Twin Peaks: Household Debt Vs. GDP (The problem is us)

[iceport]

The following dialogue is from an NPR piece this morning, Taxpayer Beware: Bank Bailout Will Hurt, from the Planet Money people.

Alex Blumberg: I talked to a guy who has something to say to people who want to pin this whole thing on banks. I talked to David Beim at Columbia Business School. He's in his office showing me a graph showing how much debt we the citizens of America are in -- how much we all owe on our mortgages and credit cards compared to the economy as a whole, the GDP. For most of American history it was below 50%. And then...

David Beim: From 2000 to 2008, it goes like almost a hockey stick. It goes dramatically upward like a rocket. It's 100% of GDP. That is to say, currently consumers owe $13 trillion when the GDP is $13 trillion. That 100% of GDP owed by individuals. That is a ton.

Alex Blumberg: I'm going to ask you a leading question because I'm looking at the graph right now. Tell me, professor, has there ever been a time in history when we've owed that much before?

David Beim: I'm glad you asked me that. And guess what! The earlier peak way off on the left part of the chart is 100% of GDP in 1929. This is a map of twin peaks. One in 1929. One in 2007.


Alex Blumberg: Does that chart scare you?

David Beim: Yes! That chart is the most striking piece of evidence I have that what is happening to us is something that goes way beyond toxic assets in banks. It's something that has little to do with the mechanics of mortgage securitization or ethics on Wall Street or anything else. It says the problem is us. The problem is not the banks, greedy though they may be, overpaid though they may be. The problem is us. We have overborrowed. We've been living very high on the hog. Our standard of living has been rising dramatically in the last 25 years and we have been borrowing much of the money needed to make that prosperity happen.

Alex Blumberg: In other words, the problem the banks are facing is the problem we as a society are facing. We all have too much debt. Getting rid of it is going to be painful.

Is this a legitimate analysis? And if so, does it worry anyone else?

--Pete

[scuttlebuttrp]

Being in construction, it worries me bigtime.
People need to spend money upgrading their homes. If they have no money I have no work. The longer it takes for these numbers to come down and the economy to right itself, the longer MY little depression will last.
I've guessed 2012 before recovery for me before, looking to extend it out to maybe 2014 now.
Making up a resume this weekend and getting a real job soon. Haven't had one of those in about 15 years.

[iceport]

People need to spend money upgrading their homes. If they have no money I have no work. The longer it takes for these numbers to come down and the economy to right itself, the longer MY little depression will last.

Right, but isn't overspending the implied reason for this whole meltdown? Continued spending won't exactly help bring down the personal debt levels faster!

The question I have is, do people really see this as a direct cause-and-effect relationship between personal debt levels, as compared to GDP, and the the largest market collapses in the past century? Or is it an oversimplified coincidence.

There have been many comparisons made between the current crisis and previous crises. But this in the first one I've noticed that makes the direct (graphic) comparison based on personal debt levels.

--Pete

[grumel]

In my opinon, private sector overspending was a necessary but not a sufficient condition for the current crisis.

[bozo]

The country's broke. It will take a few years to allow the ship to right itself.

But, right itself it will.

Bozo

[scuttlebuttrp]

Right, but isn't overspending the implied reason for this whole meltdown? Continued spending won't exactly help bring down the personal debt levels faster!The question I have is, do people really see this as a direct cause-and-effect relationship between personal debt levels, as compared to GDP, and the the largest market collapses in the past century? Or is it an oversimplified coincidence.--Pete

I think idiot bankers/ investment houses took a bad recession and made it worse. Things were going to lock up eventually because of the serious oversupply of housing, combined with outrageous prices. But then the banks happened. Welcome to today.

I was whining Pete. Commenting on the fact that since peoples personal debt was so high, they won't be spending on "unnecessary" items like housing upgrades. That's why I predicted that

MY

personal depression will probably continue until 2014. Country should be kicking along better by end of 2010.

There's lots of reasons for the meltdown. Consumer debt is just one of them.

[DaleMaley]

Being in construction, it worries me bigtime.
People need to spend money upgrading their homes. If they have no money I have no work. The longer it takes for these numbers to come down and the economy to right itself, the longer MY little depression will last.
I've guessed 2012 before recovery for me before, looking to extend it out to maybe 2014 now.
Making up a resume this weekend and getting a real job soon. Haven't had one of those in about 15 years.

This weeks's issue of Business Week has an interesting graph of new home starts. At the present monthly trend, new home starts in the US will cross the zero point in Nov 2009.



I was surprised to see the very realistic possibility of zero new home starts in the U.S.

[Sunny Sarkar]

At the present monthly trend, new home starts in the US will cross the zero point in Nov 2009.

The trend further suggested that in Dec 2009 new home starts in the US will dip below zero into negative territory as mobs of angry MBS investors finally erupt and start venting by bulldozing unsold new homes into the ground :^)

[Valuethinker]

Is this a legitimate analysis? And if so, does it worry anyone else?

--Pete

Notice the moralistic tone:

- innocent bankers made credit available to greedy consumers who lived beyond their means. The Financial Services industry was never guilty of misinformation, aggressive sales tactics or lobbying to change bankruptcy laws to their advantage

- the average American hasn't had a real pay increase since 2000, adjusting for inflation. There *was* a surge in real incomes in the late 90s, but since the late 1970s, real incomes have grown only very slowly.

The growth has been highly skewed, in that most of the real income growth has to the top 20% of income earners. Almost all, in fact.

Nonetheless all these greedy Americans have been borrowing too much.

What I actually think happened was:

- the US had massive financial deregulation. Contrast on home loans to, say, Canada, which has not, and has no subprime crisis. In Canada, if you don't put 20% down for your house, then you have to buy a payment insurance policy, underwritten by a government company. This secures the lender against default.

- real incomes, for a variety of reasons, stopped growing in the last 30 years. To have a higher standard of living, the average American had to borrow. Everything in the society supported that: itemization of mortgage deduction, ease of consumer credit etc.

