Crunch Time for American Consumers
The subprime mortgage crisis is merely the tip of a very large iceberg. Beneath the surface lies not only a sea of tenuous loans to prime borrowers, but also an assortment of other liabilities backed by auto loans and credit card debit. Now that home equity extractions, "zero percent auto financing" and "zero interest" credit card rollovers are much harder to come by, Americans must do without the credit lifelines that have previously kept them afloat.
Similar to the home buying
market, lax lending standards in the automobile marketplace have
led to gross distortions that must be painfully corrected. For
years standard practice allowed millions of car buyers to trade
in old cars (that were worth less then outstanding loans), and
roll the balances into new low interest rate loans for new cars.
Although these "E-Z" financing terms allowed many over-stretched
buyers to stay current on their debts, and vendors to move bloated
inventories, they immediately saddled lenders with loans that
far exceeded the value of the collateral. Such a situation encourages
defaults and is toxic to lenders. Vendor financing (especially
with publicly traded companies focused on short-term results)
compounded the problem as conflicts of interest encouraged lenders
to sweep these problems under the rug.
For a while at least, this
high wire lending act in the auto and credit card sectors was
kept aloft by repeated waves of mortgage refis in which extracted
home equity was used to consolidate other consumer debts. By
turning higher interest rate, non-tax-deductible consumer debt
into lower rate, tax deductible mortgage debt, consumers were
able to temporarily manage their debts. In addition, since home
equity extractions often exceeded the amounts of other debts,
the extra cash in homeowner's pockets temporarily made higher
mortgage payments more affordable. Plus with their credit cards
paid off, card holders were not only free to run their balances
back up again, but their improved credit scores resulted in even
more credit card offers.
It was inevitable that all of this debt would eventually catch up to us. Americans are now so upside down on their auto loans that new car sales will collapse; and when many loans go sour lien holders will be stuck with substantial losses on repossessed vehicles. As the music finally stops for serial credit card balance transferors, the inability to renew low teaser rates means that fewer borrowers will be able to afford their payments.
As delinquencies continue to rise rating agencies will downgrade bonds backed by auto loans and credit card debt, inflicting subprime type losses on a much wider scale. As defaults increase and losses mount, credit will tighten like a noose around the neck of America's consumer based economy. Just as subprime homebuyers are being shut out of the housing market, soon Americans will find that their credit is no longer good at car dealerships or department stores. American consumers that want to buy will need to be prepared to pay cash.
The bottom line is that a host of factors that temporarily allowed default risks to be underestimated and credit to be miss-priced have disappeared. As a result, Americans have simply borrowed more money then they can possibly repay. Ratings agencies once again missed the boat by feeding garbage data into computer models and blindly accepting what came out.
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Mr. Schiff is one of
the few non-biased investment advisors (not committed solely to
the short side of the market) to have correctly called the current
bear market before it began and to have positioned his clients
accordingly. As a result of his accurate forecasts on the U.S.
stock market, commodities, gold and the dollar, he is becoming
increasingly more renowned. He has been quoted in many of the
nation's leading newspapers, including The Wall Street Journal,
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Arizona Republic, The Philadelphia Inquirer, and the Christian
Science Monitor, and has appeared on CNBC, CNNfn., and Bloomberg.
In addition, his views are frequently quoted locally in the Orange