Credit: A Secular Change in Trend

When old Wall Street hands -- I mean those who know what they are talking about, not the charlatans and the promoters and the ivory-tower academics who are wrongly described as market experts by the mainstream media -- think about what prices might do next (no one can know for sure, of course), they often look at the data from a variety of different angles.

That might entail, for example, pulling up a daily, weekly and monthly chart on a stock or other tradeable instrument to see if the technical picture seems consistent across multiple time frames. Ideally, the best opportunities are those where each perspective offers a similarly positive (or negative) reading.

However, that doesn't necessarily mean it is impossible to make money playing a bounce in a bear market or a pullback in a bull market. Rather, discrepancies might signal the need to reassess position sizing, tighten stop-loss levels, and adjust internal radar that is attuned to picking up on certain developments that might signal an impending change in trend.

For many marketwatchers, the broader move, which might persist for years or even decades, is referred to as a secular trend. Shorter-term swings, in contrast, are often described as cyclical trends. In assessing the nature of the current investing environment, for example, some people (including me) would argue that stocks are in a secular bear market, but may be poised for a cyclical bull run.

Yet such descriptions don't just refer to swings in market prices. Clearly, other patterns of economic life can also be short-lived or extremely persistent. To be sure, it is not always easy to figure out which is which. Nonetheless, in terms of at least one familiar aspect, I would argue that what others probably see as a temporary change in circumstances is, in fact, a far-reaching secular shift.

More specifically, I am referring to the role of credit in modern society. In my view, Americans will have little choice but to lose a dependence on borrowed money that has become an increasingly pervasive feature of everyday living during the past few decades. Although there are many explanations for this, I think visitors can get the gist of it by reading the following Associated Press report, "Is the Era of Easy Credit Over for the Long Haul?"

An inflatable gorilla beckoned from the roof of Don Brown Chevrolet in St. Louis, servers doled out free bowls of pasta and a salesman urged potential customers to "come on up under the canopy and put your hands on" a new set of wheels.

But sitting across from a salesman in a quiet back room, Adrian Clark could see it would not be nearly that easy. This was the ninth or tenth dealership for Clark, a steamfitter looking for a car to commute to a new job. Every one offered a variation on the discouragement he was getting here: Without $1,000 for a downpayment, no loan.

"It's just rough times right now," Clark said. "Rough times."

For Clark, and for a nation of consumers heavily dependent on credit, there are growing signs that those rough times could prove to be more than just a temporary problem, that they could be the beginning of a stark, new reality.

Is America's long era of easy credit over?

Experts say that even when the current credit crunch eases, the nation may finally have maxed out its reliance on borrowed cash. Today's crisis is a warning sign, they say, that consumers could be facing long-term adjustments in the way they finance their everyday lives.

"I think we're undergoing a fundamental shift from living on borrowed money to one where living within your means, saving and investing for the future, comes back into vogue," said Greg McBride, senior analyst at Bankrate.com. "This entire credit crunch is a wakeup call to anybody who was attempting to borrow their way to prosperity."

A prolonged period of tighter credit is ahead, experts say.

U.S. consumers will find it much harder to get a credit card, and to carry large balances. Late fees will rise and lines of credit will be reined in. After years of buying homes with interest-only loans, or loans that allowed people to borrow more than the value of the home, substantial payments and downpayments will be required. Interest rates are also likely to rise.

Lenders, far more wary of risk, have tightened the standards they use to judge potential borrowers. Regulators will be looking over their shoulders.

The changes cap three decades in which U.S. consumers - along with businesses and government - have run up ever-increasing debt. Americans became accustomed to financing purchases large and small with plentiful credit cards, easily approved loans for cars and the latest conveniences, and by siphoning the equity in their homes. Lenders did far more than just make credit plentiful. They aggressively marketed it as a necessity, a way for the smart consumer to leverage themselves into a better lifestyle.

