Borrowers Should go for Broke

The new bankruptcy bill may deter some debtors from further "credit card kamikaze," but if property prices decline, the bill could leave millions of homeowners underwater on their mortgages. Rick Ackerman explores…

As indebtedness in its many insidious forms mounts globally toward an epochal climax, prudence begs the question of why lenders are still frantic to put even more unearned dollars in our sweaty little hands. Zero percent auto loans are everywhere; mortgage money remains easy to come by, even after a 150-basis-point tightening of administered rates; and anyone who is not deceased or in prison can borrow for 3% or less by writing a check on a revolving charge account.

Why are lenders making it so painless for us to get in even deeper over our heads? Don’t they know that it can only end badly for borrowers and creditors alike? The simple answer is that their greed has long since exceeded their good sense. Since it costs big banks and retailers almost nothing to raise funds for consumer loans, and because the alchemy of securitized debt has created a practically unlimited supply of lendable dollars, why not just go for it? And so they have, with the laudable goal of gaining market share, but with a relentless zeal that in recent years has savaged the moral and ethical boundaries of lending.

2005 Bankruptcy Bill: Credit Card Companies, Banks, and Retailers

And yet, in a legalistic sense, lenders appear to be acting rationally, if not prudently, owing to certain provisions in a bankruptcy bill that recently was enacted into law after an eight-year struggle in Congress. I followed the bill avidly each step of the way, since it represents the one instance in my adult life where I’ve been on the same side of the political fence as the likes of Bill Clinton, Ted Kennedy and Charles Schumer, all of whom opposed the measure vehemently. Not surprisingly, the bankruptcy overhaul has the enthusiastic support of credit-card companies, banks and retailers. Also not surprisingly, the legislation remained moribund under Clinton, freighted with riders and amendments that kept it bottled up in committee.

Oddly enough, it was pro-abortion sentiment that prevented the bankruptcy bill from passing earlier. As earlier amended, it would have allowed pro-lifers to use the bankruptcy courts to evade fines imposed for illegal protests, including violent antiabortion demonstrations. The issue was sufficiently nettlesome to prevent the legislation’s enactment under Clinton, but its prospects revived under a politically ascendant Bush. Now it is the law of the land, impelled by a phalanx of well-financed and highly capable lobbyists, and by a Republican majority strong enough to sweep aside all obstacles that had been imposed by the political left’s Old Guard.

In practice, the bill will make it far more difficult for an individual to walk away from debt by declaring personal bankruptcy through a Chapter 7 filing. Under the legislation, those able to pay off some of their debts would have to file under Chapter 13, which allows the court to set up a partial repayment plan. Before, debtors who got in over their heads could wipe the slate clean and start a new life, financially speaking. But under the new laws, some debts could weigh on borrowers for years, perhaps until they die; and then, presumably, the burden would shift to their survivors.

Make no mistake; the new law will cause some opportunistic borrowers to think twice before attempting to commit credit-card kamikaze. But it will also wreck the lives of many otherwise financially responsible individuals who get deeply in hock for reasons beyond their control. Take, for example, the widow who gets stuck with her deceased husband’s huge medical bills. Absent the felicity and forgiveness of Chapter 7, the woman could find herself unable to access credit for the rest of her days. Some will argue that that’s better than languishing in a debtor’s prison, but for the widow and her family, the financial purgatory of creditlessness could be almost as debilitating and demeaning.

2005 Bankruptcy Bill: The Destruction of Lives

Ominously, there is far more at stake than the fate of unfortunate widows with probate problems. For conceivably, the new bankruptcy law could destroy the lives of tens of million of Americans, whose net worth – and borrowing power – is tied to the value of their homes. What if property values were to decline in the U.S., triggering a severe recession and leaving a substantial fraction of the nation’s homeowners underwater on their mortgages? Could it actually happen? Renowned money manager John Templeton thinks s "When home prices do start down, they will fall remarkably far," Templeton said in a magazine interview. "In Japan, home prices are down to less than half what they were at the stock market peak. A property price decline of as little as 20% would put a lot of people in bankruptcy."

Templeton noted at that time, late in 2003, that Americans owed a total of $31 trillion – three times the nation’s GNP – and that this has put debtors in great jeopardy. "Think of the dangers involved. Almost everyone has a home mortgage, and some are 89% of the value of the home (and yes, some are more). If home prices start down, there will be bankruptcies, and in bankruptcy, houses are sold at lower prices, pushing property prices down further."

Now that the bankruptcy bill has become law, those who are merely decimated by the coming credit collapse may find themselves in far worse shape than profligate borrowers who literally went for broke. Pennilessness might be a ticket to financial freedom, but those barely scraping by will be on the hook for as long as they continue to work.

If Templeton is right and millions of mortgagees are reduced to subsistence living, lynch mobs will be demanding the repeal of these new laws five years from now. Until then, the lenders, having legally hedged their bets, will probably think they’re sitting pretty if the economy should implode. Any comfort they might take in this belief is delusional, however; for there can be no winners or losers in a deflationary collapse, only survivors.


Rick Ackerman
for The Daily Reckoning
March 22, 2005

Editor’s Note: Rick Ackerman is the editor and publisher of Rick’s Picks, a daily, web-based advisory geared to traders of stocks, commodities, options and mini-futures. He has been a trader himself for nearly 30 years, twelve of them as a market maker on the Pacific Stock Exchange.

The most important financial news from yesterday wasn’t even worth reading. Alan Greenspan was said to be considering a hefty increase in the Fed’s key lending rate. He’s getting spooked by inflation, say the press reports. Investors were then spooked by the fear that rates might rise faster than expected. They took out their spookiness on stocks – which dropped a bit – and the dollar, which rose.

