The following is a comment by NorthGG on this post. As always, NorthGG makes an excellent point and I didn’t want it to get lost in the comments sections. The comment is posted in its entirety: Enjoy.
Greeting SE. As always thanks for the work, it’s greatly appreciated.
There are two effects of the housing bubble, economic and financial. I would argue that the underlying demographic demand for housing (and the coming entitlement spending) is a natural bubble and that the Fed has no control over.
The boomer bubble has passed through C and I (as well as Net Imports) and now heads to G.
In my view, the Fed exacerbated the natural C, I and Net Import bubbles in the economy making their impact financial markets much bigger (i.e allowing too much leverage in the financial sector) leaving us all with huge problems once the boom turned to bust.
Lax regulation and deflationary fears pumped up the boomer economy in financial markets. This puts the Northeast section of the US at great risk given collateral prices (housing) and dependence on Wall Street Incomes; Incomes that depend on increasing leverage that is clearly mind numbingly ridiculous already.
Please note the following data table from 1961 forward, looking only at periods where growth was positive in every quarter. This is nominal Non-Financial Debt growth regressed on Real GDP growth. Debt grew slower than GDP prior to 73 and then it was lights out.
Period DtGrowth Rsq
61to69 0.37x .98
71to73 0.59x .98
75to80 1.34x .96
82to90 2.8x .98
91to00 2.07x .998
01to07 6.02x .984
Since the 2001 recession, nominal nonfinancial debt has grown at almost 10x the rate of GDP to current data! 10 times!
This debt laden economy now features (end 2008 data) nonfinancial debt per household in excess of $280,000 with a median household income of $69k (end 2008).
Every $1 trillion in incremental non financial debt is roughly $8,000 per household, well over 10% of median income. Does the Fed think it can raise the rate of inflation so that it will raise free (real) cash flow in the economy? This is crazy.
This debt to income ratio is likely even higher at the end of 2009.
What I question is the Fed's role in allowing the economy to become so levered. It allowed accelerating leverage. The Fed chose to allow the bubbles to inflate but had no game plan for when they naturally peaked and deflated. The economic volatility is natural but the decision to leverage is fostered by acceptance of regulators. What is going to be the impact on this country if (when) the government debt bubble deflates like the Nasdaq or housing? For this there is no backstop. Washington has exacerbated the 2 previous bubbles and currently does on the 3rd.
As we head into the government debt bubble, will the Fed speak out against excessive leverage already in the system as we see the government red ink explode before our eyes? Excess debt is deflationary. This is a liability crisis.
The zero bound is not stimulative (private credit continue to contract) nor is the fiscal policy. We are sowing the seeds of corrosive deflation with the Fiscal policies meant to offset it.
Debt must fall relative to GDP, there is much more pain to come on the balance sheets. What is good for the economy is bad for the banks. The Fed is simply watching the federal government do what the private sector did, lever up. That I do hold them responsible for. The Fed has favored the banks over the economy for a long period of time. Allowing debt to permeate the economy so deeply and to stand by and watch the reckless debt cycle now engulfing the public sector is outrageous.
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One thing about the private credit contraction to which I don't think enough attention is paid is the lack of demand for credit. The Atlanta Fed recently published a survey on its macro blog, for example, concluding essentially that small businesses who want credit can generally get it; but they don't have the sales/profits to support new leverage. The same story is in every beige book, and you can build diffusion indices from the Sr Loan Officer Survey that show the same thing: for a few quarters now demand for credit has generally been contracting faster than supply. And since no one driving the train seems able to tolerate (or maybe even think up) a solution that does not involve more debt, just like in China, the debt goes to where government can influence credit demand, except in the US case that's the govt itself. Those big ratios of debt growth to GDP growth mean that for all the talk of "deleveraging", since the NBER peak in 12/2007, the private sector (ex GSEs) has shed about $590 billion of debt, but the public setor (inc GSEs) has added $3.3 trillion (as of 3Q 2009 Z.1). Even since consumer deleveraging began in earnest last year, public debt has offset it almost dollar-for-dollar, for a net reduction of only about $50 billion (through 3Q).