Americans also borrow to pay medical bills, a leading cause of personal bankruptcy.

- asset values, particularly of homes, kept going up, so the debt burdens looked manageable

Is this a problem?

Yes. Because in a deflationary environment, debt burdens rise over time, not fall. Households will increase savings rate and that will further compound the recession/ depression.

The bottom line is that consumption got to 73% US GDP, and its long run average is 66-67%, and that correction is essentially 2-2.5 years of economic growth, which will just go away and be lost.

[iceport]

I think idiot bankers/ investment houses took a bad recession and made it worse. Things were going to lock up eventually because of the serious oversupply of housing, combined with outrageous prices. But then the banks happened. Welcome to today.

I was whining Pete. Commenting on the fact that since peoples personal debt was so high, they won't be spending on "unnecessary" items like housing upgrades.

Hey Royce,

Sorry if I seemed to disregard what you're going through (it's my bad manners on display). Just trying to wrap my head around how big this whole thing might actually end up being. That graph sure is sobering. What I was driving at is that I hope your own estimation isn't too optimistic, with the comparison to the Great Depression and all. I do think you're right about there being lots of reasons, lots of blame to go around. It's just tough to figure out where one factor ends and another begins -- it's all so tied up together.

Reality has always had too many heads.

(A personal hypothesis is that every time something like this happens, someone was cheating the system somewhere along the line. That's what I think was also "a necessary but not a sufficient condition".)

About the real estate market, there's a blurb about a paper in Altruist Financial Advisors' Reading Room (in the Real Estate Investment Trusts (REITs) section) that says, "This paper concludes that equity REIT performance is correlated with changes in real estate valuation, but equity REIT performance leads corresponding changes in real estate valuation. In other words, if you wanted to predict real estate valuation trends, it would be useful to note equity REIT stock performance trends in the recent past."

Vanguard's REIT VNQ started a downward trend in February 2007. Does that fit? It's still tanking fast, so maybe that doesn't bode well in the near future for the real estate market in general, if the paper's conclusion is right.

I'm starting to wonder if we're all going to come out of this "decession" somehow changed from the way we went into it. That wouldn't necessarily be a bad thing. Hope everything works out well for you.

--Pete

[iceport]

Is this a legitimate analysis? And if so, does it worry anyone else?

--Pete

Notice the moralistic tone:

Hi Valuethinker,

Not sure where that's directed. I certainly didn't get that impression from the news piece or from Beim, and I'm usually hyper-sensitive to that sort of thing. He did call the bankers greedy and overpaid. I thought it was actually a very neutral delivery of a message that could have easily been turned into a moralistic argument.

I also hope that description wasn't directed my way. I've been more outraged than anyone I know at the financial industry's greed and corruption, and congress' eagerness to aid and abet it. I wasn't trying to lay the blame on the general population instead. (Though to be completely honest, this tidbit of information led me to see for the first time how individuals outside of the financial industry could, collectively, have had a significant role in the credit crisis. More than one thing can be true at the same time.)

The simple point that struck me (as in "does it worry anyone else?") was the dramatic similarity in the personal debt levels now and at the start of the Great Depression, and I wondered out loud if there was more than just a superficial parallel. In other words, "Are we headed into a crisis of similar magnitude to the Great Depression based on this comparison?"

Seems to me you read an awful lot into either the story as delivered or my one-liner question. Otherwise, I'm very glad you chimed in. I respect your opinions and analyses greatly.

--Pete

[Valuethinker]

The simple point that struck me (as in "does it worry anyone else?") was the dramatic similarity in the personal debt levels now and at the start of the Great Depression, and I wondered out loud if there was more than just a superficial parallel. In other words, "Are we headed into a crisis of similar magnitude to the Great Depression based on this comparison?"

Seems to me you read an awful lot into either the story as delivered or my one-liner question. Otherwise, I'm very glad you chimed in. I respect your opinions and analyses greatly.

--Pete

Pete

Hi. Perhaps I read too much into the piece. I apologize if I was aggressive.

I read an 'Americans borrowed too much' tone. Well, yes, but they did so because everything at every level told them that was OK. You should see, if you go back, how Cassandras like Wynn Godley at the Levy Institute at Bard College, and Dean Banker at the Center for Economic Policy, got slated for daring to suggest as much.

In a low inflation, low growth environment the consumer debt levels are a significant concern. Because there is no way for consumers to shift that debt.

As I said, the US could lose 6% of GDP (ie 2.5 years of normal growth) in the simple loss of consumer spending UNLESS:

- government spending fills the gap
- private business investment fills the gap (unlikely if the economy is weak: business investment fell -20% last quarter, I believe)
- net exports (X-imports) fills the gap (hard to do in a global slump)

The best analogy is probably Japan 1990. However Japanese businesses were highly indebted, whereas US businesses are not, this cycle. So that's a good feeling.

Conversely Japanese consumers had lots of assets, whereas US consumers do not. So that's a big negative.

What I hope happens is that US consumers default, shifting the debt, in effect, onto US taxpayers (via the banks who are bailed out). There are housing subdivisions out there that will be bulldozed-- they'll never be inhabited. That's unfortunate, but it's analogous to the 'dark fibre' of fibre optics that was laid around the planet in the dot com bubble (with $3 trillion of bank lending) and never lit up.

Until that bad debt is not weighing on consumers, and not weighing on the banking system, it will be impossible for the US to make economic progress. A 'lost decade' a la Japan beckons where economic growth is go-nowhere, and we hover close to deflation.

The social and political tensions from that would cause more harm in the USA than they did in Japan: the US is a less homogeneous country and there is far less of 'we are in this together'. Even now Japanese unemployment is not up to western levels, and they have only recently had widespread homelessness. The US is also much more important in the world economy.

What I propose above has a bad taste because it implies the reckless are going to be let off, and the frugal pay higher taxes. But we are in a crisis, and we have to move away from moral has-beens.

The danger is of, rather than a 1930s, which is unlikely because government is a bigger part of the world economy and because the policy mistakes of the 1930s re monetary policy (allowing banks to fail) and trade restrictions have not (yet) been made.

