Possible Credit Dislocation: Be Warned

From The Market Ticker:

I have reason to suspect that the “monetary transmission mechanism” is full of rocks (again), and we are about to have another instance of what could colloquially be called “fun.” (Yes, that’s sarcasm.)

Here’s what we know and what I can deduce from it:

  • JP Morgan’s “cash position” was analyzed by a writer who published on SCRIBD, which showed that actual cash held has deteriorated radically.  By more than half in the last year.  The deterioration is continuing, not slowing.

  • I am hearing repeated anecdotes from multiple areas that foreclosed property held by banks with multiple full-price offers that include a financing requirement are being sold instead to people with actual cash at radical reductions from that price. This implies that these financing contingencies are regarded as not only potentially no good but factually no good, as if the banks know for a fact that the credit pipeline will (not might), within weeks or months (in the time required to close), disappear.  There is no other rational explanation for this behavior.

  • Citibank’s credit-card terms change implies a willingness to accept and even provoke a complete and intentional destruction of their credit card business as a very high probability outcome, given that nobody in their right mind will accept a 30% interest rate who has an alternative.  The obvious implication is that only those who can’t transfer balances out will remain and if your credit is that impaired there’s a good chance you will default – either intentionally or otherwise.  This too implies foreknowledge of a near-complete impending freeze in the credit markets.

  • The change in terms on credit accounts is NOT confined to Citibank. I have received a fax from a customer of Infibank with substantially identical terms, in which both the standard and penalty rate was adjusted to 29.99%.  This strongly implies that whatever Citibank smells the problem is not confined to them.

  • Both of these credit card “adjustment” letters are of course marginal rate changes.  That is, they are both based off the PRIME rate.  The importance of that is missed by many.  Don’t be one of them (more on that below.)

  • I recently received a back channel communication indicating that The Fed is aware that this has been and still is a solvency problem and has so briefed certain members of Congress.  This from a source believed reliable, but which cannot be independently confirmed.

This data is not conclusive.  But – if you are dependent on credit access and these anecdotes are in fact indicative of actual knowledge of an impending lock-up you are at grave financial risk.

Note that “margin” type rates that are based on the PRIME rate could hurt you far worse than you believe.  With PRIME at historic lows should any such dislocation spike the prime rate your interest rate could go much higher with little or no notice or ability to do anything about it.

IF this is going to manifest as a dislocation of some sort it will probably occur within the normal closing window for real estate transactions, since the anecdotes related to that have the best-defined “reach”, and the discounts being accepted to avoid this risk are massive to the point of denoting near-certainty of this event in the minds of the market participants who are electing to accept these cash-discounted offers.

Therefore, if you are dependent on such credit access I would take immediate action to do whatever is necessary to mitigate, to the extent you are able, the consequences of such a dislocation.

Consider how you survive returning to what essentially amounts to a cash economic posture in your business and personal life.

Note that the indications above are far stronger than what we saw going into last fall before the wheels came off.  As a consequence if these actions are those of people with real knowledge (and this is not a guess on their part) I would expect the outcome to be worse than what we saw last fall in terms of economic impact.

Those who are short dollars (synthetically or in the actual market) need to beware – if I am reading this correctly you’re about to get a really ugly surprise.

If you want to speculate on this outcome levered bets on radical dollar appreciation look like one of the best choices out there, followed closely by bearish levered bets on commodities.  I would not consider such a speculative play that is not characterized by defined risk, as this analysis is based on nothing more than observation of behavior by market participants that all point toward their foreknowledge of an event that might happen in the reasonably-near future and is not, at present, backed up with actual significant credit-spread widening or other objective criteria.

Disclosure: Initiated a small speculative, defined-risk play LONG the US Dollar (UUP CALL options for March 2010)

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