"The End of Consumer Credit as we know it"

 

In an article this week that examined the troubles brewing in Citigroup's mortgage business, the Wall Street Journal focused on Natalie Brandon, a 51 year old married woman from Granada Hills, CA, who is currently unable to make the payments on her $625,000 adjustable rate home loan from Citigroup, despite the fact that the rate will not even reset higher until June of next year. Amazingly, the Journal reported that Mrs. Brandon bought the house in 1985 for just $105,000, but had chosen to refinance five times over the past seven years, borrowing more than $500,000 and spending every single penny. While this may be an extreme example of American profligacy, it is by no means unique. Unfortunately this type of behavior typifies everything that is wrong with the modern American economy.

Had this homeowner behaved responsibly, as was typical for Americans of prior generations, her current monthly mortgage payments would likely be close to $600 and the remaining balance on her loan would be about $40,000. In eight more years she would have owned her home free and clear, and would likely be on track for early retirement. Instead, after 22 years of making mortgage payments, she is now $625,000 in debt. The article stated that she had recently tried to refinance into a 6%, forty year, fixed-rate mortgage, but it fell through. Even if she had qualified, she would have been obligated to make monthly mortgage payments of close to $4,000 until she was in her nineties.

For years, Wall Street and the media have been singing the praises of the heroic American consumer. To that end Mrs. Brandon could be portrayed as Wonder Woman. She did her part to power our consumer driven economy by borrowing and spending to her heart's content. Her last refinance even allowed her to buy a brand new Lexus. As long as she could find a greater fool willing to loan her more money, there was no limit to what she could buy. As it turned out, Citigroup was the greatest fool, left holding the bag on a $625,000 mortgage on a house now likely worth only half that amount.

Is it any wonder that we have enjoyed such a vibrant consumer based economy when a working class couple with perhaps $60,000 per year of household income can borrow over $500,000 (tax free) and buy whatever they want with the money? As the bills come due and those who have been doing all of the lending finally realize they will never be repaid, this crazy consumption binge will finally come to an end.

As the losses mount, the credit crunch will spread from mortgages to auto loans and to all forms of consumer lending. The days of Americans borrowing to consume are finally coming to a long over due end. Although it seems like science fiction to Americans raised on credit cards, within a few years most will only be able to buy those goods they can afford to pay for with cash.

In the long run of course, this will be a very positive development. Borrowing to consume is a waste of savings and undermines legitimate economic growth. Money loaned to consumers is unavailable to finance capital investment. By squandering savings on consumption, a society undermines its future standard of living.

When businesses borrow to make investments, those investments generate returns which enable the principal and interest to be repaid. When individuals borrow to consume, no investment is made and the loans can only be repaid out of reduced future consumption. As a result, business loans, especially when collateralized by real assets, are likely to be repaid, while consumer loans, collateralized by nothing but a promise to consume less in the future are much more likely to end in default. As lenders finally figure this out, consumer credit will dry up, and the American economy will enter a prolonged and severe recession. Unfortunately, an economy that lives by consumer credit will die by it as well. Hopefully a more viable economy will eventually rise in its place.

For a more in depth analysis of the tenuous position of the Americana economy and U.S. dollar denominated investments, read my new book "Crash Proof: How to Profit from the Coming Economic Collapse."

 

 

"If the dollar loses value too quickly, it could wreak havoc on the economy and financial markets - driving up interest rates and inflation and slashing Americans' purchasing power" -Peter Schiff 

 

 

"People keep talking about a Fed bailouts as if there is no cost. All the Fed can do is create new dollars. What that does is diminish the value of all the dollars everybody already has. They try to socialize the losses among all the holders of dollars" -Peter Schiff

 

 

Nov. 28 -  Federal Reserve Bank of Dallas President Richard Fisher said he's "very concerned" about the chance of faster inflation, and policy makers are weighing that risk against having "healthy, working" financial markets. "The decision will have to be based on these two counter- forces" at the next interest-rate meeting on Dec. 11, Fisher said today in Amarillo, Texas. "There are people at the table," including Fisher, who have inflation concerns, he said. Fisher's remarks contrast with comments earlier today by Fed Vice Chairman Donald Kohn, who buttressed forecasts for officials to cut interest rates by highlighting concern about "deterioration" in financial markets. Traders anticipate the central bank will act for the third straight meeting to offset risks the economy will fall into recession.......

 

"The housing bubble has burst. Prices are going to collapse and sales are going to fall through the floor." -Peter Schiff 

 

 

"With the Federal Funds Rate cut, the Fed revealed that it has no interest in defending the dollar or containing inflation. This kind of irresponsibility is all gold needs to move higher from its current levels unless the Fed somehow finds its backbone within a year or two, then gold has a good chance to take out its inflation-adjusted high of nearly $2,000 per ounce within this decade." -Peter Schiff

 

"Gold continues to consolidate around $800, weighed somewhat today by lower oil and a firmer dollar." - USA Gold Daily
 

"It's going to soon hit $90 and go north of $100 next year. We should see $150 to $200 oil in the next two to three years because of the drop in the dollar. Once Asian countries allow their currencies to appreciate, demand will explode there.'' -Peter Schiff