Constipated Lending Makes Economy Ill

Steve Rhode — Sat, 08 Nov 2008 03:50:12 +0000

Our economic life cycle is dependent on all all parties doing their fair share of the heavy lifting. Finance companies and banks lend – consumers buy stuff using credit – stuff must be built – jobs are created and so forth.

We keep hearing about a crushing windpipe grip on banks and the government pleading to them to lend again. And even though banks have taken billions of dollars from the government to start lending again, they are holding on to that money and hoarding it for a rainy day.

This recent tidbit in the Wall Street Journal made me realize just how desperately constipated the lending markets are becoming. Forget the lending to business begging that Hank Paulson has Ben Bernanke have been engaged in, there are worse pirates afloat and we have not yet spotted them over the horizon.

The deadly armada that is heading our way involves the failure of asset-backed securities.

Asset Backed Securities

In finance, an asset-backed security is a type of debt security that is based on pools of assets, or collateralized by the cash flows from a specified pool of underlying assets. Assets are pooled to make otherwise minor and uneconomical investments worthwhile, while also reducing risk by diversifying the underlying assets. Securitization makes these assets available for investment to a broader set of investors. These asset pools can be made of any type of receivable from the common, like credit card payments, auto loans, and mortgages, to esoteric cash flows such as aircraft leases, royalty payments and movie revenues. Typically, the securitized assets might be highly illiquid and private in nature.

I know; blah, blah, blah.

What that really means is that when lenders generate car loans, home equity loans, credit card receivables, student loans, equipment leases, aircraft leases dealer loans, and other similar types of receivables; they could package a lot of those types of loans together and sell them as a security to buyers. The funds generated from the sales of the securities would flow back into the lender so they could lend again. Lend and dump, lend and dump.

But if the loans are being created and packaged and nobody wants to buy them then the generators of these loans will soon have an arm full of loans to collect on but not more cash in the bank to use to generate and fund new loans.

A choked up and poorly performing asset backed securities market spells real trouble for the economy and that’s why the Wall Street Article really made me afraid about how bad the economy is going to get.

Here are the highlights of what I read.

Banks and other finance companies making loans for autos, credit cards and college tuition are having virtually no success in selling those loans to other investors, a potent sign of just how tight credit markets remain.

The market for selling such loans — by packaging, or securitizing, them into bonds — had just one $500 million deal for all of October, according to Barclays Capital. That compares with $50.7 billion worth of deals made one year earlier, according to market-research firm Dealogic. The overall market for so-called asset-backed securitization is estimated at $2.5 trillion.

Banks and other finance companies are stuck holding more loans on their balance sheets, which crimps their ability to offer new loans. That, in turn, shrinks available credit for consumers, who need it to finance an education, buy a new car, or pay for household expenses using a credit card. Banks were already reining in lending to customers as they try to reduce exposure to loans that may ultimately go unpaid.

The October dry spell has caused year-to-date securitization volumes to drop. Credit-card volumes are down 31%, auto loans are off 45% and student loans have fallen about 41%, according to Barclays. October’s sole transaction came from AmeriCredit Corp., which provides auto loans to less creditworthy borrowers.

“We are at a standstill,” said Craig Leonard, a structured-debt syndicate banker at Barclays Capital said.

The market shutdown is particularly bad news for non-bank finance companies. The ability to sell off car, education and auto loans is critical to companies such Ford Motor Co.’s Ford Motor Credit, American Express Co. and student lender SLM Corp., or Sallie Mae. Without securitization markets, they have less capital to make new loans to consumers.

But like a bad burrito, this too shall pass. How long will it take to break this financial blockage, who knows? One this certain however, it won’t happen fast enough.

New Indian Middle Class Gets Caught In the Whirlwind of Revolving Credit

Steve Rhode — Tue, 28 Oct 2008 13:00:01 +0000

From How to Get Out of Debt

But the most visible stress is on the cardholders, and it’s showing up in headlines, in call-center employees under crushing debt, even in a new Bollywood movie about middle-class people struggling with credit.

Consumer credit, whether cards or car loans, is relatively new to India. Fifteen years ago, even home loans were hard to come by. As regulations on lending were relaxed and India’s urban middle class swelled with 20-somethings hungry for the latest cellphone model, credit expanded to meet the need.

Banks went too far, analysts say, issuing cards indiscriminately to people in rural areas and lower-income groups without regular salaries. The number of credit cards in India, while still only a fraction of the population, has more than tripled in the past five years, to almost 30 million. In the year ended March 31, Indians charged more than $14 billion on their cards, more than three times the amount charged four years earlier.

The amount of unsecured loans and credit-card receivables more than three months overdue is about 7% to 9% of total loans outstanding this year, and is about to head as high as 15%, according to ratings agency Crisil Ltd. in Mumbai.

More people are turning up desperate for help with their credit-card payments, says V.N. Kulkarni, chief counselor at Mumbai’s Abhay Credit Counseling Center, which advises borrowers. Hundreds have been lining up at the center, dumbfounded by their debt and asking the most basic questions.

“They are unaware of the charges, unaware of the interest rates,” Mr. Kulkarni says. “They just take the money because it is freely available.”

It’s tough all over — and not just in the United States. In India, where revolving credit is still relatively new, consumers are struggling under the weight of crushing consumer debt, according to a story in the Wall Street Journal this morning. But it’s not just Indian consumers who are suffering. The banks that handed out this easy money are being hammered as well. Indeed, card companies that

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Constipated Lending Makes Economy Ill

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