Who’s Afraid of Phantom Debt?

Markets move money from the impatient to the patient ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ ‌ May 16, 2024 Who’s Afraid of Phantom Debt? “A lot of people just can’t stand to wait. If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that.” – Charlie Money [Reminder: In case you missed [our announcement]( The Essential Investor has merged with legacy contributors to Agora Financial. The new, larger, more inclusive project is called The Grey Swan Investment Fraternity. If you’re interested in the scope and benefits of our new endeavor, please see what prompted us to merge [here](. If you’ve been a member of The Essential Investor, keep an eye out for your new benefits.] Dear Reader, May 16, 2024 – The Consumer Price Index (CPI) wasn’t nearly as bad as analysts expected yesterday. Looking for anything — anything — to buy, traders drove the Dow, S&P 500, and Nasdaq to fresh record closes. The rally was odd. Sure, if you eat food, pay for housing, try to stay warm or cool, or are in the market for a used car… those things did not get more expensive month over month. More expensive than last year, yes. But “less” more expensive... Even Paul Krugman’s favorite, if confusing, indicator — “owner’s equivalent rent” — dropped below 6%. Weehoo! Still, goods and services continued to get more, more expensive, rising at 4.5% year over year yesterday. “Services are people-heavy businesses in which wages are crucial drivers of prices,” observes prominent financial journalist John Authers. “Unlike with food and fuel, monetary policy can be an effective counter to wage inflation, so this is an incentive for the Federal Reserve to keep rates where they are.” Blended together, the report showed inflation compounded at a fairly steady 3.4% in April, down an otherwise unremarkable .1% from March’s reading. And interest rates will remain high. Or, at least, not be cut soon. So why the rally? It’s a phenomenon. Too much money sloshing around the system not only helps make inflation sticky, it also perverts decision making in money management firms. Any news, even less bad news, is good enough news to buy something. Traders on Wall Street are antsy like boardwalk teenagers with a stack of ill-begotten franklins burning holes in their board shorts. Today, Grey Swan’s managing editor, Andrew Packer, takes a look at a certain financial innovation in subprime consumer debt that traders are eager to gobble up as they chase returns. Any returns. Enjoy ~ Addison CONTINUED BELOW... >>ADVERTISEMENT<< Former Goldman VP Reveals Mysterious "Gold Bank" With Huge Upside Potential He says the gains in this should be far greater than just bullion or mining stocks. Some folks had the chance to see 995% the last time we shared this exact "bank." Most people know nothing about it (except the rich and elite). [See his free reveal right here.]( CONTINUED... “Phantom Debt” and the Next Financial Crisis Andrew Packer, Grey Swan Investment Fraternity Don’t cheer “falling” inflation just yet. Or the Nasdaq hitting new all-time highs. There are some dangers building in the economy... And just as your wealth takes the escalator up, a debt crisis could mean if you’re unprepared your net worth will take the elevator down. The latest danger? What’s known as “phantom debt.” That’s just the name for the latest financial “innovation.” That innovation starts in a small part of the market. But it brings in big profits. So it doesn’t stop there. Companies that embrace this innovation see their stocks surge. With this reward for their behavior, they continue to grow. But eventually, the music stops. The poster child for this phenomenon is the subprime mortgage. These loans started in the mid-1990s. They started on the fringe of lending. Sure, they could offer higher rates. But that also came with the chance for a higher default. By the mid-2000s, lending standards had loosened. More importantly, investors were hungry for mortgage debt. As a result, subprime went mainstream. These loans allowed questionable borrowers to get into homes – and with home prices soaring, why worry about the risk? Banks didn’t have to worry about the loans they made… Why? Investor demand for subprime mortgages seemed insatiable. That’s because investors could get a higher rate than traditional mortgages. Borrowers saw a chance to use their homes as an ATM and get ahead financially. Of course, the music stopped. Home prices couldn’t go up at 20%+ annualized rates forever. There are only so many borrowers with no income or no jobs, which the industry dubbed “Ninjas” who wanted loans. When the dust had settled, U.S. household worth had taken a $13 