pafret Loc: Northeast

"So Who Are the Debt Slaves in this Rich Nation?"


"So Who Are the Debt Slaves in this Rich Nation?"

The American economy has split in two: How averages of wealth & debt paper over the profound risks. By Wolf Richter

We constantly hear the factoids about “American households” that paint a picture of immense wealth – and therefore a lack of risk for consumer lenders during the next downturn. We hear: “This – the thing that happened in 2008 and 2009 – won’t happen again.”

For example, total net worth (assets minus debt) of US households and non-profit organization (they’re lumped together) rose to an astronomical $92.8 trillion at the end of 2016, according to the Federal Reserve. This is up by nearly 70% in early 2009 when the Fed started its QE and zero-interest-rate programs.

Inflating household wealth was one of the big priorities of the Fed during the Financial Crisis. It would crank up the economy. In an editorial in 2010, Fed Chair Ben Bernanke himself called this the “wealth effect.” So with this colossal wealth of US households, what could go wrong during the next downturn?

Here’s what could go wrong: About half of Americans do not have enough savings to pay for even a minor emergency expense. The Federal Reserve found that 46% of adults could not cover an emergency expense of $400, such as a broken windshield. They would either have to borrow the money or try to sell the couch or something. So nearly half of the adults in the US live from paycheck to paycheck.

About 15% of American households have either zero or negative net wealth, according to the New York Fed. Negative net worth means they have more debt than assets. And nearly 47 million Americans, or nearly 15% of the population, live below the poverty line, according to the Census Bureau.

So who benefited from the “wealth effect”? Those who had the most assets. At the very tippy-top: Warren Buffet. At the other end of the spectrum, in 2016, only 52% of households owned stocks directly or indirectly. The phenomenal stock market boom left 48% – usually those below the poverty line, those who cannot cover emergency expenses, those with zero or negative net worth, etc. etc. – in the dust.

Even those Americans with good incomes have loaded up with debt to try to live the American dream. In total, it has led to this situation:
• Student loan balances have skyrocketed by 160% over the past ten years to $1.4 trillion.
• Auto loan balances have shot up 42% over the past ten years to $1.1 trillion.
• Credit card debt and other revolving debt – one bit of good news, to the great desperation of economists who want consumers to borrow more to spend more – has inched up only 7% over the past ten years.
• And households owe nearly $10 trillion in mortgage debt. But here’s the thing about those mortgages: About 41% of the owner-occupied homes were free and clear, without mortgage, according to the Census Bureau’s study in late 2016. So the mortgage debt of $10 trillion is actually borne by only 59% of the homeowners. And many of them have paid down their mortgages to a large extent. So a much smaller percentage of Americans carry the lion’s share of that $10 trillion in mortgage debt. That’s where the risks are.

The same with student loans and auto loans: those with the least amount of savings, and the smallest net worth, or those with negative net worth, owe a big chunk of this debt.

Sure, when automakers offer 0% financing on an $80,000 vehicle, a wealthy person with a credit score of over 800 may be tempted to finance it. It’s free money. Those loans are good as gold. But at the low end of the spectrum, there are subprime auto loans, which account for about 22% of total auto loans being originated. And these subprime auto loans that have been packaged into asset backed securities and sold off to pensions funds are now defaulting at rates beyond the highs of the Financial Crisis.

Student loan defaults have reached catastrophic levels. On the surface, the number of people in default on their federal student loans surged 17% in 2016 to 4.2 million, of the 42.4 million Americans with student loans. But the Department of Education conceded in January that it had massively overstated repayment rates. A subsequent analysis by the Wall Street Journal found that at more than 1,000 schools, at least 50% of the students defaulted or failed to pay down debt within seven years.

Default rates for mortgages overall are still low, though they’re inching up. According to S&P/Experian First Mortgage Default Index, the default rate rose from 0.64% in May 2016 to 0.74% in February 2017. And they will remain low as long as home prices continue to rise, as they have been in the US over the past years. In an environment of soaring home prices, homeowners, if they get in trouble, can usually sell the home for enough to pay off their mortgage. Hence defaults are not necessary.