My question is: why is it like this? Which goes back to the discussion of structural problems and America's lost decade (or longer):
http://thesecreteconomist.blogspot.com/2009/11/americas-lost-decade-already-happened.html
Why do we have capital gains instead of wages? Why do we have houses and other financial assets but no jobs? Why debt instead of wealth? And what's cause, what's effect? Is there a structural problem in the US economy because of a policy choice to favor the financial sector/class which politics could reverse? (Hard enough.) Or was the decision to make wage earners into traders of financial assets the result of no one in charge knowing what else to do in the face of an economy that no longer seems capable of providing for its people? Sometimes it seems like unless there's a John Galt ex-machina moment of radical innovation, it's going to take a government debt or other sufficiently disruptive crisis in the US to figure it out.
Fwiw, the boomer cycle is underated in my view. Boomers are trying to smooth consumption and have chosen leverage and capital gains as the mechanism. This behavior to act as leveraged investors not savers was due in part to tax incentives (low cap gains taxes on housing and securities). Savers have been penalized over and over as the debt base mushroomed.
These investments (C which is housing, I which is equities) have seen secular peaks but the money is still owed. The collapse in private sector credit has resulted in a collapse in the economies cashflow (and mulitplier), this can best be seen in the weakening tax bases.
Now the stock of debt (which does not include the net offbalance sheet liabilities, I am sure they dont net to assets) is racing away from cashflow in the system.
How much debt and liabilities will the federal governent guarantee? This is an example of how policy will exacerbate the government bond bubble.
With the number of people turning 65 set to DOUBLE next year. Entitlement spending is going to explode as the tax base weakens. This is natural. We've chosen to fund this and other expenditures by hoarding levered assets. Assets they have a much smaller base to buy them given the BABY BUST that followed the BABY BOOM. There is little mention of the baby bust phenomena. Everyone has heard of the baby boomers but little attention paid to the bust.
Another note, in Too big to fail, there is little discussion of the economy. Its a gripping book but I get the sense reading it that all that was cared about was savings those firms at any cost. Private sector credit continue to contract, so just what was Wall Street saved for? It has massive overcapacity in the underwriting space.
Debt addiction is not new, its ended many nations sovereignty through out the course of history.
We as a nation have chosen to bet the ranch on capital gains for our future consumption. Prices are simply sums of discounted cashflows, as the debt base explodes there is little cash flow left for the residual prices and this is even before the boomer effect of delevering.
The United States federal govt now borrows money to make its interest payments on its debt. Given how much debt (40%?) is funding at near zero rates. this should terrify people. We indeed may be past the tipping point.
Credit is massively overvalued, there is simply not enough cashflow to pay the obligations that are made. Monetary induced inflation will make the real debt burden explode. Interest due will rise at multiples of wage gains.
I too fear it will be a long and sad outcome to this escalating crisis. There is not the resolve in Washington to deal with this. Policy makers have kicked the can down the road with how the most recent crisis was dealt with by borrowing roughly $16,000 from every household in the states in 2008 alone.
Everything will taxed; income, estate, VAT, emails (which at leas would get rid of spam). Uncle Sam's appetite for private sector cash flow is voracious now.
The boomers have had a big party. They need to clean it up.
"Sometimes it seems like unless there's a John Galt ex-machina moment of radical innovation, it's going to take a government debt or other sufficiently disruptive crisis in the US to figure it out." BCG_81
Or a revolution.
That so many problems stem from too much debt actually presents a unique opportunity for a revolution, I think. What if everyone just stopped paying?
I definitely agree that the aging baby-boomers is not getting enough attention. "BABY-BUST" should enter the national vocabulary.
Back to your orginal comment, you are right. The problem with lending seems to be demand, or at least demand at current prices. Thanks to the actions of the Fed and the Treasury, there is plenty of liquidity and banks are willing to take at least a few chances.
Personally, I think the contraction in demand is good. I hope it is maintained as the economy eventually recovers.
Keep posting stuff like this i really like it
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