trillion hit. Or about 20% of their collective net worth. Buy Now Pay Later Today, consumer debt is following a similar pattern… As we’ve documented on many occasions, credit card debt has been hitting consistent historic highs. The divide between consumer debt and personal savings reached a peak in early 2022 and is continuing to grow. While inflation remains sticky, consumers continue to spend on food, energy, goods and services on credit. Credit card debt has hit a record high of $1.3 trillion. Meanwhile, household savings, which surged during the pandemic (not all that stimulus money hit the economy right away), is at its lowest level in a decade. It’s an ugly picture, to say the least. Meanwhile, investors are distracted by headlines crowing about inflation “less worse than expected.” Prices are still increasing. They’re increasing at a rate more than 50% higher than the Fed’s target of 2% annualized. Part of this rise comes from consumer demand. And if that demand is being fueled by debt, the end of the debt party will bring a correspondingly large hangover. What’s worse, it’s just a partial picture. There may be another few hundred billion in consumer debt that’s already “off the books.” I’m talking about Buy Now Pay Later (“BNPL”) debt. BNPL is simply the 21st-century version of the installment plan. Unlike the layaway plans that you might have used at a department store growing up, you get the product first. Today, you can use a variety of apps to purchase products, get them now, and pay later. By paying later, the lender gets to charge interest and fees … much like the subprime lender. It may seem odd to go into debt to finance a pizza, but that’s an option in today’s economy. Seriously. It’s also an option that many find irresistible. Here’s where it gets tricky BNPL debt isn’t reported to any of the credit agencies. Borrowers, who may already be up to their eyeballs in credit card debt (see above chart), probably like that part. Naturally, the BNPL companies blame the credit agencies. They say the credit agencies can’t handle the vast amount of data they’ll receive once BNPL’s start reporting. That’s a pretty ridiculous assertion. We’re talking about less than $1 trillion in new debt (so far). If they can handle the $1.37 trillion of debt data from the credit card providers, adding in the BNPL data should be no big deal. The bottom line is that this isn’t included in any of the typical debt charts or stats that look at total debt in the economy. So, we really don’t know how much of it is out there. One projection estimated it would reach $700 billion globally by 2028. Maybe it’s far less, maybe it’s more. The uncertainty is scary unto itself. And why some are calling it “phantom debt.” But what we do know is frightening. While BNPL customers may just be the “subprime” consumers in our economy, they’re taking advantage of this situation. A recent Bloomberg article noted that 42% of BNPL customers making more than $100,000 per year are late on payments. While it’s wise to be skeptical from the results of one self-reported survey, it’s a disturbing trend. Folks who make more than $100,000 per year don’t seem like strong candidates for BNPL services in the first place. And for two out of five of those users to be late on payments – possibly for something like a pizza – just indicates the danger this unreported debt could have on the economy. It’s possible that there are already thousands buried under the burden of their BNPL debt. But since that data isn’t reported, we don’t know the extent of the problem. And as with subprime, we may not know until after this inevitable financial innovation shows its dark side. If the collapse of BNPL debt triggered a financial crisis, I wouldn’t be surprised. That’s what financial “innovations” like this tend to do in time. As BNPL debt grows, investor skepticism over consumer spending and the economy “should” likewise increase. We’re as wary of the rise in subprime consumer debt as we were of subprime mortgages — and the securities they spawned before the 2008 financial crisis.. ~~ Andrew Packer So it goes, Addison Wiggin, The Wiggin Sessions P.S. We’ll be keeping an eye on subprime consumer debt all the same. Supreme mortgages were, after all, the source of Michael Burry’s fortune when he shorted them during the ‘08 crisis; the story made (more) famous in Michael Lewis’ The Big Short. P.P.S. As far as sticky inflation goes, Andrew introduced a 21st-century update to the late John Pugley’s Alpha Strategy — a long-term approach to investing while inflation persists — in the May issue of the Grey Swan Investment Bulletin. 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