If you are looking at your financial position, you should consider your assets in relation to your liabilities.
What you should do, a bank by law must do.
Banks have assets. A huge asset on the books of the biggest American banks is credit card debt. That money is owed by borrowers. Interest rates paid on these cards is far higher than rates obtainable by banks from any other class of loans.
The written credit card debt contracts are also beneficial to banks. Low card rates can be hiked without warning overnight to 20% or even 30% per annum if a borrower misses a payment to his mortgage company or any other creditor. This missed-payment information goes from the third-party creditor to a credit rating agency, and from there to the bank.
Credit card debtors have agreed to contracts that pass most of the power to the lending agencies, which are banks.
All this sounds like good news for the banking industry. But then the banking industry got into the game of politics. (Actually, I can think of few industries that got into politics earlier: the fifteenth century at the latest.) The banks began to pressure Congress last year to pass legislation to toughen the bankruptcy law. Congress complied with bank lobbying early this year, and President Bush signed this legislation into law, just as he has done with every proposed law that Congress has put on his desk since January, 2001.
SHRINKING ASSETS
Few people understand that the minimum monthly payment required by banks kept the borrower in debt for over two decades. Now, that's a loan that pays and pays and pays!
The borrowers, not understanding compound interest and paying attention only to the monthly payment's effect on their budgets, willingly locked themselves into a long-term debt contract.
This was a bonanza for the banks, which was why American banks since 1965 have dramatically increased the assets on their books attributable to credit card loans.
On October 17, the new bankruptcy law will go into effect. That is the day that the banks will see their cash cow wander off into the field toward the butcher's.
The new law cuts those juicy 20-year loans to 10 years. Monthly payments will jump accordingly.
Also, the new law requires borrowers to repay these loans even after bankruptcy.
The banks asked Congress to intervene and make things less risky for the banks. Congress did as it was told, but there will be a cost: the doubling of the minimum-balance monthly payoff. That will hit borrowers like any unexpected bill does. They will have to adjust their monthly budgets.
This will come at a time when gasoline price increases are already forcing major budget readjustments.
So, it will become more difficult for banks to increase the number of takers when they advertise their "low, low, low" rates. An asset that had been ideally suited for growth -- a long-term loan based on low monthly payback -- will now find new market resistance.
Here is the assessment of business journalist Dana Blankenhorn, who has been in the field for 25 years.
Faster write-downs of credits by borrowers means fewer assets for credit card banks. Forcing borrowers to pay back their loans, even after bankruptcy, means those assets can't be written-off, and those bankrupt borrowers can't be extended new credit. It's a squeeze on bank assets, from both sides of the ledger. So two things happen, even in the best of all possible worlds. Assets decline, while new assets become harder to generate.
For the industry that, more than any other, is an industry of contracts -- banking -- a change in the terms of contracts can have repercussions. The bankers know what's coming. The average Joe, who is up to his eyeballs in credit card debt -- maxed out -- doesn't see what's coming. He will in November, when he gets his new bill on his credit card statement. It's the law!
Millions of people (I have no idea how many, but the number may be in the 10s of millions) are already at their limits, squeaking by and paying the minimum on their credit card balances. To protect themselves, the banks made it the law that rates on balances that fall past-due automatically jump to over 30%. But this is, in fact, no protection at all. The banks' assets are frozen, and while they might be paid back in time, the chances of raising more assets (remember, loans are assets to the banks) declines dramatically once the hammer falls on borrowers.
THE MORTGAGE MARKET
New home owners have gotten in late. They are paying up to half of their monthly take-home pay to live in their newly purchased homes. Property taxes have not been hiked. This tax hike is coming. OPEC is also squeezing them. Now comes the new bankruptcy law.
People have been encouraged (by subsidies, and the fact that banks can always sell their loans to Fannie Mae and Freddie Mac) to create a mortgage "asset bubble," with interest-only and adjustable-rate loans. People were then encouraged to furnish these palaces through credit cards or second-mortgages.
This has happened nationwide, not just in the areas where the supply of new housing has been tight.
So let's say you're stretched and October rolls around. The credit card bill jumps. The natural inclination (the one encouraged by banks) is to tap the home equity. But that may already be tapped. With many tapped people forced to put homes on the market (to stave off bankruptcy) a downward spiral begins. Home equity values fall, and with each turn more over-extended homeowners find themselves with negative equity. Home equity loans must be called, mortgage loans start to default, foreclosures add more assets to the pile. (Those who deal in foreclosures are already cheering.)
No doubt, this chain of events in the housing market will be described as a side effect of the new bankruptcy law. The biologist Garrett Hardin once wrote that there are no side effects. There are only effects. Those effects that are both unpleasant and unexpected are called side effects.
The Federal Reserve will probably continue to announce increases of .25 percentage points at the next three FOMC meetings scheduled for 2005. This will push up short-term rates, which will negatively affect the adjustable rate mortgage market.
Blankenhorn's conclusions are what mine were even before I read his article.
My advice is to get in the best equity position you can before the hammer falls. Look for stocks in companies that export. Look for hard assets, foreign assets. The natural inclination in this situation will be for the government to print more dollars, but the government too is overextended, thanks to Iraq, pork and tax cuts, so when more dollars are printed the value of each dollar falls. Thus, you don't want to be in dollars.
He is speaking of dollars in relation to foreign currencies. But it's better to be in dollars during the early phase of a recession than to be in the stock market. He is predicting a recession. I will be when I see the interest rate on 90-day T-bills above the 10-year T-bond rate. We are approaching this scenario.
Get into cash, into hard assets, into foreign currencies. You have two months. If I'm wrong you can always re-adjust the portfolio next year. But I don't think I'm wrong.
And look at the bright side. Few knew, except in retrospect, that AOL's takeover of Time-Warner in 2000 meant the end of the Internet bubble.
