How Are the Green Shoots Doing? Well . . . .

Back in early May, we gave an overview of the stock market and the economy. We left open the question at the end whether some signs of life in the economy – so called "green shoots" of spring – marked the beginnings of recovery. Some six weeks later, we still have no conclusive evidence. But here are some factors.

Jobs, Spending and Housing Are Not as Weak
Retail store sales seem to have turned upward. After notable weakness in March and April, the May figures picked up by 0.5%, a quite respectable one-month gain. Most of it was higher gas station sales owing to the higher prices we've begun to suffer again, but even aside from that, other stores showed net gains. Not big, but encouraging.

Employment was still down in May, but that report surprised with the smallest decline since last September; while jobs still fell by 345,000, they had declined an average of 605,000 each of the prior seven months. It feels odd to express pleasure over 345,000 jobs lost, but we'll take what we get here. Construction and service sector job losses moderated, with retailing actually increasing the number of its employees, one of the few non-government sectors to do that.

Housing activity has stopped falling. New construction "starts" on one-family homes, that is, ground-breakings, increased for three consecutive months through May. Sales of these houses were still weak through April (latest known today; more data due later this week) but are up from a January low. The levels of these starts and sales, at 350,000-400,000, remain near record lows for the 50-some years the U.S. Census Bureau has collected these data; a healthy volume of starts has been about 1.5 million. Extraordinarily low mortgage rates, below 5%, gave some hope that activity might pick up. Historically, a recovery in housing has been one of the main forces pulling up the entire economy. But then, around June 1, mortgage rates rose sharply, surpassing 5% for the first time since early March and reaching 5.59%, the highest since last Thanksgiving. Last week, they retreated a bit, but such a sudden upshift is troublesome if the fragile sector is to develop a full-blown recovery.

But Higher Mortgage Rates and Gas Prices Raise Concern
So we've identified two concerns as we ruminate on the economy's fortunes: higher mortgage rates and higher gasoline prices. Both of these can act like weeds among the green shoots, choking them off just when they might be developing into nice plants. Fortunately the very latest moves in both show some easing; besides last week's easing in mortgage rates, gasoline prices were flat to down very slightly. And food prices remain moderate. The grain and meat prices that were so high and distressing at this time last year have largely given way; chicken is an exception, but beef, pork and even turkey prices are considerably lower now. This helps offset the pressure on tight consumer incomes from the recent surge in gasoline.

So compared with our last assessment, we're probably mildly more optimistic that outright recovery can come soon. Our hesitation seems to be joined by stock market investors, who push stock values higher, but then get nervous and push them back down. This happened yesterday with a 200-point drop in the Dow Jones average. One reason the press cited for the drop was a downgrading of the world outlook by the World Bank. That highlights an important aspect of the likely pattern of news going forward. The economy and the markets are in fact much improved over their chaotic states last fall. But bad news about the repercussions of this entire meltdown scenario will continue for some time. In our view, a poorer outlook for developing countries, while sad, is still to be expected in this chain of events. Further, and closer to home, we are likely for many months to have bad news about jobs and unemployment. Traditionally, companies wait quite a while after sales begin to turn up to commit to a larger workforce. In this age of instant information, we will be impatient to have better news right away, but don't fret. If the economy's improving trend is sustained, that will come in due course, but not next month or the month after that.

Uncle Sam Giveth and Uncle Sam Taketh Away
Two other issues. We've repeatedly promised further comments on the auto industry, especially in the wake of General Motors' bankruptcy filing three weeks ago. Prospects for these companies depend crucially on auto sales themselves. These were up in May from April, but at 9.9 million vehicles, they remain more than 30% below a year ago. Still this was the best level since December, and a recent statement from the CEO of GM indicates that company is experiencing firm sales in June as well. This is significant, since it means their customers are not scared off by the bankruptcy proceeding and have faith that the company will be around for awhile to service and maintain the cars. The General Motors reorganization plan appears to take better care of "secured" creditors than Chrysler's did, but these are both unprecedented situations and taxpayers, of course, will have a majority interest in GM.

Which brings us to a final topic, the role of the federal government in current business and financial markets. The upturn in mortgage rates we talked about earlier stems in part from an upturn in U.S. Treasury rates that began back in the winter. Yields on 10-year Treasury notes have risen from 2.27% in mid-January to 3.63% today. Some argue that these rates have risen because of expectations of higher inflation; this view has some validity. But the cause is simpler, we think: in the last six months, the Treasury has issued more than $900 billion in new bonds and notes. With tax receipts weakened by the economy and spending increased by stimulus efforts, that's about twice as much debt issuance as the volumes that had prevailed for several years through last September. This topic is one that will take at least a whole article itself, but its importance for the moment is that since mortgage rates tend to follow Treasuries, the government's "stimulus" has come with a higher cost for new housing credit. We don't think it will totally undo the relief that mortgage and housing markets have already seen, but it doesn't help. And it's one more reason we're still skeptical about the strength of any recovery in the months ahead.

