Monday, February 27, 2012

Today's links

1--Eagle owl at 1000 frames per Second towards a camera, dogwork

Video--incredible, hypnotic footage of owl in flight.

2--How Wall Street Is Raising the Price of Gas, ABC News

Excerpt: Chilton obtained an energy research report from Goldman Sachs spelling out how much the Wall Street firm estimated speculators had pushed up the real price of oil sold to make gas, due to large bets in the markets.

Using the numbers from in the Goldman Sachs report, combined with current information from the CFTC, Chilton calculated how much speculation is driving up the price at the pump for the average consumer.

He shared calculations with ABC News for the first time.

By Chilton’s calculation, if you drive a car like a Honda Civic, you’re paying $7.30 more than you should every time you fill up — to Wall Street speculators. If your car is a Ford Explorer you’re paying an extra $10.41.

For a Ford F150, he says owners pay an additional $14.56 per fill up -or more than $750 a year.

For their part, industry groups representing Wall Street say there is no evidence their trading activities actually push up the price of oil.

Chilton isn’t doesn’t buy that argument. He and the CFTC are currently attempting to implement new rules that would put limits on speculation. In response, Wall Street is suing the CFTC attempting to get an injunction, which would allow everything to remain status quo.

“They don’t want these limits,” he said. “They want unbridled ability to speculate in these markets and that’s not good for consumers. It’s not good for markets. It’s not good for the economy.”

3--There's no shortage of Shovel ready jobs? Grasping reality with both hands

Excerpt: Reversing Local Austerity: One question that arises when we talk about the possibility of reversing the disastrous push for austerity runs something like this: “OK, you say you want more government spending, but what should it spend money on?” The truth is that I think the perceived lack of shovel-ready projects was overstated even in 2009, but it was a real concern…. [W]e could get a fairly big fiscal bang just by resuming aid to state and local governments, allowing them to reverse the big cuts they have recently made…. [E]mployment by state and local governments, which has fallen around half a million, with the majority of the cuts coming from education. Moreover, the baseline should not be zero; it should be normal growth…. [W]e could put well over a million people to work directly, and probably around 3 million once you take other effects into account, without any need to come up with new projects; just transfer enough money to state and local governments to let them return to doing the essential business of government, like educating our children.

This isn’t the whole of what we should be doing, by a long shot. But anyone who thinks we don’t have good ways to stimulate demand can be refuted with this observation alone.

4--The eurozone's "real problem---excessive welfare states, fiscal profligacy or balance of payments?, Paul Krugman, NY Times

Excerpt: This is not original, but for reference I find some charts useful. In what follows I show data for the euro area minus Malta and Cyprus — 15 countries. I use red bars for the GIPSIs — Greece, Ireland, Portugal, Spain, Ireland — and blue bars for everyone else.

There are basically three stories about the euro crisis in wide circulation: the Republican story, the German story, and the truth. (charts)

...What we’re basically looking at, then, is a balance of payments problem, in which capital flooded south after the creation of the euro, leading to overvaluation in southern Europe. It’s not a perfect fit — Italy managed to have relatively high inflation without large trade deficits. But it’s the main way you should think about where we are.

And the key point is that the two false diagnoses lead to policies that don’t address the real problem. You can slash the welfare state all you want (and the right wants to slash it down to bathtub-drowning size), but this has very little to do with export competitiveness. You can pursue crippling fiscal austerity, but this improves the external balance only by driving down the economy and hence import demand, with maybe, maybe, a gradual “internal devaluation” caused by high unemployment.

Now, if you’re running a peripheral nation, and the troika demands austerity, you have no choice except the nuclear option of leaving the euro, coming soon to a Balkan nation near you. But non-GIPSI European leaders should realize that what the GIPSIs really need is a general European reflation. So let’s hope that they get this, and also give each of us a pony.

5-- Making the Case for Occupy Wall Street, Trim tabs

Excerpt: How many of you know that the market value of all US listed stocks right now is $18.7 trillion. Not only is that almost a double from the March 2009 low, but the gain itself is just over $9 trillion. Let me repeat, the value of all US stocks is up by over $9 trillion in three years. Wow.

