March 2008

The story inside, beginning on page 40, was about as depressing as the title. The “experts” are predicting a further drop in housing prices of 20 to 25 percent and they don’t see an end to this mess until 2010. They go on to explain why, and while they make a compelling argument, it is another example of someone trying to predict the future. The odds of them being right are about 50/50.

I think a bigger story concerns the title to this month’s FYI, The Other Shoe. What do I mean by that? Well, simply put, the other shoe is the potential for defaults in the credit card and home equity loan portfolios that may be just around the corner. The Federal Reserve has been lowering interest rates at a breakneck pace, 125 basis points in 10 days. A basis point is 0.01 percentage point. This represents the largest decline in that time period since the Federal Reserve began using the funds rate as its main monetary tool around 1990.

The unusual side occurrence is that as the Federal Reserve has been lowering the funds rate, the rates on credit have been going up. Not only have these rates been going up, but also the amount of credit being offered has been going down.  In other words, financial institutions are trying to make up their losses on sub-prime by increasing their fees on, among other things, outstanding credit lines. If the public is being squeezed by their adjustable mortgage rates going up and increasing credit card payments, the other shoe could drop, and a choice will have to be made as to which bill gets paid.

Don’t forget that it is not only the adjustable rates that are increasing and causing a strain on home buyers, but it is also the folks who have used their homes as an ATM machine. As their home value increased and rates declined, they either took out a home equity loan or refinanced and took the money out and spent it. Now, with the price of their homes coming down and the appreciation captured and spent, some are left holding the bag.

Some talk show hosts have gone so far as to advise their listeners that it is better to pay your mortgage and car payment and not pay your credit cards because they are unsecured. Other folks have said they need the cash flow of the credit cards and would rather miss a house payment. While credit unions may have mainly dodged the sub-prime debacle, we aren’t out of danger just yet.

As I said, the other shoe could very likely involve credit unions. We need to be ready. The fact that it could happen doesn’t necessarily mean that it will. As a precaution, at the very least, a review of the loan portfolio might be a good idea. If we aren’t comfortable with the results, some corrective action seems appropriate. I am not suggesting we do as banks are doing and raise our rates, unless they are below market levels.  I am suggesting we do an analysis on our existing loans and review our loan policies and procedures to be sure we aren’t basing today’s decisions on yesterday’s circumstances. 

We have avoided the first shoe falling and now we need to make sure, if the other shoe does fall, it will not involve us.