The financial meltdown has made clear the role an increasingly global economy played in facilitating U.S. consumers' borrowing, with banks packaging and selling debt to investors, providing cash to people who once would have been considered too risky to get a loan.

The expansion of credit has, in many ways, been a good thing. It has allowed many more people to buy homes. At a time when household incomes have stagnated, borrowing has made it possible for many people to afford purchases and cover short-term expenses they might otherwise have had to delay or abandon.

But all that borrowing came at a heavy cost.

- Americans are more reliant on debt then ever before.

The portion of disposable income that U.S. families devote to debt hit an all-time high in the second half of last year, topping 14 percent, figures from the Federal Reserve show. When other fixed obligations - like car lease payments and homeowner's insurance - are added in, about one of every five household dollars is now claimed by bills.

The credit card industry lobbied heavily in 2005 to tighten bankruptcy laws to make it more difficult for consumers to seek court protection and shed responsibility for paying off debt. But in a sign of just how much households have become dependent on borrowing, the average amount of credit card debt discharged in Chapter 7 bankruptcy filings has tripled - to $61,000 per person - from what it was before the law was passed.

"We are going to have to cut back," said Dean Baker of the Center for Economic and Policy Research, a Washington, D.C. thinktank. "We've really been living beyond our means."

- Americans, borrowing to cover ordinary living expenses, have all but abandoned saving.

The U.S. personal saving rate dropped to well below 1 percent in late 2007 and early this year, according to figures from the federal Bureau of Economic Analysis. The figure has edged up in the last few months, but the actual savings rate may still be near zero, given that many people are covering living costs by using credit cards or money saved earlier, according to the BEA. The lack of savings is a sharp contrast with the decades after World War II. Americans routinely saved more than 10 percent of their income in the early 1970s.

Now, many families spend virtually all of their incomes covering living expenses, and even that is not enough.

"In the credit era, which is like living on steroids, you're not saving money, you're not breaking even. You're actually borrowing 20 to 30 percent," said Robert Manning, author of "Credit Card Nation: The Consequences of America's Addiction to Credit."

The new era of tighter credit will largely be a mandate, as consumers are forced to adjust to tougher rules and tighter limits. But consumers have also begun showing signs of a change in mind-set, putting off purchases, buying less expensive substitutes, going out to eat less, and rethinking their propensity to do so on credit.

Consumer borrowing fell for the first time in more than a decade in August, the Federal Reserve reported this week. The decline, at annual rate of 3.7 percent, reflected a sharp drop in the category of borrowing including auto loans and a smaller decline in the category including credit cards.

The tightening of credit will force American families to cut their spending, mindful of their current paychecks instead of borrowing against future ones, said Frank Badillo, senior economist with TNS Retail Forward, a consulting and market research firm in Columbus, Ohio.

"We're going to see some fundamental changes in consumer behavior," he said.

Badillo and others compare the psychology to the way people reacted after gasoline reached $4 a gallon last summer. Prices have eased considerably since then, but consumers seem to have decided that the good old days of very cheap gasoline are over. In response, people have moved to buying smaller, more efficient cars, and trying to reduce the miles they drive. Demand for homes in outlying suburbs has declined.

Like gasoline prices, the availability of credit should improve once the current crisis eases. But consumers are confronting what some see as a long-term change.

After years of living off one income and drawing on credit to fill the gap, Portland, Ore., legal assistant Susie Shepherd and her partner, Kaite Chase, are rethinking their finances. In the past few years, they regularly ran up debt to pay Chase's tuition and repeatedly refinanced their home, pulling out equity to pay bills and drawing on lines of credit to cover expenses.

But Shepherd was caught short this fall when her brother asked for help in paying moving expenses. She tried to draw on a credit card, but found her line of credit had been cut in half. The only way to help, the couple decided, was to sell some household items.

"We'd been living on credit for so many years," Shepherd said.

Borrowing against the future has always been part of the American story.

