The U.S. is Choking on Debt Financed Expansion

From Marketwatch:

There is a marked difference between economic growth and debt-induced demand. Instead of letting the market take its medicine and enter recession in 2001, the powers that be injected fiscal and monetary drugs to dull the pain and induce stock gains.

The Federal Reserve understands the market is the world's largest thermometer and the driver of a finance-based economy. On the back of the tech bubble, in the aftermath of 9/11, following the invasion of Iraq and into the election, they administered stimulants with hopes that a legitimate expansion would take root.

Is this a conspiracy theory from tin-foil types sitting on a grassy knoll? The only difference between intervention and manipulation is communication, as we're apt to say, a fine line that's been all but erased in recent years. Hank Paulson recently highlighted The Working Group as a policy tool, an admission that effectively exposed the wizard behind the curtain. See article

While government policy set the stage for the underlying imbalances, our immediate-gratification mindset exacerbated them.

Consumers bought goods with no money down and financed those obligations at zero percent.

Many used homes as collateral and flipped into adjustable-rate mortgages at the urging of Alan Greenspan.

Total debt in this country rose to more than 400% of GDP as societal spending habits lost all semblance of consequence.

As Americans raced to keep up with the Dow Joneses, seeds of discontent percolated under the seemingly calm financial surface. All the while, the cumulative imbalances grew as society chased the bigger, better thing.

Let's start with this chart from the Census Bureau:

Notice the real (inflation-adjusted) median income is lower now than at the beginning of the expansion. That means overall income gains have been stagnant for this expansion.

Let's add a graph of the savings rate into the mix:

Notice the savings rate is hovering near zero and has been for some time. It's important to remember how we get this number. The savings rate is gross income less all expenses and expenditures; essentially it's the money that's left over after we pay for and buy all of our stuff.

So, pay has been stagnant and we've been buying more and more stuff so that essentially, we're spending literally everything we make. But notice that despite the fact that pay has been stagnant and we're spending everything we make, retail sales still increased this expansion:

Also note that real (inflation-adjusted) personal consumption expenditures also increased.

So, let's sum up.

1.) When this expansion started, US consumers were already spending just about everything they made.

2.) Median income has been stagnant for this expansion.

3.) Yet, personal consumption expenditures and retail sales increased at strong rates.

Where did the money come from?

This whole expansion has been financed by debt acquisition. Americans have clearly gone deeper and deeper into debt to keep on spending.

Now we are paying the price. All of that debt has to go somewhere. Over the last 7 years, the financial industry has been very busy buying up all of the debt, carving it into various bonds and selling it to the highest bidder. They have used a process called securitization which has been around for about 25 years and in general has been used very successfully.

Problems start to occur when people start to fudge the numbers.

Federal investigators probing the business practices of Countrywide Financial Corp. are trying to figure out what Countrywide knew -- or in some cases didn't know -- about the incomes and assets of thousands of its borrowers.

The investigators are finding that Countrywide's loan documents often were marked by dubious or erroneous information about its mortgage clients, according to people involved in the matter. The company packaged many of those mortgages into securities and sold them to investors, raising the additional question of whether Countrywide understated the risks such investments carried.

Countrywide, long the No. 1 mortgage company in the U.S. in terms of dollar value of loan originations, also was considered among the most aggressive in finding ways to make home loans to consumers whose qualifications couldn't be proved or seemed questionable, mortgage industry executives and analysts said. The Federal Bureau of Investigation has begun looking into its practices in pursuing such business, according to people close to the matter.

Now we're paying the price for these policies. And it's going to take awhile to work the problems out.

Comments

[MatthewCurtis]

Though it is true that our economy has been recently propped up by debt, this has been the case since 1971, when we left the gold standard. Check it out, inflation has been higher since we left the gold standard. Pick an inflation or debt measure and look it up, pay attention to how fast...

If you want to see something real scary look up M3 (up to 2006-- they discontinued it) at the St. Louis Fed's website. M3 messures the amount of $ in existence... you'll find that the dollar has been diluted 12 times since we left the gold standard.

look up federal debt, federal spending, consumer debt, etc. look at the magic year 1971, and look at the rapid growth.

inflation isn't the only thing that hurts an economy. with dollar being diluted so rapidly all these new dollars are being created in the form of debt and as unsound investments (current financial mess). this will continue until we reestablish a gold standard. Until then we will continue to borrow and spend more than we have, until the dollar collapses, we default on our debt and the world turns to a new currency, leaving the US in the dust, broken and reminiscent of its past glory.

