News&Views 18:Feb 5

Still, shrinking inventory is only a part of the pricing story. The banks, hungry for revenue, and facing a collapse in pricing through 2009, began to work far more of their accounts through third party agencies. Little is known to us if this strategy produced substantial revenue for the banks, but it did keep inventory from hitting the market which has had an impact on prices. Also, by holding onto these accounts for a collection cycle the banks were able to get pricing for their one agency paper by the third quarter of 2010 as high or higher, than they were able to obtain for fresh paper in January of the same year.

The large private and public debt buyers are in need of a sizable inventory to keep their organizations busy. As a result of their large appetite for fresh debt, these organizations are willing to pay higher prices to keep a steady flow of work for their collectors. The break-even point on fresh paper purchases has been extended from 37 to 48 months in several cases, for firms that are typically known as "buy and hold" debt buyers. The quarterly reports of some of the public companies are a wealth of information on the subject of price ranges and break even projections for the shareholders. These are not the type of breakeven time frames that small debt buyers aspire too. The large buyers also have access to major capital markets and overseas investors, who are willing to loan at very attractive rates to established public companies with strong track records.

The need to keep good collectors also requires the availability of good accounts to work. Many major collection houses will only take on the newest and freshest debt. Large buyers often have very sophisticated machines that must be continually fed new accounts. This pressure to keep the organizations churning and growing is placing more pressure on pricing. Competition for new products between the larger buyers is a significant reason for the escalation in fresh charge-off prices.

Finally, we would expect that speculation has come back to the debt market. The economy may be incrementally improving even without an increase in jobs, which may be starting to foster the perception that better times may lie ahead. Better economics should equate to higher recovery rates in the future. We have not seen any great improvement yet in the recovery rates, but there are certainly a few positive signs and an increasingly optimistic attitude. This optimism may be escalating the price of charged-off consumer debt even further. The trickle-down effect on the price of debt is also impacting older paper, but not with the same degree of increase that we have seen on fresh charge-offs. As long as there are willing buyers at these prices, and they are willing to wait longer periods to see a return on their investment, we can only expect fresh charge-off pricing to remain high or even edge higher.

Jobless Rate Update

On Friday February 4^th the new jobless numbers and unemployment rates (U-3) were released by the government for Januarys 2011. The official unemployment rate fell to 9.0% and 36,000 jobs were added in January. The total number of unemployed shown on the official government website for December was 14,485,000 and the number shown for January was 13,863,000 which reflect a decrease of 622,000 from the unemployment figures which would coincide with a decrease in the unemployment rate. However with only 36,000 jobs added in the month, there are 586,000 who are not accounted for in the current unemployment figures. (See Table A-10) of the Bureau of Labor Statistics website.

As we look ahead to 2011, we thought it might be useful to review some of the 2010 predictions that were made a year ago. While a few were overly optimistic, most of the forecasts that were made were right on target, and several are still applicable for the coming year.

For the past 2 years economists have warned us that this economic recovery will be far from normal.  Now, having been through the worst of the Great Recession, that reality is taking on new meaning as companies brace themselves for a long period of more of the same.  The Collection Industry, which has often considered itself somewhat recession-proof, has, like many other businesses, had to be creative in changing their business models to adjust to the new environment, sometimes multiple times. Since there has always been a direct relationship between charge-off rates, liquidation rates and unemployment, those that are still struggling looked for positive news on the horizon in the President's State of the Union address (SOTU) with regard to jobs creation.

Can Compromise Impact the Jobless Recovery?

As the President settles into the 2^nd half of his term, sobered by the November elections, a new tone has emerged.  Recognizing that if he is to have any success at all in the last half of his term, "compromise" will have to become the leading theme, and much like Clinton did in 1996 when he lost the majority in the House, Obama proved in his SOTU address that he could shift gears. Setting the tone with a symbolic, bipartisan seating arrangement, bones were tossed out to everyone and Democrats and Republicans alike each found something to clap about. Most noticeable was the attempt to rise above politics and redefine the political center to a more moderate pose, and, in a rare stab at humility, he tried to inspire unity through conciliatory grace and create a vision for "winning the future". While there were some who doubted his sincerity, the message was upbeat and was received with a fair degree of optimism by the general public. 

While the primary focus of the speech was on the economy and jobs, the speech was short on specifics on how to deal with our economic problems in a meaningful way, and long on optimistic rhetoric about the need for American innovation to meet new challenges.  Measures to reduce the deficit and freeze spending were undermined by seemingly contradictory recommendations to expand government in the way of a variety of "investments".  He characterized the country's predicament as our "Sputnik moment", alluding to American exceptionalism for the first time, in somewhat of a rally cry stating that "We need to out-innovate, out-educate and out-build the rest of the world." How that translates into reality and jobs was unclear given 2 things: 1) that he just called for a freeze on discretionary spending and 2) that the design and implementation of that vision now falls to a divided Congress.

The Economy

The slight rise in consumption last year gave the President some degree of leverage for optimism. Yet, critics of Obama's speech seemed to feel that his austerity measures were absurdly small and that the SOTU address was more of a campaign speech with empty platitudes rather than a serious attempt to deal with our tough economic problems. Economist Nouriel Roubini calls the freeze in government spending as "spare change", while former Senator Fritz Hollings pointed out that if this year's deficit is projected to be $1.5 trillion and you freeze spending, you'll still have a $1.5 trillion deficit next year.  He also took exception to the term "Sputnik Moment", saying "Heck, it's a Pearl Harbor Moment!  We've got a Pearl Harbor moment, and we've got to bet back to work!" He was also critical of the Administration's reluctance to enforce its trade policies, which he says is responsible for America's loss of it manufacturing base.