"How did those religious English people get to this country on the Mayflower? They came on what we would call the installment plan," said Lendol Calder, author of "Financing the American Dream: A Cultural History of Consumer Credit."

But the Great Depression chastened consumers. After World War II, and the explosive growth of the suburbs, consumption rose sharply. But the modern era of easy credit really began with the deregulation of the late 1970s.

In a 1978 Supreme Court decision, banks won the right to charge whatever interest rate their home state allowed and to do so across state lines. States repealed usury laws capping interest rates. Banks began pursuing consumers in ways they hadn't before.

When inflation soared in the early '80s, banks aggressively marketed credit cards to struggling consumers as a good deal. The interest rates were high, but not as high as inflation. In the recession of 1990-91, banks who saw their profits tightening seized on the margins available by lending more to consumers. When Congress eliminated income tax deductions for interest on credit cards, banks pushed home equity loans, encouraging people to take money out of their homes to pay off the credit cards.

As families took on debt, they were encouraged to follow a rule of thumb: It's OK as long as you don't devote more than 25 percent of income to borrowing costs.

Lenders, though, found a way around that. The 20-year home loan was repackaged as a 30-year loan and lenders stretched three-year car payment schedules to seven, masking the extent of the debt load.

Consumers "think they're doing fine by their parents' standards," Manning said. "But boy, have they fallen far behind."

The industry came up with subprime loans in the 1990s, then used them to encourage consumers with checkered credit history to buy homes. When very low interest rates early this decade sent home prices skyrocketing, and Wall Street demanded even more lending to feed a market for mortgage-backed securities, lenders went into overdrive. Consumers could buy with no money down and no documentation of income and were encouraged to borrow against the rising value of their homes.

Before the housing bubbled popped, many consumers were pulling money out of their houses to pay for expenditures - from boats to big-screen TVs - well beyond ordinary living expenses.

Over the years, economists have tried to figure out when, if ever, consumers might finally reach their debt limit. But each time, Americans have proven far more resilient than pessimists imagined, financing their spending by borrowing.

The credit crunch, though, may be the breaking point.

Dolores Holmes took out an interest-only $515,000 loan two years ago to buy a bed and breakfast in Lambertville, N.J., a Delaware River town popular with weekend antique hunters. Once the business took root, she planned to refinance into a fixed-rate loan and cut her cost. But as the economy declined, she had trouble filling rooms.

That increased pressure on her to find a way to cut her mortgage payments. But her accountant and financial adviser say her hopes of getting a more affordable loan are slim without a profit that convinces a lender she's worth the risk.

"I've been cutting back on anything personal," she said. "It's like everything I have has to go back into the business."

In Kansas City, Mo., David and Norine Piet were surprised to get a letter in September from USAA Federal Savings Bank that it was freezing their $40,000 home equity line of credit. The bank told the couple it was doing so because their home's value had plunged from $310,000 to $141,200.

The couple had been poised to refinish their basement to add a bedroom and make it suitable for visitors - a place to have people over and play cards, shoot pool and cook. Now that plan has been shelved.

"It's kind of like we had this $40,000 cushion there, that if anything happened we had an emergency fund," David Piet said. "At least we had a source of funds there, and now that's gone. That has caused us to cut back and try to put more money into savings, and be cautious on what we're spending money on."

The Piets are comfortable enough financially to have retired early. But for consumers of more modest means the new restrictions on credit are cutting into their ability to make what would have been relatively ordinary purchases.

Clark, the steamfitter shopping for a car, returned home to Fairview Heights, Mo., in January after a 12-month tour of duty with the U.S. Army in Afghanistan. He found a new job and expected that a regular paycheck would be enough to secure a loan for the car he needs to commute.

At the dealership last weekend, Clark and his wife, Flora Rivera, settled on a Dodge Stratus with 8,000 miles on the odometer. But the dealership was looking for a $1,000 downpayment and Clark had just $200.

