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Micro and Macro Economics – “It Stinks”
I was talking to a friend who is a contractor. He’s been in business
for a long time and has a good reputation. Renovations, additions, a
custom built house now and then were his specialty. In the good times
he had three crews working full time and a payroll of $20 grand a week.
The good times are over. I asked him how is business was going. His
response, “It stinks.”
I asked him, “What changed?”
He said something that rang a bell:
“90%
of my business came from homeowners who re-fi’ed to pay for the work
that I did. That is over now. No one has equity in their homes anymore
and if they do have equity, the banks won’t lend against it .”
Jump
from the micro to the macro economic impact of this. The following is a
graph of total mortgages outstanding. Mortgages debt grew at a 10% pace
up to 2008. Since then the total has declined.
This chart looks at the trajectory of mortgage growth based on prior years and compares it to the actual.
The
gap is very significant. Of course the trend line of mortgage growth
pre 2007 was unsustainable. Assume that instead of a crash we had a
soft landing in 2008. This graph looks at a mortgage growth rate half
of what we were experiencing. There is still a big ‘debt gap’.
These
gaps are what hurt my contractor friend. His business (and a lot of
others) lost the grist that made it all work. Money. The home equity
‘piggy bank’ is empty and busted. He has only one crew now. He is not
buying any new equipment anytime soon. His business at the lumberyard
is down 60%. The bank cut his line. His subs and suppliers want cash.
The jobs that are out there are bid low because there are a lot of guys
scrambling for work. A business that once paid payroll and income tax
is now costing us. There are 15 people getting nine months of
unemployment. As far as GDP impact goes, this company went from third
gear to reverse.
I don’t know the relationship to mortgage debt
creation and GDP. I would guess around 20%. Based on that, the gap I
described above would translate into a $300b contribution to GDP. About
2%. We desperately need that 2% right now. We aren't going to get it.
We are at least three years away from achieving growth in total
mortgage debt.
Total residential mortgages outstanding today
are at levels last seen in the 1st Q of 2007. By way of comparison the
current GDP level is about where it was at the end of 2006. For me,
this means that the economic recovery for the next few years will be
anemic at best.
Note:
The FRB data is from June 30, 2009, so it is stale. The monthly numbers
from both Fannie Mae and Freddie Mac through October confirm that there
is still no growth in mortgages. F/F’s combined books are in decline.
FHA has picked up the slack, but I doubt that there is any net growth.
FHA will have to reduce its lending in the near future. They can’t keep
lending 96.5%, they will go broke. There is no soft landing for this
segment of the economy.
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Suggested title kicker: ““90% of my business came from homeowners who re-fi’ed to pay for the work that I did. That is over now.”
This outstanding article is hiding behind a generic title: it deserved to be one of the top stories of the weekend.
you're friend is still in business due to a large client base and good work and good word of mouth, yet, what is ahead of him is not good...........all those laid off guys will start to think, hmmmm, if i can get two jobs i can be okay, so they get in there truck and seek bids, and since they have zero overhead and think they know what to do they bid em low, and bids start to go down, then another guy get's in the act, and when things finally turn those guys are gone cause they did not realize the real cost of doing business, and your friend either has half a crew, or a full crew and less money...........been there done that a few times.........good news is if he can make it out the other end, the survivors do prosper well when it turns
The problem isn't free trade. Just by reading your article I can see the problem - time frames. You used the term "historic rate of increase" for a frame of reference only 4 years in the making.
The true historical rate of increase should be many years longer, not just short term.
Economics, both macro and micro, are non-linear. Sadly, as humans, we enjoy linear thought - it makes analysis easy. But if you take a look at a longer timeline, you stop being so aggressive with longer term views if you take a more holistic view.
Case in point: when I worked at a media firm several years ago as a senior manager in sales, all senior managers were given an article that started with the sentence "all firms have the capacity to grow at double digit rates." I immediately threw the paper in the trash, and my EVP looked at me in shock saying "why did you do that?"
I explained "this article is a farce. A mature economy like ours is only capable of growth in the 2-5% range, without massive structural shifts due to entrepreneurial advancement, which we do not see today. As a result, it is impossible both theoretically AND literally for every firm to have the capacity to grow at double digit rates otherwise the economy as a whole would have this capacity. If you disagree, I'd suggest you contact any major investment firm because I think they'd love to hear why so they could benefit from your knowledge."
It is true that some firms can grow at double digit rates, sometimes for extended periods of time. But a study of standard growth curves indicates it is impossible to count on it regularly.
I view your comments on the free market to be a throw away comment due to frustration with the government's continued intrustions, which have created massive market imperfections that have shifted realistic, sane behavior. These behaviors have, because of the government, become increasingly short-sighted and geared toward beggar-thy-neighbor behavior rather than based on longer visionary growth time frames.
The free market is fine. The government has eliminated it, however.
I am going to disagree with you. From 1995 to 2008 total mortgages grew at an 11% rate. From 2000 to 2008 mortgages grew at 13%. This is not some 4 year trend I was looking at. It has been going on for a generation.