Defaults soar after home prices have started to sink from the lofty peaks that in many cities have already shot way past the highs of the prior crazy house price bubble. At that point, the proceeds from the sale of a home may fall far short of covering the mortgage.

In consumer credit, the risks are concentrated where people have no savings, where credit scores are lower, and where incomes are tight. That’s about half the households. The American economy has split in two, and they’re the other half.

For them, not much, if anything, has improved since the Financial Crisis. They’ve been left behind by the Fed’s wealth effect. But these are very large numbers, and they owe a large portion of the consumer debt, and their finances are fragile, and when the next downturn causes a hick-up in their lives, credit will unravel from the bottom up, as it already has begun in auto-subprime loans and student loans. But the glorious net-worth figures and other aggregate numbers and averages do a great job of papering over the issue.

And there may already be more beneath the surface. Read…"Great Debt Unwind: Consumer Bankruptcies Jump, First since 2010. Commercial Bankruptcies Spike.”



- http://wolfstreet.com/

lpnmajor Loc: Arkansas

Small businesses borrow money to invest in their business, on the theory that growing their business will increase profitability in excess of the cost of paying the money back. It works, to some extent, which is why it is rarely calculated. School loans, on the other hand, have no relation to potential income, and often don't guarantee any income at all. School loans and healthcare, operate on the same type of monetary system, which is " they'll pay, if they want to play " - and have no "free market" to force competitive pricing.

No one, except the wealthy, can afford secondary education or healthcare without assistance, one can buy health insurance to help pay those costs, if one can afford to, but there is no education insurance, leaving loans as the alternative. Many college educated folks work at Walmart and Burger King, because they cannot get a job in the field they studied for, or any field at all. Colleges and Universities create courses based on archaic "degree" criteria, that have no relation to actual needs in the workforce, and many degrees have no associated need in the world. In short, the healthcare delivery system and our secondary education system, including the mandatory student loan industry - are the biggest scams perpetrated on the American people ever seen.

pafret Loc: Northeast

There are too many college graduates available and this essentially shuts out trade schools. To use the educational system to provide industry with the workers with skills that they need is to provide training, not education. You can see the effects of too many college educated people in the H1B flood of advanced degree foreigners who force lesser degreed Americans out of their jobs. It is not because the work is so difficult, but instead that the employers can get better educated workers cheaper than the American workforce. This seems to be a consistent practice, most college skilled positions could be staffed by intelligent high school graduates if the employers would hire them.

lpnmajor Loc: Arkansas

That would ruin the marketing scheme of the universities and student loan companies. It's a brilliant scheme, actually - "go into debt for $80,000 and get a $40,000 job". What's not to like? That $80,000 becomes $150,000 before it's paid off, and you still only make $40,000 20 years later - or - you can go add another $65,000 to your debt for a higher degree, and make $125,000. Seems like a really good deal.

Larry the Legend Loc: Not hiding in Milton

That's what they said after each of these as well:

August 1918
January 1920
May 1923
October 1926
August 1929
May 1937
February 1945
November 1948
July 1953
August 1957
April 1960
December 1969
November 1973
January 1980
July 1981
July 1990
March 2001
December 2007

As long as there's a central bank creating money out of thin air for government to spend into the economy, there will be the 'business cycle'. It can be no other way.

samtheyank

A FRIEND IN NEED IS A GOOD FRIEND INDEED!!!

pafret Loc: Northeast

Amen to that Larry. Until we end the Fed and force Congress to live within our means we will forever be subject to periodic grinding poverty.

QuestGirl Loc: Jayhawk Country

I'm ignorant. Are those recession dates? If so, interesting that none occurred throughtout the Clinton presidency. Hmmm... So, did Reagan's "trickle-down" economics really work? Or, did Clinton do something and create a facade that blew it up? Or...both?

Larry the Legend Loc: Not hiding in Milton

Let's just say old Slick Willy was lucky in a bunch of ways. If you take a close look at those years, you'll see there's a downturn about every 6 to 10 years. Clinton just happened to move into the White House on the heels of one such bust and right after he left, there was another. Yep, he got the Lucky Dog on that one.

