Do Not Believe The Hype

Everything seems rosy with the banks. Everyday we see one report earnings and the stock prices go up regardless of what the numbers look like. First, we saw a government backed guarantee for these institutions with the TARP money. Then came the "cooking of the books" through the change in the mark-to-market regulations. This allowed the banks to alter how they wrote down the toxic debt they are carrying.

Well, if you have any sense you will see through this fluff. Mark my words: the banks will come crashing down again. They will sustain loses beyond comprehension. The government's "stress test", which I am sure all will pass admirably, will show the banks to be solvent under any conditions. Reality, sadly, will differ. We will see the banks suffer under an mountain of debt that comes crashing down. Defaults are going through the roof.

We are starting to see the first indication of this. Today, Capital One, one of the largest credit card issuer reported their 1st quarter earnings. Like many other banks, the numbers were not pretty. However, this is one that people should take note of. Capital One is a consumer credit lender. They are not into the mortgages and commercial real estate. Interest on credit cards are their game.

As you would imagine, they have a bit of exposure if people start to default at a higher rate (which they are). If you will notice, Capital One said losses will be higher than the $8.6 billion previously anticipated. They added almost $125 million to cover that this year.

Here is the problem: unemployment is rising. People in the market like to claim it is a lagging indicator of the economy. Under normal circumstances, that might be true. Yet, in this debacle it tells another story. We are most likely going to see close to 2 million more people lose their jobs in the next 6-9 months. Those people are going to encounter financial uncertainty like never before. This will start the onslaught of defaults.

The last time we saw a major recession was 1982. At that time, personal credit was restricted to a mortgage and, perhaps, a car loan. People simply did not have large credit card balances. That is not the case today. We presently have roughly $1.2 trillion in credit card debt out there. Keep in mind this is unsecured with no collateral backing it. The banks are totally exposed here.

So what is going to happen. I believe this default rate will jump to around 15% if we see unemployment move to the 10.5% rate. This will put the underemployment number closer to 20% which means 1 in 5 will be earning either none or only a portion of the money needed to survive. That will lead to a huge increase in the default rate.

What does this all mean? With $1.2 trillion sitting out there, a 15% default rate means $180 billion goes unpaid. That is a lot for the banks to absorb. In this era where the government issues $1 trillion stimulus plans, it is easy to lose site of how much money that really is. To give you some contrast, the entire infomercial industry generates $150 billion a year. The loses they will sustain are on top of all the other stuff presently affecting them.

The bottom line is to not believe the propaganda the Feds are delivering. There is a rough road ahead for all the banks. Capital One is a large creditor, but not the biggest. Citigroup and Bank of America also have billions of dollars worth of exposure. How much more do you think their balance sheets can take?

Things are grim. Consider that the next time you see some talking head on television spouting how the seeds of recovery are at hand. Things are going to get worse before they get better. Invest accordingly.

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