Credit Card Debt Soars as House Prices Plunge

The credit crunch is spreading to other areas. An earlier article I posted showed that the credit crunch was building in the car loans sector as well. The number of people unable to pay of car or credit card loans is increasing placing more stress on lenders. If there is a slowdown in the economy resulting in more job losses evne more people will lag behind in payments..

Credit Card Debt Soars as House Prices Plunge
By Dean Baker
The Center for Economic and Policy Research

Wednesday 09 January 2008

"The current rate of house price decline will destroy $2.2 trillion of wealth this year."
The Federal Reserve Board reported yesterday that credit card debt rose at an 11.3 percent annual rate in November after rising at an 8.5 percent rate in October. By comparison, credit card debt rose at a rate between 2 percent and 4 percent from 2003 to 2005.

The explanation for this surge in credit card debt is that millions of homeowners are losing the ability to borrow against their home. In the last Flow of Funds release, the Fed reported that the ratio of homeowners' equity to value stood at just 50.4 percent, down from 54.2 percent at the end of 2005, and 57.3 percent at the end of 2001. The ratio will almost certainly cross below 50 percent for the first time in history when the fourth quarter data is reported. This is a remarkably rapid decline, especially since the soaring home prices of recent years translated dollar for dollar into additional equity.

This aggregate number conceals vast differences among homeowners. More than one-third of homeowners have completely paid off their mortgages and many others are close to having them paid off. This means that a large number of homeowners have little or no equity in their home. These people are now running up credit card debt at near record rates. Of course, credit card debt cannot offset the ability to borrow against home equity for long. Total outstanding credit debt is less than $940 billion; mortgage debt was increasing at a $730 billion annual rate in the third quarter. Millions of households will soon have little choice but to sharply curtail their consumption.

The latest Case-Shiller indexes, which received little attention because they were released on December 26th, showed that house prices in the aggregate index were dropping at an annual rate of 11.7 percent in the three months from July to October. At this pace, households will lose more than $2.2 trillion in housing wealth over the next year. Some of the really big losers in the latest data were Las Vegas, where house prices were falling at an 18.9 percent annual rate over the last three months, San Diego, where they declined at a 20.3 percent rate, and Miami where they dropped at a 22.0 percent rate.

Many homeowners in these formerly hot markets put little or nothing down when they purchased homes in the last two or three years. As a result, a large percentage of recent homebuyers will soon find themselves with negative equity. This is the reason that the foreclosure crisis is spreading from the subprime segment of the mortgage market to the Alt-A and prime segment. Homeowners who find themselves owing more than the value of their home have enormous incentive to default.

The pending home sales data for November are somewhat better than most analysts had expected. While they are down slightly from the October levels, the latter were revised up to show a gain of 3.7 percent from September instead of 0.6 percent. The improvement from the August-September trough is concentrated in the West, where sales have risen by almost 8 percent from the lows hit in the summer. This probably is due more to the extraordinary weakness of the summer sales levels (down almost 40 percent from 2005) than to any real upturn in the market.


The mortgage applications index continues to give erratic readings, jumping 32 percent from last week's seasonally adjusted measure. The recent mortgage application data is hard to interpret for two reasons. First, the subprime segment of the mortgage market is underrepresented in the Mortgage Bankers Association (MBA), which constructs the index. This means that the index will not fully capture some of the falloff in subprime loans. Also, as borrowers switch from defunct subprime lenders to MBA members, it will appear in the index as an increase in lending. The other problem with this data is that a far higher portion of applications are turned down now that a year ago. Even with these factors inflating the index, the four-week average for the purchase index was just 397.9. It had been over 500 at its peaks in 2005.

Bad debts claim Citigroup boss

So for a disastrous performance Prince is paid 25 million. I wonder how much he got on resigning for pension etc. If he had been a janitor he would have just got a pink slip. At the executive level there is often a disconnect between performance and compensation.


Bad debts claim Citigroup boss
Last Updated: Monday, November 5, 2007 | 8:18 AM ET
The Associated Press
Citigroup Inc. said Sunday chairman and chief executive Charles Prince, beset by the company's billions of dollars in losses from investing in bad debt, has retired and is being replaced as chairman by former treasury secretary Robert Rubin.

Rubin, a former co-chairman of Goldman, Sachs & Co., has served as the chair of Citi's executive committee.

In an announcement following an emergency meeting of its board, the largest U.S. banking company also said Sir Win Bischoff, chairman of Citi Europe and a member of the Citi management and operating committees, would serve as interim CEO.