Stocks are very expensive – as they’ve been for a very long time. We have no doubt that they will be less expensive in the future. But as to the timing, we plead ignorance. Sooner? Maybe later.

But just as a sensible man is ready for death any day of the week, so is a sensible investor ready for the day the Dow drops. It has been a long time since stock buyers made any money. "Virtue is what used to pay," said Gordon Tullock. Investors stick with stocks as though it were a virtue – because stocks used to pay. Buyers made a lot of money in the 18 years, 1982-2000. They haven’t made any money since. Instead, they waste money in commissions and small losses… and turn to real estate. There, with their feet on the new wall-to-wall carpeting, they figure they can’t lose. We wait to find out how they will be wrong…and when they will buy real estate, not because it pays off, but because it used to.

As for the dollar, we are even surer. It, too, will go down. But against what? When? Don’t bother us about the details, dear reader, we’re macro-economists. We think big, in other words. We assure you that sometime between now and when Hell freezes over the dollar will fall to worthlessness. We’ll leave it to other to fill in the details.

The trouble most investors face is that the people filling in the details are usually bigger numbskulls than we are. Evidence of that comes from two economists discussed in today’s Financial Times. The two, one at Princeton, the other at Berkeley, maintain that the fall of the dollar over the past two years has gone far enough. They believe it has been sufficient to ease the imbalance seen in the trade figures. They also believe they have constructed a model that allows them to know things like this. What the model shows, according to the FT report, is that "as long as foreign investors, especially foreign central banks, are willing to hold U.S. assets, the dollar’s exchange rate does not need to devalue by as much as would have been the case if all the adjustment had to come from trade alone."

Yes…and as long as the sun is shining, it won’t rain. And as long as you’re breathing, you won’t be dead.

Meanwhile, a report from one of China’s leading ports tells us that containers arriving from America are 70% empty. Those leaving for America, on the other hand, are stuffed. China’s exports are increasing 30% per year; with China alone, the United States has a $162 billion trade deficit. "If empty containers were a trade item," commented one union official, "they’d be America’s leading export."

The average Chinese worker still costs his employer less than $1 per hour. The cost in America is over $20 per hour. This 20-to-1 advantage is hard to beat. But China is now moving into areas where labor costs are not necessarily the key element. As the Chinese learn new skills, they become better able to compete with high-tech industries in the West. Chinese universities turn out 350,000 new engineers each year. Now, Chinese entrepreneurs are moving into biotech, communications technology, and many other high-tech areas. As a result, even in technology, America runs a $37 billion trade deficit with China.

In the 1980s, Americans reacted to Japanese imports with a "Buy American" campaign. Soon, there will be not much left to buy.

More news, from our team at The Rude Awakening…


Eric Fry, reporting from Manhattan:

"College basketball does not possess a monopoly on madness…not even during the month of March. Investors have shown themselves to be just as capable…"


Bill Bonner, back in London…

*** GE capital withdrew a $2 billion loan facility from General Motors. The company says it can still pay its bills. Some analysts wonder how. GM is worth $15 billion, says the stock market. But it owes bondholders $300 billion.

The company is no longer a profit-seeking, capitalist enterprise. If it makes any money – the cash goes to lenders, retirees, employees, and lawyers, not stockholders.

*** Oil touched $57 a barrel yesterday. Long-term, we are bullish on oil and everything else that cannot be manufactured in China or run off from a printing press. But short-term…could oil be ready for a pullback? Maybe.

We asked Kevin Kerr his opinion on the oil market:

"Well, the oil markets seem to be waiting to see what the inventory numbers hold… however, I think investors are getting a little bit of a nosebleed up here, and are looking for an excuse to invite a healthy correction of about 4-$5. If this morning’s numbers are good in crude, we may see an immediate fall off in May of about $2 or $3…the time has come. The charts reflect the need for a moderate to severe pullback, and at these levels it is justified. The momentum crude has been showing has in essence "made its point" and now can secure that position by backing and filling around the $52 level. Otherwise, a run toward $60 at this point ensures a dramatic fall-off to below $50 for most of the summer. Some are saying this will happen in the next six to eight months, but I think the window is actually far less… two to three months."

"Crude is more likely fairly priced around $48-54 at this point, but lower or higher than that is all based on speculation. When all is said and done, oil will move higher by the years-end, but for now a correction is needed."

*** We bought a huge, old house in Normandy. It wasn’t very expensive, but now comes the job of fixing it up. After realizing that the job would take more time and more competence than we had available, we engaged an architect who, in turn, lined up various subcontractors.

We have restored a number of houses and feel we are experts at it. Still, there are always surprises. The first surprise was that the septic system drained right into the pretty canal next to the house. "You’re either going to have to put in a lot of ducks, or replace the entire system," said the architect.

The second surprise was that a strange type of orange fungus – merulle – was eating away at the floor joists.

"If I were you, I wouldn’t invite a lot of people into the library," he warned on Saturday. He had come down from Paris, followed by the draper – who was there to show us fabric samples. The architect had driven up in a new Mercedes. The draper had come in a new Jaguar. We always worry when the tradesmen we do business with drive better cars than we do.

"Are you kidding?" Elizabeth replied when we mentioned it, "Everybody drives better cars than we do."

We decided to let the point pass.

"How much do you think it will cost to get those floor joists replaced," we asked our architect.

"If you have to ask," he replied, "you can’t afford it."

"Right…well…I guess we just won’t invite many people into the library."

"No, you’ve got to get it out of there. It’s worse than termites. It will eat your whole house. It’s a kind of mushroom, you know. And don’t worry about the cost…in terms of the whole job, it’s a drop in the bucket."

"That’s what I was afraid of."

"Wait, did I tell you about the beam in the attic?"

"More fungus?"

"No, water damage…"

The Daily Reckoning