Out of control consumer debt could sink the recovery

The latest statistics show that the total amount of consumer debt outstanding in 2010 in the United States is nearly $2.4 trillion.  Based on the 2010 Census statistics, that works out to be nearly $7,800 in debt for every man, woman and child that lives here in the U.S.  This, of course, does not include mortgages and other types of debt.  About one-third of this consumer debt, or about $800 billion, is revolving debt-mostly credit card debt.  The other two-thirds is comprised of car loans, student loans, and other non-revolving types of debt.

With such extreme levels of consumer debt, and the additional debt burden on the country from mortgage, commercial, and government debt, the U.S. economy will certainly struggle for many, many years to overcome the negative impact this debt will have on our economic future.  Lenders will need to rethink how the evaluate the creditworthiness of borrowers, especially in light of the huge number od defaults we are experiencing on every type of debt.

Banks traditionally look at many factors when considering making loans, but one of the key statistics they use to determine whether or not to lend to an individual is the FICO score.  An individual's FICO score is derived through a complex and proprietary formula, but the just of it depends on prompt, on-time payment of outstanding debts and the ratio of that outstanding debt to available credit.  Late payments and defaults on debts reduces the FICO score dramatically, which can mean no loan.  FICO scores typically below about 680, especially in today's tight lending environment will typically spell doom for a would-be home or car buyer.  

Credit card companies offer revolving, unsecured loans to consumers.  Because these loans are unsecured, credit card companies can justify charging much higher rates of interest, as compared to loans with collateral, like a mortgage or car loan.  However, these days credit card companies are selling debts in default to third-party collection agencies that are increasingly using the court system to basically turn unsecured credit card debts into secured debts.  Once the collection agency sues the consumer and wins a judgment, they can garnish wages, attach assets, put liens on property, such as cars and houses, etc.  

Many of these unscrupulous collection agencies will basically lie and state (to the courts) that they have served the consumer with papers on a lawsuit, when if fact they have never done so.  The court date comes and goes without the consumer ever knowing about it, and the collection agency then secures a default judgment against the consumer for the full amount of whatever they have claimed the consumer owed, plus interest and court costs in some cases.  Once the default judgment has been obtained, it is open season on the consumer and there is little that the consumer can do, other than pay the collection agency in full.  

There are many so-called debt consolidation and debt clean-up companies, that claim they can help consumers deal with credit card companies and collection agencies, once debts have gone into default.  Most of these are either complete scams, or at best are ineffective.

What is the consumer with debt problems to do?  Most credit card companies, if the debt has not already been sold to a collection agency, will negotiate with a consumer, to either reduce monthly payments, or to settle a debt in full for less (sometimes 50% less or more) than what is owed.  When credit card companies sell debts to collection agencies, they typically only get 5% to 20% maximum on the debt owed, so they will gladly take the 50% from the consumer.  This does not mean, however, that the consumer's credit report will be undamaged.  A settlement will show-up on credit reports, and will negatively affect the FICO score, etc.  Most collection agencies, once the debt has been sold by the credit card company, will negotiate a settlement as well, usually for some reasonable percentage of the total debt.  

Consumers entering into negotiations either with the credit card company, and especially with the collection agencies, should be sure to get all terms in writing, and should ensure that the agreement states clearly that the debt will be shown to be settled in full, and that any remaining amount will never be sold to another collection agency, and no additional attempts will be made to collect any remaining balance, etc.

The process of dealing with debts in default, or a full blown bankruptcy, can be complicated, and there are specialist attorneys out there that can help.  Consumers can do a lot of the necessary work themselves, however, if they take their time, research the issue, and work the problem through to conclusion.  Doing nothing is the worst thing one can do in this situation, so if you find yourself in default, take action, be proactive, and do your homework.  There is life after credit card debt, it just takes a long time and a lot of work to discover that life!

Fed Stands Firm - U.S. Economy is more like the Titanic than a speedboat

Bernanke, in his first ever press conference for the Fed, basically stated that the Fed still feels that maintaining rates at their current levels (basically zero), is still the best course of action.  The Fed statement, which is all we typically have to go on since they haven't changed rates in so long, maintained the same language about keeping rates low for an extended period of time.