Prince's resignation, which was secured at an emergency meeting of the Citi board Sunday, was expected after the nation's largest banking company revealed it had to write down billions of dollars in bad debt.

He joined former Merrill Lynch & Co. CEO Stan O'Neal, who resigned from the investment bank last month, as the highest-profile casualties of the debt crisis that has cost billions at other financial institutions as well.

In a separate statement, Citi said it would take an additional $8 billion US to $11 billion US in writedowns. It has already said it was writing down $6.5 billion US in assets.

Prince, 57, became chief executive of Citigroup in October 2003.

Continue Article

Stock fell during Prince's tenure

Many shareholders criticized him openly for much of his tenure, as Citigroup's stock lagged its peers while Prince executed what was called an umbrella model of corporate organization, with several separate lines of business.

The company's shares closed Friday at $37.73 US, about 20 per cent below where they were when Prince became CEO.

Prince's position looked especially shaky after the company estimated that third-quarter profit would decline about 60 per cent to some $2.2 billion US after seeing nearly $6 billion US in credit costs and write-downs of overly leveraged corporate debt and souring home mortgages.

At that time, Prince said the bank's earnings would return to normal in the fourth quarter.

But when Citigroup released its third-quarter results two weeks later, the write-downs and credit costs exceeded $6 billion US, and chief financial officer Gary Crittenden indicated the outlook going forward wasn't as upbeat as Prince had predicted.

Citigroup wasn't alone in its third-quarter turmoil. When borrowers with poor credit stopped paying their mortgages, many banks not only had to take losses on those subprime mortgages, they also saw instruments in their portfolios backed by mortgages plummet in value.

But Citigroup's stumbles were particularly grievous, given the bank's size, history and CEO, who had been telling shareholders for years to give his strategy a chance. Even in October, Prince said in a call to analysts: "I think any fair-minded person would say that strategic plan is working."

The anger toward Prince was so intense that during a conference call last month, Deutsche Bank analyst Mike Mayo told Prince that investors wanted a significant change in management.

His supporters, though, argued that he was dealt a tough hand when his predecessor Weill gave him the reins, and that matching the hefty profit gains Citigroup saw in the 1990s would be difficult for any CEO.

Prince made nearly $25M US in 2006

Prince, whose compensation came to nearly $25 million US last year, is leaving under a much darker cloud.

It was not known whether Bischoff was in the running to replace Prince as CEO. Before Sunday's meeting, industry watchers floated many names as Prince's replacement.

Citigroup did a minor reshuffing in early October, combining its investment banking and alternative investments businesses into one unit.

At the time, Rubin and Saudi Arabian Prince Alwaleed bin Talal — Citigroup's biggest individual shareholder and once a critic of Prince — expressed their support for the bank's embattled CEO.

Lawrence Summers on the Credit Crunch

I do not feel qualified to comment on this but at least Summers not only gives his analysis of the causes of the problems but also possible solutions.


This is where Fannie and Freddie step in
By Lawrence Summers
Financial Times
August 26 2007

Over the past 20 years major financial disruptions have taken place
roughly
every three years, starting with the 1987 stock market crash; the
Savings &
Loans collapse and credit crunch of the early 1990s; the 1994 Mexican
crisis; the Asian financial crises of 1997 with the Russian and
Long-Term
Capital Management events of 1998; the bursting of the technology
bubble in
2000; the potential disruptions of the payments system after the events
of
September 11 2001 and the deflationary scare in the credit markets in
2002
after the collapse of Enron.

This record suggests that by 2007 the world had been overdue a major
disruption. Sure enough the problems of subprime mortgages –
initially seen
as a confined issue – went systemic as the market began to doubt the
creditworthiness of even the strongest institutions and rushed to buy
US
Treasury debt. Financial crises differ in detail but, just as there are
plot
cycles common to literary tragedies, they follow a common arc.

First there is a period of overconfidence, rising asset values and
growing
leverage as investors increase their faith in strategies that have
enjoyed a
long run of success. Second, there is a surprise that leads investors
to
seek greater safety. In the current case it was the discovery of huge
problems in the subprime sector and the resulting loss of confidence in
the
ratings agencies. Third, as investors rush for the exits, the focus of
risk
analysis shifts from fundamentals to investor behaviour. As some
investors
liquidate their assets, prices fall; others are in turn forced to
liquidate,
further driving prices down. The anticipation of cascading liquidations
leads to more liquidations creating price movements that seemed
inconceivable only a few weeks before. The reduced availability of
credit
then has a negative effect on the real economy. Eventually –
sometimes in a
few months as in the US in 1987 and 1998; sometimes over a decade, as
in
Japan during the 1990s – there is enough price adjustment that
extraordinary
fear gives way to ordinary greed and the process of repair begins.