Obviously for such a huge gain the underlying US economy, particularly wages and salaries and employment must be doing so much better than it was back in early 2009. Right? Wrong.

Early in 2009, after tax take home pay for everyone who pays taxes was just about $5.9 trillion annualized. That was down from an all time peak of $7 trillion annualized at the beginning of 2008. The main reason after tax income was down so much was a plunge in capital gains – primarily from profits on home sales.

After three years of attempts at a recovery, take home pay is now around $6.3 trillion, up all of $400 billion annually since the early 2009 bottom, or 2% a year. Wait a minute! Incomes are up only 2% before inflation per year. How does that minimal increase in take home pay justify a $9 trillion increase in market value?

Occupy Wall Street complains that Wall Street is doing great and everyone else is not. I think they have a point. Shareholder wealth has doubled up, $9 trillion to $18 trillion, and take home for everyone who pays taxes is up about 2% a year,– which is not even keeping up with inflation. After inflation wage earners are losing ground while shareholders are buying Coach and Louis Vuitton stuff at Bloomies and Nordstroms.


So wait a second, how is the stock market up $9 trillion, while the rest of the economy is flat on its butt? The simple answer is that shareholders owe it all to President Obama and Fed Chairman Bernanke. The US government has added about $5 trillion in debt over the past three years. Where did that $5 trillion go? Some of it ended up on the balance sheet of corporate America. The record amount of cash on public company balance sheet currently earns nada, nothing in terms of interest income.


Therefore, companies say to themselves, why not use this free cash to buy back shares? And so they do. And so stock prices have been going up. However, recently as the stock market has risen ever higher new stock buybacks are slowing dramatically and insider selling is spiking and insider buying is disappearing. Unless incomes start surging soon, stock prices eventually have to crash. As I have said many times, there is no way income growth can surge anytime soon. Therefore, at some point in time, I expect a major stock market crash. The only question is when.

6--The Great Repression, The Big Picture

Excerpt: We’re baffled anybody still looks to the U.S. bond market for signals of future economic activity, inflation, or even risk aversion. Case in point is today’s 7-year bond auction, which CNBC’s Rick Santelli rated an eleven on a scale of ten, i.e., a slam dunk!

Go no further, however, than the chart below to see which maturities on the yield curve are the most repressed. Prior to today’s auction, for example, the Fed owned 43 percent of all Treasury coupon securities maturing in 2019 and more than 50 percent in three of the seven issues maturing in that year.

Yesterday we caught PIMCO’s very bright and articulate Mohammad El –Erian promoting the “seven-year bucket” in an interview with CNBC,

…make sure you have some gold, some oil, and concentrate your bond exposure in the five to seven-year bucket.

Known for “Fed Surfing” or getting in front of, or riding along with, the U.S. central bank’s market interventions, don’t you think PIMCO likes the seven-year, in part, because that is where Mr. Bernanke is camped out? Front running the Fed has paid handsomely for many and we doubt it is fully dominated by macro views of inflation, economic growth, Chinese hard landings, or risk aversion.

The information we divined from today’s successful bond auction? Especially, in a maturity that has been gagged and bound by Fed intervention? Absolutely nuttin’!

Finally, we view long-term Treasury interest rates as one of, if not, the most important price in the world. Because of direct financial repression the information it now provides and the signal it sends, which is so important to capital allocation decisions, has, at best, been severely distorted. No wonder corporations are hoarding cash and reluctant to invest.

7--Golden rule or golden straightjacket?, VOX

Excerpt: What is noteworthy about the new EU Fiscal Compact, however, is that it does not even correspond to current mainstream thinking among economists as to how an ideal fiscal policy framework should operate.

I suspect most economists would agree that such a framework should have two key elements.

•First, it should guide an economy towards a moderate and sustainable level of public debt.

•Second, it should keep public debt fluctuating around this moderate level in a countercyclical fashion, with higher-than-usual deficits in times of recession being offset by improvements in the fiscal position during expansions.