I do agree with you that our long term growth prospects are not what they were. And we have not woken up to that reality yet.
bk
I think there's something to be said for scaling back free trade a little. There's nothing wrong with free trade between relatively equal (read: first world) countries. But when one country has to pay decent wages and follow environmental laws, and another country undercuts them by keeping their currency low, pays slave wages, and dumping toxic waste where it likes, that isn't exactly free trade, though it may be called that, and tariffs or something else may help country A level the playing field and help themselves out domestically.
So what do you suggest? More government/private price support to generate equity on paper, force the banks to lend against it? That's what got us in this mess.
It's sad for your friend (and more so for his fired workers) but that kind of debt fueled consumption was the real problem. Now comes the medicine, which is unpleasant. (As an aside, the government support for housing is just making the inevitable pain worse - better to chop off a leg in one whack than a hundred.)
I hope you're not serious about free trade.
…the destruction of America's middle class by confusing free trade with global labor arbitrage.
Thought For Labor Day: Conservative Dogma Pulling Marx Out of His Grave | American Engineering Association
By Paul Craig Roberts
Libertarians and free trade economists don’t realize it, but they are pulling Marx out of his grave.
Free traders are resurrecting class war, not because they are Marxists but because they confuse free trade with global labor arbitrage. Free traders turn cold shoulders to US job losses from offshore outsourcing, because they mistake the losses for the beneficial workings of comparative advantage.
Committed to a 200 year old theory that they no longer understand, free traders are cheering on the destruction of middle class jobs and the dismantling of the ladders of upward mobility that make large income disparities politically acceptable.
The destruction of the stabilizing middle class is occurring simultaneously with an extraordinary increase in income inequalities. Not so long ago CEOs were paid 20 times more than the average employee; now some are paid hundreds of times more. The "gilded age" is returning while the value of a college degree is declining.
According to the Bureau of Labor Statistics’ 10-year jobs forecast, the majority of US jobs that will be created in the coming decade will be in domestic services that do not require a college education. This is a strange job outlook for a high tech economy allegedly benefiting from free trade.
Domestic services are nontradable. The US economy has not created a net new job in tradable goods and services in the 21st century.
Free trade economists have forgotten that not all trade reflects the beneficial workings of comparative advantage. For comparative advantage to function, a country’s capital must stay at home and be allocated to activities in which the country has comparative advantage. The other necessary condition is that countries have different internal cost ratios of producing different goods.
When the principle of comparative advantage was discovered, capital was mainly kept at home under the watchful eye of the owners and protected by the country’s laws. Tradable commodities were primarily products influenced by climate and geography, guaranteeing that the cost of a yard of wool in terms of a bottle of wine would vary among countries.
Today capital is more mobile than tradable goods. Modern production functions are based on acquired knowledge and produce identical results regardless of location. When a US corporation closes a factory in Ohio and relocates its production for US markets to China, the loss of US jobs is not the result of a Chinese firm gaining a comparative advantage over the Ohio one. It is the result of US capital seeking absolute advantage in lower cost Chinese labor.
Free trade economists have completely forgotten that the flow of resources to where they have absolute advantage does not result in mutual benefit. The country that receives the resources gains and the other country loses.
When capital and technology flow from the US to China and India, the productivity of labor in China and India rises. In the US it falls.
Outsourcing is eliminating entire American occupations in engineering and information technology. As there are fewer jobs for graduates, engineering enrollments in the US are declining….
to READ MORE:
http://www.itpaa.org/modules.php?name=News&file=article&sid=1927
One has to wonder if the free trade mantra is realy in our best interests. I have doubted it for years. I think it makes Wall Mart rich it makes everyone else slaves.....
Don't wonder! It's amply proven: the free-market-ideology driven free trade is only in the best interest of your financial elites. As we all witnessed in this train wreck of a crisis, the markets are n o t self-regulating, investors are n o t
rational and the so-called beneficial financial innovation built up a nuclear time bomb of complex instruments (CDO, CDS) and dangerous procedures like repos.
No wonder the markets trembled today - and only because a little Arab financial hub has some problems paying debts! Imagine if one of the big four has a problem.
Solid piece Bruce, thank you for sharing it.
We own a custom woodwork manufacturing business and within the past ten years about 70% of all our American/ Canadian peers have closed their doors and had fire sales to pay their mortgage notes. Since 2002, Durham, NC (just outside College Park) has been eviscerated by the Chinese/ Vietnamese who import cheap lathes from Catalonia (at 1/3 the cost of safe, quality German units) and pay kids 20 cents an hour to turn columns, spindles and newels; Egypt and Saudi have recently entered the space as well since about 2005 (great timing huh).
We're lucky to have taken precautions over the past 2-3 years in explicit anticipation of this climate and what we believe is still yet to come. The industry itself is simply on life support and we can not begin to tell you how many contractors left their down payments with us and simply cancelled their jobs over the past 2 years and 2 months. We're very lucky to have good managers, great employees and an excellent niche. For whatever it is worth, the industry is absolutely dead and barely crawling with only high-end repairs being done and simply no end in sight for any turn. Entirely anecdotal but actually first hand and not relayed.