Unemployments Unexpected Consequences on Credit Debt

I have been pounding the table that unemployment is not a trailing indicator, but a leading indicator of a recovery. It is not *the* leading indicator but it certainly is not a trailing indicator. Unemployment has to be reduced (not just slowed down) in order to have any sort of sustained economic recovery.

On a large notepad, I have two tree diagrams. One is diagramming the positive side of the economy and one diagrams the negatives of the economy. On the positive side, the roots of the tree are the Fed and Treasury programs/bailouts and government stimulus programs. On the negative side, unemployment and toxic assets are the roots.

Without going into too much detail on the resulting effects, on the positive side, most of the leaves end with job creation which re-feeds the entire tree. On the negative side, the effects result in growing unemployment.

So I see unemployment as the key indicator for the economic recovery or for the continued recession/depression.

But this is not the point of this blog. While putting this tree together, something stood out to me that I hadn't really thought about but I think is a reality that will play out. Debt is what got us into the current economic decline. And while most consumers are cutting down on debt, I found an interesting possibility of a class of consumer which may actually increase debt which will cause a windfall of problems for the economy.

The unemployed, in order to avoid losing their home, and making sure they can afford the essentials, are likely to use credit cards to their limits to protect their cash as long as they can. In fact, financial advisers will tell you it is better to make sure you have money for your home and worry about paying off your credit cards later. You can always file for bankruptcy protection from creditors while still saving your home.

My point is, many credit card companies are reporting a higher rate of defaults. Many due to unemployment. But not only are the number of defaults growing, the size of the defaults are growing. Meaning, not only are people not paying off their debt, they are growing it first, before defaulting.

This is bad news for the credit card companies and it is why many are being aggressive about reducing limits and increasing interest rates, to try to avoid overuse of credit lines.

I think this spells a lot of trouble for certain credit card companies. Particularly Discover Card (DFS) and American Express (AXP). Many banks will be hit too but banks are well diversified enough not for this to cause a big impact. For these credit card companies, it could have huge ramifications.

Both DFS and AXP have had big run ups lately due to banks and other financial stocks going higher. Do not mistake DFS and AXP as the same business structure as Visa and MasterCard. Visa and MasterCard make their money on service and fees, not on credit. They have very little if any credit/debt exposure. Discover and AmEx both have heavy exposure to credit.

I think now may be a great time to look at short positions in these two companies.