P.S. Bush and these republicans are not conservatives, they are NeoCons. We need more fiscal conservatives like Ron Paul, who understand that this economy is propped up and rapidly printed dollars and lots and lots of debt. When Washington realizes we are living in an inflation/debt bubble it will be to late. we can blame bush and his cronies, but the real cancer is our "managed/m­anipulated­" financial system that lets Washington spend what it wants and passes the bill onto Americans (through inflation).

[Visceral]

Inflation I understand - more dollars means the dollars are each worth less, but there are still more dollars around to do stuff with, so the economy can grow so long as you don't print too many new dollars too fast - but how can debt finance anything? It's lack of money, negative money; isn't it? Were these banks selling shares of the interest on the money they loaned? Doing stuff with money they thought they'd have in the future when their borrowers started paying? I've been trying to follow this, but it still makes no sense at all.

[FreedomCorpse]

pay no mind to that $500 trillion dollar derivative monster behind the curtain.

[outnow]

If the U.S. was bankrupt and war would bail us out for six years, then, yes, the piper is back and wants his due. The Wall Street cops such as Eliot Spitzer and William Lerach are safely gone but the cheering of the leisure class grows dimmer with every bit of bad news about the fraud-ridden system of finance. Free trade has undermined the creation of real value in our country.

Our moral IQ is in the special needs zone. We have lost the ability to empathize. We are morally and economically bankrupt. Deregulation is another false idol. Since 1971, when the U.S. announced its inability to pay its debts, speculating in currency has placed our country into a floating standard - morally and economically. Who has confidence in Confederate dollars or play money?

[dadw5boys]

Building housing no one can afford is not Expansion it is just FOOLISH.

Lack of research in the area's housing needs, to the current levels of employment and compensation and furture risk were not done.

All it says is they were good at building houses, getting them appraised and getting loans approved for the houses with the help of appraisers who were willing to over value the property.

Expasion means building outward to fullfill needs of business or society.

Neither of those conditions were meet by building and the appraisers overvaluing these home so the loans companys could sell the loans and make more money on fewer loans.

[mbaty]

I don't know if we're all chasing the "bigger better" thing, and I wouldn't be too quick to blame greedy consumers. Considering all the ways consumers have been hoodwinked by secret fees and strange growing debts/interest rates, it's a wonder we can keep up at all. Every bank I've been too wants to dig me a whole of fees so deep I can't get out, and even the cellphone companies have a habit of tacking on excesses that were either in the fine print, or in some other way obscured from the consumer (me.) Add utilities and gas prices...We just can't do it anymore; we don't want to have to default, but the game is stacked. And some of us just aren't playing now (see post about consumers having shopped til' they drop, freegans, etc.) We have to re-find the Purpose of our economy, just like we have to refine the purposes of our government.

[Feettotheflame]

Can someone answer me this question?

Is the 200B in Fed loans to banks really a taxpayer funded buyout of risk? My understanding is that the govt is now accepting risky debt from banks in exchange for very low risk treasury bills. Please clarify this for me.

Thanks.....1776

[olephart]

Yep, you just co-signed for 200B in junk bonds.

[Robert59]

Olephart is right. That's exactly what is happening. This is nothing but another S&L bailout, only when it's said and done, it will be bigger.

[WIpatriot]

OK, just piling on. There might even be more free love coming....

[crazyv]

It all depends.

a mortgage to a strong borrower who has substantial equity in their home has an intrinsic value equal to what was lent to the borrower. If the investor holds the loan for the term of mortgage the investor is assured of getting back all their money. However, the market value of the asset maybe substantially lower since the person buying the asset is more concerned about its value if he/she is forced to sell it in say three months rather than holding for 30 years. The source of the current problem is that a lot of trading strategies were built around the assumption that assets would always trade at their intrinsic value.

Typically the Fed will not lend the full market value of the asset the difference is referred to as the "haircut". In other words even if the market value declines some the Fed is still Ok since the Fed can still sell the collateral and recover its loan.

