Consumer default; the next salvo?

SMARTSHARE

The August derivatives faded into history on August 30 with the September Nifty Futures going abegging at 59 points. Other things being equal, it indicates that punters are not gung-ho going forward.

We have begun the September series with an open interest of Rs 59,640 crore, around Rs 9,000 crore less than what it began the August series with. This gives a feeling of being light, which leaves enough elbow room to build positions without being over-burdened.

With effect from September 6, fourteen new stocks have been admitted into the derivative stable, taking the number of stocks to 207. Indices traded remain at 5. Last time, when a crop of 31 stocks was added from May 14, they had done pretty well in that settlement.

Possible intervention by the Central Banks, in the US or back home in India, could prop our markets for a while. But after the clinking of the champagne glasses stops and the effect of the painkillers wears off, we will need some hot bottles to smother the pain of the writhing markets. Another lesson the markets will quickly learn is that there is no de-coupling from the US markets.

Like-minded bears in the US are waiting for the markets to reopen on Tuesday, after the Labor Day Holiday. Most banks in the US close their third quarter books on August 31. I would not be surprised if bad news pops up after the Labor Day holiday. If you think that you have had enough of mortgage news, wait till a large bank admits to its follies.

The opening of its war chest by the US Fed has not helped matters as yet. Outstanding paper fell by $62.8 billion, or 3.1 per cent, in the week ending Wednesday to $1.98 trillion, bringing the total decline in the past three weeks to $244 billion, or 11 per cent, according to the Fed.

An estimated $1 trillion in commercial paper will mature in the next few months. As commercial paper expires, companies are forced to rely on previously arranged bank credit lines or arrange other financing. In the current environment, finding financing for maturing mortgage-backed paper has been difficult, and that's led to a squeeze on mortgage lenders.

After the corporate liquidity crunch, it may be the turn of the consumer credit defaults to ruin the US markets.

The months of May and June saw spikes in the amount of revolving debt carried by consumers, with increases of 12.2 per cent and 8.4 per cent respectively. Consumer spending, on the other hand, was relatively stable.

Read together, the evidence on hand suggests that the consumers were using their credit cards to pay their bills, rather than splurging on consumption. Going forward, consumers are going to slowly run out of credit card limits and then default on payments. Some lenders are becoming more cautious about extending credit in weaker housing markets and to people who may have exposure to certain riskier mortgages.

People were earlier using home equity appreciation to stay out of trouble with their credit cards. With prices tumbling, that's not a possibility anymore.

The Federal Deposit Insurance Corporation recently reported that late loan payments grew by 36.2 per cent on a YoY basis. The key data point here is that late payments are rising on all types of consumer loans, indicating that consumers are facing difficulties servicing debt of all types.

One in three auto-loan borrowers have payments greater than $500 a month, and 12 per cent have been late at least once. Monthly repossessions by lenders increased 15 per cent last year.

Whether it's auto loans, credit cards, mortgages or any other credit, a lot of the lending-related malaise is due to consumers who chose to live above their means.

Right now, the brunt of this problem is concentrated within mortgage lending, but it stands to reason that it's going to spread to credit cards, auto lending, and other types of lending soon. Markets ignored the oncoming mortgage crisis even though there were plenty of signs that it was coming. Expect the markets to play ostrich again.