President Obama had a great line for Wall Street in his inaugural address yesterday: “On this day, we gather because we have chosen hope over fear ...”
Bingo, Obama! Hope and fear are the yin and yang of the markets. Last week this column talked about hope as the elusive elixir of capitalism. Given the stock slaughter on Inauguration Day, seems like a good time to talk about hope's necessary counterbalance: fear.
For most of the past year we have been way out of balance. Unmitigated fear has been allowed to wrack and ruin Wall Street, overwhelming any semblance of hope. The biggest financial companies define this panic pandemic. They already are battered beyond recognition: Citigroup lost $112 billion in market value last year, J.P. Morgan Chase’s market cap plunged by $60 billion, Goldman Sachs lost $51 billion and Morgan Stanley $33.2 billion.
Yet they got clobbered again on Tuesday. In a single day Citi fell 20%, JPM dived 21%, Goldman slid 19% and Morgan Stanley was down 16%. All four stocks are up by 10% or better today. Cold comfort.
Gone are the good ol' days when traders dumped bank shares because the next quarterly earnings report might disappoint. This savage selloff is driven by the fear that these huge financial contraptions may not survive at all.
Maybe it serves ’em right. The big banks are akin to the House That Jerks Built. First they loaded up on arcane and obtuse securitizations of millions of mortgages infected with a sliver of subprime risk. Then they profited on fear by selling credit default swaps that promise a payoff if a company goes belly-up on its bonds--even if you never held the bonds in the first place.
Now they pay the price of frightfulness. Credit swaps on the banks' own bonds are wildly inflated, raising their cost of selling debt. News headlines tell us the defaults are spreading from home loans to other kinds of debt: commercial real estate, credit cards, car loans, college loans and on and on.
But it is difficult to distinguish between justifiable alarm and overdone, outright panic. If rising defaults are killing the banks’ business and cutting off their cash flow, that is a true financial crisis. Yet if, instead, the defaults really aren’t that high and it is merely investors’ fear of further writeoffs, that is an accounting crisis. (The vast majority of the huge charges have been non-cash items reflecting the dire outlook for on-the-books valuations, not an actual hemorrhaging of real cash.)
So how bad is it really?
The default rates on myriad types of debt are ridiculously low given the waves of fear gripping the world markets—and entirely survivable. Take a look:
Home mortgages: Yes, 7% of the 80 million outstanding mortgages are in delinquency right now, but the growth is in loans that are 90 days late or worse, not in new laggards that just became 30 days late. Meaning the worst could be over. (Source: Mortgage Bankers Association.)
Home equity loans: Horrors! Some 2.6% of home-equity loans are in delinquency as of last September. From the previous quarter, that was up only seven hundredths of a percentage point. (Source: American Bankers Association.)
Commercial mortgages: Less than 1% of the loans in commercial mortgage backed securities are 30 days delinquent; less than 1.4% are 90 days late. (Source: MBA.)
Credit cards: The delinquency rate is at 4.8%, and only 2.2% of credit card accounts are 90 days late or worse. Seems like annual interest rates of 20% to 30% can more than ease that pain. (Source: Haver Analytics.)
Car loans: Delinquent auto loans hit an all-time record in the third quarter of 2008: all of 3.25%, up from 3.07% the previous quarter. Big deal! (Source: ABA.)
The late-pay rates are similarly low on loans for RV’s, mobile homes, boats and property improvement. Rarely before, if ever, have so many investors been paralyzed by so much fear over so low a level of loan defaults. What’s killing us is the unknown of just how junky all those mortgage-backed securities and the like might be.
That will become clearer in time, as the feds look at setting up a “bad bank” to buy up all that detritus, or perhaps lifting the mark-to-market rules that helped create this accounting crisis. Meanwhile, investors should grow some courage. It harks back to another historic inaugural address, this one by the newly elected Franklin D. Roosevelt on March 4, 1933: “The only thing we have to fear is fear itself.”
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