credit card grace period law
Knowing The Recession
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This article is a successor for an article I wrote on October 11, 2007 during which I suggested that the recession can be far worse than a lot of people believed and that the affect on stock market trading, the economic climate, economic vitality and inflation might be significant. Inspire the week after Thanksgiving weekend in addition to being I contemplate last week’s market sell-off which week’s dramatic rally, I do know that the stresses have grown more evident and i can’t help but contemplate what might certainly be in store for pick up.
For the positive side we have been almost six years into an expansion plus the US economy is maintaining growth albeit at the slower pace. Unemployment remains low except in sectors relevant to housing yet it’s edging up. Corporate profits have already been good in 2010 however they declined a little inside the third quarter. Until the first full week of November the stock market indices were at or near all time highs, regarded late trading continues to be increasingly volatile. The loan crisis of August now is apparently only a problem with the financial sector to control. The Fed has lowered rates 3 times indicating it wants to protect the economy. On top the situation is looking OK.
But look beneath the surface mnblkjhq along with the picture changes. The credit crunch has lost its crisis atmosphere however, many sectors with the credit markets remain paralyzed. This paralysis is currently affecting businesses and consumers in areas besides property. Equity investors are nervous as evidenced with the stock market’s extreme volatility. The Dow was 1,000 points off its all time high plus the S&P 500 being down year-to-date, though both bounced back on rate of interest cut hopes. The housing market is within a deep recession moving towards a depression. Declining home values are siphoning off huge amounts of consumer wealth while rising food and price is eating into family budgets. Unemployment is edging up in most states and consumer confidence are at a two-year low. Consumer inflation is 3.6% year-to-date and edging higher. On top of it all, we have been entering an election year and geopolitical events tend to be more unstable and dangerous than they are since WWII.
As consultants, business owners and senior executives our job might be aware of what on earth is happening on earth, anticipate how events might impact our clients or our businesses and turn into before the curve by taking action to mitigate identified risk. We’re not able to relax because things are running smoothly now. We’ve got to look ahead at what might or might not be.
I see seven interrelated threats that companies, senior executives and Boards of Directors should understand, anticipate and cover that allows you to minimize the negative consequences should several of these be realized. The primary threat may be the growing recession because for the way after enough time it unravels it might bring about any or even more in the other six – depression, recession, inflation, stagflation, legislative action unfavorable to business and geopolitical crisis. This can be a businessman’s effort presenting the important points in a way that enables other your list to generate sense of all this.
The financial lending Markets
Perhaps the greatest risk towards the economy and our businesses is based on the financing markets. While the credit markets have calmed down ever since the crisis atmosphere of August, the base problem still exists as evidenced by the insufficient liquidity inside the capital markets and also the huge write downs being taken at public financial institutions. Now it is understood the ultimate seriousness of the loan crisis still remains in sight, and folks are beginning to recognize that for the way it unfolds it could actually result in any or all of recession, inflation, stagflation and geopolitical upheaval.
Now it is clear that this massive amount of debt underlying the globe financial state is a chance of unwinding due to collateral defaults. The primary focus with the matter are Collateralized Debt Obligations, or CDOs. CDOs are derivative securities, like based on another asset. Trillions of dollars of these instruments are intended and sold within the last few six years. As outlined by Satyajit Das, one of the world’s leading experts in derivative securities for more than Twenty years, $1.00 of real capital supports $20.00 to $30.00 in loans. This means each dollar is leveraged 20 to 30 times! He estimates derivatives outstanding to become $485 trillion, or eight times global gross domestic product of $60 trillion. The scary thing is that no person really knows for sure who holds all this paper.
The catch is global then there is only a limited amount the Fed or any other central banks is capable of doing to handle it. The reason being a lot of the problem is based on the unregulated shadow banking system[1] looked as the main alphabet soup of highly levered non-bank investment conduits, vehicles and structures. The effects of securitization is the fact credit risk moved from regulated entities where it might be observed to places where it had been unregulated and hard to observe. Without regulators and keep an eye on cross-border flows and quality standards, investors really didn’t really know what we were looking at buying or what it was actually worth.