Now for the depend part- is the market value of the asset that the Fed is using honest. Is the haircut large enough to compensate it for a further decline. Lastly, could the asset in fact be sold i.e. are these assets in fact marketable. If they are then what the Fed is doing is not a bail out but part of its core mission to act as a lender of last resort for the banking system in periods of market panic. On the other hand if the valuation are not honest or the haircut not substantial enough than yes they are being bailed out.

As tax payers we should insist that when agencies engage in this kind of intervention the tax payer should benefit from any appreciation in the private companies stock price while the assistance is in place.

[dadw5boys]

Now is the perfect time for the USA to begin printing it's own money the "SILVER CERTIFICATE" and pay off the Federal Reserve. We you buy them out for $0.50 cents on the dollar. Silver is high right now so that would make the U.S. S C Dollar really high in value.

[WIpatriot]

I say DEFAULT on the Fed, pay them NOTHING in interest. Just up and do it. Oh yeah, and no more printing money with Congress' approval. AND, let's have a look at those books....

[LeftRight]

As far as defaulting on the national debt, do you really want to send the whole world into a dark age? Cause I hope that you realize the only thing holding the US dollar up is the faith that the federal gov't recognizes it. And the only thing (even now!) holding the world economy up is the US Dollar.

[Sundialsvc4]

I always enjoy studying your charts. Now, what I want to see is... what is the effect of Federal deficit-spending in this mix?

It's a different sort of debt, because the "borrower" can "borrow" without limit, as nobody in the real world can do. No matter how much debt is held by the consumer, and no matter how "good" that debt may or may not actually be, all of THAT debt is held by someone who is actually supposed to be on-the-nickel to "pay it all back and then some."

In contrast to this, then, the Federal Government (which "borrows" about $1 million a minute 24/7/365), supposedly has "a perfect credit-rating by fiat" because it can always "borrow" more money anytime it wants to. But it never has to PAY it all back. It does not have to induce any form of economic activity whatsoever (e.g. "workin' for a livin'") in order to attain for itself the fiscal ability to repay the debt it incurs.

"The prevailing wisdom" is that, well, the foolish consumer-borrower did all this to himself, and banks made it worse by fanning the fires ... but honestly, Hale, I think there's a whole lot more to this story, which might be found if we pull back a little bit on the ol' zoom-lens and consider a bigger picture.

Does this inspire any future articles for you? I hope so.

[hellinabucket]

I agree. Its all focused on the consumer/homeowner which I suspect is just the tip of the iceberg. How about all the COMMERCIAL/ECONOMIC DEVELOPMENT entities that built shopping centers & strip malls & office parks? Where do they fit in in this puzzle is what I would like to know!

[Henry]

hellin:
Commercial real estate (multi-fam, office-plex, stip-mall and shopping centrs) all revolved into double and triple valuations in the 2000s. Their ability to "maintain" is a function of rent revenue which is based on occupancy rates. Add to this the debt-service requirements for the financing that puts them on the map. If the loans are written at the 1 yera U.S. Treas +2.50% (which many of them are) then you have a financing "cost" that is minimal and this maintains value, i.e. currently 4.5%. When the 1 yr U.S. Treas goes to 7.0 and the interest rate on the debt-service of the financing goes to 9.5% then you'll see waves of defaults. Vacancy is number one and interest rates number two. This economy is dependent on low interest rates.. It is that simple. If the dollar falls big time and interest rates have to increase rapidly, look for all hell to break loose in real estate value.

[WIpatriot]

Henry's right, hellina. If the retail sales stay down, vacancy will rise and that will be the start of the commercial real estate shakes.

[Sundialsvc4]

That is also interesting, I agree, but kindly notice that it's a wee bit different from what I've suggested that our good Mr. Stewart should soon pursue. Any "real" borrower, whether an individual homeowner or a real-estate developer, ostensibly must repay the money back with interest ... and to do that, unless his last-name is Ponzi, he must earn the money and the interest.

But the Federal Government does not have to do that. Wanna "borrow" $96,000 a SECOND to settle next-year's budget? Sure, why not. Well, tell me, how exactly is this different from all those wheelbarrow-loads of German currency from post-World-War-One? When you can "borrow" without limit, how can it be said that you are in fact "borrowing?" You're making money for nothing just as surely as Mr. Ponzi did and in much the same way. Flooding the world with it. During the time you've taken to read this, about $3 million new dollars have "POOF!" magically appeared. From where? From what? And, with what net-effect and with what consequences?

