American Businesses and Consumers are NOT Deleveraging ... They Are Going On One Last Binge

→ Washington’s Blog

Everyone knows that the American consumer is deleveraging ... living more frugally, and paying down debt.

Right?

Well, actually, as CNBC's Diana Olick pointed out
in April, many consumers are stopping their mortgage payments, and then
blowing the money they would usually pay towards their mortgage on
luxuries:

I opened up a big can of debate
Monday, when I repeated some chatter around that consumer spending
might be juiced by all those folks not paying their mortgages.

They have a little extra cash, so they're spending it at the mall.

Some of you thought the premise had some validity, others, as is often the case, told me I was an idiot.

Well after the blog went up Erin Burnett put the question to Economist Robert Shiller, of the S&P/Case Shiller Home Price Index, during an interview on Street Signs.

He didn't deny the possibility, and added:

"In some sense there might be a silver lining in that."

Then I decided to ask Mark Zandi, of Moody's Economy.com, who will often shoot down my more ridiculous theories.

I asked him if this was a crazy idea:

No,
not crazy. With some 6 million homeowners not making mortgage payments
(some loans are in trial mod programs and paying something but still
in delinquency or default status) , this is probably freeing up roughly
$8 billion in cash each month.

Assuming this cash is spent (not too
bad an assumption), it amounts to nearly one percent of consumer
spending. The saving rate is also much lower as a result. The impact on
spending growth is less significant as that is a function of the
change in the number of homeowners not making payments.

I'm not sure I would say this is juicing up spending, but resulting in more spending than would be the case otherwise.

Many
of these stressed homeowners (due to unemployment) are reducing their
spending, just not as much as they would have if they were still making
their mortgage payment.

Okay, so 6 million
American homeowners are not being super frugal about either paying their
mortgages or saving the money for another investment.

But surely the hundreds of millions of other Americans are reducing debt and deleveraging, right?

In fact, as the Wall Street Journal notes
today, the overwhelming majority of debt reduction by consumers is not
due to voluntary debt reduction, but due to defaulting on their debts
and having them involuntarily written down by the banks:

The
sharp decline in U.S. household debt over the past couple years has
conjured up images of people across the country tightening their belts
in order to pay down their mortgages and credit-card balances. A closer
look, though, suggests a different picture: Some are defaulting, while
the rest aren’t making much of a dent in their debts at all.

First,
consider household debt. Over the two years ending June 2010, the
total value of home-mortgage debt and consumer credit outstanding has
fallen by about $610 billion, to $12.6 trillion, according to the Federal Reserve.
That’s an annualized decline of about 2.3%, which is pretty impressive
given the fact that such debts grew at an annualized rate in excess of
10% over the previous decade.

There are two ways, though, that
the debts can decline: People can pay off existing loans, or they can
renege on the loans, forcing the lender to charge them off. As it
happens, the latter accounted for almost all the decline. Over the two
years ending June 2010, banks and other lenders charged off a total of
about $588 billion in mortgage and consumer loans, according to data
from the Fed and the Federal Deposit Insurance Corp.

That means
consumers managed to shave off only $22 billion in debt through the
kind of belt-tightening we typically envision. In other words, in the
absence of defaults, they would have achieved an annualized decline of
only 0.08%.

The Journal graphically shows that virtually all debt reduction is due to loan charge offs:

Karl Denninger notes:

From a peak in 2005 of $13.1 trillion in equity in residential real estate, that value has now diminished by approximately half to $6.67 trillion!

Yet outstanding household debt has in fact increased from $11.7 trillion to $13.5 trillion today.

Folks, those who claim that we have "de-levered" are lying.

Not
only has the consumer not de-levered but business is actually gearing
up - putting the lie to any claim that they have "record cash." Well,
yes, but they also have record debt, and instead of decreasing leverage levels they're adding to them.

In
short don't believe the BS about "de-leveraging has occurred and we're
in good shape." We most certainly have not de-levered, we most
certainly are not in good shape, and the Federal borrowing is what, for
the time being, has prevented reality from sticking it's head under the
corner of the tent.

Indeed, as I've pointed out
repeatedly, the government has done everything it can to prevent
deleveraging by the financial companies, and to re-lever up the economy
to dizzying levels.