Only time will tell where we are in this cycle. There have been some
signs
of returning normalcy over the past week, but we cannot judge whether
they
represent a false spring or the end of a crisis phase. There may be
further
shoes to drop in the financial sector. The impact on consumer
confidence and
spending that has driven US expansion over the past several years
remains
unknown.

While it is too soon to draw policy lessons, we can highlight questions
the
crisis points up. Three stand out.

First, this crisis has been propelled by a loss of confidence in
ratings
agencies as large amounts of debt that had been very highly rated has
proven
very risky and headed towards default. There is room for debate over
whether
the errors of the ratings agencies stem from a weak analysis of complex
new
credit instruments, or from the conflicts induced when debt issuers pay
for
their ratings and can shop for the highest rating. But there is no room
for
doubt that – as in previous financial crises involving Mexico, Asia
and
Enron – the ratings agencies dropped the ball. In light of this,
should bank
capital standards or countless investment guidelines be based on
ratings?
What is the alternative? Sarbanes-Oxley was a possibly flawed response
to
the problems Enron highlighted in corporate accounting. What, if any,
legislative response is appropriate to address the ratings concerns?

Second, how should policymakers address crises centred on non-financial
institutions? A premise of the US financial system is that banks accept
much
closer supervision in return for access to the Federal Reserve’s
payments
system and discount window. The problem this time is not that banks
lack
capital or cannot fund themselves. It is that the solvency of a range
of
non-banks is in question, both because of concerns about their economic
fundamentals and because of cascading liquidations as investors who
lose
confidence in them seek to redeem their money and move into safer, more
liquid investments. Central banks that seek to instil confidence by
lending
to banks, or reducing their cost of borrowing, may, as the saying goes,
be
pushing on a string. Is it wise to push banks to become public
financial
utilities in times of crisis? Should there be more lending and/or
regulation
of the non-bank financial institutions?

Third, what is the role for public authorities in supporting the flow
of
credit to the housing sector? The lesson learnt during the S&L debacle
was
that it was catastrophic to finance home ownership through insured
banking
institutions that borrowed short term and then offered long-term
fixed-rate
home mortgages. Now a system reliant on securitisation, adjustable rate
mortgages and non-insured financial institutions has broken down.

I am among the many with serious doubts about the wisdom of the
government
quasi-guarantees that supported the government-sponsored entities,
Fannie
Mae, the Federal National Mortgage Association, and Freddie Mac, the
Federal
Home Loan Mortgage Corp , as they have operated in the mortgage market.
But
surely if there is ever a moment when they should expand their
activities it
is now, when mortgage liquidity is drying up. No doubt, credit
standards in
the subprime market were too low for too long. Now, as borrowers face
higher
costs as their adjustable rate mortgages are reset, is not the time for
the
authorities to get religion and discourage the provision of credit.

This crisis could have a silver lining if it leads to the careful
reflection
on these vital questions.

The writer is the Charles W. Eliot professor at Harvard University

Wall Street Journal recognizes Minsky

Minsky may have been to a certain degree influenced by Marx. He was probably obscure because he did not say too many things the establishment wanted to hear!

Wall Street Journal - August 18, 2007

In Time of Tumult,
Obscure Economist
Gains Currency

Mr. Minsky Long Argued
Markets Were Crisis Prone;
His 'Moment' Has Arrived

By JUSTIN LAHART

The recent market turmoil is rocking investors around the globe. But
it is raising the stock of one person: a little-known economist whose
views have suddenly become very popular.

Hyman Minsky, who died more than a decade ago, spent much of his
career advancing the idea that financial systems are inherently
susceptible to bouts of speculation that, if they last long enough,
end in crises. At a time when many economists were coming to believe
in the efficiency of markets, Mr. Minsky was considered somewhat of a
radical for his stress on their tendency toward excess and upheaval.

Christopher Wood, a widely read Hong Kong-based analyst for CLSA
Group, told his clients that recent cash injections by central banks
designed "to prevent, or at least delay, a 'Minsky moment,' is
evidence of market failure."

Indeed, the Minsky moment has become a fashionable catch phrase on
Wall Street. It refers to the time when over-indebted investors are
forced to sell even their solid investments to make good on their
loans, sparking sharp declines in financial markets and demand for
cash that can force central bankers to lend a hand.

