Looking for the Sunny Side

  Call it cautious optimism, a mildly positive outlook for a stagnant U.S. economy finally beginning to stir. That pretty much describes many economists' expectations for 2004.
  The unemployment rate is leveling off, short-term interest rates are stable, and corporate spending is increasing, all good signs for the flagging economy.
  If you add in the much-greater-than-expected increase in the third-quarter gross domestic product, the prospects appear even rosier. The 7.2% annualized rise was the strongest in almost 20 years. That compares to a 1.4% rate in the first quarter and 3.3% in the second quarter.
  "Things look better," says Edward O. Bankole, managing director of the Asset Finance Group for Moody's Investors Service. "The clouds seem to be dissipating."
  Adds Keith Leggett, senior economist for the American Bankers Association: "We've had a huge amount of fiscal stimulus in the form of increased government spending and the tax cut, which is going to generate a positive impact on the economy."
  Nevertheless, obstacles remain. Some economists are referring to the improvement in the economy as a jobless recovery. "We're all excited that the new claims for unemployment have gone down," says Darcy Walker, a former Citibank and Discover lending executive and now president of Chicago-based consultancy Darcy Walker & Associates LLC. "It isn't that exciting."
  Walker notes that in the last two years, there have been 2.8 million jobs lost in the U.S. The total number of unemployed is in the 8 million range and that "doesn't include another 1.7 million people who aren't even looking for jobs. They have given up," she says.
  Employment rose 57,000 in September, but the unemployment rate held at 6.1%. That's down from a peak of 6.4% in June. And the rate should continue "to go down but not smoothly and not fast," says David Wyss, chief economist at Standard & Poor's.
  What's more, no one expects a repeat of the sharp increase in the GDP any time soon. Instead, they're looking for growth somewhere in the range of 3% to 4% for 2004. That's because "the current spike is driven by the tax cut and rebates," raising doubts about whether the expansion can be sustained, Wyss says.
  "The federal government has bought about a year of growth here," Wyss says. "After that, my suspicion is we revert back to trend."
  The card industry also is losing the benefit of the mortgage refinancing and home-equity boom in which cardholders took out loans against the value of their houses and used the money for new spending. "That's been playing a very important role over the last 2-1/2 years in driving consumer spending and thereby economic activity," Leggett says.
  But at the same time the refinancing boom fueled consumer spending, it also proved a drag on issuers' receivables growth, says Stuart A. Feldstein, president of Hackettstown, N.J.-based SMR Research Corp. That's because people used the money, obtained at a low interest rate, to pay off higher-rate card debt.
  "People were using a lot of these loans to pay off card balances, causing the credit card industry's growth in receivables, on which they rely for interest income, to slow down enormously," he says.
  "A lot of people perceived that the slow-down in card industry growth was due to a weak economy," Feldstein adds. "But when you look at various measures of consumer spending, it really wasn't much of a slow-down at all."
  The problem, Feldstein says, was that people were "still using their credit cards and charging more than ever, but they were at the same time increasingly paying off their balances."
  But as the economy heats up, so do the long-term rates found on mortgages. "Interest rates have been a little squirrelly, but virtually all the forecasters believe that mortgage rates will be higher in 2004," Feldstein says. "You just need a little uptick in rates to cause these (refinancings) to slow down. After all, if you just got a loan at 5.6%, why would you want to replace it with one at 5.9%?"
  However, home-equity loans are pegged to short-term rates and remain cheap, still offering competitive rates compared with credit cards, he says, adding "you can still get a home-equity loan at 4% interest."
  Meanwhile, bad debt continues to pile up, due in large part to ever-higher bankruptcy filings. That's bad news for issuers because bankruptcies account for as much as 40% of chargeoffs.
  And there is no relief in sight.
  "There will be no significant abatement until we have new legislation that will combat the incredible number of fraudulent claims and exaggerated claims, and the growing popularity of bankruptcy as a refinancing tool," Feldstein says. He adds that in a recent random survey of bankruptcy petitions, SMR found between 20% and 30% that appeared to be fraudulent.
  Chances for bankruptcy reform in 2004 seem slim. "The (credit card) industry's lack of response is disheartening," Feldstein says. "It's pending-it never quite goes away and it never quite gets passed."