In relation to the first element, moderate debt levels, the compact emphasises the need for an explicit trajectory whereby countries can return towards a 60% debt-to-GDP ratio. I think this addition to the Stability and Growth Pact is a positive one and one could make an argument for placing it on a formal EU-treaty footing.

Far less positive, however, is the so-called golden rule setting a legally binding maximum structural deficit of a 0.5% of GDP when a country has a debt ratio above 60% and a maximum of 1% when a country has a debt ratio lower than 60%. In addition, independent of the ‘cyclical adjustments’ that are factored in to structural deficits, the maximum actual deficit shall be 3% of GDP.

The idea of the desirability of balancing the national budget may appear self-evident to its designers, embodying as it does the wisdom the famous Swabian housewife. However, an economy is not a single household and, as we know from the paradox of thrift, these comforting comparisons can be highly misleading when applied at an aggregate level.

The truth is that, far from golden, this rule is a poor one that doesn’t correspond to either of the principles of good fiscal policy just mentioned.

In relation to long-run debt levels, this rule, if followed over time, will lead to debt ratios well below those considered sustainable and moderate. An economy’s debt-to-GDP ratio tends to converge towards the ratio of the average deficit percentage to the average growth rate of nominal GDP (see Whelan 2012). So, for example, an economy with an average growth rate of nominal GDP of say, 4%, following a policy in which average deficits are a maximum of 1%, will end up with a maximum debt-to-GDP ratio of 25%, far below what is required to operate a sensible and stabilising fiscal policy....

Because Eurozone member states cannot set their own exchange rates or interest rates and do not receive any federal transfers, these severe restrictions on the only available macroeconomic policy tool are likely to be particularly damaging to macroeconomic stability in the Eurozone. Indeed, they may contribute to its long-run failure rather than help to keep it together....

Because Eurozone member states cannot set their own exchange rates or interest rates and do not receive any federal transfers, these severe restrictions on the only available macroeconomic policy tool are likely to be particularly damaging to macroeconomic stability in the Eurozone. Indeed, they may contribute to its long-run failure rather than help to keep it together....

At least those who inflicted damage on the world economy by sticking to the Gold Standard in the 1930s can claim to have been following prevailing economic thinking. The politicians who have designed these rules will have no such defence.

Ideally, debate about this treaty in all European countries should move beyond misleading analogies about the prudence of households balancing their books to focus on its actual long-run implications. Once passed into treaty form, it will be extremely difficult for European citizens to change these rules. Hopefully, it is not too late to prevent the golden rule from becoming a golden straightjacket.

8--Donovan: The Foreclosure Fraud Settlement Is Strong Because of the OCC Settlement, Firedog Lake

Excerpt: I’ve been amused by the consistent pushback from HUD’s Shaun Donovan, who has made himself into a leading figure just by his ubiquitousness, as it relates to the foreclosure fraud settlement. Donovan has been the point person to rebut criticism of the settlement, and he is back again today in CNN.

The settlement, which hasn’t been released or even decided as far as we know, raised so many questions that Donovan has had to divvy up his rebuttal in parts. His subject today is the $2,000 for foreclosure victims, which is pretty indefensible. In fact, Donovan doesn’t really try to defend it. “Some have questioned whether $2,000 is enough redress for families who lost their homes improperly. The answer is obviously no.” He then adds that the money is best seen as a measure of accountability for both foreclosure fraud and servicer abuse, like improper fees or an inability to inform borrowers of options when they fell into delinquency.

Moving away from that inadequate $2,000, Donovan says that there are other ways for individuals to get the restitution they deserve:

For families who suffered much deeper harm — who may have been improperly foreclosed on and lost their homes and could therefore be owed hundreds of thousands of dollars in damages — the settlement preserves their ability to get justice in two key ways.

First, it recognizes that the federal banking regulators have established a process through which these families can receive help by requesting a review of their file. If a borrower can document that they were improperly foreclosed on, they can receive every cent of the compensation they are entitled to through that process.