Let me use this opportunity to shatter a misconception here. Many people seem to think that a President has some influence or sway over economic activity during his tenure. Well, he does, but not to the extent that the business cycle can be tamed. Presidents do not really control economic activity any more than they control the weather, except to note the imposition of politically motivated executive actions through one regulatory agency or another. It's through executive action, such as regulation, that Congressional legislation is enforced. If Congress passes a bill, and the President signs it, the various government agencies, under the President's purview, craft regulations to execute the bill into law. Those regulations become part of the legal statute and are imposed on people and businesses (depending on the bill), and the cost of staying in business is raised because the cost of regulatory compliance has been raised by statute.

As the cost of doing business rises, business income must also rise, or the business becomes unprofitable and is bankrupted. To avoid this, they must either cut costs or raise prices, or some combination of both. Generally, cost-cutting involves a reduction in quality or packaged quantity of product produced. For instance, a machine shop may use a lower grade of metal, or a cereal producer may reduce the weight of product in each box. Alternately, or even simultaneously, the business may raise prices to cover any shortfall not addressed by the quality / volume adjustments. Even for an industry savvy businessman, there are no easy answers when overhead goes up.

So there you have it. A new regulation is enacted and put into law. Businesses are forced to cover the cost of complying with this new regulation. Economic reality requires those businesses to make up for the more negative bottom line and thus products are lowered in quality and higher in price. If this product is a component part for a more complex product made by a second company, not only does the second company also have to comply with the new regulatory requirements, thus seeing their overhead costs also rise, but the cost of component parts also rises. Double-whammy. Now this second business is faced with an even bigger problem than the first one, and the cycle repeats.

If this second business is unable to 'balance the books', they go out of business. The supplier business, having lost their customer, is no longer able to make sales and also goes out of business. The raw materials suppliers are now faced with the situation where they are seeing falling sales and rising costs. They too, are forced to close their doors due to the subsequent negative income.

Understand, this is not the recession-ridden 'boom-bust cycle', which is a completely different animal, this is how government regulation of business stifles economic activity.

As a general rule, more regulations, less economic activity. Less regulations, more economic activity. In case you're wondering how many pages of regulations currently exist in force in Washington, DC; nobody really knows. Some estimates put it in the millions. So next time you pony up an exorbitant amount of money for a dinky little chocolate bar, don't blame the shopkeeper, just look at all the thousands of regulations the maker had to comply with just to get that candy in your hand.

QuestGirl Loc: Jayhawk Country

I thought I asked a simple question.

Yes, I understand. My Blue Bunny Natural Vanilla Bean half-gallon has dropped down to one and one-half quarts, and the price has only risen. This has happened sometime during the course of the last 4, if not 8 years. I can buy it at loathesome Walmart for just under $4. Any place else it sells for nearly $6. I've always blamed the company, not the shopkeeper. I'm still waiting for my Blue Bell half-gallon Coffee to return to the market in my area.

It never occurred to me to blame the government! I'm overjoyed now, I have the true culprit. Having now been schooled on regulations and the "fundamental transformation" process to enact them. Yippi!!!

Larry the Legend Loc: Not hiding in Milton

Pleased to be of service.

QuestGirl Loc: Jayhawk Country

You always enlighten my Quest, Mr Legend!!!

Nickolai

De regulation gave us the S&L collapse , the World Com, and Enron scandals, The Electrical utilities bankruptcies and rolling black outs, the Dot Com bust, and the 2007-8-9 financial collapse and the too big to jail wall street banksters

QuestGirl Loc: Jayhawk Country

Who's responsible for that de-regulation(s)?

Larry the Legend Loc: Not hiding in Milton

The Monetary Control Act of 1980 removed many restrictions on thrifts and credit unions; the Garn-St. Germain Depository Institutions Act of 1982 gave thrifts greater latitude to invest in real estate loans; and the Tax Reform Act of 1986 fundamentally altered the banking landscape in many ways. Essentially, the (local) S&L's were 'allowed' to compete in the marketplace for real estate business against the (national) big banks on a level playing field for the first time, and the Wall Street bankers were losing business to these smaller and more local institutions at an alarming rate.

