We continue to have a serious problem with Greenspan's claim that bubbles are "incontrovertibly evident only in retrospect." History will not be kind to this analysis. After all, the signs of bubble excess have been obvious for some time. All one has to do is look at excesses that have become endemic to both our financial system and economy. And while the stock market bubble looks to be in trouble, just as alarming are the signs of the vulnerability of the great credit bubble of the 1990's.
With this in mind, Greenspan has good reason to suggest that bankers be on their guard. Behind the headlines of a rip-roaring economy is some disturbing fine print. For example, the FDIC expects bank failures to cost the deposit insurance fund more money this year than any year since the banking crisis of the early 1990s. The agency thinks that five failed banks will cost the fund $510 to $810 million. Most of this expected loss will come from a single failed bank, First National Bank of Keystone in West Virginia. Incredibly, this non-household name could rank in the top 10 failures of the past 20 years. The reason for the failure? According to an American Banker article, about $500 million in bank loans simply "disappeared."
We believe that recent bank failures reflect increasingly weak underpinnings after years of lending excesses. And it's important to remember that in this so-called new era, a bank's riskiest activities don't show up in the common measures of bank safety. The bulls argue the banking system is well reserved. However, we see considerable risks not appreciated by the bulls with their focus on traditional reserve ratios. Importantly, off-balance sheet derivative exposure is certainly not captured in the reserve to loan ratio. And consumer loans, the banking fad of the 1990s, are acutely vulnerable to a bursting of the bubble and we believe that traditional reserves will prove grossly inadequate. Furthermore, the merger and acquisition boom clouds the picture and clearly heightens the risk of loan defaults going forward.
Meanwhile, other threads of the so-called new era economy are beginning to fray. According to Moody's, global bond defaults have ballooned to their highest level since 1991. Moody's says emerging market problems are the culprit outside the U.S., but here at home, defaults are driven by bankruptcies. As a result, defaults now represent 5.78% of all bonds outstanding, up from a low of 1.7% in 1997. The spike in default rates seem tame compared to the 13% figure of 1991. But there's one difference that bears repeating. These are the good times.
Moody's analysts blame U.S. defaults on rising rates and the ability of marginal companies to float bonds in the l996 to 1998 high yield bull market. In other words, credit was so easy that even the worst companies got funded. Similar signs of excess abound in the IPO market. To what degree bankers fell prey to this hyper-enthusiasm remains to be seen.
We do know, however, that banks (and non-banks) have been absolutely giddy over the American consumer. Financials institutions have helped consumers ratchet up annualized borrowing 70% from 1997 through the first quarter of this year. While some may argue that much of this increase was made possible by financial ingenuity, the consumer's ability to service all this debt remains in question.
According to figures from Stuart Feldstein, world-class expert in consumer credit, the American consumer's ability to service debt has already deteriorated to recession-style levels. For example, net charge off rates have already reached the 5.09% peak of 1992. And in 1998 there were 5.1 bankruptcy filings per 1,000 residents, compared to 4.19 in 1996 and 3.4 in 1991.
These numbers are especially troubling when you consider that consumers have experienced the best of times, including falling interest rates, windfalls from refinancings and debt consolidation via home equity loans. But a look at the debt load explains why the consumer is struggling to heft it. Debt as a percent of per capita income reached 111.7% in 1998 vs. the 103.6% in 1991. Except for 1997, this ratio has advanced without fail since 1982. And remember, debt has increased as consumer savings has plummeted.