Second, the agreement preserves the right of homeowners to take their servicer to court. Indeed, if banks or other financial institutions broke the law or treated the families they served unfairly, they should pay the price — and with this settlement they will.

OK, so in the first place, Donovan is talking about the OCC (Office of the Comptroller of the Currency) consent orders. He doesn’t mention that they are a sham. The foreclosure reviews will be overseen by “independent” consultants chosen by and paid by the banks. What I wrote in November still holds:

This is part of the consent order between banks and the Office of the Comptroller of the Currency, known around these parts as the Office of Bank Advocacy. And they just aren’t to be trusted as a legitimate regulator. The servicer reforms in the consent decree consist mainly of the servicers being told to follow current guidelines. And these foreclosure reviews are a joke. The third party, “independent” reviewers? They’re hired by the banks. And they’re bringing in entry-level functionaries, the equivalent of robo-signers, to do the reviews. Let’s just say I don’t expect them to be exactly rigorous. And that’s even worse, because at the end of the process, the banks will be able to say that an independent review cleared them of wrongful foreclosures. And a federal regulator backed them up on it!

Keep in mind that the OCC has already said publicly that basically nobody was wrongly foreclosed upon (OCC Acting Director John Walsh based this on a sampling of a whopping 2,800 foreclosure files). So I don’t expect a process they created with the banks to dispute that very much.

The second thing that Donovan says is that homeowners still have a private right of action. I’m trying to figure out how a settlement with regulators could ever take that private right of action away. So this isn’t worth really saluting. But furthermore, if private rights of action were so important, someone tell me why we have a law enforcement apparatus? Obviously the answer is that law enforcement at the state and federal level have far more resources from which to draw. A private individual at risk of foreclosure will strain to keep up with the fusillade of white-shoe lawyers the banks will fire at them.

The answer is that $2,000 is totally inadequate, and so are the alternatives, especially when you’re talking about a sustained criminal enterprise. I know we’re told that this is just the beginning of a larger effort for accountability – we promise! – but I’ll give Simon Johnson the last word on that:

Among the fundamental principles of any functioning justice system is the following: Don’t lie to a judge or falsify documents submitted to a court, or you will go to jail. Breaking an oath to tell the truth is perjury, and lying in official documents is both perjury and fraud. These are serious criminal offenses, but apparently not if you are at the heart of America’s financial system. On the contrary, key individuals there appear to be well compensated for their crimes [...]

Indeed, at stake in the mortgage settlement are fundamental and systemic breaches of the rule of law – perjury and fraud on an economy-wide scale. The Justice Department has, without question, all of the power that it needs to prosecute these alleged crimes fully. And yet America’s top law-enforcement officials have consistently – and now completely – backed off.

9--Is the Federal Reserve Responsible for High Oil Prices?, The Atlantic

Excerpt: There is one reasonable way to argue that the Fed has helped pump up oil prices, but it doesn't have much to do with the value of the dollar. Instead, it's all about bond yields. It's possible that, thanks to the super, super low interest rates on U.S. Treasuries, investors seeking higher returns are pouring their money into commodities such as oil. Or, to put it another way, speculators might be driving up prices.

It wouldn't be entirely surprising if that were happening. One of the explicit goals of QE2 was the push investors into assets other than Treasuries, and pump up their value in the process. Unfortunately, we really don't have a perfect way of knowing when the price of oil is being driven by commercial demand, or by speculation. So if you're determined to blame the Fed for the price of gas, you might be able to do it. It'll just be hard to prove your theory.

10--Germany puts more pressure on Greece, Financial Times via Mish

Excerpt: The Financial Times reports Athens told to change spending and taxes.

"European creditor countries are demanding 38 specific changes in Greek tax, spending and wage policies by the end of this month and have laid out extra reforms that amount to micromanaging the country’s government for two years, according to documents obtained by the Financial Times.

The reforms, spelt out in three separate memoranda of a combined 90 pages, are the price that Greece has agreed to pay to obtain a €130bn second bail-out and avoid a sovereign default that the government feared would throw Greek society into turmoil.