Here's the 'official' narrative:

Severe economic downturns in the early 1980s and early 1990s, and the collapse in real estate and energy prices during this period were key precipitating factors in an increasingly unstable financial environment prevalent throughout these years. Fraud (primarily looting or control fraud) and other types of insider misconduct played a major role in the overall crisis as well. If anything, government regulation contributed to the crisis. The Tax Reform Act of 1986 fundamentally altered the banking landscape and engendered conditions that directly exacerbated to the banking crisis.


WorldCom first:

In June, 2002, the telecommunications company reported that it had fired Chief Financial Officer Scott Sullivan, and accepted the resignation of senior vice president and controller David Myers, after an internal audit found improper accounting of more than $3.8 billion in expenses over five quarters. That's nearly $800 million per quarter, or over $250 million a month. That is fraud on a colossal scale, the like of which had never been seen before.

"This is why the market keeps going down every day - investors don't know who to trust," said Brett Trueman, an accounting professor from the University of California-Berkeley's Haas School of Business, in an interview with CBS MarketWatch. "As these things come out, it just continues to build up." When you don't know who you can trust, by default, you don't trust anyone. As for Worldcom, the company's shares, among the most heavily traded on Wall Street in the few months leading up to June, 2002, fell as much as 76 percent in after-hours action following the announcement and at one point were trading at 20 cents each. In the previous January, they were trading at about $15.

WorldCom restated its financial results for all of 2001 and the first quarter of 2002 taking almost $3.8 billion in cash flow off its books, wiping out all profit during those times. The misstated billions were also very bad news for ordinary WorldCom workers: 17,000 of them were either fired outright or laid off.

The company said the accounting irregularities, which did not conform to Generally Accepted Accounting Principles, included transfers between internal accounts of $3.06 billion in 2001 and $797 million in the first quarter of 2002. Deregulation, you say?

Now on to Enron:

An ENRON Scandal Summary of the acts of Embezzlement undertaken by ENRON Executives may be defined as the criminal activity involving the unlawful and unethical attainment of monies and funding by employees; typically, funds that are embezzled are intended for company use in lieu of personal use. While the ENRON executives were pocketing the investment funds from unsuspecting investors, those funds were being stolen from the company, which resulted in the bankruptcy of the company.

Due to the actions of the ENRON executives, the ENRON Company went bankrupt. The loss sustained by investors exceeded $70 billion. Furthermore, these actions cost both trustees and employees upwards of $2 billion; this total is considered to be a result of misappropriated investments, pension funds, stock options, and savings plans – as a result of the government regulation and the limited liability status of the ENRON Corporation, only a small amount of the money lost was ever returned.


Now this is one instance when the incompetence of government in all things economic really shines out.

Dateline: April 7, 2001.
The Pacific Gas and Electric Company, California's largest investor-owned utility, filed for bankruptcy protection today, declaring that politicians and regulators had not moved quickly enough to resolve an energy crisis that has caused periodic rolling blackouts and is costing the state billions of dollars.

Legislators and regulators had been loath to bail out Pacific Gas and Electric or the No. 2 utility, Southern California Edison, whose billions in debt to wholesalers and marketers stem from flawed state deregulation that did not allow the utilities to pass on rising costs to consumers.

Negative cash flow directly caused by government removal of regulation on one aspect of the utility business but not on another interrelated aspect. Essentially, restrictions on wholesale electricity were lifted to encourage Texas generating companies to 'export' electricity to Southern California where demand far outstripped supply capabilities. Prices for this service immediately skyrocketed, leaving Pacific Gas and Electric, and Southern California Edison with significantly higher overhead. This situation was unresolvable because of regulatory prohibitions on raising prices. When the utilities petitioned the California government to allow them to raise prices to compensate for this loss, they were effectively told to pound sand. hence bankruptcies and rolling blackouts.


For many, this was their first exposure to the concept of a 'stock market bubble'. Essentially, a 'bubble' describes what happens when basic investing fundamentals are ignored in the rush to 'cash in' on a given market mania. The profits are impressive and real; unfortunately, the losses are even more impressive and just as real when the bubble 'bursts'.