The danger is of a 'lost decade' a la Japan. And I'd have to say, right now, there must be a 50/50 chance of that.

[VictoriaF]

What I hope happens is that US consumers default, shifting the debt, in effect, onto US taxpayers (via the banks who are bailed out). There are housing subdivisions out there that will be bulldozed-- they'll never be inhabited. That's unfortunate, but it's analogous to the 'dark fibre' of fibre optics that was laid around the planet in the dot com bubble (with $3 trillion of bank lending) and never lit up.

(...)

What I propose above has a bad taste because it implies the reckless are going to be let off, and the frugal pay higher taxes. But we are in a crisis, and we have to move away from moral has-beens.

Hi Valuethinker,

I can see your point about the need to shift the debt, let off the reckless, etc. However, why to bulldoze existing houses? This seems incredibly wastful. Dark fiber remained dark, it was not dug out.

Thanks,
Victoria

[Valuethinker]

What I hope happens is that US consumers default, shifting the debt, in effect, onto US taxpayers (via the banks who are bailed out). There are housing subdivisions out there that will be bulldozed-- they'll never be inhabited. That's unfortunate, but it's analogous to the 'dark fibre' of fibre optics that was laid around the planet in the dot com bubble (with $3 trillion of bank lending) and never lit up.

(...)

What I propose above has a bad taste because it implies the reckless are going to be let off, and the frugal pay higher taxes. But we are in a crisis, and we have to move away from moral has-beens.

Hi Valuethinker,

I can see your point about the need to shift the debt, let off the reckless, etc. However, why to bulldoze existing houses? This seems incredibly wastful. Dark fiber remained dark, it was not dug out.

Thanks,
Victoria

Victoria

If the houses remain empty, they become magnets for crime, and despoil a neighbourhood-- who wants to buy next to a derelict house. This is more or less what happened in Detroit.

In Buffalo, people break into them to steal the copper pipes and wiring.

Many of these houses built at the bubble peak were too large to be maintained by the sort of people moving into those areas. Or too far from work and other amenities. Or those amenities like schools will never get built, because the municipalities won't have the tax revenues they expected.

So what you tend to find happening is that eventually the local municipalities repossess them for tax purposes, and then bulldoze, thus removing eyesores from the neighbourhood.

There is a famous neighbourhood outside of Detroit, which was laid out during the boom of the 1920s (American passenger car sales in 1929 were not again reached until something like 1946). You could, 25 years ago, drive out into these farmer's fields, and see fire hydrants and curbs laid out, waiting for the houses which were never built. A fire hydrant in the middle of a farm field.

We are on that point in at least some of the more grotesque excesses of the 2000s housing boom.

[btenny]

I'm sorry VT but I think you are way off base here. You live in England. How do you propose to know so much about the USA and all our subdivisions and the local quirks. Remember all real estate is local. Yes there will be houses bulldozed. But the ones that will be torn down are old houses in bad neighborhoods that should never have been sold or mortgaged. These houses were run down back in 1990 and now will finally be destroyed. Think parts of Detroit or New Orleans or dozens of other older cities.

Yes some subdivisions will not be completed and roads will be abandonded but not completed houses. No one will pay to bulldoze a new house that have not been sold. Forget it. It will not happen. There is just no incentive by anyone to spend money to tear down a new house. Yes some of these new houses will be abandonded by the mortgage companies and the taxes will not be paid but eventually they will get sold for taxes or some small sum to a speculator. There are just too many people who still have money living near these places that will buy the left over houses. These new houses are being sold right now in Florida and Las Vegas and Phoenix and LA at huge discounts (think $80K-$120K for a $350K house) and then rented back to the same people who owned them last year at greatly reduced monthly costs.

Now as far as US consumer debt the real issues that this author makes misses the mark in a key area. The whole world inflated real estate prices way too much. Prices in London and Rio and Paris and Moscow and the rest of the world all went up too much versus the peoples ability to repay the mortgages that were taken out. Look at Iceland and the Eastern European countries, everyone took out a loan and now cannot repay them. The same happened all over the world. Even Japan has a problem but the issue there is too much government debt not consumer debt. So much of the world has a problem of too much debt. So the world needs to deflate/inflate and take a time out for a few years while this stuff deflates and wages and currencies inflate. Not just the US, the world has a problem.

Bill

[Valuethinker]

I'm sorry VT but I think you are way off base here. You live in England. How do you propose to know so much about the USA and all our subdivisions and the local quirks. Remember all real estate is local. Yes there will be houses bulldozed. But the ones that will be torn down are old houses in bad neighborhoods that should never have been sold or mortgaged. These houses were run down back in 1990 and now will finally be destroyed. Think parts of Detroit or New Orleans or dozens of other older cities.

Yes some subdivisions will not be completed and roads will be abandonded but not completed houses. No one will pay to bulldoze a new house that have not been sold. Forget it. It will not happen. There is just no incentive by anyone to spend money to tear down a new house. Yes some of these new houses will be abandonded by the mortgage companies and the taxes will not be paid but eventually they will get sold for taxes or some small sum to a speculator. There are just too many people who still have money living near these places that will buy the left over houses. These new houses are being sold right now in Florida and Las Vegas and Phoenix and LA at huge discounts (think $80K-$120K for a $350K house) and then rented back to the same people who owned them last year at greatly reduced monthly costs.

Now as far as US consumer debt the real issues that this author makes misses the mark in a key area. The whole world inflated real estate prices way too much. Prices in London and Rio and Paris and Moscow and the rest of the world all went up too much versus the peoples ability to repay the mortgages that were taken out. Look at Iceland and the Eastern European countries, everyone took out a loan and now cannot repay them. The same happened all over the world. Even Japan has a problem but the issue there is too much government debt not consumer debt. So much of the world has a problem of too much debt. So the world needs to deflate/inflate and take a time out for a few years while this stuff deflates and wages and currencies inflate. Not just the US, the world has a problem.