They range from the sweeping – overhauling judicial procedures, centralising health insurance, completing an accurate land registry – to the mundane – buying a new computer system for tax collectors, changing the way drugs are prescribed and setting minimum crude oil stocks

The programme is much, much more ambitious than economic reform,” said Mujtaba Rahman, Europe analyst at the Eurasia Group risk consultancy. “This is state building, as typically understood in traditional low-income contexts.”

Most urgency is attached to a 10-page list of “prior actions” that must be completed by Wednesday in order for eurozone finance ministers to give a final sign-off to the new bail-out at an emergency meeting scheduled for Thursday.

Among the measures that must be completed in the next seven days are reducing state spending on pharmaceuticals by €1.1bn; completing 75 full-scale audits and 225 value added tax audits of large taxpayers; and liberalising professions such as beauty salons, tour guides and diet centers

11--The Housing Recovery In One Index, dshort

Excerpt: ...housing is a major contributing component to long-term economic recovery. Each dollar sunk into new housing construction has a large multiplier effect on the overall economy. No economic recovery in history has started without housing leading the way. So, yes, housing is really just that important, and we should all want it to recover and soon. The calls for a bottom in housing now, however, may be a bit premature, as I will explain. ("must see" chart)

The Total Housing Activity Index shown here is a composite of the sales of new and existing homes, new construction permits for single family homes and new single family home starts. As you can see, we are still near the same lows that we were in 2009 at the end of the recession. Furthermore, and what is really worse, is that the "recovery" was built on the back of a whole slew of tax payer funded bailouts, tax credits and incentives from HAMP to HARP to the Home Buyer Tax Credit. Not quite the recovery the government was hoping for.

The recent bumps in housing have been due to the warmest winter on record in the last 5 years, which is skewing the seasonal adjustments. With 1 in 4 home owners under some form of duress with their mortgage, it is only a function of time until a further erosion in price resumes, particularly as banks start to deal with the backlog of foreclosures and delinquencies that are on their books.

The bottom line here is that, while we have witnessed a very mild recovery in housing from the depths of the abyss, it is important to remember that it has been with the help of extensive artificial support, including the zero interest rate policy by the Fed and "Operation Twist", which has suppressed interest rates on mortgages to historic lows. That won't last forever, and as we wrote in our article on "Why Home Prices Have Much Further To Fall": people buy payments not home prices.

The shear magnitude of the TOTAL inventory that must be cleared, the potential for rising interest rates, a weak employment market (no job = no house), declining real incomes and rising inflationary pressures will likely keep the housing market suppressed and disappointing for quite a while into the future. This is just a function of economics.

Have seen the low point in housing? Has bottom truly has been put in? Perhaps. A bottom, however, doesn't mean that a sharp rise in prices or activity is just around the corner. This particular patient could very well remain comatose for much longer than people expect.

12--People Buy Payments - Not Houses, dshort

When the average American family sits down to discuss buying a home they do not discuss buying a $125,000 house. What they do discuss is what type of house they need, such as a three bedroom house with two baths, a two car garage and a yard. That is the dream part. The reality of it smacks them in the face, however, when they start reconciling their monthly budget.

Here is a statement I have not heard discussed by the media. People do not buy houses - they buy a payment. The payment is ultimately what drives how much house they buy. Why is this important? Because it is all about interest rates.

Over the last 30 years, a big driver of home prices has been the unabated decline of interest rates. When declining interest rates were combined with lax lending standards, home prices soared off the chart. No money down, ultra-low interest rates and easy qualification gave individuals the ability to buy much more home for their money. The demand for home ownership, promulgated by the Fed, the finance and real-estate industry, drove prices far beyond rational levels. Easy credit terms combined with a plethora of psychological encouragement, from home flipping and house decorating television to direct advertisement of the "dream of homeownership", enticed families to bite off way more than they could ever hope to chew.

