Loan Delinquencies Spread to Other Forms of Consumer Credit

The economic downturn and home mortgage crisis is being felt in other areas of the banking industry, and the result may be a second wave of bank failures, this time in regional and local banks. In an article entitled, “New Crisis Threatens Healthy Banks,” the Washington Post reports that delinquencies are up in credit card payments (which had been previously reported), home equity loans, and—most strikingly—construction loans (see the Post graphic below). Many smaller banks that avoided the subprime mortgage market are, nonetheless, mainstays of the home equity and construction loan business in their areas. As a result, this spread of delinquencies may lead to problems for these smaller institutions.

Although we were not hearing anything about it at the time, this graph also shows that delinquencies in construction loans actually led the foreclosure crisis. The uptick in construction loan delinquencies appears to begin in mid-2006, which is before the current crisis began. In contrast, the consumer aspects of the crisis hit a year later in mid-2007, just as foreclosures began to soar. The graph below, which comes from econoday.com, shows that mortgage interest rates bottomed out in 2005 and and began to rise in late 2005 and early 2006. New home sales fell accordingly, and delinquencies in construction loans followed.

All of this dramatizes the powerful role of the real estate market in stimulating our current economic difficulties. Of course, once these real estate trends got the ball rolling, our sleeping problems with consumer debt (home equity loans & credit cards) just made matters worse. Much worse.

How Do We Change Values?

On Tuesday of this week, David Brooks had a very good column called “The Great Seduction” about the America’s epidemic of personal debt. The article is based on a new report issued jointly by the Institute for American Values (which concerns itself with marriage and divorce, among other things) and a number of other think tanks, including Demos and the New America Foundation. The report and Brooks’ column make a number of very good recommendations, such as credit card reform, regulation of payday lenders, and programs to promote saving. But at the end of the column Brooks returns to one of his regular themes:

There are dozens of things that could be done. But the most important is to shift values. Franklin made it prestigious to embrace certain bourgeois virtues. Now it’s socially acceptable to undermine those virtues. It’s considered normal to play the debt game and imagine that decisions made today will have no consequences for the future.

He is, of course, correct, but the difficulty is knowing how to change values. We can state our values and identify our chosen virtues, much as Franklin did, but merely calling for a kind of behavior does not always do the trick. Values often follow behavior, rather than the other way around. We acquire many virtues by practicing them. Parents model truthful statements, hard work, and thrift, and they reward us for following their lead. Our modern problem stems from those instances—and there are many—when our behavior is molded by commercial and technological developments, and a new and less virtuous value results.

Take, for example, pornography. Once a very seamy commodity consumed by only the most depraved members of the community. To find it, you had to go into parts of town most people preferred not to visit. Then came the VCR. With the introduction of videocassettes that could be watched at home in privacy, many of the social barriers were removed. Distribution took a further leap forward with hotel and home cable systems, and finally, the internet really brought pornography home. The result is that, despite our highly religious society (compared, for example, to Europe), pornography has become much more acceptable than it was thirty years ago. Jenna Jameson has written a bestselling book How to Make Love Like a Porn Star, and the line between acceptable celebrity and unacceptable celebrity has been blurred. Porn has come out of the closet, driven not by a change in values but by a change in technology. Behavior that is popular begins to appear normal. Today, only child pornography is truly beyond the pale.

So the problem with thrift is that debt is the new pornography. Actually the two have come along together. The introduction of credit cards, 800-telephone numbers, home shopping channels, and the internet have served to eliminate many of the natural barriers to indebtedness. We live in a consumer society that depends on spending and has made it easy to act impulsively 24-hours a day. Popularizing thrift as a virtue is important, but unless we also find ways to encourage virtuous behavior, we are unlikely to demonstrate those values. Brooks’ column—and the report upon which it is based—make many good suggestions, but we also need to acknowledge the powerful effect of the contemporary marketplace on our choices to spend and save. If we can make it easier to show virtuous behavior, the change of values Brooks seeks will follow.

Mortgage Bankers Association: Worst Quarter in Twenty-five Years

According to a new report from the Mortgage Bankers Association, fully 1 in 10 American homeowners are now in foreclosure or behind on their payments. Furthermore, the problems are not limited to the subprime sector but are evident at all levels of the mortgage industry. Many borrowers with previously perfect records are now falling behind on their payments. In the first quarter of this year, 2.47 % of homes were in foreclosure, up from 2.0 % in the previous quarter. The mortgage crisis has not yet hit bottom.

So where is the response? Where is Ben Bernanke? Where is Congress? Where is the President? Bear Stearns was an instant, over the weekend bailout, but when it comes to the problems of everyday homeowners, you're on your own. We’ve got an 800-number for you, but beyond that we’ve got a big nothing.

The Arbitrary Pricing of Branded Products

Yesterday’s NY Times ran a story in Thursday Style called “Dress for Less and Less.” The article’s premise is that, despite rising prices for food and gasoline, the cost of clothing has gone down. As examples, the author, Eric Wilson, cites Levi 501 jeans that were $50 in 1998 and are $46 2008 and Lacoste polo shirts that went from $95 to $75 in the same time period.

It is difficult to take such a story seriously. All the products mentioned are highly branded, in most cases high-end or designer goods (Vuitton, Ralph Lauren, Brooks Brothers), and quite expensive. Most middle class shoppers will not be paying $325 for a DVF wrap dress, and I have never paid even half of $75 for a polo shirt. But the interesting question is why? Why have these clothing prices come down? Wilson gives two explanations:

Over all, apparel prices have gone down primarily because of two factors: the overwhelming movement of manufacturing to countries with cheaper labor, where the clothes are made, and increased competition between traditional retailers and discounters, where the clothes are sold.

The outsourcing of jobs provides savings for all clothing manufacturers, and the article does not assert that discount prices have moved down to a similar degree. So the answer is price competition. Cheaper non-branded goods are being offered by discounters, and, in some cases, discounters are selling the same items for less. The elasticity of price for these more expensive products reveals the premium we pay for brand name goods and how arbitrarily manufacturers and retailers set their prices. Despite somewhat lower prices today, we can assume these branded items are still profitable—else they would not be sold. The profits are just a little smaller than they used to be.

The Psychology of Netflix

The spending response is strongly affected by two variables: effort and time. The Netflix system of DVD rental by mail has succeeded by reducing both. Before Netflix, renting a movie required a trip to the video rental store, which took both time and effort. Ordering online meant that by planning ahead you could always have a movie on hand, so you could watch a movie without going out to get it. Furthermore, Netflix’s enormous selection and sophisticated searching and recommendation system make it much more likely you will find movies you really want to see.

The one drawback of the Netflix system is that you cannot be completely impulsive. The movies you order come in the mail, so at very least, your viewing selection must take place a day or two before you watch. You have to plan ahead. Finally, even if you have one of the Netflix plans that allows you to have several movies on hand at a time, a serious weekend movie binge can burn through your stack of DVDs, forcing you to wait until the postal service has time to replenished your supply.

So Netflix is an incompletely impulsive indulgence. You cannot make a movie choice on a whim, click, and immediately start watching, but several companies have been working on this “problem,” wrestling with various technical hurdles in an effort to provide their customers with unfettered indulgence. Yesterday, the NY Times reported that Netflix will now offer a $100 box that will connect to your television and allow downloading of good quality movies over the internet. You use your computer to do the ordering, but you watch the movie on your TV. For those who use it, almost complete impulsivity will be possible. If a friend tells you that you should see a particular film you have never seen before, you can begin watching it in a matter of seconds. Furthermore, once you have purchased the box, you will be able to view as many movies as you want without extra charge. The service will be a free feature of your Netflix subscription and there is no limit to the number of movies you can watch. So, although the thought of the ultimate couch potato, endless weekend movie binge is a bit worrisome, it will now be possible. No need to get out of your pajamas.

For Netflix, the advantage of this system is protection against losing customers to Apple or Tivo, but the effect of this innovation (do we call this progress?) on the consumer will be more movie-watching. The pause in the action created by the postal system will be stripped away, and impulsive and completely uninhibited movie indulgence will be possible. Is this a good thing? Yes and no.

Media Packaging of Good and Bad Economic News

No matter how bad it gets, there are always experts out there willing to put an upbeat spin on the economy, and the media seems to have a bias in favor of positive economic news. In local news, “if it bleeds, it leads” is the defining rule, but when it comes to economic news, we always want to hear that things will be just fine.

Today the CNN webpage is running an Associated Press article with the headline “Economists see credit crisis nearing end,” a happy thought, indeed, but the first paragraph is much less cheery:

WASHINGTON (AP) -- First the good news: The worst of the painful housing slump and the credit crunch might come to an end this year. Now the bad: The economy will weaken further and unemployment will rise.

Like this passage, much of what follows in the article, based on a report from the National Association for Business Economics, is just as mixed. Again, the more optimistic view of the “credit crunch” is really a statement aimed at investors and business people hoping to find money to borrow. There is no “credit crunch” for everyday folks. Instead, there is a debt crunch, and the article predicts increasing unemployment and, to make matters worse, reports that economists are uncertainty about whether housing prices will hit bottom by the end of the year.

The real world for most consumers is hinted at in a paragraph added at the bottom of the article. CNN’s “ireport” team makes the following appeal:

Are you buried under a pile of debt and need help getting out? Did you recently manage to pull yourself out of debt and want to share your story? Tell us about your experience with debt and how the current credit crisis is affecting you. Send us your photos and videos, or email us to share your story.

Personal debt is still a hot story line because there is so much of it out there, but it would be nice to put a happy spin on a dismal circumstance. So please send us a few success stories.

Consumer Choice: Dumping Starbucks and Whole Foods

As people begin to feel pinched, it is interesting to see how the retail economy is affected. Where are consumers cutting back and—equally as interesting—where are they not? Earlier in the month we heard that Starbucks had experienced a 21% drop in earnings. If there is a single suggestion that personal finance advisors give so often that it has become laughably hackneyed it is to stop buying coffee at Startbucks. “Those latte grandes add up.” Well, it would appear that someone has been listening. Many other coffee options are available, and even without going so far as to brew coffee at home, the caffeine addict can easily steer clear of Starbucks and find cheaper beverages nearby. Demand for Starbucks coffee is highly elastic. Similarly, Whole Foods is experiencing a significant slump. When the going gets tough, higher-priced organic foods look like a luxury.

On the other hand, discounters are doing quite well. Walmart and TJMaxx are expected to show very good earnings. All of this points to a shift in consumer choice that provides clear evidence of an economic down-turn.