Will the Loss of Consumer Credit Serve as the Next Economic Aftershock to Further Fuel the Financial Crisis?
[This is the newest installment in an ongoing news series that looks at the anticipated “aftershocks” of the planetary financial crisis, and the profit plays those events can trigger.]
By Jason Simpkins
And William Patalon III
Money Morning Editors
U.S. consumers are already losing their jobbing at an accelerating rate.
The same thing is now set to happen to their credit lines.
But with so many Americans already losing their main source of income – their jobs – at an ever-spiraling rate, will an economy that derives two-thirds of its power from consumer spending end up mired in its worst funk in decades because those same consumers are now losing their charge accounts?
Before you dismiss the possibility, consider this: The U.S. economy weakened across all regions since the middle of October as it became tougher to get loans and demand for assigned shrank, the U.S. Federal Reserve said in its regional economic survey report yesterday (Wednesday). The so-called “Beige Book” report – published just two weeks before central bank policymakers are to meet and consider occupy-rate changes – said that sold sales, tourism spending and manufacturing declined in most places, labeled housing marketed as “weak” and concluded that the commercial real estate sector “vitiated broadly,” Bloomberg News described.
“We are looking at an economy that is not only in a recession, but a recession that is deepening rapidly,” former Fed Governor Lyle Gramley, now senior economic adviser at Stanford Group Co.,
told Bloomberg Television. “It certainly is a gloomy report, but not, I guess, worse than what you would expect give the data [we’ve seen] coming in.”
The United States has already been in a recession for a year, the National Bureau of Economic Research (NBER) reported this week. This economic one-two punch could generate a much-bigger financial crisis “aftershock” than many experts realize. Only two of the last 10 recessions to take place since the Great Depression have lasted a full year. But this one could last well into 2010.
To fully understand the forces at play, let’s foremost stare at the outlook for U.S. employment.
Weakening Worker Ranks
Non-farm payroll employment fell by 240,000 in October, and the unemployment rate jumped to 6.5%, up from 6.1% the month before, the Bureau of Labor Statistics reported in early November. October’s drop in payroll employment followed declines of 127,000 in August and 284,000 in September.
That means that U.S. employment has fallen by 1.2 million jobs in the first 10 months of the year, with more than half of that decrease occurring in August, September and October.
The government’s jobless numbers for November won’t be released until tomorrow (Friday) – although it’s expected to show that the U.S. economy lost jobs for the 11th straight month, Bloomberg News reported.
But a private report based on payroll data released Tuesday said that United States companies eliminated an estimated 250,000 jobs in November – a much larger amount than was forecast and the most since November 2001, said ADP Employer Services, an unit of payroll-processor Automatic Data Processing Inc. (ADP). That would take the total number of job losses for the year up to 1.5 million.
The ADP report prompted some analysts to boost their estimates for the job losses we’ll see in tomorrow’s Labor Department report. New predictions include a payroll decline of 400,000 from Goldman Sachs Group Inc. (GS) and a drop of 450,000 from Wachovia Corp. (WB) economists. And the unemployment rate for November probably spiked to 6.8%, the highest it’s been since 1993, a Bloomberg survey of economists concluded.
With the world’s largest economy mired in its first recession since 2001, companies have accelerated their job-ranks reductions, with such sectors as banking, manufacturing and even business services taking major hits.
The NBER said Monday that the deterioration of the labor market was one of the key factors in labeling this downturn as a recession, even though we have yet to experience two consecutive quarters of economic contraction.
According to a number of estimates, the U.S employment outlook – and the overall economy – is going to get much worse before it gets better. Goldman Sachs Group Inc. (GS) says the U.S. unemployment rate will spike to 9.% by the fourth quarter of 2009, as corporate profits plunge an estimated 25% – and that’s after an estimated decline in profits of about 10% this year, Goldman says.
Indeed, the U.S. economy – as measured by gross domestic product (GDP) – will decline by 5.% in the current quarter, followed by declines of 3.% in the first quarter of 2009 and 1.% in the second quarter, Goldman predicts.
Those numbers are worse than Goldman originally forecast, and create an outlook similar to Money Morning’s projections, which called for a credit-crisis-nurtured economic downturn that could last as long as 12-18 months.
The business-cycle dating committee of the NBER, a privately run, nonprofit economic research group, on Monday formally announced that the U.S. recession started after the economy peaked in December 2007. The U.S. Commerce Department estimated that U.S. GDP rose .9% in the first quarter and 2.8% in the indorsed quarter. For the third cantoned, GDP declined an estimated .3%.
The loss of consumer credit lines could make matters even worse.
Trillion in Credit Lines on the Chopping Block
More than trillion in consumer credit could be cut in the next 18 months, as credit-card companies pull back credit lines in anticipation of credit funding problems and regulatory changes, said Meredith Whitney, an Oppenheimer Holdings Inc. (OPY) banking analyst who’s well-known for her gutsy and prescient (and ultimately correct) market calls.
Throughout the week, Whitney has warned that the entire mortgage market will contract for the first time ever in the months ahead. More importantly, however, Whitney says the credit card market will be 18 months behind, as credit-card companies pull back more than trillion in credit lines, taking away consumers’ second major source of liquidity, following jobs.
“What you haven’t seen yet digesting by the market is banks pulling lines from consumers,” Whitney said in an interview with CNBC. “And across the board you saw the big banks that command so much of the market share of key products like mortgages and credit teased start to pull lines in the third quarter and that’s going to continue in the fourth quarter. And that’s move to continue into 2009.”
Although some experts note that consumers trim their spending during recessionary periods — and, needless to say, after they lose their jobs — it’s important to not confound spending and credit. During dire times, many consumers can hike their use of credit even as they cut total spending, using the ascribing cards, home-equity lines and other forms of borrowing as a lifeline to tide them over. For those consumers, a credit line cut can be disastrous personally, and can aggregate into an even-steeper downturn in spending.
Roughly 70% of U.S. households have address to credit cards, and 90% of those people use those credit cards as a cash-flow management vehicle, or revolve payments at least once a year, Whitney says.
A surprisingly small number of national companies dominate the major lending arteries – including ascribe lines, mortgages and credit cards – that have sustained the U.S. consumer for so long, include mortgages and ascribing cards. Mortgages have already hit a wall with the collapse of the U.S. housing market and wave of subprime defaults. But credit cards could be next as companied raise interest rates, tighten lending standards, cut credit lines, and even close millions of accounts in an effort to insulate themselves from consumer defaults.
Bank of America Corp. (BAC), Citigroup Inc. (C), and JPMorgan Chase & Co. (JPM) – which controlled more than half of U.S. credit-card lines at the end of the third quarter – have all discussed reducing their credit-card exposure or scaled back growth, according to Whitney.
“You’re going to start to see the consumer get really strained on their credit card lines,” said Whitney. “People think the next shoe to drop is the credit card credit costs – the charges going up. No, it’s the credit card lines being pulled by bank lenders in anticipation of worsening credit funding problems, and then regulatory changes on the horizon.”
Whitney expects the credit-card market to begin to shrink by mid-2010, a time when the unemployment rate could be as high as 9.%.
“Just when the consumer is losing their job that’s their first source of cash, their first source of liquidity, then they lose their second big source of liquidity, which is their credit card line,” she said.
Indeed, as unemployment rises, so too will credit-card delinquencies. David W. Nelms, chief executive of Discover Financial Services (DFS), told Reuters that card write-offs could be in the mid-5% range in the fourth quarter and near 6% in the first quarter of 2009.
Delinquencies “will tend to