The Fed did raise their inflation forecast (CPI) from 1.3% to 1.7% to 2.1% to 2.8%, and cut its GDP forecast to 3.1% to 3.3% from 3.4% to 3.9% (I think we will come in around 2% to 2.5%), for 2011.  They do see improvement in the unemployment rate from previous forecasts, to a range of 8.4% to 8.7% (it was 8.8% to 9% previously).  

For 2012, core inflation (ex food and energy) is now seen running at 1.3% to 1.8%, from the previous estimate of 1% to 1.5%, and U.S. (GDP) growth is now seen at 3.5% and 4.2% in 2012, and 3.5% to 4.3% in 2013.

I feel that the Fed is entirely too optimistic (about everything), and believe that they will be forced to start raising rates aggressively, very shortly.  The U.S. economy, I always say, is like the Titanic, not so much in that is is going to sink (although that is certainly a real possibility), but in that it is a huge ship with a small rudder - changes in rates, even dramatic changes, do not impact the economy for at least two quarters.  If the Fed waits too long to start raising rates, they may be too late to stem the tsunami of inflation.  Also, if they wait too long, they will be forced to raise rates at a much faster pace - so fast that it may stifle the economy.  A slower, more reasonable, moderate pace could be sustained without killing the economy, but they need to start right away (probably should have started about 6 months ago).  

Other countries, like Australia, China, and the ECB (European Central Bank), have already begun raising rates.  This has put even more pressure on the dollar.  A weak dollar can be good for our economy in the short-run because it makes our goods less expensive for foreign buyers.  But, in the long-run, a weak dollar will result in higher inflation, and will demand more drastic rate increases to defend our currency.

Commodity prices would begin to adjust back down, if we were to start raising rates.  We will have to raise rates anyway; it's just a question of when and not if.  Since we know this to be true, it would make more sense for the Fed to start raising rates sooner rather than later (right now), and to do so at a moderate pace that reduces inflation, including commodity price inflation, and still is slow enough to support continuing economic growth.  I fear they will wait too long (it may be too late already), and by the time they realize their error, they will be forced to drop the hammer on rates, which will feel like we are all getting hit over the head with a giant sledge.  

Is the U.S. a bad risk?

The recent change from S&P on their outlook for the U.S. as a AAA credit begs the question: Is the U.S. a bad credit risk?  Although this is an interesting question, and the answer is probably no, like a lot of things in life, the reality is that country risk is not absolute, it is relative - relative to other countries.

Despite the fact that our national debt and budget deficits are enormous, and skyrocketing, we have to compare ourselves to other countries, to evaluate the changing perceptions of U.S. credit risk.  In the developed world, basically every country, with the exception of Germany, made the same mistakes we made, that put us into this pickle.  Excesses in real estate and the credit markets in general, drove the worldwide economic collapse that resulted in the accumulation of not only huge national deficits, but also personal debt as well.

Even if we break the current debt ceiling, which is a virtual certainty, and even with the very real possibility (probability) that the U.S. credit rating will fall below AAA in the next year or two, the U.S. is still today, and will remain, the strongest economy on the planet, and therefore, to most, the safest place to put money.

While the fact that we will likely remain at the top of the heap economically is somewhat comforting, it does not mean that we will not feel some pain.  The reality is that financial markets trade on risk and reward perceptions.  If the risk of the U.S. is perceived to increase, as will be the case if and when our credit rating is lowered, the cost to service our debt or take on more debt, will increase.  In practical terms, the rates we will need to pay on new bonds issued will have to go up to compensate investors for that perceived increased risk.  If we couple this with a rising interest rate environment, which I believe we will be entering shortly, we could have a slingshot effect on the rising cost to maintain our debt and finance future budget deficits.

This scenario is very real, and has lead to the devaluation of many currencies around the globe.  We need to watch the value of the dollar closely, since rising inflation will be the trigger that forces the Fed to start the interest rate raising cycle.  The more the threat of inflation, the more aggressive the Fed will need to be with rates, and the greater the impact will be on the cost of servicing our debt (and the more negative will be the impact on economic growth as well).

Stocks getting spanked

The Dow is off almost 250 points and is falling fast after S&P changed their outlook on the U.S. debt situation to negative.  They maintained their AAA rating on the U.S., but made it clear that things are deteriorating.

The reaction in the stock market to this news underscores two key truths:

1.) Valuations are obviously very rich, otherwise negative news would not elicit such a negative response in prices;

2.) The serious debt issues facing countries across the globe is not going away, even though investors seem to ignore the obvious.

