Who’s Going To Stop The Madness?

by Dave Kranzler, Investment Research Dynamics:

Every month consumer debt in aggregate hits a new record. Auto loans and student loans have been hitting monthly record highs for quite some time. In November credit card debt hit a record high in total and increased a record monthly amount for any one month. Mathematically this can’t go on forever. In fact, there are signs – indicators not reported widely by the financial media and, predictably, completely disregarded by Wall Street – that indicate the debt party is coming to an end. Events that follow the end of the party will be less than pleasant for the majority of U.S. households.

Every week in the Short Seller’s Journal I present data which reflects the deteriorating condition of middle class America. For definitional purposes, “middle class” is defined as any household that is unable to afford their own politician, which means 99.5% of all households.

As an example, buried in Wells Fargo’s Q4 earnings presentation was data that showed charge-offs in WFC’s credit card loan portfolio in Q4 soared 21% vs. Q3. The charge-off rate as a percent of average loans outstanding increased to 3.66% in Q4 from 3.08% in Q3. This is a 19% increase in the charge-off rate. While this might seem like a low number outright, not only is it headed in the wrong direction, it’s not too far below the nationwide bank credit card charge-off rate in 2007 of 4.15%. Again, this fits my thesis that the financial condition of the average household is deteriorating.

In addition, the dollar volume of auto loan originations at WFC declined 33% and home mortgage originations fell 26%. in Q4 2017 vs 2016. WFC’s mortgage applications in Q4 dropped 16% in dollar volume from Q4 2016. And its application pipeline (applications submitted and waiting for the purchase to close) declined 23% for the quarter vs Q4 2016.

WFC is the second largest mortgage originator after Quicken Loans. It is also a major player in auto loan underwriting. If auto and mortgage loan origination statistics are declining at a double-digit rate at WFC, it’s a good bet that this is a secular trend across the industry. Simply put, middle America – the 99.5%’ers – are running out of capacity to assume even more debt. This in turn will translate into a unexpectedly precipitous drop in consumer spending, especially on large-ticket items like cars, furniture and homes.

I stumbled on a blog a couple weeks ago called  A Cold War Relic. The proprietor works at an auto dealership and presents valuable insight on the factors that will drive auto sales into the ground and send auto loan defaults soaring. His latest post, “What’s Going To Stop Me,” is well worth reading:

This dark momentum could strangle the industry, but everyone refuses to stop it. Every time a customer accepts a $500 monthly payment on another overpriced compact crossover, they are feeding that momentum. When dealers structure deals for far more than the car is worth, they are feeding that momentum. The problem is: who is going to actually tell anybody “no?” Customers want their cars and refuse [do not have the funds] to put money down to get them. A large number of dealerships are fighting to attain sales numbers the market can’t currently support.

I get cursed out every month when our store misses the targets set for us by the manufacturer, even though I’m fighting against larger stores offering deeper discounts on new cars. On top of that, it’s not just your credit criminal customer that isn’t reading what they’ve signed anymore. When you have consumers with 700+ FICO scores rolling over portions of debt they already couldn’t handle on top of new debt and financing the whole thing over increasingly long terms at interest rates they arguably no longer deserve. The problem is that prime credit customers are slowly becoming credit criminals.

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