need to demand better wages. It's not selfishness-- it's what's needed to restore some semblance of an economy.

The Mogambo Guru on derivatives

If you're not familiar with The Mogambo, he's quite funny and his column makes reading the economic news a bit easier. Here he is talking about "derivatives" -- essentially, a bunch of bets that banks have placed with each other, and which will eventually raze large parts of the financial world:

And when combined with all the other hundreds of trillions of dollars in other derivatives around the world, we are talking about more than a quadrillion dollars in various bets and hedges, a figure that I figure must be more than the total value of everything in the whole world because even $1 quadrillion comes out to, for each of the Earth’s six billion inhabitants, $166,667 each! Gaaahhh!

The worst part is that the real, in-your-face nominal total of global derivatives may actually be several quadrillion, or even the hundreds of quadrillions of dollars, as has been previously estimated, I forget where, but you can trust me on this one because you don’t forget a thing like learning of a $225 quadrillion estimate for total global derivatives outstanding, which is 4,500 times as large as the world’s $50 trillion GDP, which is so bizarre that I can hardly imagine it, and have drunk many, many shots of various alcoholic beverages trying to get to the “zone” where I can even vaguely comprehend such a figure, which seems to be that narrow “window of opportunity” right before I pass out after raising my head up off the floor and loudly declaring “$166,667? Sure! Why not?”

A lot of these derivatives cancel out-- JP Morgan Chase owes a billion to Goldman Sachs, but Goldman owes a billion to Chase on some other contract, so it comes out even. But we don't know who's got what. Nobody really knows which banks might be left standing and which will be mere smoldering ruins, once these contracts start getting triggered. Certain banks will never be allowed to go under, and the Fed will print new money to give to them to plug the holes in their balance sheets, even if it means decimating the dollar.

The fact that gold has no counter-party risk will be a big part of its appeal, in the not-distant future.