My daddy told me that "money doesn't grow on trees," but from the looks of what these people are doing, apparently it does.

[Robert59]

What you're saying is accurate Bonddad, but the real question is why didn't the Republicans let us feel the full effects of the recession in 2000 and 2001? It would be easy to point the finger at 9-11, but that's too easy.

The real reason is to hold on to power. Anyone could see the writing on the wall back in 2000. People were pulling their money out of the losing stock market and throwing it into real estate. After all what could be safer than investing in a man's castle, his home? Prices skyrocketed losing all correlation to income. Greenspan and others knew it was the Lusitania, but they purposely chose to look the other way, claiming there was no need for oversight. And with interest rates so low and money so easy to get plenty of fools lined up to borrow money using their castles of course as collateral.

Consumer spending is the driver of this economy so all that money being pumped back into the economy gave the illusion everything was great, but it was all an illusion, the house built on quicksand.

But it allowed Republicans to maintain their grip on power even as Iraq became more of a mess. Just think what congress would look like if the economy tanked and we were still in Iraq. Democrats or even the Green Party would have a 2/3 majority.

The Fed's latest move, to buy the Republican Party more time. Get past the November elections, possibly lose the presidency and a few more seats in congress, but prevent the Democrats from getting the numbers they need to make real change.

They don't give a darn about the American people. What they'll do beginning in '09 as this 200 billion investment by the Fed goes bust (I wonder how much of that debt will be paid back and why wouldn't you offer as collateral worthless paper?) and the economy really goes into the toilet is blame the Democrats (they will be in control by then). And without the magic 60 to even consider bills they'll do nothing.

The economy will fix itself but not very well and the Republicans will come charging to the rescue in '10 promising all sorts of remedies (more voodoo economics) and the gullible American people (these are the same people who still think Hussein is behind 9-11 and Bush is akin to the second coming) will vote them back in.

That's what I see in my crystal ball. The 360 billion we taxpayers are pumping back into the economy will make a few more people rich, buy us a few more months at most of a healthy appearing economy, but will ultimately have to be paid for by the same taxpayer (talk about creative accounting, borrowing another 360 billion dollars).

I'm so frigging depressed.

[LeftRight]

Why didn't they allow us to feel the recession of 2000, 2001? Simple, they knew that if we felt the full effects of that (which was precipitated by the "tax cuts" of 2001, and the tech bubble bursting) they knew that we'd vote the democrats into power again in 2002. Then 9/11 came and it was a godsend to them!

[MilwaukeeDan]

Bonddad, another informative post, thanks. I think the American people are just following what their government is doing, living on that open ended credit card. I was just reading financial news from Germany and there is much sceptisism of the latest FED sceme. The dollar hit a new low against the Euro. The United Arab Emirates are deciding whether to continue pegging its currency to the plummeting dollar. Qatar was also thinking of bailing on the dollar in January. "The positive dollar impact of yesterday's coordinated central bank operationsis already proving unsustainable as the US currency falls across the board," said Ashraf Laidi, chief foreign exchange strategist for CMC Markets in New York. When do you press the panic button on the falling dollar?

[WIpatriot]

Dan, they broke the panic button a few years back....

[Bushfire]

The public following what their government was doing? The public were called "hero's" for keeping the consumer spending going through the 2001 recession. Then, the fed's low interest rates kept the machine buzzing along until the fed began fighting "inflationary pressures" with repeated interest rate hikes... pulling the plug and the party fell into chaos. Now, the hero's are being punished.

[LeftRight]

so wait, you're saying that I've been right this whole time, and the bushes have been disasterous for the country the whole time that they've been in office!?!?!?!?!?! I'm shocked Bondad! Shocked!

[johnnybb]

Ron Paul is right, and he has been talking about this for years!

Learn more at http://www.ronpaul2008.com/issues/inflation-tax/

[Henry]

Face it. When real interest rates are negative, it is very intelligent to borrow and not to save. The brilliant ironey is that this brand of economic stupidity is brought to us by "conservatives".
Ever thought of exposing the dunce-boy, the Texas nin-cum-poop, for the moron-in-chief that he as turned out to be???
Doesn't he hold an MBA from Hahvud?
How about Andrea Mitchell exposing the big fraud, easy-Al? Her husband. (does this speak volumes about the media)