Monday, October 1, 2012

Household financial burdens fall to 30-yr low


According to the Fed's latest calculations, as of June 30, 2012, households' debt and overall financial burdens had fallen to a 30-yr low. From the peak in Q3/07, the burden of households' total financial obligations has fallen by almost 17%: from 19% of disposable income to 15.8%. This is big deal.

"Financial burdens" are calculated by comparing debt service payments and total financial obligations to disposable income. This is very different from the numbers bandied about in the press, which compare total debt to income or GDP in order to argue that there is still a lot deleveraging to come. The problem with the latter is that it is an apples-to-oranges comparison, since total debt is a stock—a fixed amount—whereas income is an annual flow. The Fed's method compares flows (annual payments on the stock of debt) to flows (annual income). Owing $100,000 with an interest rate of 10% is much more burdensome than owing the same amount with a 3% interest rate, just as it is easier to service a debt with a 10% interest rate when one's income rises 10% a year, than it is when one's income rises only 3% a year.

The data for June showed a modest reduction in financial burdens of all types. But financial burdens have declined significantly in the past 5 years, and are now back to levels last seen in the early 1980s. Households have accomplished this rather impressive task by a) paying down debt (i.e., deleveraging), b) defaulting on debt, c) refinancing and taking on new debt with much lower interest rates (mortgage rates are at all-time lows), and d) increasing their disposable income. With the exception of the unfortunate cases in which households have had to default on their debt obligations, the story is a virtuous one, and it has been driven by an increase in overall risk aversion, increased work, and an increase in savings.

It is also worth noting that a significant amount of deleveraging has effectively occurred even as the economy has managed to grow (albeit slowly). Deleveraging does not have to be synonymous with deflation or recession. Deleveraging occurs when the demand for money increases, and the demand for money tends to increase during periods of rising uncertainty. Increased money demand can be satisfied by increasing one's holding of cash and cash equivalents and/or reducing one's debt. (Conversely, increasing one's leverage is equivalent to a decline in one's demand for money, since debt is equivalent to "shorting" money.) Deleveraging can be bad for an economy's health if the central bank fails to respond to the increased demand for money. The Federal Reserve was slow in responding in late 2008, but they more than made up for that mistake by engaging in two unprecedented quantitative easing programs (with another just beginning) which have resulted in the creation of $1.4 trillion of excess bank reserves to date. When the supply of money equals or exceeds the demand for money, then an economy can undergo lots of deleveraging without major problems, and that is precisely what has happened since 2008.

There have been some major adjustments made in this economy in recent years, and this lays the groundwork for a healthier economy in the years to come. What's lacking now are the proper incentives to spur growth. 

18 comments:

Gloeschi said...

Have you heard about Total Credit Market Debt Owed (TCMDO at the Federal Reserve Bank of St. Louis website)? Take a look, then report back to me if you see any deleveraging.

mmanagedaccounts said...

pntsPu 5
I am in the process of reducing my mortgage interest rate by more than 2%. My homeowners insurance is much higher than five years ago, and real estate taxes are somewhat higher. Auto insurance is a little higher.

I have essentially no revolving credit, and my income is substantially higher.

I am contributing to the data referenced by Scott, and I am subtracting from the TCMDO referenced by Gloeschi.

I have deleveraged a great deal.

The Coral Gardner said...

Scott, I'm a longtime reader of your blog and would like to say "Thank-you" for all your hard work and patience.

I was wondering if you might consider writing about how QE1-3 has actually changed the money in circulation. In particular it seems the Fed is careful not to explain how much of the QE has been "sterilized", how much has turned into excess banking reserves, how many short term Bills from Operation Twist are being allowed to turn into cash, and how the Fed plans on "mopping up" this liquidity without creating a spike in 10 Yr Treasury rates.

Anyways, your thoughts in general are always greatly appreciated and helpful!

Joe in NY

Gloeschi said...

@ Coral Gardner: Since financial crisis, Fed has increased assets (and therefore liabilities, or money in circulation) by $2trn. $1.5trn, or 75%, have come back to the Fed as excess reserves. So only $0.5trn "made" it into the economy. Compare that with the reduction, for example, of debt outstanding by issuers of asset-backed securities from $4.5trn to $2trn (or 2.5trn - 5x the amount the Fed was able to add). When you want to buy a car and finance it, you need credit (unless you are one of the lucky few who can pay in cash). Credit depends on your FICO etc, but also on ability of whoever finances you to access capital markets. Credit = money. No credit = no car. Look at the emergence of "deep subprime" car financing with average FICO scores LOWER (579) than before Lehman and you realize the car market is currently scraping the bottom of the barrel of buyers just like the housing market did in 2006/7.
Re "mopping up": I don't think the guys at the Fed lose any thought over how to clean up the mess - they will long be gone to teaching their bullsh1t once a week at a university. The assets they bought will never leave the Fed (read: the taxpayers' book).

Dr William J McKibbin said...

I hope Scott is not saying that because the American people are shedding debt, that the government gets credit for that...

Dr William J McKibbin said...

