Oct242014

Have lenders purged the Ponzis?

Delinquency rates on consumer loans hit a record low as lenders can-kick legacy loans and tighten standards to eliminate Ponzis.

Ponzi_wineThe financial media is abuzz with talk about tight credit and how it must be made looser to stimulate lending and the economy. This chatter, plus lenders’ natural desire to increase business, combines as pressure at the bottom of the credit cycle to prompt lenders into making bad loans again. But why did credit get this tight?

Once credit starts to contract, prices fall, and lending standards tighten until borrowers no longer default. If this were not the case, falling prices would cause large lender losses on the bad loans. Only the most creditworthy borrowers are extended credit, and these borrowers are required to put substantial amounts down to protect the lender’s loan capital. Once prices reverse, lenders start taking on more risk, more borrowers enter the buyer pool, and the cycle starts all over again.

The availability of credit cycles from periods of tight underwriting standards to periods of lax standards. When credit is tight is when credit-fueled markets like real estate are most stable. In a tight credit environment, lenders are very focused on ensuring the borrower can repay the loan and the lender can recover their capital if they don’t. It would seem obvious and intuitive that lenders would always be focused on those things, but competition tends to drive standards down as lenders take more risk.

In the early stages of the credit cycle, lenders begin extending credit to less creditworthy borrowers. This adds to the borrower pool, and in the case of real estate, it adds to the buyer pool. This influx of new buyers is an increase in demand which causes prices to rise. Rising prices give lenders greater assurance they will recover their capital in the event one of these less creditworthy borrowers defaults. In fact, the entire subprime business model was built on this phenomenon.

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Subprime always had high default rates, but as long as the inflow of new subprime borrowers was strong, prices would rise and subprime lenders would not lose much money when they foreclosed. In essence this is a Ponzi scheme because it only succeeds as long as prices are rising. Once prices stop rising, the high default rates cause huge losses which wipes these lenders out.

For credit to expand and standards to loosen, poor credit risks including people running personal Ponzi schemes must be purged from the system. Only once the Ponzis are gone is it safe to expand credit, hopefully to new stable borrowers rather than Ponzis-in-training.

All signs point to us being at the bottom of the credit cycle. Interest rates are low, delinquencies are low, complaints about tight credit are common, and aggregate credit balances are rising again. Have lenders finally purged the Ponzis? If so, we are at the bottom of the cycle, and credit can safely expand again.

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Why Americans are paying their loans on time

By Ruth Mantell, Published: Oct 7, 2014 3:08 p.m. ET

WASHINGTON (MarketWatch) — Consumers are paying their bills on time, with a barometer of their lateness falling to a record-low rate, thanks to better habits, stricter lending standards and an improving economy, according to a report released Tuesday.

I would like to think better habits were part of the deal, but realistically, the improving delinquency rates was due to lenders following stricter lending standards and not giving loans to borrowers with bad spending habits.

A gauge that tracks delinquencies in eight major types of closed-end loans, such as credit to buy cars or pay for property improvements (home-purchase mortgages aren’t included), dropped in the second quarter to 1.57% — the lowest rate in the data’s four-decade history, according to the American Bankers Association. The delinquency rate shows the share of loans for which borrowers’ payments are at least 30 days late.

The delinquency rate in the second quarter was down from 1.63% in the first quarter and 1.76% in the year-earlier period.

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Record low delinquencies is a clear signal of the bottom of the credit cycle. The low reached in 2004 was a false reading caused by a rapid expansion of credit and the profusion of personal Ponzi schemes. When the alternative is delinquency, people will borrow money to pay bills, the modern Ponzi scheme.

At least a few major trends are playing out here. One, while the economy isn’t firing on all cylinders yet, the labor market is firming and shoring up family finances, said James Chessen, ABA’s chief economist.

The fact that the economy is not doing well is a direct result of the collapse of millions of personal Ponzi schemes.

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“There has been a steady improvement over the last three years,” Chessen said. “When you have jobs, growing income and wealth increasing, and a concerted effort by consumers to deleverage and manage their debt in a better way, that all leads to lower delinquencies.”

That’s all wishful thinking and nonsense. The real improvement was caused by lenders cutting off the Ponzis.confident_Ponzis

Also, with the financial meltdown still casting a shadow over family finances, borrowers are behaving better and lenders have imposed stricter standards, he said. Rather than letting bills pile up, consumers are paying off their balances each month.

“There were some hard lessons learned,” Chessen said. “Consumers are making purchases, but not adding as much to their debt levels. Will consumers continue that good behavior over the next 10 years? It’s hard to say.”

The consumers today will continue their good habits, but the expansion of credit will bring in a new generation of Ponzis who won’t be so well behaved.

Here are recent delinquency rates for the eight types of closed-end loans (these loans have fixed amounts of money, fixed repayment periods and regularly scheduled payments) tracked by the composite ratio:

  • Personal loan delinquencies fell to 1.62% in the second quarter from 1.73% in the first quarter
  • Direct auto loan delinquencies fell to 0.72% from 0.76%
  • Indirect auto loan delinquencies fell to 1.55% from 1.74%
  • Mobile home delinquencies rose to 3.56% from 3.37%
  • RV loan delinquencies fell to 1.09% from 1.14%
  • Marine loan delinquencies fell to 1.34% from 1.42%
  • Property improvement loan delinquencies fell to 0.97% from 1.00%
  • Home equity loan delinquencies fell to 3.36% from 3.57%

ABA also tracks delinquencies for open-end loans (the balance changes depending on a borrower’s use):

  • Bank card delinquencies fell to 2.43% from 2.44%
  • Home equity lines of credit delinquencies fell to 1.50% from 1.57%
  • Non-card revolving loan delinquencies rose to 1.92% from 1.79%

These are all good signs. The stage is set for credit expansion and an improving economy. Let’s hope lenders aren’t off to the races again.

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