Bill

Bill

I do recall reading on Calculated Risk about bulldozes. Perhaps I misremembered.

If you go back to Florida in the 20s say, or some other real estate bubbles, there were developments that were just never occupied, I believe (including that one outside of Detroit).

On the continued hollowing out of US cities it may be that happens, ie it is the inner city that gets bulldozed, not the exurbs. Another view is that, for the moment, America is less enamoured with urban sprawl than it was. I expect the answer will depend on which city we look at.

It is certainly the case (CR had some nice links) that some of the shopping malls that got built will get bulldozed. There are some links to empty shopping malls in, eg, OC, CA. Just empty. I remember the same phenomenon from the commercial property busts of the early 90s-- in Toronto at least, and other places as well.

Agree with you the debt problem is global. Debt to GDP particularly high in the US (and UK, and Spain and Ireland) but it is global. However it appears that the high debt to GDP countries will take the pain.

On the housing bubble certain countries very much worse effected than others: US, UK, Ireland, Spain, Baltic Republics. Australia's housing bubble had already 'popped' as of 2005 and Canada just hasn't had a housing bubble in the same way (though watch Vancouver, and Calgary will take a big hit on oil prices) a reminder that 'yes Virginia, banking regulatory regimes do matter'.

It's those bubble countries where I think consumer spending will recover only slowly (as it did Japan) and the damage to the financial system is concentrated.

On the international spectrum, it is the current account deficit countries, by and large, which are in the soup.

[grumel]

Only the United Staates had this anomal huge ever increasing foreign account deficit over 10 years or so. Only one country had this combination of low private saveings and an always increasing government budget deficit during an economic boom period. The regulation failure and the overspending has just one single important source, the United Staates.
Those problems are all well known and have been discussed in lenght since quite a long time. Such relativization , oh see the others did something similar are dangerous. They distract the view from the actual problem.

[SP-diceman]

Yeah grumel.

If I was in Europe Id be jealous of the US too.

Europe is collapsing under its own weight.

You see they have the "little" economies.

When Iceland hit its subprime problem.
The problem was it was Iceland.


Thanks
SP-diceman

[grumel]

Again.

This is so stupid. It does not even matter if the external effects are bigger than the internal effects or not. Lets asume for a second that the sky is falling in Europe. Congratulations, relative gain over Europe, absolute loss for everyone. So China is winning this round. Realpolitik is so irrational.

[Norbert Schlenker]

If current problems are the result of too high a debt/GDP ratio, then perhaps it's worth looking at sectors other than households too.

[Jack]

The bottom line is that consumption got to 73% US GDP, and its long run average is 66-67%, and that correction is essentially 2-2.5 years of economic growth, which will just go away and be lost.

But debt to GDP does not tell the whole story. GDP does not measure the appreciation of assets.

The housing bubble gave consumers the illusion that they had been given a pay raise increasing their income by $10,000 or $20,000 per year. Within the context of the information available to them, consumers were perfectly rational to increase their consumption -- they had become richer. Everyone from Greenspan on down was telling them that there was no problem, that there was no housing bubble. Exacerbating the problem were the people all over the world willing to lend to American consumers in order to cash in on the housing bubble.

Now that the phantom income has gone away, the real debt to GDP requires adjustment.

[dual]

If current problems are the result of too high a debt/GDP ratio, then perhaps it's worth looking at sectors other than households too.

Thanks for the plot, but the government debt part is highly misleading. The figures seem to include only current debt and not unfunded obligations. There is no way state and muni debt has stayed constant.

[Jack]

Thanks for the plot, but the government debt part is highly misleading. The figures seem to include only current debt and not unfunded obligations.

"Unfunded obligations" are not debt any more than your next year's power bill is a debt.

[AlohaJoe]

I'm sorry VT but I think you are way off base here. You live in England. How do you propose to know so much about the USA and all our subdivisions and the local quirks.

What information do you feel you have in the US that isn't available to people outside the US?

[dual]

"Unfunded obligations" are not debt any more than your next year's power bill is a debt.

That's nonsense. I don't have to pay next year's power bill if I don't use the power. The government has to pay these bills regardless what happens. For example, public employee pensions are guaranteed in contracts to their unions. These are the same as a mortgage or credit card contract that you sign. They are the taxpayers' debt.

[hewhomustnotbenamed]

There are housing subdivisions out there that will be bulldozed-- they'll never be inhabited.

Interesting concept for full employment(bulldozing) and boosting home values(lower supply).

Hey didn't fdr do the same thing in the depression , slaughtering pigs to boost prices.
Oh ,Never mind all those people pictured in soup lines were just staged as part of a vicious propaganda campaign to discredit the New Deal.

[Jack]

"Unfunded obligations" are not debt any more than your next year's power bill is a debt.

That's nonsense. I don't have to pay next year's power bill if I don't use the power. The government has to pay these bills regardless what happens. For example, public employee pensions are guaranteed in contracts to their unions. These are the same as a mortgage or credit card contract that you sign. They are the taxpayers' debt.

Are you planning on freezing in the dark? How about next year's grocery bill? Are you planning on starving as well? Otherwise I assume you will be paying those bills in the future. These are no different than the so-called unfunded obligations. We don't call them debt.

If future expenses were called debt, then the average 21-year-old coming out of college would have a "debt" of about $3.75 million, representing his 75-year unfunded obligation to pay for his food, shelter, health care, transportation, taxes, etc. But we don't call these debts. They are future expenses to be paid for with future income, the same as the unfunded obligations.

[Valuethinker]

I'm sorry VT but I think you are way off base here. You live in England. How do you propose to know so much about the USA and all our subdivisions and the local quirks.

What information do you feel you have in the US that isn't available to people outside the US?

Joe

Thanks for your comment! Appreciated

He is on the ground, I am not-- just a websurfer, me.

I do however have first hand experience of the early 90s real estate crash in the US and Canada. It's fair to say that houses built in the late 80s were not bulldozed in general.