As Jim Quinn wrote last month:

You
can’t open a newspaper or watch a business news network without seeing
or hearing that consumers and businesses have been de-leveraging. The
storyline as portrayed by the mainstream media is that consumers and
corporations have seen the light and are paying off debts and living
within their means. Austerity has broken out across the land.

***

Below
is a chart that shows total credit market debt as a % of GDP. This
chart captures all of the debt in the United States carried by
households, corporations, and the government. The data can be found
here:

http://www.federalreserve.gov/releases/z1/current/accessible/l1.htm

Total
credit market debt peaked at $52.9 trillion in the 1st quarter of
2009. It is currently at $52.1 trillion. The GREAT DE-LEVERAGING of the
United States has chopped our total debt by 1.5%. Move along. No more
to see here. Time to go to the mall. Can anyone in their right mind
look at this chart and think this financial crisis is over?

During
the Great Depression of the 1930′s Total Credit Market Debt as a % of
GDP peaked at 260% of GDP. As of today, it stands at 360% of GDP. The
Federal Government is adding $4 billion per day to the National Debt.
GDP is stagnant and will likely not grow for the next year. The
storyline about corporate America being flush with cash is another lie.
Corporations have ADDED $482 billion of debt since 2007. Corporate
America has the largest amount of debt on their books in history at $7.2
trillion.

Indeed, as this chart courtesy of Zero Hedge confirms, traditional banking liabilities are higher than ever:

Granted, the liabilities of the shadow banking system have fallen off of a cliff.

But Tyler Durden argues:

The
latest plunge in the shadow banking system is merely the most recent
confirmation that the deleveraging in America is only just beginning.

So what does it all mean?

The government, big financial companies and the American consumer are all guilty of fighting deleveraging instead of voluntarily paying down their debt.

Like
a junkie looking for "one last score", the entire country has sold out
our future to try to keep the artificial high going a little longer.

As I pointed out in July 2009:

Every independent economist has said that too much leverage was one of the main causes of the current economic crisis.

However ... the Federal Reserve and Treasury have, in fact, been encouraging massive leveraging.

***

Economists
pushing voodoo theories justifying the tremendous increase in leverage
were promoted and lionized, while those questioning such nonsense were
ridiculed.

In other words, economists and financial advisors - in
academia, government and elsewhere - have been subservient to the
financial elites, and have trumpeted the safeness and soundness of
cdos, credit default swaps, and all of the rest of the shadow economy
which allowed leverage to get so out of hand that it brought the world
economy to its knees.

This is no different from the promotion of
sports doctors to become team doctor when they are willing to inject
various painkillers and feel-good drugs into an injured football star
so he can finish the game. If he is willing to justify the treatment as
being safe, he is promoted. If not, he's out.

Economists have
acted like team docs for the financial giants. When the football team
doctor who gives the injured patient steroids and stimulants and tells
him to get back in the game, it might be good for the team in the
short-run, but the patient may end up severely injured for decades.

When
economists have prescribed more leverage and told the banks to go
trade like crazy to get the economy going again, it might be good for
the banks in the short-run. But the consumer may end up being hurt for
many years.

Using another analogy, this is like prescribing"hair of the dog" to the suffering alcoholic or heroin to the withdrawing junkie.

And as I wrote in August 2009:

In an essay entitled "The risk of a double-dip recession is rising", Nouriel Roubini affirms two important points:

This
is a crisis of solvency, not just liquidity, but true deleveraging has
not begun yet because the losses of financial institutions have been
socialised and put on government balance sheets. This limits the ability
of banks to lend, households to spend and companies to invest...

The
releveraging of the public sector through its build-up of large fiscal
deficits risks crowding out a recovery in private sector spending.

In other words, Roubini is confirming what Anna Schwartz and many others have said: that the
problem is insolvency, more than liquidity, that the government is
fighting the last war and doing it all wrong, and that we should let the
insolvent banks fail.

Roubini is also confirming that
incurring huge deficits in order to have the federal government itself
act as a super-bank is causing a reduction in - and "crowding out" a
recovery in - private sector spending. [Roubini also said
last year: "Deleveraging requires the writing down of debt as
reflationary policies are not a free lunch and won't solve the debt
overhang problem"].

As I have repeatedly pointed out, a
recovery cannot occur until we move through the painful deleveraging
process. But instead of allowing this to occur, the government is
trying to increase leverage as a way to try to re-start the economy and save the insolvent banks. See this, this and this.