U.S. ingenuity: In the post dot com bubble and 9/11 world of ultra low interest, US Banks saw their net interest margins shrink along with their loan volume which negatively impacted profits. To ensure the banks developed ingenious ways of creating significant fee income by bundling volumes of consumer (many low income) and leveraged buy-out loans into just what are called Asset Backed Securities (ABS) to be removed to institutional investors like “bonds”. The investors then start using thise ABSs as collateral for the next high-yielding debt instrument known as a Collateralized Debt Obligation. These CDOs were purchased by Asia and Mid-East governments, hedge funds and pension funds seeking rated high-yield instruments by which to fit their mountains of emerging markets cash. Financial engineers built towers of securitized debt with mathematical models which are fundamentally flawed, while managers overloaded on high-yield debt instruments they didn’t understand. All on the way financial institutions pocketed huge fees while shifting trillions of dollars of risk off their balance sheets and into your hands of investors. Approximately this past year alone Wall Street bankers (such as money center commercial banks) generated $27.4 billion in fee income from the origination, securitization and sale of exotic Asset Backed Securities.
Due to low interest rates in the united states and Japan most CDOs were bought with borrowed money. In other words, borrowed money bought borrowed money. Due to high people’s credit reports the CDOs might be used as collateral for more borrowing. These triple borrowed assets were then used as collateral for commercial paper purchased by risk adverse money market funds. If your assets underlying these securities commence to default in huge numbers (sub-prime loans), the CDOs lose value and the institutions holding them incur losses. And because nobody knows for certain who’s going to be holding this paper many people are scared of dealing with new counterparty risk. The financing markets become illiquid and several banking companies finish up holding quite a bit of CDOs for the purpose there is no or limited market.
Asset Backed Security basics: Let’s take collateralized mortgage obligations (CMOs) considering they are the best to comprehend. Into their simplest “pass through” form banks as well as other lenders originate loans, warehouse them for a brief time, package them in to a bond, possess the bond rated and then sell the link to investors. As opposed to making money through the net interest margin within the lifetime of the root loans, the originators earn origination fees and payments from servicing rights. Investors who buy CMOs are purchasing future cash flow from your underlying loans’ principal and rates of interest. As the CMO is rated through the rating agencies the investment price equals the long run profit discounted into a yield like rating on the bond. The benefit of this technique to the originator would be that the fees comprise front, the servicing rights offer an ongoing way to obtain fee income unless sold, the financial lending risk is used in the investor along with the investment proceeds enable the originator to produce still more loans. The investor receives a rated instrument which has a yield appropriate towards rating.
The role of rating agencies: Ratings on bonds convey an agency’s assessment in the probability of default. Investors depend on ratings when coming up with investment decisions due to rating agency’s background. For example, on the 21 year period Moody’s AAA rated bonds demonstrated a .79% chance of default by year 10. Inside asset backed securities world similarly rated loans or bonds are combined inside a portfolio, then divided into different tranches together with the riskiest tranches using first loss, receiving the best credit ratings and supplying the highest yield. Similarly the very least risky tranche takes the past loss, receives the very best credit score while offering the minimum yield. In this way a portfolio composed of B rated individual securities can be packaged to supply senior tranches that receive an a and even AAA rating and junior tranches that get a junk rating.
Bubble trouble: Recently double bubbles drove US economic growth through providing unprecedented liquidity for the markets: 1) asset securitization, most notably subprime loans; and a couple) the shadow banking system, thought as hedge funds, pension funds and the whole alphabet soup of highly levered non-bank investment conduits, vehicles and structures like ABSs, CBOs, CDOs, CLOs, CMOs, SIVs and CDSs. The joint development of the two of these bubbles was grounded from the irrational belief that ideals would forever increase no matter what affordability, and entry to capital at low interest rates could well be unlimited because holders of “safe” asset backed commercial paper would forever roll their investments. Belief in the former proved unfounded in 2007 when subprime loan defaults soared, which caused a de facto run on the shadow banking system as investors refused to roll their asset backed commercial paper holdings and demanded their money back.
