Saturday, March 28, 2009

Are We Headed For A Credit Card Meltdown?

Everybody likes to point their fingers at the government, or blame the banks for the economic mess that we currently find ourselves in, but maybe we as consumers have helped facilitate things more than most of us like to admit. Everybody likes to accuse the banks of being greedy, but ultimately they are in the business to make money for themselves and their shareholders, not to be charitable to the general public. We are all grown adults, and those of us that have made poor financial choices should take responsibility for them, learn from them, and move on.

The current financial crisis stems in part from people over extending themselves in the real estate market, obtaining mortgages that they couldn't really afford to pay, for assets that were declining in value. Not to mention the individuals using their property as an ATM to fund their indulgent lifestyles. The rapidly depreciating real estate market led to many individuals being in way over their heads, leading to foreclosures, short sales and the like. Many of us want to blame the banks, but they didn't force anyone to buy a house they couldn't really afford, they didn't force anyone to borrow beyond what they could feasibly pay back based on their incomes, they didn't force anyone to take equity out of the homes to spend on luxuries they didn't need, they simply helped facilitate what the consumer demanded.

Now don't get me wrong, I am not supporting some of the banks actions - they were irresponsible and reckless at times. I believe that if we knew more of what goes on behind the scenes and off the balance sheets at many banks, then the markets would fall much more than we have already witnessed, but I do think we need to take part of the responsibility.

Now we are left with a situation where those of us that were responsible with our finances, and made "smart" choices, are the people having to bail out the irresponsible and greedy! The scariest part of the situation is where we are headed from here.

The government and the media seem to be painting an overly optimistic picture of the current economic environment, saying that the worst is over and that the Federal Reserve has everything under control. I don't think we could be further from the truth, as two further bubbles are readying themselves to pop. I have already touched on the treasury bubble in a previous post, so I will not discuss it here, but the other bubble that is looming large is the credit card bubble.

Credit card companies have been seen to be raising interest rates, cutting credit lines, and closing inactive accounts. This serves to reduce consumer spending and confidence, and is a self-feeding cycle as it leads to reduced FICO scores, leading to reduced access to credit which in turn causes a further reduction in spending, hurting the economy further in the process.

The worrying thing is that with the level of unemployment still rising, we are seeing more and more people using credit just to survive and make essential purchases. People have already cut back significantly on large purchases such as houses, cars and vacations, they have also cut back on luxuries, electronics and the like. People are now relying on credit for essential, day to day purchases such as food, clothing and energy. Now, I don't know about you but I find this scary! Credit card companies have been reporting increasing numbers of delinquencies, and I fear the worst is still to come.

The Federal Reserve already has it's hands full with the banks, auto makers, insurance companies and the like, it cannot start bailing out individuals too! With rising unemployment, and reduced access to credit, the economy is close to a tipping point where the whole house of cards could come down at any minute.

Disclosure - At the time of writing the author held shares in
ProShares Ultrashort 20+ Year Treasury ETF (TBT) and Direxion Financial Bear 3X ETF (FAZ).

1 comment:

  1. Interesting points. I too agree that there seems to be too much optimism but dont know for sure to what extent.