I know that it’s not always possible to avoid having one more monthly payment. Things happen, and life’s circumstances sometimes make borrowing unavoidable.
I get that. Recently I needed to fly out to the West Coast for a family funeral. I didn’t have the extra funds, so it all went on the credit cards. Unavoidable. But what can you do?
So, I’m not talking about those essential payments that you have to make. And turn out to increase your debt profile.
Today, we’re looking at something different from that; we’re looking at those optional payments, those “I wanna…” that come along. Something that might be nice to have, but is not essential.
Those are the items that I’m encouraging you to postpone.
Why?
Before we begin, let me give you the standard disclaimer: I’m projecting into the future what I think will happen, and how I see the economy evolving. I may be wrong, and things may not turn out the way I think they will a year from now. I can live with that. If that happens, you will have just postponed a couple of extras that you’ve already said you can live without.
OK, that said, let’s go.
Here’s where I think we’re headed. Inflation is already rearing its ugly head, driven by the Iran conflict and the commensurate rise in energy prices; we’re seeing it begin to take off.
This is an early call. In June, the latest reported month, the Consumer Price Index stood at just 3.5%, down from 4.2% the month before. From the short-term perspective, it may appear that inflation is improving.
But hold on. In 10 months last year, the inflation rate was in the 2% range, only hitting 3% twice, in January and September. And in those two months, CPI Inflation was just 3%; now we’re at 3.5%. That extra 1/2% matters.
It all put that nation’s central bank, the Federal Reserve, in a bind. Despite a new Chairman, Kevin Warsh, and the President asking for lower rates, it looks like the Fed will now need to RAISE interest rates. Something that nobody wants, but now seems inevitable.
However, in the end, it might not matter to you and me, the average American consumer. That’s because the banks you and I have our credit cards, home loans, and consumer loans with are already raising their interest rates.
Six years ago, the average credit card rate was just 16%; eight months ago, the average credit card interest rose to 20.78%, a 4 3/4% increase.
What’s more, if you thought you could avoid these high credit card rates by getting a personal loan, it doesn’t look good. We’ve all seen those advertised personal loan rates at 5% or higher. But have you tried to qualify for one? I went through the exercise to see what I’d find. As a retired homeowner with excellent credit, the best rate I could get was 30%.
Now I’m sure that someone who is 20 years younger, with a well-paying job, and excellent credit could secure a much lower interest rate; perhaps the 5% advertised rate applies to them.
But the point is that if you’re outside the bank’s preferred target customer profile, you’re unlikely to secure those advertised rates.
And this should be a warning to the rest of us, those who don’t fit the target group – try not to borrow.
At this point it’s time to raise the curtain on what’s behind the bank’s thinking. It’s the real reason banks are so persnickety on who they want as customers, at this time in the financial cycle.
If you’ve noticed those credit card offers that used to stuff your mailbox have diminished to almost nothing. Most banks, with a couple of exceptions, are no longer looking for new customers. Instead, they’re just trying to preserve their current client base.
Take a look at the country’s number one bank, JP Morgan Chase. Over the past year, JP Morgan has doubled its loan loss reserve, from $2 billion to $4.2 billion. Now, a bank’s loan loss reserve is an estimate of how many bank customers will fail to repay their loans.
Banks are experts at this particular estimate; they have to be. Whether a bank survives a coming financial crisis depends on whether it has estimated how many loan defaults it will have. After all, the bank will end up paying the defaulted loan themselves – a loan loss.
So, this should be the screaming headline on every financial publication: JP Morgan doubles its loan loss reserve. But no, just silence. Instead, banks increase your credit card interest rate and other loan interest rates (remember that 16%-20%+ increase?).
The banks don’t want you and me to leave. We’re the ones who pay our bills on time, and have a good credit score because of it. The banks want us to continue to pay our bills on time. And further, they’d like us to pay a little extra, because our neighbor might default. The bank can use the extra fee income from us to offset the loss from our neighbors.
That’s how it works.
Most people fail to realize that the financial world is constantly changing, progressing from expansion to contraction. Going from times when money is easy, loans are plentiful, and interest rates are low.
To times when all that reverses. Loans become hard to get, interest rates rise, and banks increase their loan loss reserves. These times often lead to recessions.
And I believe that’s where we’re headed.
