Mastercard's EPS: $1.57
First Call Estimate: $1.14
Market Reaction: $129.10 + 14.25
America's 25 Year Debt Bender: Priceless
Wednesday, Mastercard was the talk to the street as it blew away earnings estimates with a 70% increase in profits. The market stopped to applaud as it continued its drunken ascent. I believe that Mastercard bulls are justified in their bullishness. However, I don't think Mastercard's success can coexist with the rest of the market in the current lending environment we face. As buried in that earnings report are signs of a global Debt-addiction quickly spiraling out of control.
Whether you believe in the materiality of sub-prime lending's effects on the Economy or not, consumer lending has and will continue to tighten up. Congress is going to investigate the practice and most people will not want to be even associated with a sub-prime loan. Well, nobody except the credit card companies (more on that later). Although Mastercard benefitted greatly from global growth (as many of our companies have), its U.S. purchasing volume still increased nearly 8%. After hearing the earnings call on Bloomberg, I was struck by a comment by one of the commentators when she said, "This confuses me. Where is this borrowing coming from?" Mastercard and its Homeboys – The Plastic Pushers. Let's look at the figures. I have graphed data obtained from the latest consumer credit report of Revolving Debt and Real Estate Debt Outstanding:
Source: Consumer Credit Report Data
It was quite difficult to find good data to state my case so bear with me (It's funny how the data that portrays reality is either discontinued or updated infrequently – probably just a coincidence). The actual credit card data was not adjusted for seasonality, and rather than tinker with data I put this up. If anyone has any better or more accurate data they would like to post either supports or refutes my case be my guest. I'm not that big on Economic Data anyways ever since meeting with someone who once put it together. He said they basically would "make up" data in order to hit a deadline – similar to my actions to dealing with Physics labs in High School. Moving on - although Revolving Debt includes loans other than credit card debt – credit card debt is revolving. I know this is poor logic but revolving loans are usually unsecuritized, therefore should command a higher rate. We can see this relationship pretty much throughout the data – with lower cost readily available debt for the most part takes up most increases in debt use. Clearly, real estate debt took a nose dive in the first quarter, but revolving debt didn't come along for the ride. This is because the American Consumer is addicted to debt and its effect – Consumption. With the Government cracking down on sup-prime mortgage loans (called "Brick" on the streets) and their dealers feeling the heat – what is a Consumer left to do but try to go score some unsecured debt, aka "Liquid Plastic". Since the consumer has inflated the value of his/her securities (i.e. their house – not to mention the stock market and retirement assets), her or she must move on to the harder stuff – the Liquid Plastic. Sub-prime loans, or "Brick" can be thought of as the "Gateway Debt" and as we all learned in health class – if not used recreationally, this kind of debt is much more expensive, dangerous and will eventually screw your life up. Let's see how "Liquid Plastic" is a much more expensive Consumption fix than "Brick". Let the extended metaphor begin…
Below I have listed quarterly lending terms:
Source: Survey Terms of Business Lending
This chart is straightforward, Liquid Plastic is much more expensive than any secured debt – which closer to the New Car Loans (or "Speed"). Below I have listed an additional table which portrays how Brick can be so addictive.
Source: FreeLunch.com
This chart shows the Prime Rate plotted against the 30 Year Mortgage Rate. It basically shows the economics behind a Brick addiction, aka SUB-prime loans (see 2005 onward). This data was updated for the 1st Quarter and from here on out the 30 year rate is worthless to most consumers. They are more likely to pay a rates of Prime or higher if they want some Brick, but they've already used too much of their home equity on that anyways. If you are an average consumer basically you can either finance your house or get a personal loan or credit card. Personal loans will be offered at or above Prime because they are unsecuritized and require a higher rate of return. Therefore, at this point people are and will continue borrow at a higher cost than they have in the past. Since consumption has remained strong and Real Wages have been somewhat stagnant, consumers are now starting to drain their personal equity at high costs to Consume.
This data illustrates how addicted the Consumer is to Brick and why Liquid Plastic is going to be dangerous. With a modest job recovery offset by inflation there has been stagnant wage growth. Falling home prices add on to this along with abysmal savings rates – yet Consumer Confidence remains high. How can this be so? Well, maybe the Consumer is "high" on Consumption.
The availability of Brick, Speed, and Plastic has severely altered has severely screwed up collective consumer and market psyche. Benjamin Franklin wrote, "The definition of mental Insanity is doing the same thing over and over and expecting different results." We did our fair share of Brick in the '80's and saw some of the effects, after a few years of trying to stay clean – we experimented with Liquid Plastic in the 1990's as well as Corporate Brick and saw the effects again. A tragedy struck us in 2001, however and it really hit home. Unable to deal with our emotions we decided to drown ourselves in debt – chasing another Consumption Buzz and soon enough got heavy into Brick, Speed, and now appear to be moving to Liquid Plastic. Let's examine how this progression has occurred in more detail. (From here on out I will use the collective "we" to describe Debt-addicts – because we all are).
A major side effect to debt-abuse is inflation. Our experiments with Brick in the 1980's caused housing inflation, in the 1990's liquid plastic and Corporate Brick helped add to stock market inflation. Well, surprise surprise…it turns out that Over-Consumption can lead to inflation. We not see this, instead we lump the two together because of the positive response mechanism it brings. As we see our assets inflating with their use of Debt we believe this is good – and at first it is. However when food and energy prices start to go up because of using Speed to Consume Hummers and Tahoe's, we need more debt to get the same buzz. After Brick helps us get that buzz back from buying a McMansion or a beach house – they soon find ourselves unable to get the buzz from that either. We believe we need more debt to get out and fellow Brick-heads shout on CNBC yelling at the Fed to relax some of the regulations so that we can get more cheap Brick. The Fed, in attempts to curb an epidemic stands ground – at least it seems. While appearing to fight a war on Debt behind the scenes, a covert operation is going on in the background to try to make Brick, Speed, and Liquid Plastic more readily available on the streets - using the tax revenues the added Consumption brings to fund some of its less than popular missions (much like the CIA has rumored to have done in the past and continues to do with heroin, cocaine, and other common street drugs). Debt addicts start to become unstable and desperate as they hear that their Brick supplies are drying up and begin to go on a binge of consumption and inflation hardly awakening from its Debt-induced stupor. At this point Brick, Speed, and Liquid Plastic have spread overseas and are beginning to develop the same collective psyche's – altering correlations and relationships that were once the norm, as Barry Ritholtz points out. Enter Mastercard.
When I think of credit card companies, 70% EPS growth isn't really something to expect unless you have a world of Debt-addicts – which is what he have. Mastercard knows this and like other companies who produce addictive products (Phillip Morris, Wynn, MGM, Merck), they have a strong lobby and have already insured that they can reel in as many Addicts as possible with the Consumer Credit Card Protection Act of 2005. Similar to a bartender or casino who reels addicts in with freebies or "first one's on the house" type deals, this act allows companies to offer teaser rates and other perks and makes it much harder for them to leave eliminating Universal Default – even when they have had too much.
So yes, Mastercard's earnings were good. I have no reason to believe they won't continue to improve. With a nation, moreover, a world filled with "debt-heads" and by securing themselves as the lender of last resort, they have probably booked those gains for another year. But, debt-heads will soon learn that their consumption of Consumption through Debt is killing them. The other thousands of companies and their shareholders will feel the sting as well – as they are also debt-heads and consume through the income they generate from other debt-head's Consumption. In Economics it is called the Multiplier and is directly related to the Marginal Propensity to Consume. Hopefully, the future won't be so bleak, but Mastercard's latest quarter and the tape would say otherwise.
-β
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