The Next Shoe is Dropping

The global markets are finally catching on. The only thing that matters is the economy. Sure, the markets get excited about a new President or another bailout/stimulus package, but it always comes back to the economy.

Right now, the economy is in bad shape and getting worse. And the markets are just realizing it…again. The worst part is, two of the three sources of consumer spending power, housing and stock market wealth, have dried up.

Housing Wealth

The drop in housing prices is already starting to have an impact on equity extractions as well. The “your house is an ATM period” is over. Equity extractions are when consumers tap home equity lines of credit, second mortgages, or any other type of borrowed money against the equity value a homeowner has built up.

Net equity extractions from U.S. homeowners fell to about $10 billion last quarter. This is down tremendously from 2004 through 2006 when homeowners would extract about $160 billion in equity value each quarter. And it’s not going to change anytime soon.

If we consider the stock market as a bellwether of expectations, we can see the real estate market won’t be coming back anytime soon. Just look at how rough it has been for over-leveraged REITs over the past year. The housing wealth source has all but dried up.

Stock Market Wealth

Dow, S&P, Nasdaq, commodities, emerging markets…everything is way down. Trillions of dollars in wealth have been eliminated. When your average consumer pulls up their brokerage or 401K statement and sees nothing but red, they’re not thinking this is the time to upgrade washing machines, TVs, or get a new car.

Credit Card Wealth

We’ve known all that for a while and the impacts on consumer spending have been expected. Now, the third source of consumer spending power, credit cards, is collapsing as well.

As we warned in mid-October in Why Market Rallies Won’t Last, credit cards are the last great source of consumer spending power. But they won’t be for long:

“The last hope for keeping consumers temporarily afloat is credit cards. All signs point to this source being completely dried up.

“Over the past few weeks credit card companies have slashed the amounts they are willing to lend to risky customers. Most of them won’t even open up new accounts for high-risk individuals. And they cut their marketing budgets too. According to CBS News, HSBC sent out 54% less direct mail advertisements and Citibank has sent out 45% less.

“The credit card issuers have become risk averse and are finally limiting the total credit available and the amount of customers they’re willing to take on. Credit card spending, the third leg of American ‘wealth’ is going away too”.

Yesterday, we got the worst news of all. The private sector is no longer willing to lend to credit card issuers.

For the first time in 14 years no one has been willing to buy bonds backed by credit card loans. This is absolutely huge news that is just one sign of the continuing decline in credit card lending.

You see, credit card issuers like Bank of America (NYSE:BAC), JP Morgan Chase (NYSE:JPM), and American Express (NYSE:AXP) lend money on credit cards. Then they bundle those loans up and sell them off to institutional investors like insurance companies, hedge funds, and mutual funds looking for income. That way they can lend more and more without taking on much of the consumer debt or the risk themselves.

The institutional investors like the debt because they would get a greater rate of interest in exchange for the greater risk. Now, they consider the risk isn’t justifying the reward of a few extra bucks in interest payments.

Now that no one is willing to buy it, the banks and credit card issuers will be forced to curtail lending even more. It’s all part of the downward spiral of credit contractions. This is a just a sign the last great source of American consumer spending power is drying up.

It’s Not Just an American Problem

India is facing similar problems with its formerly debt-loving middle class. reports:

“[Indian] Bankers said the trend has intensified in recent months and the portfolio may have shrunk by about 10% this fiscal year so far. This is significant as the industry has seen growth at an average 30% in each of the past four years.

“The percentage of non-performing assets, or NPAs, in banks’ credit card portfolios has almost tripled, going up from 5-8% in fiscal 2008 to 15-20% in the current fiscal. NPAs are the portion of the credit card portfolio where a customer has not paid dues for at least 90 days.”

It’s getting pretty bad in India and leading Indian banks like ICICI (NYSE:ICB) are going to have a lot of problems to deal with. But its’ not just India, Mexico is having its own issues with consumer credit as well.

Wal-Marts in Mexico, which extend credit to their customers, are starting to take measures to limit the risks associated with consumer lending. Last week, Mexico’s Wal-Marts upped the interest rate on the credit it extends to customers to 70% per year.

It’s tough to imagine too many consumers willing to pay that kind of interest rate to buy anything other than absolute essentials.

The Impact

Credit cards are the final source of U.S. consumer spending power growth. We both know that is not an option.

This spells even more bad news for an ailing U.S. economy. Nothing will get turned around for good until the employment situation starts to improve. Until then, there are plenty of trading opportunities for a volatile market but cash is still probably the safest place to be for the short-term.

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