Many of the jobs lost overseas during this recession may not return. And, whether Obama really recognizes that production is an important key to recovery remains to be seen, as does how his own party will respond to his shift in policy. Sadly no politicians seem prepared to make the hard decisions.  Without reducing entitlements and tackling tort reform the prospects of turning this economy around and kindling job growth any time soon are bleak.

Effective Job Creation, or Token?

Obama sidestepped any talk of the high unemployment rate, choosing more lofty and soothing rhetoric about the importance of job creation and the foundations that need to be built to set that in motion. The vague plan to create jobs was rooted in familiar territory - adding more government stimulus to the economy in research, transportation, technology, infrastructure, education and energy.  While freezing government spending might seem like an impediment to funding these "investments", given the fact that recent budgets have been astronomical due to TARP and other stimulus spending, that might not be the case at all.  The more important question is how effective will it ultimately be in stimulating the economy and creating jobs?  As with any plan, the devil is always in the details of how it is structured and implemented, while in concept this has to be better than giving it to the banks (that is, unless that is what they do), much will depend on how much gets into private sector hands, and even more importantly, how much increases the GDP to make a dent in the deficit.

The President hedged his bets with some uncharacteristically pro-business rhetoric calling for lower corporate taxes and abandoning unnecessary regulation, which seemed more Reaganesque than Progressive and helped the Dow spike over the 12,000 for the first time since June 2008. Concessions to the private sector were aimed at coaxing a $2 trillion corporate investment back into the economy in the hope that it will ultimately find its way to significant hiring. But, not much will be accomplished on that front unless Obama can convince his own party to join him in true bipartisanship.  Post speech indications are that neither party is willing to work together to get the job done - Democrats because they believe that government can solve the problem and Republicans because they believe that government is the problem. Ideology has us at a stalemate.

Changing Paradigms

We find ourselves in a vicious circle with no clear way out. We need to add 1.5 million jobs per year to keep from sinking deeper and about 5 million to bring us back to full employment.  Without those jobs, people aren't likely to start spending and without spending, businesses are unlikely to hire. With the combined unemployment and underemployment[1] figure at 17.4, the highest since the 1930s, and no relief in sight, we face an array of new problems added to the ones we current have.  Most experts believe that the official statistics grossly understate the magnitude of the unemployment problem. Last fall, Mark Zandi, of Moody's Economy.com, said that he thinks the unemployment will remain high for the foreseeable future, going so far as to use the word "permanent". If that is true, pervasive unemployment will have consequences that reach well beyond the struggling individual or family.  An article by Don Peck in the Atlantic, discusses in great length the effects of protracted unemployment on family, society and politics.  In "How A New Jobless Era Will Transform America", Peck states that visible signs are emerging that will likely effect the next generation of young adults and possibly the one following.  Statistics show that young adults graduating from college in recession years never close the gap in income over those graduating in boom years. In addition, Lisa Kahn, economist at Yale found that they were less likely to have professional careers or work in prestigious environments. Those that floundered in the job market often had trouble getting traction, and long stretches of unemployment often led to drinking, destructive behavior and psychological problems.  And, because many service businesses favor women, the impact has hit men the hardest straining the traditional family dynamic, and threatening family stability as many women come to terms with their husbands not being the bread winner. Moreover, unemployed men are vastly more likely to bring violence into the home.

It is clear that we can't rely on many of sectors that have traditionally led the way to recovery in the past (Automotive, Housing, Financial, etc) to do so again. Typically deep recessions spark innovation and it's that entrepreneurial spirit that Obama called on in his SOTU address. While the fact that the stakes are high may motivate some, the challenges are great.  Gearing up will require new skills, so in some respects many workers with outdated skills will be starting over.  In addition, creative potential in this country is much more limited than in the past due to more stringent patent laws, as well as a corporate perspective that is focused on quarterly returns rather than long term value. Even more stifling, according to economist Edmund Phelps, winner of the 2006 Nobel Prize in Economics, is the fact that we have "a financial industry that for a generation has focused its talent and resources not on funding business innovation, but on proprietary trading, regulatory arbitrage, and arcane financial engineering." Phelps predicts that after the recovery is complete, the new floor for unemployment will shift from 4%-5% to 6.5-7.6%.

It's time to Bite The Bullet

While economists have speculated on the type of recovery we are facing (V, U, W or L), and debate the course of action required to heal it, only time will tell the story and it is likely that whatever it is, it will be different than past models.  The one thing that they agree on is that the current recovery is anemic. The economy will not get rolling again and jobs created without restoring confidence to the market place and that will simply not happen without some major changes in the way this country operates.  The uncertainty that swept over the economy when it began to crumble in 2007 has remained like a pall over the country.  The failure of the $800b stimulus, on top of the TARP bailouts reinforced the belief that government is just winging it.

All the warm and fuzzy talk aside, there was no "there" there in the President's address; nothing to indicate that we are getting serious about the precarious position we are in.  As we teeter on the edge of the default precipice, we are indeed at a "Pearl Harbor moment".  Agree or not with their message, if the Tea Party movement accomplished anything, it was to communicate that the people do not support a "business as usual" Congress. What we need at this time is a leader that will lead and not just govern.  One that will face up to the hard choices and put our obese government on a strict diet.  Dealing honestly and forthrightly with our problems will restore confidence in our government, here and abroad, and begin a real process of healing that will finally stimulate economic growth and reduce the high rate of unemployment.