Regarding Scott's "proper incentives to spur growth," I would argue that those incentives are epitomized by Apple Computer -- what we need is for consumer manufacturing of durable goods to outsource of their labor activities -- otherwise, the incentives are not there -- regulations are not the issue -- profits on the level earned by Apple Computer is now the standard, and that means outsourcing more aggressively for profits -- the US cannot compete with the Apple Computer manufacturing model except in defense -- herein lies the challenge for America -- how to accelerate the outsourcing of manufacturing...

Dr William J McKibbin said...

PS: The US construction sector has potential to generate organic growth in America -- the manufacturing sector does not, except perhaps in defense -- food processing is another sector with organic growth potential -- US manufacturing is a lousy bet...

Unknown said...

With just Honda of the "Big 7" left to report sales, Ward's Auto is estimating September auto sales at ~14.8 million SAAR. Previous post-recession high was 14.52 million in August. If the number holds up after the remaining auto makers report, it will completely demolish any chance of Q3 being in a recession. Also bodes well for Friday's jobs report.

Unknown said...

Ward's Auto now reporting final auto sales SAAR at ... are you ready? ... 14.89 million.

No recession here.

Dr William J McKibbin said...

@Unknown, the good news is that all US automakers are busy outsourcing more and more of their operations overseas in order to bolster margins as sales rise -- the US cannot build a cars that return profits in the global marketplace -- that can be fixed by moving the entire US automobile manufacturing operation overseas in the next 15-25 years -- until I see fat dividend checks coming form automakers, I view their performance as disgraceful -- we need for the automakers to get focused on making their shareholers rich instead of their employees -- until that day comes, the US auto industry is doomed.

PS: When do you expect dividend checks to increase by at least 300% in the auto industry -- my view is that dividends are too far off to make auto stocks worth owning...

Unknown said...

@ Dr William:

In case you haven't noticed for the past 20 years, *more* US auto sales are being sourced from US factories. Most Japanese auto makers sell most of their US sales from US or Canadian plants, and even Hyundai and Kia are catching up their. GM even makes the subcompact Sonic in Michigan, and Ford recently said it would be adding some production of the Fusion (which is currently made in Mexico) to Flat Rock, Michigan. Look it up if you don't believe me.

Unknown said...

Here ya go:

Ford To Add 1,200 Workers At Detroit-area Plant
^
"Ford has only made Fusions in Mexico until now. But labor contracts passed in 2007 and 2011 lowered Ford's U.S. costs, and the company promised to move some production from Mexico to the U.S."

Dr William J McKibbin said...

@Unknown, in case you haven't noticed, the automobile industry is subsidized by the US government and the industry still can't manufacture cars profitably -- it's time for the people leading the car industry to move automobile manufacturing overseas once and for all, and eventually make some money for their shareholders -- the automobile industry is not the future of America -- far from it...

PS: Full disclsoure, I do own stock in Daimler -- more at:

http://www.daimler.com/

Unknown said...

Let's see just how unprofitable one American auto manufacturer - GM - actually is. Here's a link to their earnings releases webpage since the beginning of 2010. All links are PDF's.. Note that the more recent numbers would be *even better* if it weren’t for GM’s struggling Opel division in Europe.

Q2 2012: Net Income of $1.5 Billion on Revenue of $37.6 Billion
Q1 2012: Net Income of $1.0 Billion on Revenue of $37.8 Billion
Q4 2011: Net Income of $500 Million on Revenue of $38.0 Billion
Q3 2011: Net Income of $1.7 Billion on Revenue of $36.7 Billion
Q2 2011: Net Income of $2.5 Billion on Revenue of $39.4 Billion
Q1 2011: Net Income of $3.2 Billion on Revenue of $36.2 Billion
Q4 2010: Net Income of $500 Million on Revenue of $36.9 Billion
Q3 2010: Net Income of $2.0 Billion on Revenue of $34.1 Billion
Q2 2010: Net Income of $1.3 Billion on Revenue of $33.2 Billion
Q1 2010: Net Income of $900 Million on Revenue of $31.5 Billion

So, 10 straight quarters of profitability, only 3 of which were below $1 billion.

Dr William J McKibbin said...

@Unknown, and have a look at the dividends paid in the Q1 2012 10-Q report -- all of those notes and gibberish resolve into zero dividends paid to common share owners -- hmmm -- I like to own stock in companies that pay dividends to me the common share owner, not provide outlays to everyone else other than me -- sorry, but GM is not for me -- but, good luck to you...

Gloeschi said...

Autos: $60bn taxpayer money for 60,000 US employees. Could have sent each one of them home as a millionaire.
Look at Ford: 37bn market cap, 114bn EV => net debt of 81bn. You'd be lucky to get a couple of dividends out of that leveraged POS before it folds.

Ed R said...

The increase in USG deficits is the mirror image of the deleveraging of homeowners and businesses. It is as simple as that.

Given a certain level of GDP the paydown of debt by consumers and business must equal the increase in debt by the USG.

Once you try to attach a value judgment to one or more of these three effects you are no longer an economist, you have become an idealogue.

Scott Grannis said...

Ed: Wrong on several counts. You are forgetting foreigners, who at times finance a significant portion of our government deficit. Where did I make a value judgment? Debt is never the key variable, in any case. What matters is how the money that is borrowed is spent. In my book, when government borrows money it usually spends the money inefficiently. The private sector usually spends borrowed money more efficiently. 'Nuff said.