Changing models, changing ratings: As sub-prime loan defaults rose in 2007, in contravention on the rating agencies’ mathematical models, CMOs did start to collapse. As defaults accelerated the rating agencies were made to review their models. On July 10, 2007 the rating agencies changed their models and downgraded many CMOs. This caused panic and uncertainty among CMO investors and the contagion quickly spread to every one other types of CDOs.
Uncertainty and risk: Investors thought that the default distributions on the ratings on their own asset backed securities were just like the default distributions of the individual assets backing them. Following mass downgrade of July 10th investors concluded these were mistaken. Investors not knew for several the default distribution of whatever they owned. What they did know was that the model where they based their investment decisions had ended up being wrong. When Investors have no idea the things they do not know there’s uncertainty. Uncertainty differs from risk. Risk might be quantified and diversified, uncertainty cannot. Uncertainty causes investors to step away with the result that asset backed securities financial markets are essentially frozen, bid-ask spreads are wide and “indicative” (not firm) and plenty of investors say they just are not looking for any ABS risk. This is a killer for your shadow banks.
Banking inside shadows: Unlike insured, regulated real banks, shadow banks fund themselves to your large degree with uninsured commercial paper which can or most likely are not backstopped by liquidity lines from real banks. The cisco kid banking product is particularly prone to a run that is when commercial paper investors refuse to rollover their investment when their paper matures. Which induces the shadow banks to tap their back-up liquidity lines with real banks and/or liquidate assets at fire sale prices. And this happened in July and August as outstanding asset backed commercial paper plunged $300 billion plus the Libor spread on the Fed Funds rate widened by 50 basis points. The finance markets had effectively frozen.
Cosmetic fix for a structural problem: That led to the Fed’s 50 basis point cut inside discount rate on August 17th along with the Fed Funds rate on September 18th and October 16th that were meant to create liquidity within the credit markets. But all they did was calm the markets, not create the liquidity. The reasons were three fold: 1) banks hate to borrow in the discount window because the Fed happens to be described as lender of final measure (read troubled bank); 2) the discount rate remained a 50 basis point premium on the Fed Funds rate; and 3) seeing that the rating and pricing models for securitized debt had been shown to be faulty, the genuine banks were planning to decrease experience of the cisco kid banks, not increase it.
Frozen Solid: As subprime mortgage defaults increased and agencies lowered their ratings, investors, banks and funds began taking a look at all derivative backed paper with suspicion, refusing to just accept becoming collateral to the short-term commercial paper that provides liquidity to today’s money markets. Around 53% of $2.2 trillion US commercial paper has become backed by assets, and 50% from the assets are CDOs. That’s over $500 billion in commercial paper backed by CDOs. As of November 2nd collateralized commercial paper had declined for 11 straight weeks in a amount totaling $300 billion or 25% on the amount outstanding at the end of July. Further, as much as $300 billion in leveraged finance loans were “orphaned” simply because could not be sold or used as collateral (which means they must take place in portfolio about the lender’s balance sheet). Large segments from the credit markets were frozen solid.
Ok now what: Could simply how much securitized debt the population institutions hang on their balance sheets, and it also comes down to many billions of dollars. But the amounts don’t are the reason for the off-balance sheet exposure these institutions should the highly leveraged special purpose companies they established to create, buy and trade this paper, in order to the private hedge funds that borrowed from the banks and represent counterparty risk likewise. Within the third quarter most of the public institutions took large write-downs against the derivatives held independently balance sheets, including Citigroup, WAMU, Lehman Bros., Merrill Lynch, Deutsche Bank, UBS and Countrywide. However, the write downs cost you simply a fraction of the Level 2 and Level 3 assets[2] hence the fear is far more will have to be down on paper as underlying collateral defaults increase.
Indeed, in October and November the write-downs have accelerated with Citigroup, Merrill Lynch, JP Morgan Chase, Bank of America, Wachovia, Freddie Mac while others all announcing multi-billion reserves for expected losses. Thus far over $66 billion in provisions for losses are already announced plus much more is predicted. Two much talked about CEOs are already fired, Citigroup and Freddie Mac happen to be downgraded, may cut their dividends and are also raising capital to fulfill minimum regulatory requirements. The consequence of leverage in a declining publication rack that losses are amplified. As value decreases other assets have to be sold (usually for much less) to keep covenants. When derivatives are sold at a discount, accounting rules require that all similar assets in the debt chain be reduced through the same discount. This quickly drains more liquidity through the system making the worldwide liquidity situation worse.
