2008
Q
What knock-on effects occur in 2008?
A
Posted December 25, 2007
2008 Will likely see the continuation of credit contraction. If the capital markets held the current guidelines for the 3 years prior to 2003, lenders would not have extended more than $2 Trillion in debt. If the capital markets held to guidelines prior to 1998, more than $5 Trillion would not have occured.
Going forward, the slowdown in credit availability will have significant knock-on effects for all those items bought with mortgage credit (or having to do with the value of homes) or a few steps away from that process (like RVs). Investors should understand that this huge change in parameters for loans is effectively a credit extinguishment over time or a credit contraction as those former loans cannot be refinanced and many go bad. But that does not mean all price pressures will disappear.
Here's why: Consider when investors overbuild Xs (fill in X with any good: housing, hotels, internet goods, etc.) using a great deal of capital available in an economy. Investors could have sent capital to other projects (like energy and food production) but did not. Two issues follow. What happens to the debt when bondholders discover the X's will not meet profitability and what happens when investors find other goods (food and energy) in short supply.
If the authorities prevent banks from selling the bonds which funded the X's like they are with subprime and Alt-A loans (for fear the banks would register as insolvent), many economic actors will have to sell good assets to generate funds. New money, of course would make the price pressures from the underlying shortages worse. The Fed cannot help much in this environment.
So good assets will fall substantially in price. Enterprising investors may find excellent opportunities. (Note that the profits from goods now stable or rising in price will eventually provide new buyers for good assets and those assets will revalue).
During the contraction, credit problems spread. As consumers and businesses find their income doesn't meet their needs, they borrow from other sources (such as commercial loans and credit cards) and a significant portion find themselves falling behind. For example: the credit outstanding and 30 days late for 17 of the largest credit card portfolios rose 26% YOY in October of 2007. (Entire story)
Implications for the loan market: until one or several major players in the "supply of loans" fails, the market will remain under pressure. A failure of a major bank means the liabilities disappear, while the entity sells assets at a huge discount to their value, which causes the buyers (frequently the other players in the same industry) to have "instant equity". Until banks can find $1 for 50 cents to such an extent that another bank failure can be absorbed without insolvency, the process of contraction continues.
You should know that bank depositors hold the liabilities of banks as their own assets. So ultimately, depositors take the losses, either directly (loss of value) or indirectly (inflation through monetized government purchasing power). Stay conservative with your bank.
2008 Will likely see the continuation of credit contraction. If the capital markets held the current guidelines for the 3 years prior to 2003, lenders would not have extended more than $2 Trillion in debt. If the capital markets held to guidelines prior to 1998, more than $5 Trillion would not have occured.
Going forward, the slowdown in credit availability will have significant knock-on effects for all those items bought with mortgage credit (or having to do with the value of homes) or a few steps away from that process (like RVs). Investors should understand that this huge change in parameters for loans is effectively a credit extinguishment over time or a credit contraction as those former loans cannot be refinanced and many go bad. But that does not mean all price pressures will disappear.
Here's why: Consider when investors overbuild Xs (fill in X with any good: housing, hotels, internet goods, etc.) using a great deal of capital available in an economy. Investors could have sent capital to other projects (like energy and food production) but did not. Two issues follow. What happens to the debt when bondholders discover the X's will not meet profitability and what happens when investors find other goods (food and energy) in short supply.
If the authorities prevent banks from selling the bonds which funded the X's like they are with subprime and Alt-A loans (for fear the banks would register as insolvent), many economic actors will have to sell good assets to generate funds. New money, of course would make the price pressures from the underlying shortages worse. The Fed cannot help much in this environment.
So good assets will fall substantially in price. Enterprising investors may find excellent opportunities. (Note that the profits from goods now stable or rising in price will eventually provide new buyers for good assets and those assets will revalue).
During the contraction, credit problems spread. As consumers and businesses find their income doesn't meet their needs, they borrow from other sources (such as commercial loans and credit cards) and a significant portion find themselves falling behind. For example: the credit outstanding and 30 days late for 17 of the largest credit card portfolios rose 26% YOY in October of 2007. (Entire story)
Implications for the loan market: until one or several major players in the "supply of loans" fails, the market will remain under pressure. A failure of a major bank means the liabilities disappear, while the entity sells assets at a huge discount to their value, which causes the buyers (frequently the other players in the same industry) to have "instant equity". Until banks can find $1 for 50 cents to such an extent that another bank failure can be absorbed without insolvency, the process of contraction continues.
You should know that bank depositors hold the liabilities of banks as their own assets. So ultimately, depositors take the losses, either directly (loss of value) or indirectly (inflation through monetized government purchasing power). Stay conservative with your bank.