Comments on: Strategic Defaults Fuel Spending

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By: Zachary Scheidt

Zachary Scheidt — Tue, 13 Apr 2010 20:48:08 +0000

Hey Alan,

Rather than modeling a complex formula (which often can lead to a false sense of clarity – and would likely be fairly unreliable – remember, we’re dealing with human nature here…) I prefer to look at retail from a couple of different vantage points.

First – The current trade is UP. Fundamentals are supported by default spending and speculative trading is driving equity multiples higher. So to step in and short now would be dangerous – in fact, there are some great short-term LONG trades setting up.

Second – RISK is very high… If the strength in retail is built on the unsustainable practice of strategic defaults, then eventually the bubble will burst and prices will come down – timing is difficult to determine but long-term investors should hold retail positions in an open hand and consider decreasing exposure on this strength.

Third – Charts will be an invaluable tool for determining the timing for the ultimate decline. I’m expecting to see some of the most speculative names stage breakouts that quickly fail, for moving averages of retail ETFs to be violated, and then after the first few signs of failure, the entire industry could come under pressure.

It may sound “off the cuff” but I would rather put out some small “feeler” trades in a few select short names and then build into more size once the full retreat is underway. Not a sophisticated model, but a carefully crafted – risk managed way of approaching the situation.

Thanks for the comments!
Zach

By: ALAN KELLY

ALAN KELLY — Tue, 13 Apr 2010 19:28:29 +0000

Zach, thanks, then re your eventual retail short thesis: There are approx 7 million mortgages seriously delinguent. It seems many are using the unpaid premiums to shop and plan to have little cash other than their 3 month deposit when they are forced to rent (in which case banks won’t waste legal fees/time on legal persuit). You need a lot of insight on the likely timing of these foreclosures to judge the downturn of this huge unintentional ‘bank financed’ retail stimulus program. Since there will be rolling waves, ARM trigged start dates etc, it’s a complex equation. I suspect this may unfold more slowly than expected, propping up retail longer than seems reasonable.
How do you model this complex, parallel series of dynamics in deciding when to eventually short retail?

By: Zachary Scheidt

Zachary Scheidt — Tue, 13 Apr 2010 18:57:14 +0000

While mortgage contracts can take on many different nuances, my understanding is that the majority of mortgages are not “non-recourse” meaning the bank actually can come after other personal assets. The homeowner may or may not declare bankruptcy, but more often than not, the lender would have a legitimate claim on cash in a bank account.

By: ALAN KELLY

ALAN KELLY — Tue, 13 Apr 2010 14:35:25 +0000

Zach, your comment “anyone facing foreclosure is also facing bankruptcy”, (therefore won’t pile up cash). I thought mortgages were ‘non-recourse’ loans, so while defaulters will destroy their credit, they won’t be facing personal bankruptcy, therefore can keep the upaid mortgage cash?

By: Zachary Scheidt

Zachary Scheidt — Wed, 07 Apr 2010 17:31:59 +0000

Jeff – I think you are taking that statement a bit out of context – I’ve never been one to rely solely on the government numbers – but you can’t deny most retailers have been reporting strong sales increases – and this is true not just for luxury spending but regular mom and pop stores – from basic essentials all the way to purely discretional items – you HAVE to account for these increases even if you throw the government numbers out the window.

AlexR – You make a great point – strategic defaults really ARE a stealth stimulus, and the bill is unfortunately paid by the taxpayers and by true paying homeowners who will see the value of their properties further decimated by the eventual foreclosures that MUST happen.

Donald – I agree with you in principal on the regional banks – but do you have some short opportunities in particular? Would love to see some tickers you’re watching.

Will DiJohn – you state that “anyone facing foreclosure is also facing bankruptcy” and you are right. So why would ANYONE in their right mind pile up cash that will be frozen and taken away during the bankruptcy process?

Atareen – you’re right – same song, second verse. I think it was

PTJ who said that the real tragedy of this crisis is that we haven’t learned a thing – in fact we’ve learned the WRONG lessons. The lesson consumers have picked up is that if you act irresponsibly enough, someone will come behind you and help you out.

Thanks for the comments guys!
zachstocks.com

By: Danny Furman

Danny Furman — Mon, 05 Apr 2010 13:49:05 +0000

There is definitely some truth to the argument, however a bigger factor is the state of panic people were in a year ago. YOY comparisons are silly to hold in high regard and numbers are not impressive compared to per capita spending in 2007 and prior. Addicted consumers are simply leveraging themselves on smaller budgets, this uptick is not a sustainable trend.

By: Athens 22

Athens 22 — Mon, 05 Apr 2010 13:47:40 +0000

I live in one of the least affected states, Texas, and I personally know people who are doing exactly this. One girl I know (good paying job and recently divorced) hasn’t made a payment in a year while working on a modification. She now spends most of her time buying $1,200 purses for only $800 on Ebay….. “But it was too good a deal to pass up”………. I kid you not!!