I wonder though if this time might be different? The reason being that some of these subdivisions were started, but are:

- way too remote from work, shopping etc.
- schools etc. will never get built
- neighbours will never appear

Now in theory that is impossible: eventually the rent falls to the point where they get occupied. But what if the economic activity just dries up?

Remember in places like Florida, and, I believe, Phoenix, REAL ESTATE DEVELOPMENT is a key local industry.

And that industry just blew away with the economy, like desert dust.

[Valuethinker]

"Unfunded obligations" are not debt any more than your next year's power bill is a debt.

That's nonsense. I don't have to pay next year's power bill if I don't use the power. The government has to pay these bills regardless what happens. For example, public employee pensions are guaranteed in contracts to their unions. These are the same as a mortgage or credit card contract that you sign. They are the taxpayers' debt.

Are you planning on freezing in the dark? How about next year's grocery bill? Are you planning on starving as well? Otherwise I assume you will be paying those bills in the future. These are no different than the so-called unfunded obligations. We don't call them debt.

If future expenses were called debt, then the average 21-year-old coming out of college would have a "debt" of about $3.75 million, representing his 75-year unfunded obligation to pay for his food, shelter, health care, transportation, taxes, etc. But we don't call these debts. They are future expenses to be paid for with future income, the same as the unfunded obligations.

Yes but the US 21 year old also has GDP.

The US economy will grow over the next 70 years. US population is still rising and will do so until well into the late 21st century.

Looking at 'debt' without looking at assets is like looking at the debt of a company and assuming that the company's operations have no value.

The US is NOT heavily indebted by comparison to other developed nations (public sector debt) AND the US has growing demographics, much more so than almost any other developed nation.

So the US is OK.

HOWEVER

There are certain obligations which cannot keep growing at the current rates:

- local and municipal government pension scheme liabilities

- healthcare obligations and costs -- cannot infinitely grow at GDP +3% real

By contrast, Social Security is actually in pretty good shape. At the peak, US SS payments will be a smaller share of GDP than many developed nations have NOW.

On the Federal Deficit, the last 8 years have not been good for fiscal prudence, and taxes will inevitably have to rise. It's not so much the deficit the US is piling up now (which is the mirror of a very bad economic situation) but the loss of government fiscal position in the early 00s.

[Valuethinker]

The bottom line is that consumption got to 73% US GDP, and its long run average is 66-67%, and that correction is essentially 2-2.5 years of economic growth, which will just go away and be lost.

But debt to GDP does not tell the whole story. GDP does not measure the appreciation of assets.

The housing bubble gave consumers the illusion that they had been given a pay raise increasing their income by $10,000 or $20,000 per year. Within the context of the information available to them, consumers were perfectly rational to increase their consumption -- they had become richer. Everyone from Greenspan on down was telling them that there was no problem, that there was no housing bubble. Exacerbating the problem were the people all over the world willing to lend to American consumers in order to cash in on the housing bubble.

Now that the phantom income has gone away, the real debt to GDP requires adjustment.

I was speaking of consumer spending as a % of GDP. The 6% drop I foresee will, in fact, be replaced by savings (from the perspective of household sector).

Which is where you link in your thoughts. Consumers won't be able to increase debt at the past rate, because of the situation of their personal balance sheets.

So consumers will, long run, go back to saving 6-8% of their incomes (long run US average).

The danger is overcorrection due to the fall in GDP. Go back to Canada in the early 90s (very bad recession) and you see savings rates of 14%. Economy stuck in the glacial ice.

[TheEternalVortex]

- real incomes, for a variety of reasons, stopped growing in the last 30 years. To have a higher standard of living, the average American had to borrow. Everything in the society supported that: itemization of mortgage deduction, ease of consumer credit etc.

But that's not true! Real income per capita is at least 50% higher than 30 years ago.

Household income hasn't increased significantly but that's entirely explained by smaller households (more single parent households).

[grumel]

Maybe valuethinker counts income per workhour for the median worker while you count the simple average income which is higher due to an increasingly unequal income distribution, a higher share for capital holders and a higher labour participation rate.

[Valuethinker]

- real incomes, for a variety of reasons, stopped growing in the last 30 years. To have a higher standard of living, the average American had to borrow. Everything in the society supported that: itemization of mortgage deduction, ease of consumer credit etc.

But that's not true! Real income per capita is at least 50% higher than 30 years ago.

Household income hasn't increased significantly but that's entirely explained by smaller households (more single parent households).

Hi

I believe that the median income has not risen.

The average income has risen.

What has happened is that almost all the real income gains have accrued to the top 1/5th of income earners.

In fact, to be more micro, most of the income gains have accrued to the top 1/2 of 1% of all income earners.

Why this is so is an interesting speculation for labour economists. One strong thesis is 'the 3 tenors effect'. Opera Tenors are not necessarily paid more htan they were, but Pavrotti/ Placo Dominto and ?Ferez? were paid unimaginable sums compared to previous opera stars.

[btenny]

Well Value and Aloha the feet and eyes on the ground are so important in vast areas of society versus an electronic eye hole that it has been named. The "peak hole effect" was described about 25 years ago. You know the results as Doctors operating on the wrong side of the brain because they draped over the whole patient except for a small hole. Same issue when a doctor cuts the wrong leg in surgery. It also occurs in thousands of other places when people only see a small part of the whole picture. Think a construction worker cutting a pipeline that the "computer plans" said was in the next block but is right where he dug a trench. Think reading a magazine on the Internet and not seeing the "special adverstising section" ad label on the top of the page that changes the story completely.

I discovered the effect when trying to design and build large electronic circuit boards and integrated circuits when we first started using computers to keep the images. Plane builders and ship builders and city planners discovered the same issues when they first started computerizing plans. We all found lots of issues with computer only models and it took lots of talent and time to overcome the problems.

The internet is computerizing all kinds of information in small chunks and then letting people in remote locations view it. This gives the remote viewer a idea of some facts but not necessarily enough to make a good decision. So beware of the Peak Hole effect on the internet...