The problem is that Clark, 22, has almost no credit history, a problem compounded by the time he spent serving overseas. A few months ago, multiple banks would have been happy to give such a consumer a loan, salesman Scott Ziegler said. But now only companies offering pricier subprime loans are interested, and that still doesn't solve the problem of the downpayment.

Clark left the dealership without a loan, but decided to put down his $200 as a deposit and try to find another source for the remainder of the downpayment. In recent weeks, such scenarios have become the norm, said the dealership's loan manager, Jarrod Campbell.

"I'm getting a lot more customers who are saying, 'I've been to 10 other car lots,'" Campbell said, "and no one will give me a loan."

Comments

[Independent Accountant]

A big part of the problem is that interest rates are too low! Joe Schmoe has no incentive to save with 2-4% interest rates when inflation is say 5-7% and the interest is taxable. John Williams at shadowstats thinks inflation is higher. Zimbabwe Ben is increasing the monetary base at a furious pace, which ensures higher measured inflation in the future. Everything the Paulson-Bernanke dynamic duo is doing is wrong.

[roger]

credit is a positive thing provided it is used selectively
and with responsibility,it is dam stupid to borrow for every
paraphernalia which is what the American public has been doing.

[peggy]

When the dust settles, it will be obvious that the American worker is underpaid and without the resources to move ahead. Once we start living within our means, it will be plain to see that we are a poorer nation than we want to admit. No unions, no guarantee of health insurance or retirement, no reasonable access to college for much of the population, no quality child care, no decent sick time or vacations, etc.,etc., all point to our diminished status. Wake up America, and get leadership and government with decent priorities.

[WeeklyTA]

Blog of the Week :)

[Michael Panzner]

Thanks, John, for the "Blog of the Week" kudos!

[PDamian]

Blog of the YEAR, more like. Thanks for good writing, good info and good warnings. Good grief ...

[ron]

Banks exist to create debt and the modern global financial system has used excess leverage to generate a massive credit binge on a world wide scale but no where near the consumer level practiced in the U.S. Clearly leverage credit creation is underwater while world gov't try desprerately to reinvent the credit wheel the years of excess credit leverage has generated a business cycle that will whither and die under normal credit/banking regulated life. The result will be a long period of credit deflation bringing about the loss of millions of jobs and business that depend on excess credit creation to survive. The moves generated thus far by the FED and other CB are meant to defuse a run on the banks and pay off the politically connected rather then a meaninful cure.

[H. Spencer]

Reading this Associated Press Story referenced (I had already read it elsewhere) shows just how we are seeing returns to the 60's and 70's. That's the way is was--A goodly downpayment to purchase a car--and that's the way it should be. Nothing should be financed without a 25% downpayment, and then the shortest possible finance terms, ie: Car Loan NO MORE than 24 to 36 months. Best yet is go "Cash Only" and that means being your own bank. Save up the cash and pay cash for the car, boat, widget, whatever. Having savings is being your own banker. You then try and persuade yourself to put out the cash to buy. I feel sorry for the folks in the referenced story, but self-discipline is what it takes to win out. CASH ONLY PURCHASES!!!!

[WeeklyTA]

I have a few questions, and they might seem dumb, not they're not specialty and might fall more under yours.

1) Why did the U.S. Treasury ship $800 billion worth of Amero to China? This was not covered by the media and they do not talk about the Amero.
2) When will the USD become obsolete and the Amero circulated?
3) North American Union and the end of the constitution?
4) What's this talk about complete economic collapse and martial law?
5) Imminent economic collapse by the end of 2008?
6) Military U.N. exercises on U.S. soil in preparation for massive civil unrest?
7) Secret House of Reps. meeting discussing martial law.
...and more questions.

This might sound like some conspiracy type of BS, but there's got to be some truth to this. What's true, what's false or is this all BS?

[Martin]

I'm sorry, but I don't think that it is wrong to insist that people make a $ 1,000 down payment when buying a car.