Of course, all of the massive government spending might also be putting

governments themselves at risk . . . but that is another story.

Comments

[fwiw imho]

Paul?  Paul Is that you?  Stimulus didn't work because it wasn't big enough?

Go lecture Germany on that point.

[More Critical T...]

Go lecture Germany on that point.

Funny that you'd mention that as I happen to be german :-) (I suspect Tyler could confirm my european IP from the logs?)

I know of two friends who during the crisis went into KA (Kurzarbeit) and avoided unemployment that way and are now back into full employment again. This was much less stressful to everyone involved than the equivalent US method of hire, fire, try-to-find-work cycle would have been.

There are also other laws in Germany that act as an implicit economic stimulus: for example if a company hires a young person fresh out of university (Praktikant) there are subsidies that pay part of the wages. This dampens long-time unemployment.

I actually like these automatic stimulus laws better than the free-cheque handouts the US stimulus was - as they specifically target those who cause depressions: unemployed people. The multiplicator of such kind of specific stimulus is higher than that of broad-based stimulus such as tax breaks or bank bailouts / QE.

Is it a fail-proof method? Nope - if an economy has broad, structural problems then nothing but a full-blown crisis can bring it out of its bad state. But practice has shown it that it can certainly protect against demand shocks caused by a financial crisis - without hurting the industries that were and are in good shape.

The problem with the upcoming US depression is that it is hurting everyone, in an almost masochistic way: instead of just hurting the industry that caused the crisis. (==a bubble in housing coupled with excessive risk-taking by financial institutions in that very segment)

[More Critical T...]

Wrt. Germany, you missed this bit:

Germany with an implicit stimulus. (Germany has automatic stabilizers via the 'Kurzarbeit' laws which allow workers to not go unemployed but stay with reduced pay and reduced work time - paid by the german government.)

As a GDP percentage the german economic stimulus was larger than the US one - and their post-recession recovery was stronger than that in the US.

The biggest stimulus of all was applied by China. They have barely suffered any recession and worry about bubbles now, not about a possible decade (or more) of depression.

Say what you want about China, but they know how to run a proper capitalist economy ;-)

[fwiw imho]

Paul, perhaps I was a bit to obtuse for you.

Obama send your buddy Timmy over to lecture you guys on "how it should be done".

We need more stimulus, more govenment jobs, more, more more.  In fact, use the stimulus to save more govenment jobs.  Next year we'll send more stimulus to save the govenment jobs we saved last year. and so on and so on and so on.......

[More Critical T...]

We need more stimulus, more govenment jobs, more, more more.  In fact, use the stimulus to save more govenment jobs.  Next year we'll send more stimulus to save the govenment jobs we saved last year. and so on and so on and so on.......

Why do you assume that this has to go on forever? The New Deal kind of stimulus didn't go on forever either.

Once an economy recovers rising interest rates syphoon off the excess money again. Companies will also invest more money, the population will rise due to increased standards of living, etc. etc.

Unless your argument is that economic growth is bad and that financial shocks are just 'tough luck', and should be survived via suffering a few decades while all global competitors of the US stimulate the heck out of their economies ...

What an efficient stimulus has to do is to cover the output gap caused by economic shock events, with roughly the same spending as the gap caused by the shock is. (Otherwise we end up symmetrically shrinking a whole economy and all segments of it, instead of only letting the sector shrink that caused the bubble.)

I.e. what happens now is that America is voluntarily giving up its existing economic capacity - while also worsening its own demand shock. It amounts to saying that no matter how far away a sector is detached from real estate, it must suffer and shrink.

(The answers from chinese and german politicians to that US policy are pretty predictable: "Thank you!!!". They are competitors of the US on the global market and welcome a shrinking US economy.)

So I don't agree with the view that a stimulus is necessarily bad - I don't think the USA is 100% broken as-is in its entirety, with no viable and functional sector remaining - so I think a temporary bridging of the output gap would be wise. In fact, both China and Germany have done exactly that and are now better off than the US.

Can a stimulus be over-done? Certainly - the Chinese have been running a non-stop stimulus program for 20 years, and reaped phenomenal growth rates - largely at the expense of all other countries. (Also, if you just print money dumbly without balancing the yield curve you can push an economy into hyperinflation.)

I suspect you disagree with me on every point? :-)