She has always spent extravagantly and continues to do so. I think people have learned how to game the system too well.

I too wondered if these types of people are holding up consumer spending. I believe you are correct. Nice article!!

By: cayman

cayman — Mon, 05 Apr 2010 13:46:49 +0000

I kinda agree, that consumers planning strategic defaults would be kinda stupid to go shopping….the article has an element of truth to it but probably not all strength in consmer is due to strat defaults.
But if treasury and BAC are going to write off the portion of ones mortgage above the market vaue of the property then this could be the writedown that ends it all…resulting i a real stimilus.

By: Will DiJohn

Will DiJohn — Mon, 05 Apr 2010 13:46:20 +0000

I doubt very much that people are spending their mortgage payment money on discretionary or self-indulgent items. Planning a strategic default means you are also smart enough to know you better stash a nest egg for the 1st, last, and security on your new rental property… at least 3 months of your mortgage payments, plus moving costs which can amount to another 2 or 3 months of mortgage money. Anyone facing foreclosure is also facing bankruptcy or else the mortgage company is coming back at them for the post-auction lose relative to the original mortgage value. So you must expect to save for legal fees too.
And expecting strength in a few retail stock prices to be caused by improving consumer spending is another illusion. Stock prices are the “anticipation” of future earnings. Right now we have lots of money sitting on the sidelines, desperate to recover losses from the past 2 years. That money will be chasing all kinds of investments, driving up prices on speculation alone.
I do think that strategic defaults are the consumers portion of the bank bail-out money and as more underwater consumers realize it is their only way to recover from real estate losses, foreclosures will continue to grow.
I think people are buying only what they have to. Hopefully that is enough to keep our stagnated economy going, but we still have a lot of hard hurdles ahead. Of course, companies will out-compete one another but I’m not looking for aggregate revenues or consumer spending to grow in any industry. The notable exception is energy and food commodities, we are going to pay through the nose for those.

By: market ace

market ace — Mon, 05 Apr 2010 13:45:22 +0000

First you have to look for some truth in the statistics because while the gov’t reports retail sales increasing (ignoring real inflation) sales tax revenues keep going down so the gov’t stats are very suspect.

The author has accounted for much of the money suddenly available to stimulate the consumer. Add in a feeling of live high on the hog now because doom is coming also seems to prevail. Just as people live high on the hog just before filing BK, most consumers are seeing the handwriting on the wall for the economy and the country so enjoying it while they can.

There is no penalty for walking away from debts and undervalued assets so why is anyone paying debts or taxes today?

By: Donald Ingram

Donald Ingram — Mon, 05 Apr 2010 13:44:53 +0000

AlexR – Many of these CRE loans came with a line-of-credit also, what is occuring is a ‘double whammy’. When the CRE loan is in trouble, the banks are finding that their line-of-credit is being completely drawn down to service the loan, before defaulting or turning the asset over to the loan vendor. Therefore leaving a gaping hole in their balance sheet. CRE loan + line-of-credit default.
Many smaller regional banks are at risk because of their over-exposure to the CRE/C&D markets. More bank failures to come.

By: AlexR

AlexR — Mon, 05 Apr 2010 13:44:34 +0000

Great article. One comment is worth repeating: “These strategic defaults are the people’s bailout and ends up being a massive stealth stimulus.” I’ll add it’s also a stealth expansion of the money supply. The money is flowing from the bailed-out banks to not only the defaulted owners, but also to the intermediaries who are now making a killing on under-priced foreclosure sales (same-day flips have been seen, but probably won’t hit the mainstream media for months). Did the Fed see this coming? If not, well, we’ve finally found a credible reason for inflation to pick up!

By: CautiousInvestor

CautiousInvestor — Mon, 05 Apr 2010 13:43:27 +0000

In addition to strategic defaults, spending from black market activities would boost spending but would not be seen in incomes………just as strategic defaults. With the savings rate haven fallen to 3% and incomes stagnating, there’s not much to drive consumer spending going forward unless there will be a batch of strategic defaults as ARM and AltA mortgages reset over the next two years.

By: igropub

igropub — Mon, 05 Apr 2010 13:41:45 +0000

I believe the average “consumer” is clueless about the weakening dollar unless (s)he travels outside the US. We are constantly prodded to spend now while while the goods are on sale (which is every day). See the good little consumer hampsters spend, spend, spend. Recovering economy? Sure why not. Let’s go buy something to celebrate.

By: Donald Ingram

Donald Ingram — Mon, 05 Apr 2010 13:41:09 +0000

Another reason for the uptick in consumerism would be a further fall of confidence in the dollar. The USD has fallen about 15% as compared to other fiat currencies. Yet the dollar has declined about 35% relative to gold during the same time frame.
Along with the return of the consumer, the savings rate has leveled off and is now lowering. This could reflect a change in the attitude of the saver as being one of pessimism towards the dollar. Spend now while the dollar still has some value versus hanging onto it and watching it’s purchasing power disappear.