4 Pillars of Debt in Danger of Collapse

Last month I was in a series of high-level meetings with members of Congress and the Senate in Washington.

While there’s been major news about the Supreme Court, my discussions were on something that both sides of the aisle are coming to consensus over.

You see, issues that impact your own bottom line are way more about economics than they are about politics. On Capitol Hill, leaders know that. They also know that voters react to what impacts their money. That’s why, behind the scenes, I’ve been discussing issues focused on protecting the economy.

Behind closed doors, we’ve been working on how to shield the economy from Too Big to Fail banks and how the U.S. can better fund infrastructure projects. These are initiatives that all politicians should care about.

Underneath the surface of the economy is a financial system that is heavily influenced by the Federal Reserve. That’s why political figures and the media alike have all tried to understand what direction the system is headed.

Also last week I joined Fox Business at their headquarters to discuss the economy, the Fed and what they all mean for the markets. On camera, we discussed this week’s Federal Reserve meeting and the likely outcomes.

Off camera, we jumped into a similar discussion that those in DC have pressed me on. Charles Payne, the Fox host, asked me what I thought of new Fed chairman, Jerome Powell, in general. Payne knew that I view the entire central bank system as a massive artificial bank and market stimulant.

What I told him is that Powell actually has a good sense of balance in terms of what he does with rates, and the size of the Fed’s book. He understands the repercussion that moving rates too much, too quickly, or selling off the assets, could have on the global economy and the markets.

Savvy investors know that if the U.S. economy falters, because everything is connected, it could reverberate on the world.

That’s why I could forecast that the Fed would raise rates by 25 basis points last week ahead of time. And they did. However, there’s now even less reason to believe the Fed will raise rates at the next meeting in December.

Why is that?

First, Powell has made clear that he doesn’t see inflation heating up as a threat. Second, even though last quarter’s GDP growth figures were relatively high, the reality is that much of that growth came from trade war spending and preparation.

Another big chunk of the GDP growth the U.S. has experienced is based on debt. When considering the real problem of debt, the record consumer debt numbers in the U.S. paints a picture so that you can see how and why the Fed will likely have to reverse course.

At a time when we find ourselves “celebrating” the 10-year anniversary of the collapse of my old firm, Lehman Brothers, and the government bailout of banks, the structure of big banks has really not changed. They remain Too Big to Fail.

The big banks got subsidies and were propped up by quantitative easing (QE) to resurrect themselves into appearing financially healthy. The same cannot be said of all consumers in the country.

It’s consumers that have now piled on debt — and at much higher interest rates than the banks and large corporations have been given.

Indeed, to make ends meet, there have been four main pillars of consumer debt that have hit new records.

According to a recent New York Federal Reserve Bank report, total consumer debt is at higher levels now than going into the financial crisis.

By breaking down what that debt is, you can best understand how to navigate the world of finance, understand your own portfolio better and make more sound investments.

Here they are:

Overall Household Debt.

The state of household debt, which literally takes into account the combined debt within a given household, continues to flash red. According to a 2017 household financial survey by the Fed, “About one-quarter of U.S. adults have no retirement savings. And 41% say they would not have enough savings to cover a $400 emergency expense.”

The overall level of consumer debt has hit a new record. It’s now $618 billion higher than it was at its prior peak at $12.68 trillion during the third quarter of 2008 – right before the onset of the financial crisis.

The total borrowing of Americans hit $13.29 during the second quarter of this year. That’s up $454 billion from a year earlier. The fact is that borrowing has risen for 16 consecutive quarters.

Credit Card Debt.

The total of U.S. credit card loans has increased by $45 billion this year to a massive $829 billion total.

Despite cheap rates for banks, the average credit card interest payment rate is 15.5%. It was at 12.5% only five years ago. And, yet people keep borrowing.

The total revolving credit card debt now stands at a record of $1.04 trillion, higher than its last 2008 peak.

Borrowers have paid a painful $104 billion in credit card interest and fees in just the last year. That figure is up 11% from the prior year, and up 35% over the past five years.

What you should know if you have a credit card is that if the Fed continues to raise rates, that any associated debt will become even more expensive.

Student Loan Debt.

During my meetings in Washington and with even media figures, student debt continues to be a central topic of concern. The fact is, student loans cannot be given bankruptcy status and therefore are much more complex when evaluating the U.S. economy.

Currently, the amount of student loans grew to $1.41 trillion in the second quarter of 2018. That figure has nearly tripled since the beginning of the financial crisis. Student loan debt is now the second highest consumer debt held.

That crippling amount of debt makes it harder for graduates to find jobs that will help them alleviate the costs of their education. It also means that those with student loans will have less money to deploy into the economy — which will impact economic growth overall.

Auto Debt.

While the rising cost of manufacturing autos has impacted the automotive sector, it has not deterred consumers from borrowing money.

Total auto debt in the U.S. has shot up to $1.24 trillion. That figure is up $48 billion from just a year ago.

The reason this sector is so important now is that a lot of loans being given are of the subprime variety. Subprime loans were the exact kind of high rate loans that caused the last financial crisis — only last time they were given to mortgage borrowers.

Auto loan delinquency rates are already higher now than they were during the financial crisis. The auto loan sector will continue to be one to watch for signs of financial faltering.

As we head into the holiday season, these four debt triggers matter even more.

Companies that consumers buy products from, especially bulky items, could see a very tepid holiday season in terms of sales.

Any business that faces additional costs will likely pass that on to the consumer. That could come in the form of transportation expenses (shipping) required to get products to your door. Companies that work on that business model could struggle. The additional costs and the implied logistics demand that the bigger the item, the higher the cost — which all adds onto the debt.

The expectation is that consumers will be more selective in their year-end purchases, both because of their debt and the need to economize their own personal finances. That’s why shares in retailers like L Brands, Floor & Decor Holdings and Michaels Companies have each declined more than 30% year to date.

Our economy rests upon four crumbling pillars of debt. If one of these collapses, the entire superstructure may not be far behind.


Nomi Prins

for TheDaily Reckoning

The Daily Reckoning