In 1968 the average American family maintained a mortgage payment, as a percent of real disposable personal income (DPI), of about 7%. Back then, in order to buy a home, you were required to have skin in the game with a 20% down payment. Today, assuming that an individual puts down 20% for a house, their mortgage payment would consume more than 15% of real DPI. In reality, since many of the mortgages done over the last decade required little or no money down, that number is actually substantially higher. You get the point. With real disposable incomes stagnant as inflationary pressures rise, that 15% of the budget is becoming much harder to sustain.

With this in mind, let's review how home buyers are affected. If we assume a stagnant purchase price of $125,000, as interest rates rise from 4% to 8% by 2024 (no particular reason for the date - in 2034 the effect is the same), the cost of the monthly payment for that same priced house rises from $600 a month to more than $900 a month - a 50% increase. However, this is not just a solitary effect. ALL home prices are affected at the margin by those willing and able to buy and those that have "For Sale" signs in their front yard. Therefore, if the average American family living on $55,000 a year sees their monthly mortgage payment rise by 50%, this is a VERY big issue....

Since home prices on the whole are affected by those actively willing to sell, the rise of interest rates lead to declines in home prices across the board as sellers reduce prices to find buyers. Since there are only a limited number of buyers in the pool at any given time, the supply / demand curve is critcally affected by the variations in interest rates.

This is why the Fed has been so adamant to suppress interest rates at very low levels and have injected trillions of dollars to achieve that goal. They understand the ramifications of rising interest rates, not only on home prices, but also on the $3 Trillion in debt they are currently carrying on their balance sheet.

There are basically two possible outcomes from here. First, Ben Bernanke and his gang artificially suppress interest rates for a very long period of time creating the "Japan Syndrome" in the US, which leads to rolling recessions and a general economic malaise. Or, secondly, interest rates rise back towards more normalized levels as the economy begins a real and lasting recovery. I am really hoping for the later. In either case there is a negative and sustained impact to housing going forward. The excesses that were created over the last 20 years will have to be absorbed into the system, allowing prices to return to a more normalized and sustainable level.

None of this means that home construction, sales, etc. can't stabilize at these lower levels even as prices revert to their long term median price. However, stabilization and a recovery, such as the media is currently hoping for, are two vastly different things. We are very early in the entire deleveraging process, and until the excesses are removed from the system, the real housing bottom may be more elusive than anyone expects.

13--How Goldman helped Greece mask its debt, zero hedge

Excerpt: There are also some who remember that back in February 2010, it was none other than the Federal Reserve that tasked itself with uncovering whether Goldman did anything "illegal" by engaging in currency swaps to make the Greek economy appear rosier than it was: "We are looking into a number of questions related to Goldman Sachs and other companies and their derivatives arrangements with Greece," Bernanke said in testimony before the Senate Banking Committee.... Greece in 2001 borrowed billions, with the aid of Goldman Sachs in a deal hidden from public view because it was treated as a currency trade rather than a loan....Goldman Sachs spokesman Michael DuVally declined to comment on the Fed's probe. "As a matter of policy we don't comment on legal or regulatory matters," DuVally said. Goldman Sachs had defended the transactions in a statement posted on its Website Sunday. The firm said they had a "minimal effect" on Greece's overall fiscal situation." Maybe, just maybe it is time, two years later, for the world to hear something, anything, from the Fed as to what its seemingly quite extensive investigation into Goldman's has yielded.

14--Guest Post by JW Mason: The Dynamics of Household Debt, economist's view

Excerpt: It’s a well-known fact that household debt has exploded in recent decades, rising from 50 percent of GDP in 1980 to over 100 percent on the eve of the Great Recession. It’s also well-known that household borrowing has increased sharply over this period. ... In fact, though,... while the first one is certainly true, the second is not.

How can debt have increased if borrowing hasn’t? Though this seems counterintuitive, the answer is simple. We’re not interested in debt per se, but in leverage, defined as the ratio of a sector’s or unit’s debt to its income (or net worth). This ratio can go up because the numerator rises, or because the denominator falls. Household leverage increased sharply, for instance, in 1930 and 1931 (see Figure 1) but people weren’t were consuming more in the Depression; leverage rose because incomes and prices were falling faster than households could pay down debt. Similarly, changes in interest rates can change the debt burden without any shift in household consumption...

