The Debt Bubble Is Beginning To Burst

There will be numerous excuses issued today by perma-bull analysts and financial tv morons explaining away the nearly 10% drop in new home sales.  Wall Street was looking for the number of new homes, as reported by the Census Bureau, to be unchanged from June.  June’s original report was revised higher by 20,000 homes (SAAR basis) to make this month’s huge miss look a little better.  The primary excuse will be that new homebuilders can’t find qualified labor to build enough new homes to meet demand.

But that’s nonsense.  The reason that home builders can’t find “qualified” labor is because they don’t pay enough to compete with easier alternatives, like being an Uber driver, which can pay nearly double the wages paid to construction workers.  I had a ride with a Lyft driver, a family man who moved to Denver from Venezuela, who to took a job in construction when he moved here.  As soon as he got his driver’s license, he switched to Lyft because it was easier on his body and paid a lot more.  If builders raise their wages to compete with alternatives,  they’ll be able to find plenty of qualified workers but their profitability will go down the drain unless they raise their selling price, in which case their sales will go down the drain…which is beginning to happen anyway.

Toll Brothers, which revised its next quarter sales down when it reported yesterday, stated that new home supply is not an issue in the market for new homes.  No kidding.  I look at the major public builders’ inventories every quarter and every quarter they reach a new record high.

The real culprit is the record high level of household debt that has accumulated since 2010. The populace has run out of its capacity to take on new debt without going quickly into default on the debt already issued.  Mortgage purchase applications are a direct reflection of this.  Mortgage purchase applications declined again from the previous week, according to the Mortgage Bankers Association.  In fact, mortgage applications have declined 14 out of the last 20 weeks.  Please note that this was during a period which is supposed to be the seasonally strongest for new and existing home sales.  Furthermore, since the beginning of March, the rate on the 10-yr bond has fallen over 40 basis points, which translates into a falling mortgage rates.  Despite the lower cost of financing a home purchase, mortgage purchase applications have been dropping consistently on a weekly basis and at a material rate.

The NY Fed released its quarterly report on household debt and credit last week. In that report it stated, “Flows of credit card balances into both early and serious delinquencies climbed for the third straight quarter—a trend not seen since 2009.”

The graph above is from the actual report (the black box edit is mine). You can see that the 30-day delinquency rate for auto loans, credit cards and mortgages is rising, with a sharp increase in credit cards. The trend in auto loans has been rising since Q1 2013. The 90-day delinquency graph looks nearly identical.

I’m not going to delve into the student loan situation. Between the percentage of student loans in deferment and forbearance, it’s impossible to know the true rate of delinquency or the true percentage of student loan debt that is unpayable. Based on everything I’ve studied over the past few years, I would bet that at least 60% of the $1.2 billion in student loans outstanding are technically in default (i.e. deferred and forbearance balances that will likely never be paid anyway). In and of itself, the student loan problem is growing daily and the Government finds new ways to kick that particular can down the road. At some point it will become untenable.

The auto loan situation is a financial volcano that rumbles louder by the day. Equifax reported last week that “deep subprime” auto delinquencies spiked to a 10-year high. Deep subprime is defined as a credit score (FICO) below 550. The cumulative rate of non-performance for loans issued between 2007 and Q1 2017 ranges from 3% (Q1 2017 issuance) to 30%. The overall delinquency rate for deep subprime loans is at its highest since 2007. To make matters worse, in 2016 deep subprime loans represented 30% of all subprime asset-backed securitizations.

Combined, the percentage of auto, credit card and student loan delinquencies and rate of default is as big or bigger than the subprime mortgage problem that led to the “Big Short.” To compound the problem, the nature of the underlying collateral is entirely different. A home used as collateral has some level of value. Automobiles have collateral value but a shockingly large number of borrowers have taken out loans well in excess of the assessed value of the car at the time of purchase. Unfortunately for auto lenders, used values are in a downward death spiral. Credit card and student loan debt have zero collateral value.

NOTE: The stock market has not priced in the coming debt apocalypse nor has it begun to price in at all the upcoming Treasury debt ceiling/budget fight that is going to engulf Capitol Hill before October. The Treasury apparently will run out of cash sometime in October. Supposedly the Fed has a back-up plan in case the issue can’t be resolved before the Government would be forced to shut-down, but any scenario other than a smooth resolution to the debt ceiling issue will reek havoc on the dollar, which in turn will send the stock market a lot lower. In my view, between now and just after Labor Day weekend is a great time to put on shorts.

5 thoughts on “The Debt Bubble Is Beginning To Burst

  1. The sub prime is turning radioactive. Yesterday here in The UK a sub prime lender Provident financial shares fell 74%. They are a door to door lender. They cut their dividend and the CEO resigned (amusingly called Mr Crook) The regulator is now investigating part of their business.

    “The huge reversal in fortunes is down to a big change to Provident’s business that has gone awry. Debt collection rates plummeted from 90% in 2016 to 57% after the company changed from using self-employed agents to full-time “customer experience managers.” Customers are also borrowing £9 million a week less.”

    “Provident offers door-to-door loans to subprime borrowers who would usually be turned away from traditional lenders.”

    Now this is quite a small outfit, but I think it just reinforces what you are saying is going on in the sub prime market. People are maxed out on debt.

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