Mr. Minsky, who died in 1996 at the age of 77, was a tall man with
unruly hair who wore unpressed suits. He approached the world as "one
big research tank," says Diana Minsky, his daughter, an art history
professor at Bard. "Economics was an integrated part of his life. It
wasn't isolated. There wasn't a sense that work was something he did
at the office."

She recalls how, on a trip to a village in Italy to meet friends, Mr.
Minsky ended up interviewing workers at a glove maker to understand
how small-scale capitalism worked in the local economy.

Although he was born in Chicago, Mr. Minsky didn't have many fans in
the "Chicago School" of economists, who believed that markets were
efficient. A follower of the economist John Maynard Keynes, he died
just before a decade of financial crises in Asia, Russia, tech
stocks, corporate credit and now mortgage debt, began to lend
credence to his ideas.

Following those periods of tumult, more investors turned to the
investment classic "Manias, Panics, and Crashes: A History of
Financial Crises," by Charles Kindleberger, a professor at the
Massachusetts Institute of Technology who leaned heavily on Mr.
Minsky's work.

Mr. Kindleberger showed that financial crises unfolded the way that
Mr. Minsky said they would. Though a loyal follower, Mr. Kindleberger
described Mr. Minsky as "a man with a reputation among monetary
theorists for being particularly pessimistic, even lugubrious, in his
emphasis on the fragility of the monetary system and its propensity
to disaster."

At its core, the Minsky view was straightforward: When times are
good, investors take on risk; the longer times stay good, the more
risk they take on, until they've taken on too much. Eventually, they
reach a point where the cash generated by their assets no longer is
sufficient to pay off the mountains of debt they took on to acquire
them. Losses on such speculative assets prompt lenders to call in
their loans. "This is likely to lead to a collapse of asset values,"
Mr. Minsky wrote.

When investors are forced to sell even their less-speculative
positions to make good on their loans, markets spiral lower and
create a severe demand for cash. At that point, the Minsky moment has
arrived.

"We are in the midst of a Minsky moment, bordering on a Minsky
meltdown," says Paul McCulley, an economist and fund manager at
Pacific Investment Management Co., the world's largest bond-fund
manager, in an email exchange.

The housing market is a case in point, says Investment Technology
Group Inc. economist Robert Barbera, who first met Mr. Minsky in the
late 1980s. When home buyers were expected to have a down payment of
10% or 20% to qualify for a mortgage, and to provide income
documentation that showed they'd be able to make payments, there was
minimal risk. But as home prices rose, and speculators entered the
market, lenders relaxed their guard and began offering loans with no
money down and little or no documentation.

Once home prices stalled and, in many of the more-speculative
markets, fell, there was a big problem.

"If you're lending to home buyers with 20% down and house prices fall
by 2%, so what?" Mr. Barbera says. If most of a lender's portfolio is
tied up in loans to buyers who "don't put anything down and house
prices fall by 2%, you're bankrupt," he says.

Several money managers are laying claim to spotting the Minsky moment
first. "I featured him about 18 months ago," says Jeremy Grantham,
chairman of GMO LLC, which manages $150 billion in assets. He pointed
to a note in early 2006 when he wrote that investors had become too
comfortable that financial markets were safe, and consequently were
taking on too much risk, just as Mr. Minsky predicted. "Guinea pigs
of the world unite. We have nothing to lose but our shirts," he
concluded.

It was Mr. McCulley at Pacific Investment, though, who coined the
phrase "Minsky moment" during the Russian debt crisis in 1998.

Laurence Meyer, who served on the faculty with Mr. Minsky at
Washington University in St. Louis, was a Federal Reserve Governor
during those turbulent times. Mr. Meyer says that when he was an
academic, Mr. Minsky's work didn't interest him very much, but that
changed when he went into the real world. He says he grew to
appreciate it even more when he was at the Fed watching financial
crises unfold.

"Had Minsky been there, he probably would have been calling me and
alerting me along the ride. And that would have been a good thing,"
Mr. Meyer says. "Every year that goes by, I appreciate him more. I
hear myself sometimes and I think, oh my gosh, I sound like Hy Minsky."

Steven Fazzari, an economics professor at Washington University, says
that Mr. Minsky would have supported the Federal Reserve's recent
move to provide cash and cut the rate it charges banks on loans from
its discount window to try to avert a financial crisis that could
spill over to the economy. But he would probably be worried, too,
that the moves might be bailing out investors who would all too soon
be speculating again.

Having seen recent events unfold in the way his friend and former
colleague predicted, Mr. Fazzari says, "I hope he's someplace saying,
'Aha, I told you so!'"

