Contrary to popular opinion, pockets are still deep

Atalaya Capital Management, an alternative investment and advisory firm, has posted a white paper on the near future for consumer finance in the US, and on investments tied to consumer credit, writes Christopher Faille.

In particular, the data Atalaya presents shows that since 2010, consumers have increased savings. This is in part because of pandemic-era government stimulus programmes that allowed consumers both to increase savings and to pay down debt. Even the impact inflation makes by eating into consumer savings is gradual, and “in-line with the long-term upward sloping savings trend”.

Furthermore, consumers have consistently reduced their debt-to-income ratios in the 14 years since the global financial crisis.

The debt service ratio, the share of income used to service debt, where “servicing” includes both interest payments and amortisation, tells its own story. The debt service ratio of non-financial corporations has been very volatile: falling after the global financial crisis, then rising in the mid-Obama years, then declining again in the final Obama years, rising again in the early Trump period but falling during the pandemic.

The same ratio for US households has no such zigzag. It has been either in decline or on an occasional plateau ever since the GFC. This, as Atalaya notes, means that households/consumers have a cushion against reverses, and argues against an upcoming spike in loan delinquencies. More broadly, the white paper predicts that US consumer credit will perform well in the months and quarters to come.

Fundamental worries

This doesn’t mean Atalaya takes the view that all is sweetness and light in the US macroeconomic outlook. In a recent phone call, Ivan Zinn, founder and managing partner of Atalaya, discussed some related ideas. In part, he said, the thesis of the white paper involved the dynamics between the Federal Reserve and the macroeconomic situation.

“The fundamentals will get worse before they get better. When they get worse, the Fed will change course and instil more liquidity into the system. That won’t play itself out quickly, likely not until 2023.” On Monday 3 October, the value of the equity of the Swiss bank Credit Suisse took a nosedive. This generated concern in some quarters that the second-largest Swiss bank was having a “Lehman Brothers moment” and even that a new GFC might be upon us. Zinn made short work of such fears.

“Credit Suisse made some mistakes and created headline problems,” he said. “Lehman had headline problems as well as balance sheet problems, and it lost access to capital. Lehman ultimately had a solvency problem. The two are not comparable.”

In its white paper, Atalaya uses a psychological hook for its exposition of these ideas. It discusses the Dunning-Kruger effect: the fact that people who only know a little bit about a complicated field often believe they know a lot. Fortunately, as they learn more, their understanding of their ignorance grows, and they descend from the mountain of confidence (which Atalaya bluntly calls “Mount Stupid”) on which they had resided.

The person who says “a volcano will erupt under Times Square next week. I know because I’ve been reading up on geology on a website”, is an example of the Dunning-Kruger effect. So are people who believe, on the basis of slight evidence, in a collapse of consumer credit in the US, a coming spike in loan delinquencies, and so forth.

Atalaya’s new paper aims to “help folks descend from Mount Stupid” in this particular respect. In the investing world, the Dunning-Kruger effect creates opportunity. Atalaya is confident that its capital “will grow ever more valuable as banks and other private credit lenders remain bearish on the consumer and the platforms that serve them”.