As I’m sitting her enjoying my extra hour (thanks daylight savings), having a few home baked goods (thanks mom), and vaguely pay attention to the TV (thanks Adult Swim), I am also catching up on some RSS reading that I did not manage to get to over the last 24 hours.

One story that was lost in the mix comes from The Wall Street Journal: CIT’s Swoon Hit Taxpayers

The focus of the article is initially addressing the financial hit US taxpayers will take – roughly $2.3B in tax payer funds, thank you very much – but actually contains information that has not surfaced on a major scale when discussing expected CIT Bankruptcy.

Question one: How will a bankruptcy impact CIT Bank, the CIT retail banking unit?

It will not.

The Utah based bank, with roughly 10B in assets, will not be part of the bankruptcy filing.  The recent Capmark Financial bankruptcy followed the same pattern, so keeping the retail banking unit out of restructuring is not surprising. This does not guarantee the banking unit is out of the woods…

Question two: What type of credit contraction will take place?

While the worldwide impact on credit cannot be measured with any sense of accuracy at this point the lending capacity of CIT moving forward can be identified.  That number – roughly 20% or less of the 2007 capacity. If that statistic is not making you question how big this bankruptcy filing has the potential to be I’m not sure what would.

My initial reaction would be to ask what institution will step in to take up the slack but I cannot think of a bank will to take such risk.  I cannot think of three banks willing to take that risk, actually.  While some business will be serviced by other financial institutions, the cost of credit will be higher and less funding will be available. This may lead to a wave of small business bankruptcy throughout the United States.

As stated previously I feel this event – coupled with two other recent events – may be felt for years to come in ways people cannot yet comprehend.

In a time when credit is contracting banks feel the need to penalize responsible credit users.   Credit card companies are going to start placing fees on users who do not maintain a balance, pay their bills in full and/or do not send enough within a 12 month period.

Citigroup, meanwhile, has started charging annual fees to card holders who don’t put more than a specific amount on their cards, typically $2,400 a year. Other banks are charging inactivity fees if customers don’t use their credit cards during a specific period of time. You heard that right: You could be spanked for staying out of debt.

Just amazing, isn’t it?

Last week, I believe, the news hit the wires that credit card delinquency hit the highest level ever – 6.5%. That was a good sign the high unemployment was starting to hit the consumer in the pocketbook. It was just a matter of time that consumer credit scores started to fall…

From the third quarter of 2008 to the first quarter of 2009 — the latest data available — the average TransUnion credit score dropped 6 points to 651, the credit bureau says. Scores fell more dramatically in states hardest hit by the housing bust: California saw a 10-point drop, for example, and Arizona, 11.

“Consumers are feeling the bite of the current recession,” says Ezra Becker, a director in TransUnion’s financial services group. “With delinquencies showing up in credit files, it’s not surprising that the average score is decreasing somewhat.”

More and more it seems that people are deciding – do I pay for food or do I pay the mortgage this month (or some other bill). This leads to individuals push off payments and a hit on the credit score. I know of two such people. All they are guilty of is being laid off, now their credit is crap – and they’ve eaten through some of their retirement funds as well.

Before we jump on the “well, you shouldn’t have lived outside your means” bandwagon, there is a good chance that a number of these people didn’t do anything wrong. They didn’t live outside their means but just found themselves in the proverbial “wrong place at the wrong time.”

All of this makes me ask does the credit rating system need to be revamped? Is there a better way of ranking/rating the buying power of a person than simply sticking a number on a file that belongs to their name?

I don’t have an answer to the question, it was just random thought…

Last evening I was reading my RSS subscriptions, commenting on some threads about the Feds decision to lower interest rates, and I really started to think about the US (and world) economies. Ultimately, the question “is another depression on the way” came to mind yet again…  So I decided to put some things down on paper (and then into the blog) in order to assess the question.

• The speed of current deep recession

The US went from a shallow recession, with low unemployment, to one of the worst financial crises since 1929 in a matter of weeks.  Yes, the events were in the building for months, if not years, but it all came apart in roughly 4 to 6 weeks…. and no one was prepared for how quickly it happened.  

• Credit is hard to come by

The credit industry is contracting, and contracting fast.  Credit Card companies are cutting limits of superior borrowers, for some it’s hard to get a mortgage, companies – solid companies – cannot find funding even though they have revenue to cover their costs, and banks are not lending to each other.  Basically, spending is crawling because the pool of money has shrunk

• Oil is down today, but…

The price of energy (oil, specifically) was on a wild ride the last 4 years, up to almost $150 this past summer and down to $40 the past week.  However, due to limited supplies and production, oil will start to rise over the next year once the economies of the world begin to stabilize, causing pressure on economic growth once again.

