Turns out the whiz kids in Silicon Valley aren’t the only ones playing with funny money these days. So are mom-and-pop Americans.

In the same week that Facebook (FB) plunked down $12 billion in stock to buy WhatsApp, the latest report from the Federal Reserve Bank of New York revealed that U.S. consumers don’t mind spending money they don’t have in the bank, either.

In the last quarter, household debt increased by $241 billion, the biggest rise in more than six years.

Is this a legitimate cause for concern or merely symptomatic of a legitimate economic recovery?

The answer matters immensely to our overall investment outlook. So let’s discuss…

[ad#Google Adsense 336×280-IA]From Deleveraging to Releveraging

As we all know, consumer spending drives the U.S. economy. The more spending there is, the more optimistic we should be about GDP growth.

Of course, since we’re not a nation of savers like, for example, China, most of that spending gets financed. Put simply, we borrow to grow.

Therefore, as Tim Duy, a former U.S. Treasury economist, told Bloomberg recently, “Signs that consumers are starting to releverage again and take on more debt are consistent with the idea that we’re turning a corner on the recovery.”


But let’s not be naïve, Mr. Duy. Everyday Americans don’t exactly possess a stellar track record of borrowing responsibly.

We tend to borrow, and borrow, and borrow some more until lenders tell us “no.” As it stands, 28% of Americans now have more credit card debt than cash in their savings account, according to a recent Bankrate.com survey.

My point? We need to keep a careful watch on consumer behavior for signs of excessive borrowing. Because it always leads to ruin.

The good news? There’s nothing to panic about (yet).

Far From the Brink

We’re nowhere near peak borrowing levels again. In fact, total indebtedness remains 9.1% below the high-water mark of $12.68 trillion hit in 2008.

Delinquency rates on all types of debt, except student loans, are trending lower, not higher. Ditto for bankruptcy filings.

Here’s what concerns me, though…

At the same time as consumers are forgetting about their financial sins of the past and leveraging up again, banks are encouraging it.

They’ve been quietly extending more credit to consumers. Total aggregate credit card limits increased by 5% in the last year to $2.91 trillion. That’s the highest level since late 2009.

Even more troubling… banks, including Wells Fargo & Co. (WFC), are loosening credit standards on mortgages.

And believe it or not, subprime loans are making a comeback, too. Only this time, industry insiders are calling them “nonprime” loans.

(Lipstick on a pig, anyone?)

“The word ‘subprime’ in a lot of people’s minds is dirty, but the product today is much different, much safer.” So says Brian O’Shaughnessy of Athas Capital Group, which began making subprime loans about nine months ago.

Given higher down-payment requirements and stricter verification processes, O’Shaughnessy makes a valid point.

To be fair, at about $3 billion, the current amount of subprime lending qualifies as a mere trickle compared to the $625-billion flood we witnessed in 2005.

Nevertheless, we can’t downplay the significance of the re-emergence of subprime lending. It signals a key transition to more risky behavior.

And I’m afraid it’s not the only example…

More Risky Business

One of the newest investment fads on Wall Street involves slicing and dicing debt tied to single-family homes and selling the bonds to investors.

Does the term “financial weapons of mass destruction” sound familiar?

It should, because collateralized debt obligations (CDOs) like this, which went south, are what ultimately sparked the credit crisis.

But Wall Street assures us that it’s different this time. (Don’t they always?)

You see, instead of securitizing mortgages of actual homeowners, they’re securitizing the mortgages of investors who purchased homes and turned them into rental properties.

Private equity giant, The Blackstone Group (BX), sold the first of these single-family rental bonds last year. The $479-billion offering attracted six times that amount in demand.

I’m sorry, but the new twist on securitization doesn’t fool me. It’s just as potentially dangerous, as it allows well-heeled investors in single-home rental properties to leverage up and buy even more homes.

Like I said before, there’s never a happy ending to excessive borrowing.

Bottom line: It’s not time to sound the alarms yet. Clearly, though, attitudes and actions involving debt are shifting, sowing the seeds for another financial crisis.

We’d be wise to keep a close watch on these trends.

Ahead of the tape,
Louis Basenese


Source: Wall Street Daily