Our young people do not understand this problem very well so society will have issues with this as we adopt more electronic stuff all over the world. But beware lots of things need to be examined by real people in person with all their senses to make real evaluations.

Bill

[LH]

The graph would have been more interesting had it been put up BEFORE the recent drop, and used to postulate ex ante that we are in real danger of a depression again.

In fact, like the great depression, economists/historians/professors will write defintive articles about why it happened, how it could have been avoided had the people back then had a clue, and didnt do stupid things like contracting the money supply etc. etc. They may use this graph, and in 2040, people will wonder how stupid we were back in the old days, and the graph shows it all.... Until of course they go through their downturn as well, and note that there leaders seem pretty clueless about how to respond. Buy up mortgages, no give money to banks directly, make bad bank, no bad bank, nationalize, no nationalize.... Heh. In twenty years, I sure it will all be clear what we should be doing, even though whatever clarity they come up with by consensus, may be completely wrong : ) They cant test it, so by defintion, it gets taught as right : ) Neat stuff. This graph may well play a part in future textbooks (primative 2009nians)depending on how things turn out.

Thanks for the post, neat graph,

LH

[nisiprius]

I read an 'Americans borrowed too much' tone. Well, yes, but they did so because everything at every level told them that was OK. You should see, if you go back, how Cassandras like Wynn Godley at the Levy Institute at Bard College, and Dean Banker at the Center for Economic Policy, got slated for daring to suggest as much.

Read some of the "pay down my mortgage or not?" threads in this forum and see what the general tenor is.

I'm not sure what the "conventional wisdom" is these day, but a lot of people feel that a loan is exactly the same as cash, that once you get the loan it's not really the bank's money any more, and that financially wisdom consists of borrowing as much money as you can all the time and paying it back just as slowly as possible. I don't know how prevalent that is, but it's not a tiny minority view.

I must admit it wasn't until last week that I became aware a) that people enter retirement still owing on their mortgage, which is shocking to me, and b) that this is not considered frickin' insane, or even terribly unusual.

It's all of a piece with the rise of the state lotteries and the casinos and the Indian reservation gaming.

[Valuethinker]

Well Value and Aloha the feet and eyes on the ground are so important in vast areas of society versus an electronic eye hole that it has been named. The "peak hole effect" was described about 25 years ago. You know the results as Doctors operating on the wrong side of the brain because they draped over the whole patient except for a small hole. Same issue when a doctor cuts the wrong leg in surgery. It also occurs in thousands of other places when people only see a small part of the whole picture. Think a construction worker cutting a pipeline that the "computer plans" said was in the next block but is right where he dug a trench. Think reading a magazine on the Internet and not seeing the "special adverstising section" ad label on the top of the page that changes the story completely.

I discovered the effect when trying to design and build large electronic circuit boards and integrated circuits when we first started using computers to keep the images. Plane builders and ship builders and city planners discovered the same issues when they first started computerizing plans. We all found lots of issues with computer only models and it took lots of talent and time to overcome the problems.

The internet is computerizing all kinds of information in small chunks and then letting people in remote locations view it. This gives the remote viewer a idea of some facts but not necessarily enough to make a good decision. So beware of the Peak Hole effect on the internet...

Our young people do not understand this problem very well so society will have issues with this as we adopt more electronic stuff all over the world. But beware lots of things need to be examined by real people in person with all their senses to make real evaluations.

Bill

Bill

maybe those exurbs won't get knocked down-- the houses built. But some of the structures in them will do so. Starting with those vacant shopping malls.

I have lived through (2) real estate crashes.

Note the evidence shows that being on the ground and seeing things actually distorts your view. Because as human beings, we overvalue what we can see and remember (recency effect).

We are actually better judges of data if we are at a remove from it.

[Valuethinker]

I read an 'Americans borrowed too much' tone. Well, yes, but they did so because everything at every level told them that was OK. You should see, if you go back, how Cassandras like Wynn Godley at the Levy Institute at Bard College, and Dean Banker at the Center for Economic Policy, got slated for daring to suggest as much.

Read some of the "pay down my mortgage or not?" threads in this forum and see what the general tenor is.

I'm not sure what the "conventional wisdom" is these day, but a lot of people feel that a loan is exactly the same as cash, that once you get the loan it's not really the bank's money any more, and that financially wisdom consists of borrowing as much money as you can all the time and paying it back just as slowly as possible. I don't know how prevalent that is, but it's not a tiny minority view.

I must admit it wasn't until last week that I became aware a) that people enter retirement still owing on their mortgage, which is shocking to me, and b) that this is not considered frickin' insane, or even terribly unusual.

It's all of a piece with the rise of the state lotteries and the casinos and the Indian reservation gaming.

I entirely agree with you about:

- the surprise re mortgage and retirement. Amazed banks would lend on that basis

- the 'casino economy' effect eg gambling. Australia has one of the world's most deregulated gaming industries, and a culture of gambling, and perhaps not coincidentally, one of the world's lowest savings rates

- credit became another form of addictive drug. Cheap and easily available with no thought on supplier or user of the long term consequences

[grumel]

Read some of the "pay down my mortgage or not?" threads in this forum and see what the general tenor is.

The thinking in this topics exists all over the world. Humans are by nature somewhat irrational and financial sales people certainly do all to enforce this bad idear to get more fees. The overall seize of the problem with all bad comeing together ( expect borowing in a foreing currency, that fault was left for the smaller countries) is unique especially for such a rich country. Poorer countries often have a foreign account deficit, which is rational to some extend.

[Valuethinker]

Read some of the "pay down my mortgage or not?" threads in this forum and see what the general tenor is.

The thinking in this topics exists all over the world. Humans are by nature somewhat irrational and financial sales people certainly do all to enforce this bad idear to get more fees. The overall seize of the problem with all bad comeing together ( expect borowing in a foreing currency, that fault was left for the smaller countries) is unique especially for such a rich country. Poorer countries often have a foreign account deficit, which is rational to some extend.

