- If you are looking at your financial position, you should
consider your assets in relation to your liabilities.
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- What you should do, a bank by law must do.
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- Banks have assets. A huge asset on the books of the
biggest American banks is credit card debt. That money is owed by borrowers.
Interest rates paid on these cards is far higher than rates obtainable
by banks from any other class of loans.
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- The written credit card debt contracts are also beneficial
to banks. Low card rates can be hiked without warning overnight to 20%
or even 30% per annum if a borrower misses a payment to his mortgage company
or any other creditor. This missed-payment information goes from the third-party
creditor to a credit rating agency, and from there to the bank.
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- Credit card debtors have agreed to contracts that pass
most of the power to the lending agencies, which are banks.
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- All this sounds like good news for the banking industry.
But then the banking industry got into the game of politics. (Actually,
I can think of few industries that got into politics earlier: the fifteenth
century at the latest.) The banks began to pressure Congress last year
to pass legislation to toughen the bankruptcy law. Congress complied with
bank lobbying early this year, and President Bush signed this legislation
into law, just as he has done with every proposed law that Congress has
put on his desk since January, 2001.
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- SHRINKING ASSETS
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- Few people understand that the minimum monthly payment
required by banks kept the borrower in debt for over two decades. Now,
that's a loan that pays and pays and pays!
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- The borrowers, not understanding compound interest and
paying attention only to the monthly payment's effect on their budgets,
willingly locked themselves into a long-term debt contract.
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- This was a bonanza for the banks, which was why American
banks since 1965 have dramatically increased the assets on their books
attributable to credit card loans.
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- On October 17, the new bankruptcy law will go into effect.
That is the day that the banks will see their cash cow wander off into
the field toward the butcher's.
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- The new law cuts those juicy 20-year loans to 10 years.
Monthly payments will jump accordingly.
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- Also, the new law requires borrowers to repay these loans
even after bankruptcy.
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- The banks asked Congress to intervene and make things
less risky for the banks. Congress did as it was told, but there will
be a cost: the doubling of the minimum-balance monthly payoff. That will
hit borrowers like any unexpected bill does. They will have to adjust
their monthly budgets.
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- This will come at a time when gasoline price increases
are already forcing major budget readjustments.
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- So, it will become more difficult for banks to increase
the number of takers when they advertise their "low, low, low"
rates. An asset that had been ideally suited for growth -- a long-term
loan based on low monthly payback -- will now find new market resistance.
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- Here is the assessment of business journalist Dana Blankenhorn,
who has been in the field for 25 years.
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- Faster write-downs of credits by borrowers means fewer
assets for credit card banks. Forcing borrowers to pay back their loans,
even after bankruptcy, means those assets can't be written-off, and those
bankrupt borrowers can't be extended new credit. It's a squeeze on bank
assets, from both sides of the ledger. So two things happen, even in the
best of all possible worlds. Assets decline, while new assets become harder
to generate.
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- For the industry that, more than any other, is an industry
of contracts -- banking -- a change in the terms of contracts can have
repercussions. The bankers know what's coming. The average Joe, who is
up to his eyeballs in credit card debt -- maxed out -- doesn't see what's
coming. He will in November, when he gets his new bill on his credit card
statement. It's the law!
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- Millions of people (I have no idea how many, but the
number may be in the 10s of millions) are already at their limits, squeaking
by and paying the minimum on their credit card balances. To protect themselves,
the banks made it the law that rates on balances that fall past-due automatically
jump to over 30%. But this is, in fact, no protection at all. The banks'
assets are frozen, and while they might be paid back in time, the chances
of raising more assets (remember, loans are assets to the banks) declines
dramatically once the hammer falls on borrowers.
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- THE MORTGAGE MARKET
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- New home owners have gotten in late. They are paying
up to half of their monthly take-home pay to live in their newly purchased
homes. Property taxes have not been hiked. This tax hike is coming. OPEC
is also squeezing them. Now comes the new bankruptcy law.
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- People have been encouraged (by subsidies, and the fact
that banks can always sell their loans to Fannie Mae and Freddie Mac) to
create a mortgage "asset bubble," with interest-only and adjustable-rate
loans. People were then encouraged to furnish these palaces through credit
cards or second-mortgages.
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- This has happened nationwide, not just in the areas where
the supply of new housing has been tight.
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- So let's say you're stretched and October rolls around.
The credit card bill jumps. The natural inclination (the one encouraged
by banks) is to tap the home equity. But that may already be tapped. With
many tapped people forced to put homes on the market (to stave off bankruptcy)
a downward spiral begins. Home equity values fall, and with each turn more
over-extended homeowners find themselves with negative equity. Home equity
loans must be called, mortgage loans start to default, foreclosures add
more assets to the pile. (Those who deal in foreclosures are already cheering.)
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- No doubt, this chain of events in the housing market
will be described as a side effect of the new bankruptcy law. The biologist
Garrett Hardin once wrote that there are no side effects. There are only
effects. Those effects that are both unpleasant and unexpected are called
side effects.
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- The Federal Reserve will probably continue to announce
increases of .25 percentage points at the next three FOMC meetings scheduled
for 2005. This will push up short-term rates, which will negatively affect
the adjustable rate mortgage market.
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- Blankenhorn's conclusions are what mine were even before
I read his article.
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- My advice is to get in the best equity position you can
before the hammer falls. Look for stocks in companies that export. Look
for hard assets, foreign assets. The natural inclination in this situation
will be for the government to print more dollars, but the government too
is overextended, thanks to Iraq, pork and tax cuts, so when more dollars
are printed the value of each dollar falls. Thus, you don't want to be
in dollars.
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- He is speaking of dollars in relation to foreign currencies.
But it's better to be in dollars during the early phase of a recession
than to be in the stock market. He is predicting a recession. I will be
when I see the interest rate on 90-day T-bills above the 10-year T-bond
rate. We are approaching this scenario.
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- Get into cash, into hard assets, into foreign currencies.
You have two months. If I'm wrong you can always re-adjust the portfolio
next year. But I don't think I'm wrong.
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- And look at the bright side. Few knew, except in retrospect,
that AOL's takeover of Time-Warner in 2000 meant the end of the Internet
bubble.
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