Paul Krugman on the Credit Crunch

I just wonder if part of this crisis is not the result of the Bush administration animus against regulation. If there had been stricter regulations in the sub-prime mortgage market requiring genuine credit assessment before loans could be made, many of the defaults that are now happening would have been avoided. No loans would have been made.

NY Times, August 10, 2007
Op-Ed Columnist
Very Scary Things
By PAUL KRUGMAN

In September 1998, the collapse of Long Term Capital Management, a
giant
hedge fund, led to a meltdown in the financial markets similar, in some

ways, to what’s happening now. During the crisis in ’98, I attended
a
closed-door briefing given by a senior Federal Reserve official, who
laid out the grim state of the markets. “What can we do about it?”
asked
one participant. “Pray,” replied the Fed official.

Our prayers were answered. The Fed coordinated a rescue for L.T.C.M.,
while Robert Rubin, the Treasury secretary at the time, and Alan
Greenspan, who was the Fed chairman, assured investors that everything
would be all right. And the panic subsided.

Yesterday, President Bush, showing off his M.B.A. vocabulary, similarly

tried to reassure the markets. But Mr. Bush is, let’s say, a bit
lacking
in credibility. On the other hand, it’s not clear that anyone could
do
the trick: right now we’re suffering from a serious shortage of
saviors.
And that’s too bad, because we might need one.

What’s been happening in financial markets over the past few days is
something that truly scares monetary economists: liquidity has dried
up.
That is, markets in stuff that is normally traded all the time — in
particular, financial instruments backed by home mortgages — have
shut
down because there are no buyers.

This could turn out to be nothing more than a brief scare. At worst,
however, it could cause a chain reaction of debt defaults.

The origins of the current crunch lie in the financial follies of the
last few years, which in retrospect were as irrational as the dot-com
mania. The housing bubble was only part of it; across the board, people

began acting as if risk had disappeared.

Everyone knows now about the explosion in subprime loans, which allowed

people without the usual financial qualifications to buy houses, and
the
eagerness with which investors bought securities backed by these loans.

But investors also snapped up high-yield corporate debt, a k a junk
bonds, driving the spread between junk bond yields and U.S. Treasuries
down to record lows.

Then reality hit — not all at once, but in a series of blows. First,
the
housing bubble popped. Then subprime melted down. Then there was a
surge
in investor nervousness about junk bonds: two months ago the yield on
corporate bonds rated B was only 2.45 percent higher than that on
government bonds; now the spread is well over 4 percent.

Investors were rattled recently when the subprime meltdown caused the
collapse of two hedge funds operated by Bear Stearns, the investment
bank. Since then, markets have been manic-depressive, with triple-digit

gains or losses in the Dow Jones industrial average — the rule rather

than the exception for the past two weeks.

But yesterday’s announcement by BNP Paribas, a large French bank,
that
it was suspending the operations of three of its own funds was, if
anything, the most ominous news yet. The suspension was necessary, the
bank said, because of “the complete evaporation of liquidity in
certain
market segments” — that is, there are no buyers.

When liquidity dries up, as I said, it can produce a chain reaction of
defaults. Financial institution A can’t sell its mortgage-backed
securities, so it can’t raise enough cash to make the payment it owes
to
institution B, which then doesn’t have the cash to pay institution C
—
and those who do have cash sit on it, because they don’t trust anyone

else to repay a loan, which makes things even worse.

And here’s the truly scary thing about liquidity crises: it’s very
hard
for policy makers to do anything about them.

The Fed normally responds to economic problems by cutting interest
rates
— and as of yesterday morning the futures markets put the probability
of
a rate cut by the Fed before the end of next month at almost 100
percent. It can also lend money to banks that are short of cash:
yesterday the European Central Bank, the Fed’s trans-Atlantic
counterpart, lent banks $130 billion, saying that it would provide
unlimited cash if necessary, and the Fed pumped in $24 billion.

But when liquidity dries up, the normal tools of policy lose much of
their effectiveness. Reducing the cost of money doesn’t do much for
borrowers if nobody is willing to make loans. Ensuring that banks have
plenty of cash doesn’t do much if the cash stays in the banks’
vaults.

There are other, more exotic things the Fed and, more important, the
executive branch of the U.S. government could do to contain the crisis
if the standard policies don’t work. But for a variety of reasons,
not
least the current administration’s record of incompetence, we’d
really
rather not go there.

Let’s hope, then, that this crisis blows over as quickly as that of
1998. But I wouldn’t count on it.