I remain cautious; looking for opportunities to re-enter at lower valuations/lower levels on the S&P.  Watch for the S&P 500 to challenge the 1,250 level shortly.  If it hold, I will likely put a little cash back to work.  If it cracks 1,250, I will look for lower levels before I risk my cash.

Google disappoints after the bell

Google reported after the market close today (Thursday, April 14th) that its first-quarter net income rose to $2.3 billion, or $7.04 a share, from $1.96 billion, or $6.06 a share in the same period a year earlier. Net revenue for the period ended March 31st rose to $6.5 billion. Excluding one-time items, Google said earnings for the period were $8.08 a share. Analysts polled by FactSet Research had expected Google to report first-quarter earnings excluding items of $8.11 a share, and $6.3 billion in net revenue.  

This was a disappointing report, and Google's share price is suffering in after-hours trading, with the stock down about $32 per share, or about 5.5%.  Tomorrow should be very interesting!  It's Friday, and with Google trading lower we could and should see a big sell-off in tech, and perhaps in the entire market.

Don't forget to check out my column in tomorrow's Santa Barbara News Press on the April 18th Tech Brew at Fess Parker Double Tree Resort!

Watch for commodity, stock and real estate prices to fade

Interest rates will inevitably rise.  Other countries, including China and some in Europe, and even the ECB (European Central Bank) have already started raising rates, weakening the dollar and putting further pressure on the Fed to raise rates here at home.  Inflation in commodities is rampant, and sooner or later (probably very soon) the Fed will be forced to raise rates.  A sharply rising interest rate environment is death for commodities, and with the current very high price structure for commodities across the board, we should see a significant sell-off for commodities in the near future.

Stocks don't do all that well in a rising rate environment either, and real estate usually performs even worse.  High interest rates is the other shoe to drop for real estate.  We have been lucky thus far not to have high rates, even though real estate prices have fallen more than 40% from the October 2007 peak here locally in Santa Barbara (and in most markets across the country by substantial percentages from their peaks).  If (when) rates begin to rise, real estate prices and sales activity will no doubt be negatively impacted.  It is already next to impossible for people to get loans, even if they have stellar credit, 20% or more to put down, and plenty of free cash flow to service the loan.  As rates rise, the monthly cash outflow, for a given loan amount, will increase dramatically.  Banks are already reticent to loan, so with rates rising, they will be that much more reluctant to provide financing.  Add all this up and it makes for a very tough real estate market for the foreseeable future.

Weather can be a significant factor for businesses - Published in the Santa Barbara News Press in February of 2011

Living in Santa Barbara, and Southern California in general, we tend to take the weather for granted.  I moved to California from Texas specifically because of the bad weather in Texas and for the good weather here.  For businesses, the weather can actually be a serious consideration, and a factor that can make or break others.

Over the past several weeks, the U.S. has experienced several powerful winter storms that have dropped huge amounts of snow, and iced streets.  The two days after Christmas were so bad in some areas that after-Christmas sales were affected so significantly that some retailers missed their earnings projections for the fourth quarter.  This week’s storm that hit Chicago buried cars and trucks on freeways, and was the third heaviest day for snow on record for the city, in more than 126 years.

When the employment numbers were released for December, we were informed that unemployment claims were down significantly from estimates, not because more people found jobs, but because the weather in December was so bad in several states that unemployment offices had to operate for fewer hours on several days.

The development of the Internet and e-commerce is still in its infancy, but it is clear that online commerce is here to stay.  In fact, Christmas sales saw a 12%+ increase in online sales, versus less than 1% for brick and mortar only operations.  

Many retailers including Target Corp., Costco Wholesale Corp. and Macy's Inc. reported sales gains below Wall Street expectations for the third quarter, and especially for December. Bon-Ton Stores Inc.'s sales were virtually flat and company officials blamed the severe snowstorms., and The Gap suffered a surprise 3 percent drop in December. (Analysts had expected a 2.6 percent increase.)

The overall holiday retail sales season was actually the strongest since 2006, but sales really fell off in December, in large part due to the poor weather around the country.  Early holiday discounts, which started in late October, drove big sales early in the season but also had consumers completing their shopping before December even began. A lull early in December and the blizzard of December 26^th in the Northeast also took a heavy toll on sales.

