Macro-Economics for the Smaller Retailer by:Ron Pawlowski
I decided to detour from traditional retail ideas and issues in this article becauseof something that is looming on the horizon that all small retailers should be cognizant of. It's worth talking about large scale economics because they drive all industries, including retail.
We all know that the sub prime mortgage fiasco triggered the 2008 collapse of the stock market as interest rates reset themselves leaving many home owners unable to make these revised payments on houses they had virtually no equity in. Many simply mailed their keys to the bank and moved on creating a glut of houses that are greatly devalued and cannot be sold.
Space here does to permit me to elaborate on the backdoor shenanigans that transpired to create this mess at the banks as well as at government level, but the good news is that in spite of the worthless influx of cash to prop up the banks, the sub prime disaster is largely over. In other words, the losses have worked through the financial system, and the sub prime mortgages have essentially bled out.
On a global level, the U.S. dollar continues to slide. This is because the world has ended its love affair with the U.S. greenback and prefers other currencies to invest their wealth in. Recent increases in energy prices like oil have bolstered the U.S. dollar but only serve to slow down its ongoing spiral into the abyss.
All of this will affect interest rates and as the dollar drops, interest rates prior to a period of deflation (like the one we are now in....) must go up to protect the dollar. What does the inevitable rise in interests rates mean down the road?
Sub-prime mortgages only made up about 15% of the market. The remaining 85%, six times the sub prime amount are made up of other adjustable rate mortgage (ARMs) instruments.
While it isn't subprime ARMs that are resetting this time, neither are they prime loans. Those eligible for prime loans wisely tended to stay away from ARMs but this group of conservative borrowers is very small and almost insignificant.
The next to go are the Alternate ARMs, Option ARMs and Unsecured ARMs. Alternate ARMs are loans to the folks who are a small step up from subprime. Unsecured loans are a 50-50 proposition; either the borrowers were good enough that they weren't thrown into the CDS pool, or they were so risky no one would insure them.
Those two are bad enough. But Option ARMs are problem. These are loans with choices on how large a payment the borrower will make. The options include interest-only or, worse, a minimum payment that is less than interest-only, leading to "negative amortization" - a loan balance that continually gets bigger, not smaller. Imagine what happens with those when it's time to readjust the interest rate!
Once the carnage begins, will it be as bad as the subprime crisis? That's the $64K question. Perhaps not. For one thing, subprime loans were a much larger chunk of the market when they started going south. For another, there's been a lot of refinancing as interest rates dropped; that should help ease the default rate. And the U.S. government has massively intervened, with measures designed to prop up those who would otherwise lose their homes.
On the other hand, we're in a severe recession, which wasn't the case when the subprime crisis started. More people will be unable to meet payments. And the housing market has continued to decline, pressuring both marginal homeowners and banks that can't sell foreclosed properties.
Is the stock market's next crash on the way? All factors indicate a definite YES. Which day will it be? It's impossible to foretell. It could be in a month, or not for another year.
But make no mistake about it, the second crash is coming. It can't be prevented, no matter what desperate measures Obama and his hapless financial advisors come up with. All we can hope for is that, with a little luck, it won't be as severe as the first one. But it will last longer. We aren't out of the woods yet.
The order of the day is to be very conservative. Expect a mild but prolonged storm, but prepare for a financial tornado. It's worth saying again - there are six times more adjustable rate mortgages out there that will reset in the next 18 months than the subprimes we experienced. It's hard to say what the effect will be but the sheer size of the mortgages in question make it necessary for the small retailer to get ready for a prolonged battle.
Take Action Today:
1) As a small retailer, take the time to study future economic trends. Newspapers and many internet sites can provide you with unbiased information.
2) Understand that another financial bubble is coming, yet no one knows how deep its effect will be. Sub prime mortgages have bled out, however many conventional and high risk ARMS are coming due in a recession.
3) As a small retailer do not look at recent market recoveries as sustainable. We have another financial storm to get through.
4) Build up as much cash reserves as you can over the next 18 months. Minimize your debt as much as you can and defer large capital expenditures wherever possible until 2011.
5) Plan to make your business as solid as possible as we enter 2010 and you can get through whatever level of severity the next bubble burst brings upon us.
About the author
Ron Pawlowski is a Managing Partner at The Retail Institute. He has 30 years of experience in the Retail Industry, a Bachelor's Degree in Science as well as an MBA.
The Retail Institute is dedicated to the support of the small to medium retailer through timely informative articles as well as affordable retail seminars, manuals and systems.