The fog of battle  of "Slightly-Less-White Thursday"  has now dispersed a bit. Numerous commentators declared that the weakness in subprime, made manifest by the New Century and HSBC announcements, would not spread beyond that narrow category. The remainder of the week seems to have proved the optimists right.
What caught my attention during this exercise, though, was this Street article  that put forth a theory as how the firewall around subprime is constructed. As quoted by the author, senior economist at Deutsche Bank Torsten Slok implies that subprime’s customers rest mostly in the bottom 20 percent of Americans by income. He then notes that this bottom quintile’s share of the American pie has shrunk roughly 17% from a very low base in 1970, and in 2005 stood at only 3.4% of total income.
Before proceeding off to a soothing discussion about how financial institutions are much better hedged against a shock like this than in the 1980s, Slok uses some arguments I didn’t quite follow to show that subprime borrowers in the loser quintile can’t hurt the economy. Since the economy is consumer-driven, and these people are so poor, whatever happens to them won’t have a serious impact. Is this really how America works nowadays? If nothing else, this proves beyond a doubt that Jesse Jackson was in the right room on Wednesday when he spoke at Senator Dodd’s predatory loan hearing.
Notes and References: "Subprime Time Bomb: With HSBC and New Century Financial suffering losses from subprime borrowers, which other mortgage lenders face an unpleasant reckoning?", by Maya Roney, BusinessWeek, February 9, 2007. : As Doomer Old Mike remarked, Doom’s sidebar characterization of "Black Thursday" was a bit premature, even with the question mark. : "Stocks Fiddle as Subprime Burns", by Liz Rappaport, TheStreet, February 8, 2007.
Slok notes that adjustable-rate mortgages, or ARMS, make up only 20% of the total outstanding single-family mortgages, and ARM resets add up to about $18 billion in 2007. He adds that this is a small amount compared with annual consumer spending of around $9 trillion. The impact of the resets will account for less than 0.2% of total consumer spending, says Slok.
"Low-income households account for a smaller share of total consumer spending than they used to," he writes. The poorest 20% of the U.S. took in 3.4% of total income in 2005, down from 4.1% in 1970.
: This might be a weakness in Slok’s argument. If Joe & Jane Sixpack option-ARM borrowers were more typically a 50th percentile lower-middle-class couple, the rest of the Deutsch Bank economist’s logic loses some weight. Slok seems to be conflating the bottom fifth of mortgages with the bottom fifth of Americans, but aren’t most of the latter renters?