No one knows for certain to what extent any entity is exposed so many people are reluctant to tackle new counterparty risk. This is why the loan markets remain just one single bit of bad news faraway from panic. The financing markets also impact stock market trading which until recently had in part been driven by CDO type instruments which go in the heading of “structured finance” (LBO, MBO, stock buy-backs), by corporate liquidity created through the issuance of asset backed commercial paper by the securitization gains reported by publicly traded banks, funds and other banking companies. If deals don’t end up being done, if corporate liquidity dries up or if banks, mutual funds and others continue reporting large losses on derivative securities, this market is at risk of a sell-off when we have seen inside the first and third weeks of November.
Deflating bubbles: Thus current market volatility is more than a correction. It is fear of a gigantic liquidity bubble deflating. The Fed cannot prevent this by lowering interest levels or injecting liquidity considering that the dilemma is not how much money inside the system. The problem is that investors are questioning the entire risk transfer model as well as associated leverage and counterparty risk. The August credit crisis would not disappear completely, it just moved away from the top of the page. Consider this – vast amounts of dollars of investment grade CDOs are held by state and native pension funds. These money is generally restricted for legal reasons to buying only investment grade paper. What the results are if your investment grade CMO in a pension fund portfolio is downgraded to non-investment grade and even junk status? The fund needs to market these securities, most likely for much less. This is why lots of people who see the extent to which the world economy has been supported by debt are responsible for risk mitigation an increased priority. Such as people at the Federal Reserve and Treasury Dept.
Contagious crunch: Because the structure for your securitization of subprime mortgages ceased to be effective, that asset class imploded. Rather than being contained since the Wall Street and Beltway authorities predicted, Wall Street soon began repricing other classes of financial risk assets (charge card and car loans portfolios, etc.) to improve risk premiums (lower valuations). But the contagion isn’t limited by portfolios of securitized assets.
The housing recession is clearly being exacerbated using a mushrooming mortgage crunch as lenders raise credit standards and lower loans. And because the financial pressure from housing goes in family budgets lenders start to discover increased plastic card and car finance delinquencies and defaults requiring increases in reserve requirements because of these asset classes. When reserve requirements rise lending sets and terms acquire more onerous. Interest levels, late charges and penalties get higher, credit limits are reduced and grace periods are shorter. These are typically early signs and symptoms of a well used credit crunch. The trend in all credit markets toward less and more expensive credit is a continue the economy in 2008. The amount of your drag is very anyone’s guess since the subprime meltdown puts the economy in uncharted waters.
A companion article titled “The Seven Threats to Your Business in 2008″ will probably be published this date and definately will explain the opportunity impact which the market meltdown could have for the general economy and also your business specifically.
[1] Shadow Banking Strategy is an expression coined by Paul McCulley of PIMCO
[2] Level 3 Assets are those assets in which there is no market. Level 2 Assets are assets for the purpose you will find there’s thin, erratic market. Since there is no reliable rate of these assets, accounting rules and securities regulations allow the institutions to find out value using internal valuation models. The result is that a CDO may very well be valued at .95 at one institution while at another institution that same CDO may be valued at .90.
For added inquiry associated with this matter, then you must take a look at prevent the credit crunch
Are credit card companies required to give a grace period on purchases before beginning finance char
my credit card company charged me a late fee of $35.00 for a late payment of two days.Is this legal?
my mother says that they recently passed a law prohibiting the charging of late fees if within a certain grace period.Anyone know what the new law is in regards to late fees on a credit card??
There is no such law preventing late fees. The new law (in USA) does prevent them from raising the interest rate on an existing balance, unless it is a teaser rate that expires. But that does not mean that they cannot charge a late fee if you do not pay at least the minimum payment on time.
You can read the whole bill if you want to:
http://thomas.loc.gov/cgi-bin/bdquery/z?d111:H.R.627: