Thursday, October 16, 2008

Bad Mortgages Are Just The Beginning

credit card healthYesterday I talked a bit about how, through the bailout bill, the government was given the authority to invest the $700 billion in things outside of mortgage debt, the requirement being that the investment be critical to supporting the U.S. economy. This has led to auto finance companies to lobbying the government for aid. I also threw out that we could soon be looking at credit card companies such as American Express following suit. I thought that I should expand a bit on this and explain that mortgages are by no means the only problem assets for banks right now, and even though the other debt out there hasn’t received the same type of publicity, the threats are serious.

Mortgage debt has been the poster child for this financial crisis, and rightly so, considering the sheer size of the market and the juicy stories about people getting swindled and then losing their homes. With property prices falling across the country and borrowers defaulting at record paces, banks began to see losses mount beyond their worst case projections. We all know where that has led. Now we have passed bailout after bailout and are desperately trying to fix this mess before all the troubled debt out there brings down the financial system as we know it. Unfortunately for us, there are some other factors that could contribute to this degradation as well.

Americans have almost $2.6 trillion in consumer credit outstanding, according to the Federal Reserve. Credit card defaults rose 45 percent for JP Morgan Chase in quarter three, according to a Washington Post article, and they are expecting things to only get worse. Auto finance companies are echoing the sentiment. This has me worried.

Typically, owner-occupied mortgage borrowers are going to pay their mortgages above every other bill they have. That means they will default on their credit cards, car loan and whatever else before they stop paying their mortgage. They know that if they stop paying their mortgage, they will lose their home, whereas if they stop paying their credit card bill, all they lose is their credit rating. So the fact that credit card defaults are rising as quickly as they are tells me that people are at the end of their ropes. Before they might have been able to get by with using one credit card to pay another, but with banks actively reducing the credit lines of existing borrowers, and being more selective about new borrowers, this option is running out. What happens next is that these people are going to stop paying their mortgages, which will mean a double whammy for banks.

To make matters worse for banks, when people don’t pay their credit card bills, they essentially are out of luck because it is unsecured debt. When people default on their mortgages, at least the bank can go after the house. With car loans banks can go after the car, but since cars depreciate so fast they really are left with little (sounds kind of like the real estate market in some areas).

Despite the attempts by the government to “rescue” the industry it appears things might be getting even worse, and I think it is pretty clear by now that $700 billion isn’t going to be close to enough to actually right this ship.

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