But strangely, despite the example of the Depression (and Irving Fisher’s famous diagnosis of rising debt burdens caused by falling prices and incomes (Fisher 1933)), no one has systematically examined what fraction of changes in private debt can be attributed to changes in interest, growth, inflation and new borrowing. In a new paper, Arjun Jayadev and I attempt to fill this gap, applying the standard decomposition of public sector debt changes to household debt in the United States for the period 1929-2011. (Mason and Jayadev, 2012.) Our findings challenge the conventional narrative about rising household debt.

What we find is that the entire increase in household leverage after 1980 can be attributed to the non-borrowing... — what we call Fisher dynamics. If interest rates, growth and inflation over 1981-2011 had remained at their average levels of the previous 30 years, then the exact same spending decisions by households would have resulted in a debt-to-income ratio in 2010 below that of 1980, as shown in Figure 2. The 1980s, in particular, were a kind of slow-motion debt-deflation, or debt-disinflation; the entire growth in debt relative to earlier periods (17 percent of household income, compared with just 3 percent in the 1970s) is due to the slower growth in nominal income as a result of falling inflation. In other words, there is no reason to think that aggregate household borrowing behavior changed after 1980; indeed households reduced their borrowing in the face of higher interest rates just as one would expect rational agents to. The problem is that they didn’t, or couldn’t, reduce borrowing fast enough to make up for the fact that after the Volcker disinflation, leverage was no longer being eroded by rising prices. In this respect, the rise in debt-income ratios in the 1980s is parallel to that of 1929-1931. ...

Think of it this way: If you borrow money and your income in dollars rises by 10 percent a year (3 percent real growth, say, and 7 percent inflation) then you will find it much easier to pay off the debt when it comes due. But if you borrow the same amount and your dollar income turns out to rise at only 4 percent a year (the same real growth but only 1 percent inflation) then the payment, when it comes due, will be a larger fraction of your income. That, not increased household spending, is why debt ratios rose in the 1980s.

Neither the 1980s nor the 1990s saw an increase in new household borrowing — on the contrary, the household sector in the aggregate showed a primary surplus in these decades, in contrast with the primary deficits of the postwar decades. So both the conservative theory explaining increased household borrowing in terms of shorter time horizons and a general lack of self-control, and the liberal theory explaining it in terms of efforts by those further down the income ladder to maintain consumption standards in the face of a falling share of income, need some rethinking. Given the increased availability of credit and rising inequality, some households may well have chosen to increase spending relative to income, and those lower down the income ladder presumably did rely on borrowing to maintain consumption standards in the face of stagnant wages. But for the household sector in the aggregate, until 2000, there is no increased household borrowing to explain. ...

An important point to note ...[is] that in the period of the housing bubble — 2000 to 2006 — the conventional story is right: during this period, the household sector did run very large primary deficits (averaging 3.3 percent of income), which explain the bulk of increased leverage over this period. But not all of it: even in this period, about a third of the increase in debt was due to ... mechanical effects... And in the following four years, households reduced consumption relative to income by nearly as much as they increased it in the bubble years. But these large primary surpluses barely offset the large gap between interest and (very low) growth and inflation over these four years. In the absence of the headwind created by adverse debt dynamics, the increase in household leverage in the bubble would have been effectively reversed by 2011.

We draw two main conclusions. First, as a historical matter, you cannot understand the changes in private sector leverage over the 20th century without explicitly accounting for debt dynamics. The tendency to treat changes in debt ratios as necessarily the result in changes in borrowing behavior obscures the most important factors in the evolution of leverage.

Second, going forward, it seems unlikely that households can sustain large enough primary deficits to reduce or even stabilize leverage. ... As a practical matter, it seems clear that, just as the rise in leverage was not the result of more borrowing, any reduction in leverage will not come about through less borrowing. To substantially reduce household debt will require some combination of financial repression to hold interest rates below growth rates for an extended period, and larger-scale and more systematic debt write-downs. ...

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