Credit and Debt Bubbles
By 2010, consumer credit card debt in the United States will reach $1.177 trillion [source: NPR]. It's not hard to understand why: As of July 2008, a staggering 14.5 million Americans don't have a job and 46 million don't have health insurance [sources: BLS and NCHC]. As the bills pile up, desperate families turn to the only credit available: plastic.
Many people don't have the cash to make even the minimum payments on their credit cards, causing credit card defaults to reach a 20-year high [source: NPR]. While this will undoubtedly mean record numbers of personal bankruptcies, it could also bankrupt the entire economy. Here's why.
One reason the damage from the housing bubble was so widespread was that mortgage debt was securitized (transformed into a tradable asset) and sold to investors. As homeowners defaulted on their mortgages, lenders took huge losses, as did the global investors -- including some of the largest investment banks -- who had purchased these mortgage-backed securities.
The same ripple effect will occur when millions of Americans default on their credit card payments. Credit card debt has also been massively securitized. Securities backed by consumer credit card debt represent a $365 billion market [source: Huffington]. When those securities crash, expect the rest of the market to follow.
In other news, as the stock market careened ever downward, hordes of spooked investors flocked to safer pastures: the bond market. In the rush to buy T-bills -- traditionally one of the safest, if lowest yielding investments around -- investors have excessively inflated T-bill prices.
The price of a bond is inversely proportional to its yield [source: Investopedia]. So the more the price goes up, the less you make when the bond matures. This simple mathematical truth could mean big-time losses for bond investors. Investment guru Warren Buffet thinks the deflation of the "treasury bond bubble of late 2008" will be as bad, if not worse, than the housing bubble [source: Krantz]. Gulp.
To make matters worse, some economists fear that the Fed is printing too much money to finance its generous stimulus packages and corporate bailouts. When and if that money begins to circulate through the economy, there will be a glut of dollars that will increase prices. You know this as inflation.
What does this mean to bond investors? When bonds mature, not only will their yields be close to zero, but they will be cashed in for dollars that are worth a fraction of their original value. In other words: loss, loss, loss.