  Record Bankruptcies
  Others share Feldstein's opinion. Attorney David P. Goch, a lobbyist who closely monitors bankruptcy matters, says it's unlikely the 108th Congress will agree on a bankruptcy bill before the 2004 elections, despite the House of Representatives' passage of such a bill last March.
  While the latest reform measure, H.R. 975, passed 315 to 113, it doesn't have a Senate version yet. And Goch doesn't expect a serious effort to move a reform measure because passage would trigger a rush of bankruptcy filings before the current, more liberal rules expire. No politician wants to be associated with higher bankruptcies in an election year, says Goch, a partner with the Washington, D.C., law firm of Webster, Chamberlain and Bean.
  What troubles many observers is that personal bankruptcy filings continue in record numbers. Filings will hit a new high of 1.6 million this year, Bankole says. That comes on the heels of record highs of 1.45 million in 2001 and 1.54 million in 2002, according to the American Bankruptcy Institute.
  In 2003's first half, there were 835,080 bankruptcies.
  Although the economy is improving, issuers should not expect any significant drop in bankruptcies in 2004, which have become a way of life for many Americans, Bankole says. "It's just the norm, consumers are very comfortable with (filing) bankruptcies," he adds.
  While the growth in bankruptcy filings eventually will "slow and possibly fall," the level of filings is expected to remain high, Bankole says.
  The coming retirement of the Baby Boom generation could put additional pressure on credit quality, Walker says. "These Boomers have lived better than any generation before, and they've lived on credit to support their lifestyle," she says. "The question is, what are they going to do when they start to retire, when their income begins to decline."
  Baby Boomers not only are moving beyond their prime borrowing years, but they also have shown a propensity to file for bankruptcy, she says. "This is a population that has demonstrated a reluctance to suffer stress. 'Oh dear, I'm in debt. I think I'll go bankrupt.'"
  What's more, new federal regulations pose major challenges to collections efforts, says Chaomei Chen, vice chairman of credit and collections at Providian Financial Corp. The regulations, which are designed to establish minimum monthly payments to avoid negative or prolonged amortization, will put additional strain on consumers' ability to pay, Chen says. And increased scrutiny of work-out and hardship programs will limit issuers' ability to provide debt solutions to delinquent customers.
  "This means it will be harder and harder for us to collect and more pressure on consumers," she says.
  Historically, improvements in the job market lag the economy, and credit quality lags the job market, the ABA's Leggett says. "We really haven't seen a turn in the job market yet, and probably won't until 2004," he says. "That means we're looking at continuation of the high delinquency and chargeoff rates probably through the remainder of this year and through a good portion of 2004."
  The ABA says 4.04% of bank credit card accounts were 30 days or more overdue in the second quarter, down slightly from the record 4.07% in the first quarter and 2002's fourth quarter. Some 4.51% of bank card receivables were overdue, unchanged from the first quarter but up from 4.08% a year earlier.
  The card industry should be able to continue to take advantage of lower funding costs going into next year, Leggett says. The Federal Open Market Committee, which sets short-term monetary policy for the Federal Reserve, in October decided to leave the federal funds rate at 1%, a 45-year low.
  "On an annualized basis, there is very little inflationary pressure," Leggett says. "Interest rates will remain stable at least until the middle of next year."
  After that, however, the Fed likely will move to take "excess liquidity out of the market ... and return rates to more of a normal level," he says.
  But higher cost of funds won't necessarily have a large impact on issuers' bottom lines, because the job picture should be improving by then, economists say. "My feeling is that the falling loss rate will somewhat offset the higher cost of funds, and excess spread should remain healthy," Wyss says.
  The economy in 2004 also should get a lift from capping the capital gains tax at 15%, instead of 20%, Feldstein says. "The guy with $5 million in the stock market is going to benefit enormously, and that happens to be the person who buys a Mercedes instead of a Chevy Nova," he says. "He's the guy who buys the yacht, not the guy who buys the used rowboat."
  But finances aren't the only factors that can affect the economy. In the past, geopolitical considerations-most recently the wars in Iraq and Afghanistan and the fight against terrorism-have dampened consumer sentiment, stifled business spending and weighed on the stock market. But "while they're still out there, they're not as big a driver of the economy," Leggett says. "In early 2003, it was more of the uncertainty about what's going to happen. Once something happens, businesses and consumers can adjust to it."
  With three harrowing years behind them, issuers are looking for good news. Their hope is that the economy will take a turn for the better in 2004.