Wednesday, December 26, 2007

Consumer Co-dependency

It appears that the abused average American has finally had enough. Target reported that Christmas sales were very weak and lowered their revenue growth numbers for December quite a bit. Add in the margin pressure from discounting and earnings in that sector should be a mess. The problems seem to be widespread and for once, stocks actually seem to be reacting to obvious fundamental problems. This should really be no surprise at all but sadly, equities have ignored fundamentals for so long that it's a shock when reality intrudes on the feeding frenzy.

Here at Financial Jenga, we've been documenting the many pressures facing consumers for some time now. Housing and mortgage debt were covered in Where to Start? We wrote about the deteriorating employment situation and failure of government statistics to reflect it in Behind the Numbers. The collapse of personal savings and explosion of total household debt was the theme of First Principles. Why is anyone surprised that a consumer sector with no savings, huge debts and fewer jobs would decide that reducing spending the the right course? "When you're in a hole, quit digging" is just common sense.

Of course, common sense has been in short supply for years. Americans have been able to get away with all sorts of foolishness and the banks and other lenders have been their enablers. It is simply human nature to slip into wishful thinking that there really IS a free lunch out there somewhere. Mark Twain once described a banker as "a fellow who lends you his umbrella when the sun is shining and wants it back the minute it begins to rain." Former uber-banker and CEO of Citigroup, Chuck Prince pretty much confirmed Twain's characterization back in July when he said:

When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.

Apparently, Chuck has stopped dancing and wants his umbrella back - except that he's no longer CEO. The reason he's not CEO now is because he waited too long to grab the umbrella and it looks as if he was right that "things will be complicated."

Banks are always willing to lend when they think there's little risk. That doesn't mean they are right in their risk assessment. Consumers have proven willing to borrow as long as they think they can make the payments. They are often overconfident on that front. The confidence of both is being pressured by the weak job market. Banker's willingness to lend is also falling with the value of the loan collateral - especially housing. Consumer confidence faces additional challenges due to higher food and energy prices. They were both wrong to be confident because they confused cyclical and secular economic forces. They also failed to recognize that their own behavior was the cause of the spike in asset prices. They borrowed and lent money used to buy the assets and prices quite naturally rose. Then they all congratulated each other on how smart they all were to "get in on a rising market." Now the prices are falling and the debt will still be the same size.

Consumers have a co-dependent relationship with their bankers - who have enabled destructive behavior for years. It appears that both sides are ready to walk away now that the relationship serves the needs of neither side.