• Debt is overwhelming…

The government is so far in debt, it will never be repaid, and our financial institutions are in the same boat . Essentially, we are spending money today that we don’t have in order to solve a problem.  In doing so, however, we may be creating a bigger problem down the road.  

Oh, yea, and the consumer is so far into debt that they have no money and cannot obtain credit (see #2).  If the consumer cannot spend, how will the economy recover?

• Unemployment is on the rise…

Going from historic lows to levels not seen in about 20 years, unemployment will play a big fact in any the economy’s recovery.  If it continues to rise, problems will persists.

• Mortgage meltdown, real estate bubble…

Huge over production of housing, mortgages to anyone and everyone that had a heartbeat and property values inflated beyond true value…. it plays into everything.  Spending, debt, credit…. and if this does not stabilize, how will the credit markets stabilize?

There were initial thoughts…  I do believe the economy is dangerously close to moving into another depression.  While I do not believe any depression will mirror the Great Depression, it is strikingly like the Long Depression on 1873.

Without a doubt, the actions taken by the government will provide some type of recover in the market – I just doubt if it will be a sustained recovery.

Oh, and another random thought… 

I am slightly concerned about how the stock market has been acting the last two weeks.  It is back to trading upward on negative news.  The economic situation has not changed, so why the movement towards the positive?  

Either a bottom has been found or a suckers rally is taking place…. I just hope it is a bottom.

The news is littered with stories of the mortgage implosion, home prices falling, financial institutions with record losses, and consumer sentiment at low levels but the headline that really stuck out at me today was this: Credit card industry may cut $2 trillion of lines.

This is a scary thought in terms of the U.S. economy when you read this quote from banking analyst Meredith Whitney:

“In other words, we expect available consumer liquidity in the form or credit-card lines to decline by 45 percent.”

Almost * HALF * of all consumer credit, in the form of credit cards, is expected to evaporate within the next year.

HALF.

The debate on usage of person credit is a long and heated discussion, one I am not about to address, however, even the most responsible of credit holders may feel pain in if this becomes a reality. Individuals with outstanding credit, those who have done nothing wrong, may no not be able to purchase…. You know… buy things… as in keep the consumer economy moving forward

The impact of such a contraction will send a shock wave through all sectors of the economy. It makes me wonder what the bailout money that was allocated to credit card companies is being used for. Apparently, it is not to increase consumer liquidity.

This is a bit of interesting news that came out of the Fed today:

The Federal Reserve announced on Tuesday that it will purchase as much as $600 billion worth of mortgage-backed assets from fledgling companies in hopes of jump-starting lending by banks nationwide.

But it was less than two weeks ago the Fed said:

Purchasing toxic assets from troubled lenders, once the centerpiece of the rescue effort, is now seen as “not the most effective way” to use the government funds, Paulson iterated.

What I cannot tell from the information released today is if the assets mortgage-backed assets the Fed will now purchase are toxic or not. Also, lost in the news coming out today is the fact that the Federal will lend up to $200 billion to holders of securities backed by consumer debt (credit cards, student loans, auto loans).

I almost get the feeling that the government is now in 100% reactionary mode, just throwing money at any problem they see. Remember, uncertainty creates fear.

There are a number of things that are being said in the news / press / world of blogs that I need to be addressed.

The Stock Market is not the economy

Without a doubt, the stock market is wild right now.  The press gets excited when the wild swing and destruction of capital takes place, but it has happened a number of times in the past – it’s all part of capitalism.  It happened in 2001, in 1990, 1987, early 80s… and on and on and on.

Corporate scandals, poor business practices, and just plain dumb luck will lead to situations like this all the time.  Currently, the financial industry is in disarray but this does not equate to an overall bad economy.  While economic growth is not historic highs it is also not contracting.  As of now, the United States is not, officially, in a recession.

The collapse of AIG, et al., is not a giant conspiracy

I want to know if people are still taking their medication.  More and more there are stories / commentaries that the bailout of AIG is due to the company being a front for the government or that we are heading into a financial dictatorship.

The reason AIG was given what amounts to a structured bankruptcy is quite simply. Their debt, the bonds they offered, was considered to be some of the highest-grade investment vehicles on the market.  Just about every major company in the WORLD owns said bonds and if the assets suddenly became worthless, the potential for failures of companies worldwide was very real.

The $700 Billion dollar rescue is the right thing

The creation of a Resolution Trust is the right thing to do and creates a bottom for the mortgage industry – the mortgages are now set with a value established by asset managers, backed by the government, and create a tradable security for the investment market.    Furthermore, as the real estate market improves the government will be sitting on A HUGE asset bank that goes right back into the treasury.

This is all caused by poor regulation, greed and policy

Yes, policy created this current situation, but it wasn’t Bush policy – it was Clinton policy.  President Clinton pushed extensive changes allowing lenders to distribute and fill “questionable” loans, his legislation – essentially – allowed the sub-prime mortgage industry to start.

In 2002, Ron Paul called for change due to the financial risk, in 2003 President Bush recommended a regulatory overall to prevent a collapse and in 2005 John McCain warned of a financial collapse but NO one acted.

Who failed to act?  Congress.

Bankers utilized the “loose” regulation and got greedy.  They started to issue loans to individuals who could not afford their loans and, next thing you know, boom there is a crash.

This is life…

The stock market, the economy and life are full of ups and downs.  What the government is doing right now is attempting to provide stability to the financial and credit markets, and as the economy as a whole.  Is it what I want to see in a free market society, no?  Is it the right thing to do, yes.

What the financial markets face today are two ugly monsters, walking hand and hand, causing devastation wherever they seem to go.

First off, the economy is stuck in the middle of a Sub-Prime mortgage crisis. Essentially, banks became greedy and started handing out mortgages and loans to just about anyone who had a pulse, couple this with falling real estates values and there is a disaster waiting to happen.

A large number of the recipients of said loans often had poor credit and little to no money down on the property they purchased. Suddenly, home owners can no longer pay on their mortgage (loss of a job, mortgage rates changed) and the bank is left with property deflated in value and no one to pay on the loan. This means financial institutions are now holding “bad debt” – receivables that can no longer be collected on – which needs to be covered on the company’s balance sheet. When the bank can no longer cover the debt situations like Countrywide, Lehman Brothers or Bear Stearns take place, they go out of business and the remaining assets, or anything of value, are purchased by competitors for pennies on the dollar.

The second crisis facing Wall Street – no, the economy in general – is now a credit crunch.

Due to the risk seen in the mortgage industry, and the bodies on Wall Street, banks and institutions are unwilling to provide, or make it incredible difficult to obtain credit for, individuals or companies.

You want a new car? Maybe you cannot get a loan because your credit is under 700. What about that oil producer? BigOil Co. wants to expand operations but cannot obtain a loan because the cost is too great, there by reducing a competitive advantage. Worse yet, companies that need bridge funding – funding for the short term to fund operations – may be unable to get the cash they need and as a result go out of business.

AIG, one of the largest bond insurers in the World, is being hit by both the sub-prime crisis and the credit crunch.

One of the many products AIG offered was insurance on financial products and what is hurting the company at this point is their insurance of mortgages. When a financial institution had a loan that is considered to be “bad” they file a claim (AIG) in order to recoup their money. While AIG could be able to insure the mortgage portfolio of one institution, say Country Wide for example, it did not have enough money to fund the portfolios of Country Wide, Lehman and Bear Sterns combined. So, what does the company do? Go to the credit market…but that well may be dry due to the credit crunch as described above, leaving the company trying to find a buyer for it’s assets, find funding at a steep price, or going bankrupt.

Note: Constellation Energy fell almost 40% as investors fear banks may pull lines of credit – this is how the credit crunch can impact ALL aspects of the world economy.

The sub-prime crisis triggered the credit crunch. As a result every individual, world wide, is at risk of being impacted in some way – be it large or small. The lack of credit or liquidity has the ability to send economies around the world into recession. If businesses are not spending money, people are not spending money, and economies shrink until the deflation has worked out of the system.

While I understand the government’s reason for stepping in to socialize Fannie Mae and Feddie Mac, I am sure I agree with the decision to do so. The only thing I can assume is the impact on the U.S., and potentially global, economy was so great no other option existed. So, in this political season the question that seems to be asked quite often is “What policy could be put in place to stop this?” Short answer: none.

As much as people do not want to hear it, this is what happens in a free market. Ups and downs occur. The government should not be rescuing companies because of their greed or poor judgment, nor should they be bailing out the “man on the street” that purchased too much home.

The one place government does need to look; however, is their enforcement of financially significant data. A number of the financial institutions with bad debt were unable to tell investors or regulators just how much risk was on their books (i.e. – we don’t know how many of our loans are bad). This lack of visibility in financial information led to the sudden collapse of firms like Bear Sterns and Lehman

Funny thing… I thought SOx was going to fix all of that.

Hang on, the ride is going to be bumpy for some time.

Others Covering:

The Anchoress: Wall Street Woes, Media Meltdown & More
Hot Air: Who’s policies led to the credit crisis
Right Voices: Dodd says he was on top of the financial crisis
Flopping Aces: Democrats rewriting history once more
The Dude’s Blog: Disingenuous Dems Lying About Credit Crisis