Although high-tech standard bearers, such as Intel, Cisco, and Oracle were driving the organic growth in the technology sector, it was the upstart dotcom companies that fueled the stock market surge that began in 1995.

The dotcom bubble was the result of a combination of the presence of speculative or fad-based investing, the abundance of venture capital funding for startups and the failure of the 'dotcoms' to turn a profit. Investors poured money into Internet startups during the 1990s in the hope that those companies would one day become profitable, and many investors and venture capitalists abandoned a cautious approach for fear of not being able to cash in on the growing use of the Internet. Essentially, they did not care that a 'dotcom' startup had a P/E ratio of infinity, speculation ruled the day. Companies that had yet to generate revenue or profits or, in some cases, even a finished product, went to market with initial public offerings that saw their stock prices triple and quadruple in a single day, creating a feeding frenzy for investors.

The NASDAQ index peaked on March 10, 2000, at 5048, nearly double over the prior year. Right at the market’s peak, several of the leading high-tech companies, such as Dell and Cisco placed huge sell orders on their stocks, sparking panic selling among investors. Within a few weeks, the stock market lost 10% of its value. As investment capital began to dry up, so did the life blood of cash-strapped dotcom companies. Dotcom companies that had reached market capitalization in the hundreds of millions of dollars became worthless within a matter of months. By the end of 2001, a majority of publicly traded dotcom companies folded, and trillions of dollars of investment capital evaporated. Oops. Regulators didn't see that one coming!


'Too big to jail'. I like that. It's a good play on words and it is absolutely true. They should have been jailed. For fraudulently misleading investors about the quality of their derivative products.

The years before the crisis saw a flood of irresponsible mortgage lending in America. Loans were doled out to “subprime” borrowers with poor credit histories who struggled to repay them. These were dubbed 'subprime' loans. The 'subprime' part was due to the fact that the initial interest rate was significantly below the prime rate, making it temporarily affordable to riskier borrowers.

These risky mortgages were passed on to financial engineers at the big banks, who turned them into supposedly low-risk securities by putting large numbers of them together in pools. Pooling works when the risks of each loan are uncorrelated. This worked well, for the banks. Investors bought the safer investments because they trusted the triple-A credit ratings assigned by agencies such as Moody’s and Standard & Poor’s. This was another mistake. The agencies were paid by, and so beholden to, the banks that created the CDOs. Once these 'subprime' mortgages began resetting and reverting to market rates of interest, many borrowers saw their payments double overnight and were unable to service this amount of debt. Starting in 2006, America suffered a nationwide house-price slump. This was a disaster, for the securities investors holding all these subprime loan agreements.

Trust, the ultimate glue of all financial systems, began to dissolve in 2007—a year before Lehman’s bankruptcy—as banks started questioning the viability of their counter-parties. AIG buckled within days of the Lehman bankruptcy under the weight of the expansive credit-risk protection it had sold. The whole system was revealed to have been built on flimsy foundations: banks had allowed their balance-sheets to bloat, but set aside too little capital to absorb losses. In effect they had bet on themselves with borrowed money, a gamble that had paid off in good times but proved totally catastrophic in bad.

Suddenly, nobody trusted anybody, so nobody would lend. Non-financial companies, unable to rely on being able to borrow to pay suppliers or workers, froze spending in order to hoard cash, causing a seizure in the real economy. Ironically, the decision to stand back and allow Lehman to go bankrupt resulted in more government intervention, not less.

Regulators and bankers ignored existing regulations, exasperating the bust when it inevitably came. When economies are doing well there are powerful political pressures not to rock the boat. With inflation at bay central bankers could not appeal to their usual rationale for spoiling the party. The long period of economic and price stability over which they presided encouraged risk-taking. And as so often in the history of financial crashes, humble consumers also joined in the collective delusion that lasting prosperity could be built on ever-bigger piles of debt.

And there we have it. I think it is blatantly obvious that government intervention in economic matters is never going to improve the situation, but will act to make things worse, sometimes much, much worse.