We were in this weird world where teh Anglo-Saxon countries behaved like emerging markets, borrowing like crazy on their current account deficit, and the emerging markets, traumatized by 1998, ran big current account surpluses to finance that.

Now the weird world is coming to an end.

The problem in Europe, at least, Iceland, Hungary etc. was allowing individuals to borrow in foreign currencies, thus bypassing their own national monetary policy. This was a personal 'convergence play' on the Euro, and it has gone disastrously wrong.

Even in the Emerging Market surplus countries, government rectitude was offset by private agents borrowing abroad.

Hence the crisis in the mass liquidation of risk. Private capital flooding out of Emerging Markets.

Meanwhile the Anglo Saxon housing markets refuse to stabilise.

[Harold]

The subdivision discussion some of you are having reminded me of a fascinating Atlantic article from a year ago: http://www.theatlantic.com/doc/200803/subprime

[Valuethinker]

The subdivision discussion some of you are having reminded me of a fascinating Atlantic article from a year ago: http://www.theatlantic.com/doc/200803/subprime

If oil prices stay low, this is probably way too apocalyptic.

But looking at some of those suburbs, (exurbs), one does feel that some were built too far away from too much. And, as the article predicts, they could turn into the 'new slums'.

Had gasoline prices stayed at the near $5 (California) that they reached, then the 'sprawl' might have been quite curtailed, at least for a while.

[btenny]

Harold, Thanks for the link to the Atlantic article. It really tells it how it is in some of the new Exurbs in the western US. Slums or severly depresed areas is the likely outcome for many of these new places.

This is what I was trying to get at with VT and others who are not on the ground in Arizona or California or Nevada. These big new subdivisions are all built and half or so of the houses are occupied. But these owners will not move because they cannot sell for enough money to allow them to move. The same as the slums in New Orleans or Detroit. And no one will tear down finished houses. But these houses will be sold so cheaply that they will be rented out to lots of bad tenents or let run down so severly they will occupied by the homeless or other derelicks. Thus hurting the whole neighborhood.

But you are right that many shopping mall developers built in these new areas thinking they would be fully occupied. Well that is now bust. So the malls are almost completely empty and will go broke soon. And no one will ever move into the ones that are not complete. So yes those half finished malls may be torn down and the land used for other purposes.

But again I cannot say it strong enough. You have to be there in person and get the 10,000 foot view and the 10 foot view to not have a "peak hole effect" problem in understanding the issues. That's why the Army has Generals who visit war zones and Majors and Sergeants who fight the wars.

Bill

[btenny]

Well Value I have lived thru 3-4 housing busts in the west depending on how you count. So yes I know a lot about the issues out here and how they effect prices. So did the bankers but they did not want to admit it.

1973-4 Recession. Bought my second house in a partially completed subdivision that took 6 years to finish due to the downturn.

1980 Recession. Bought my third house at 16% interest when no one else was buying. I was lucky to sell my second house that same year but had to sell it twice as the first buyer canceled out of escrow.

1989-90 RTC Mess. Lived near several big lots with half finished houses that were owned by the Resoultion Trust Corp and other large land tracts sold by the RTC. Had kids costs so did not buy then but sure liked the good prices and many friends made fortunes from the fall out. Lived 5 miles or so from the Phoenician Resort that cost $500M to build and had $60M in artwork that was sold to the Kuiatees for $100M or so with $20M or so down. They then sold the artwork the next day for $40M.

2001-2002 Recession. Sold my third home three times and had it fall out of escrow twice due to 9-11 and related issues.

So I know a lot about real estate and recessions in the US west and was shocked when people kept paying more and more for houses than they could afford and than they were worth. I was against over priced real estate by 2003 or so and have been renting since then in northern Californa.

And I am pretty sure we have a long way to go in this recession. Real estate prices here are still way too high and will fall much more taking lots more banks and people with it. Too many people cannot afford to buy at the current prices and unemployment is still going up so they are getting no help there. Plus many are still thinking they can sell for 2008 prices.

Bill

[iceport]

The graph would have been more interesting had it been put up BEFORE the recent drop, and used to postulate ex ante that we are in real danger of a depression again.

LH,

I agree. Maybe somebody like Dean Baker has done that, but I haven't read enough of his stuff to see it.

- credit became another form of addictive drug. Cheap and easily available with no thought on supplier or user of the long term consequences

VT,

Interesting that you use this analogy! I've been using a very similar one to counter the anger and blame I hear directed at individual borrowers for the sub-prime mortgage bust. Some of the individual borrower-addicts may have had moral failings, there is no question; not all can be absolved of all wrong-doing by virtue of their ignorance or bad luck. However, the biggest villians by far, IMHO, are the lender-pushers who knew full well that no good could ultimately come of supplying the junk except their own enrichment, but they were amoral enough to keep dealing anyway. Who ends up penniless on the street, and who on their own private islands? I know which group gets a bit more of my sympathy. Both sides of the deal were necessary to create the epidemic, and the problem costs our whole society. Unfortunately, the demand seems to be one of the more destructive facets of human nature that we can't seem to "just say no" to.

--Pete

[Valuethinker]

The graph would have been more interesting had it been put up BEFORE the recent drop, and used to postulate ex ante that we are in real danger of a depression again.

LH,

I agree. Maybe somebody like Dean Baker has done that, but I haven't read enough of his stuff to see it.

- credit became another form of addictive drug. Cheap and easily available with no thought on supplier or user of the long term consequences

VT,

Interesting that you use this analogy! I've been using a very similar one to counter the anger and blame I hear directed at individual borrowers for the sub-prime mortgage bust. Some of the individual borrower-addicts may have had moral failings, there is no question; not all can be absolved of all wrong-doing by virtue of their ignorance or bad luck. However, the biggest villians by far, IMHO, are the lender-pushers who knew full well that no good could ultimately come of supplying the junk except their own enrichment, but they were amoral enough to keep dealing anyway. Who ends up penniless on the street, and who on their own private islands? I know which group gets a bit more of my sympathy. Both sides of the deal were necessary to create the epidemic, and the problem costs our whole society. Unfortunately, the demand seems to be one of the more destructive facets of human nature that we can't seem to "just say no" to.