From October 31^st through January 1^st, revenue at stores open at least a year rose 3.8 percent over last year, according to an index compiled by the International Council of Shopping Centers. That's the biggest increase since 2006, when the measurement rose 4.4 percent.  However, the index slid to a 3.1 percent increase in December after a 5.4 percent rise in November, highlighting the drop off in December activity.  More expensive retailers saw better-than-expected sales. Abercrombie & Fitch Co., which saw robust gains that beat Wall Street estimates, though it had to discount to lure shoppers in.  Luxury stores, including Saks Inc. and Nordstrom Inc., also reported big increases as the rallying stock market kept affluent customers spending.

"The overall season was good, but the strength came from the beginning of the season," said Michael P. Niemira, chief economist at International Council of Shopping Centers.

December's gains came on top of a 3.6 percent gain in December 2009, while November's impressive increase compares with a 0.2 percent decline in November of 2009.  These numbers are based on “same-store-sales,” or sales from stores open at least one year (excluding sales from stores open less than one year).

However, changes in shopping habits and other factors have led the figure to lose some of its luster as a yardstick. Some stores exclude online revenue, which soared 12 percent overall and accounts for 8 to 10 percent of total holiday spending. Online spending spiked 17 percent the week after Christmas, according to comScore, possibly getting a boost from shoppers cooped up by snow.

In addition, many retailers have stopped reporting monthly figures, including some of the biggest chains: Wal-Mart Stores, Best Buy Co. and Sears Holdings Corp. Only about 30 merchants report now, down from about 60 at the end of 2005.

Analysts say that the holiday 2010 season also marked the time that spending in many categories returned to pre-recession levels. Online spending, as well as spending on groceries, auto parts and clothing, are now above the pre-recession peak, according to MasterCard Advisors' SpendingPulse, which tracks all transactions including cash.

Despite spending increases overall for the holiday season, many retailers are planning to raise prices in the Spring to counter skyrocketing commodity prices.  Brooks Brothers Inc. is raising prices on all cotton items by an average of 10 percent, for example.  It is not clear whether price increases will result in higher profit margins, or lower revenues and therefore lower profits. 

One thing appears certain – weather-related disruptions, which have always been a problem for retailers, will continue to impact sales.  More importantly, with the increase in online sales volumes, and the increasing level of comfort consumers have with online purchasing, brick and mortar retailers will be fighting an uphill battle. 

The growth in online sales of better than 12 percent during the holidays, dwarfing the 3.6% increase in overall sales, underscores the growing importance of online sales for retailers, and also the risk to those not offering an online shopping option. 

My feeling is that, each time a consumer attempts to shop at a brick and mortar store, only to be thwarted, due to weather, traffic, time-constraints, or because the store simply does not stock the item of interest, the retailer is vulnerable to losing that consumer permanently to the e-commerce world.  Human beings are creatures of habit, and behaviors are difficult to change, whether it is overeating, watching too much television or spending too much time at the mall.  But, once that behavior is changed, especially when a consumer becomes an online shopper, there is a high likelihood (and a high risk to the brick and mortar retailer) that the consumer will be an online shopper for good.

To me, this is a significant trend that will only expand as time passes.  We see its impact all around us, with stores closing, such as Borders and Barnes & Nobel, and others, such as Blockbuster, barely clinging to life as they navigate bankruptcy court.  More and more, online retailers are gaining market-share at the expense of the traditional, brick and mortar businesses. 

Local businesses can benefit in at least two ways from the trend towards online commerce and poor weather in many parts of the country.  First, the Internet is not going away, and e-commerce will continue to outpace overall sales, and sales growth at brick and mortar stores.  Local businesses should take this to heart, and wherever possible, offer their wares online.  Second, to the extent possible, Santa Barbara businesses should try to draw consumers here during those months when the weather is usually poor elsewhere.  A more concerted, focused effort on the part of local businesses to attract consumers to town during the winter months to shop could result in meaningful sales increases.

Many businesses have waited and watched as e-commerce sites have exploded, not wanting to embrace new technologies, or to spend the extra money to develop e-commerce sites for their businesses.  They have stood by and watched other lesser companies in many cases, take their customers away, and have watched their profits dwindle.  Local businesses should embrace these trends and aggressive pursue strategies to appeal to the growing number of online shoppers, who are here to stay.