Credit Card Debt

It seems every week or so, just as we get going on a certain topic for Ways of the World, a new event occurs that upstages our current discussion. This time, of course, it's the General Motors bankruptcy. We had seen this coming, as we wrote here some time ago, and we do want to talk about it with you. But for today, we'll stick to our current program: some commentary on consumer borrowing and a little on the new law.

Americans had a total of $945 billion in credit card debt at the end of March, according to Federal Reserve data. Other government information tells that there were about 130 million households in the country at that time. These figures divide out to an average credit card debt per household of just over $7,200. A different Fed survey of consumer finances that covers 2007 indicates that half of the households who have a credit card had at least $3,000 in balances then. The constant publicity and recent legislation regarding credit cards suggests that this debt must still be growing, evidently without bound.

But this is not so. In the last six months, the total amount of credit card debt has started to go down. That is, people really are paying off more than they're adding in new charges. The graph below shows clearly that an unprecedented contraction in credit card debt is occurring.

In fact people are apparently constraining quite considerably their use of credit cards for new purchases. The Fed data also show that the rate of finance charges added to balances increased markedly in the first quarter this year to 13% from 12% in the prior quarter. So people's debt paydowns are large enough and their new charges small enough that their total balances are falling despite the higher interest costs.

Indeed, total consumer spending has been falling, an unusual development in and of itself. People have historically tended to keep expanding their outlays, even during recessions. They just increase spending more slowly then. But this second graph shows the striking difference now – and one big reason for it: the lower outlays for gasoline in recent months. Gasoline is one item we think people tend to charge heavily to credit cards, so this could be a factor in the reduced debt. But as we are all painfully aware, gasoline prices have tilted back up once again in the last couple of months, subsequent to the periods covered by our data here. So we will have to see what happens to the spending and borrowing figures yet to be published.

About those higher interest costs. There are probably several reasons they have gone up. This specific measure is the actual finance charges as a percent of the outstanding balances. One factor we can cite is higher delinquencies, eliciting more late fees on top of the interest. The delinquency rate for the first quarter (Q1) is 6.50%, up from 5.66% in Q4 and the highest ever in the 18-year history of this information; this means that people are more than 30 days behind making even a minimum payment on 6.5% of their outstandings. A second issue is probably higher interest rates; banks may be thought to profiteer in setting their rates, and indeed the new federal legislation addresses such a perceived strategy. On the banks' behalf, though, we would point out that risk is much higher now, so higher rates are not surprising and can even be seen prudent. And third, from a political viewpoint, the banks may well have wanted to raise their rates in anticipation of just such restrictions on them as were enacted last month. More rate hikes and other actions may come in the months ahead, before the various features of the law become effective.

The new law, the Credit CARD Act of 2009*, signed by President Obama on May 22, will help make the setting of credit card lending terms a less abrupt and more orderly process, requiring 45 days' notice for a change in terms, for instance. At the same time, we think a couple of the features are actually too hard on the banks. The banks probably set themselves up for the stricture against raising rates on outstanding balances. This is a popular item among consumers and likely reflects the often substantial hikes the banks forced on them; one example we saw was an increase from 12% to 24%. In contrast, floating interest rates on mortgages don't get doubled; many have a ceiling of 2% on each increase. Banks might well have followed such a more measured strategy with credit cards too. But we believe the banks deserve to be able to do something about the rates. In a mortgage or a car loan, there's a maturity date. The bank knows when to expect its money back – and it is the bank's money that we have spent up front – but in a credit card situation, the bank doesn't really know how long the customer will take to repay. So there's an added element of risk here that's not present with other kinds of loans.

And we're therefore even more concerned about the new rule prohibiting the banks from raising rates when the customer defaults on some other debt. This "no cross default" provision hardly seems reasonable to us, even if the customer is current on the credit card bill. Clearly, the customer carries more risk if they're missing other payments. But, yes, raising this rate would make the customer's life harder.

So none of this is as simple as it looks. These parts of the law would look to make high credit limits less profitable for banks, so they might well cut limits more. And we'd surmise that they will exercise greater scrutiny before granting credit to someone with spotty records elsewhere. Maybe they should have done that to begin with, but a good number of people are likely to be unhappy at getting rejected for a card in the first place or for an application for a higher limit. Maybe in the end, that would actually be to people's benefit.

----------------------------------------
*Credit Card Accountability, Responsibility, and Disclosure Act" – Credit CARD. Here's the White House Fact Sheet on the law: http://www.whitehouse.gov/the_press_office/Fact-Sheet-Reforms-to-Protect-American-Credit-Card-Holders/

And we also call your attention to an informative consumer website: http://www.creditcards.com/, which has rate quotes and other helps. It's the kind of catalog of credit card information that http://www.bankrate.com/ is for savings.

By coincidence, Debbie Loeb posted another helpful credit card site on Hodgepodge the same day as our original post here. See http://www.cardratings.com/. Thanks, Debbie!