--Pete

Lenders became the equivalent of cigarette companies. Providing their product to whomever they wanted and could entice.

I do think most human beings are, by nature, bad at finance-- I could tell you some horror stories about my personal finance!

And some percentage of the population, perhaps 10%, perhaps 20%, have a relationship with consumer debt that approximates the cigarette smoker or the alcoholic or the crack cocaine user (scientists reckon that cigarettes are the most addictive of the 3, btw). I was talking to a colleague here and she is afraid to pay off her credit cards (on which she is maxed) because they simply reduce her credit limit by the amount paid down. How can anyone live that way? This is a highly intelligent professional.

At this point I think we cannot just shoot the victim. Yes there were people who were silly about money-- there always are.

But as a society we cannot, now, afford to take that view. We need to clean up balance sheets and get on with repairing the economy.

Mostly I favour some form of conversion of the 'under water' borrowers into rental. Their debt gets wiped out but so does their equity. The mechanics of achieving this in a securitized value chain (ie the lender is not the servicer is not the holder of the debt etc.) are truly mindbending, involving state law as well as federal.

If I could change the course of history I would have Tanta at Calculated Risk not die from cancer, and be sitting on a presidential committee on restructuring the home lending market. That woman knew more about the nitty gritty of the home lending market, and could communicate it better, than anyone I have ever encountered.

Her piece (still on the site) 'mortgage servicing for uber-nerds' is a classic.

[Valuethinker]

So I know a lot about real estate and recessions in the US west and was shocked when people kept paying more and more for houses than they could afford and than they were worth. I was against over priced real estate by 2003 or so and have been renting since then in northern Californa.

And I am pretty sure we have a long way to go in this recession. Real estate prices here are still way too high and will fall much more taking lots more banks and people with it. Too many people cannot afford to buy at the current prices and unemployment is still going up so they are getting no help there. Plus many are still thinking they can sell for 2008 prices.

Bill

Bill

I think we are pretty much reading off the same page. Perhaps I am too pessimistic that some of these 'monsters' will be torn down.

My father grew up in a 'monster' from a previous boom-- the 1860s Victorian one, if you please. As he said 'when you have 7 toilets, someone has to clean them'. As the 20th century matured and domestic servants went out of fashion, these houses became unsustainable*. And his childhood home was, in the end, torn down.

That, plus the experience of Toronto in the 80s, said to me that 'shipwrecked' is a possible outcome.

But generally we agree. It will be more commercial space that comes down, perhaps, and some of these exurbs will become the 'new slums'.

Also that the real estate market, potentially, still has a long way to fall.

Which has very bad implications for stabilizing the banking system.



* classic line from Agatha Christie 'I never believed I should be rich enough to own a car, and too poor to have a servant'.

[iceport]

The bottom line is that consumption got to 73% US GDP, and its long run average is 66-67%, and that correction is essentially 2-2.5 years of economic growth, which will just go away and be lost.

But debt to GDP does not tell the whole story. GDP does not measure the appreciation of assets.

The housing bubble gave consumers the illusion that they had been given a pay raise increasing their income by $10,000 or $20,000 per year. Within the context of the information available to them, consumers were perfectly rational to increase their consumption -- they had become richer. Everyone from Greenspan on down was telling them that there was no problem, that there was no housing bubble. Exacerbating the problem were the people all over the world willing to lend to American consumers in order to cash in on the housing bubble.

Now that the phantom income has gone away, the real debt to GDP requires adjustment.

I was speaking of consumer spending as a % of GDP. The 6% drop I foresee will, in fact, be replaced by savings (from the perspective of household sector).

Which is where you link in your thoughts. Consumers won't be able to increase debt at the past rate, because of the situation of their personal balance sheets.

So consumers will, long run, go back to saving 6-8% of their incomes (long run US average).

The danger is overcorrection due to the fall in GDP. Go back to Canada in the early 90s (very bad recession) and you see savings rates of 14%. Economy stuck in the glacial ice.

Valuethinker,

It's actually scary how similar your response is to the one given by Treasury Secretary Tim Geithner before the Senate Finance Committee today when asked to address the comparison of household debt as a %-age of GDP in 1929 and in 2007 -- as described in the NPR piece. It's as if you prepped him!

Here is Planet Money's reference to a C-SPAN video of the exchange, Some Doll House Or Other, and the C-SPAN video, Treasury Sec. Geithner Explores Ways to Pay for Health Care. The exchange takes place just after about the 2 hour, 19 min, 40 sec mark -- and yes, there's a slider on the video player that lets you jump right to that mark.

At the end of the response in which he echoed Valuthinker's caution about an overcorrection, Geithner added this, "But you're right to point out that part of what we're going through is a necessary process of adjustment after a long period where people were borrowing beyond their means. And that makes this recession -- will make this recession deeper and more traumatic than it otherwise would have been."

That's what I was afraid of. :roll:

Thanks very much, VT, for your insights.

--Pete

[mtl325]

Just to dovetail on the idea of individual's savings rate. That 6-8% figure won't result in well capitalized households. We aren't looking at a return to fiscal responsibility, we're looking at deleveraging.

To an economist paying down debt is the equivalent of saving. It's a funky conception, but the savings rate is calculated as income minus current spending. After the deleveraging we're not going to see consumers with a lot of dry powder to deploy.

There is a macro silver lining here. The average American is only leveraged at a bit more than 1x income (all debts: mortgage, cc, student loans ect) if personal debt = GDP. Other than the nina loans, the banks weren't allowing people to go more than 4-5x income. These 'highly levered' people built up large amounts of CC debt after getting a mortgage. Thus the consumer will be back before the banks that were levered at up to 50x.

We just have to hope that consumer leverage does not increase due to more unemployment.

[grumel]

US foreign debt was around 15% of gdp a year or so ago. Not much of a problem.