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Earlier this month I highlighted the fact that the wealth of U.S. households reached new all-time highs in the first quarter, and that was due in large part to the healing processes that began in the wake of the financial crisis. It's all part of the same story: risk aversion surged in the wake of the financial crisis, and this resulted in a big increase in the demand for money, which in turn shows up in a big reduction in the leverage of the household sector.
Here are some charts that tell the tale:
As a result of smaller debt burdens, increased savings and rising equity and home prices, household leverage (total liabilities as a percent of total assets) has dropped by 30%, from a high of 22% in 2009 to the current 15%. Household leverage today is about the same as it was in 1990. In a sense, we've rolled back some 25 years of debt accumulation.
If we have a problem today, it is not "too much debt." On the contrary, the private sector has plenty of capacity to take on more debt. Our public sector, of course, has gobs of the stuff, but at least the deficit has shrunk to a manageable size—for now. At about 74%, federal debt relative to GDP is large, but not terribly large, and is relatively stable.
The U.S. government has borrowed tons of money at historically low interest rates, and has been skewing the maturity of its debt longer for several years now—as any rational borrower would have, in order to "lock in" low rates. If interest rates rise, Treasury will look like a genius, while private sector owners of all that debt will look like fools. One reason that short-term interest rates are still close to zero (3-mo. T-bill yields are essentially zero as I write this) is that bond fund managers are very much aware of the risk of rising rates, and are hedging their portfolios by stocking up on cash and cash equivalents. (Very low short-term rates are prima facie evidence of very strong demand for short-term securities.) But they can only do so much, since holding zero-yielding cash means giving up lots of extra yield while waiting for interest rates to rise, and the timing of that rise is still very much up in the air. I've been wrong on this for years, but that doesn't deter me from continuing to think that yields are more likely to rise by more than expected, than to fall further.
19 comments:
Have you ever tried to reproduce these charts on consumer debt service burden looking at the bottom 90% of US households (based on wealth or income)? My sense is that since 2000, the growth in household income (adjusted for inflation) only occurred in top 10% group. Also, growth in capital exceeds growth in economy (r > g), so top 10% accumulating more wealth, while bottom 90% stayed flat or drifted lower.
Perhaps excluding top 10% (not big borrowers on non-mortgage lending anyway), the charts will tell a very different story -- i.e., the bottom 90% household do not have the ability to "lever up" anymore, since they are still stuck with very high debt service burdens (already too high levels of mortgage, auto, student, and credit card loans) and real incomes are not growing (unlike past demographic driven secular cycles like 1955 or 1985).
Any thoughts?
William: thanks, all that wine and food in Italy must have dulled my math skills.
Gobs of capital on the sidelines, not only in the US but globally as well. More capital than can be deployed, given current demand.
Maybe interest rates can go up, but with such a supply of capital...
Interesting question: no sign of recession but they often do not knock first. So if the economy slows and goes to recession, what does the Fed do?
The Fed will attempt to control rising interest rates through Interest on Excess Reserves (IOER) manipulation coupled with Overnight Reverse Repurchases (ON RRPs). I assume the Fed would cut IOER to 0% or go negative to raise decrease excess reserves and increase Velocity of M2 Money Stock.
http://research.stlouisfed.org/fred2/series/M2V
http://research.stlouisfed.org/fred2/series/EXCSRESNS
The question on my mind is...how high can the Fed raise IOER during this cycle and how low will the Fed go during the next downturn?
Scott - Any thoughts on how IOER will factor into the latter half of this cycle and during the next downturn?
The bottom 90% are burdened by high prices of education, housing, and healthcare. Really, you have to remove my multimillionaire friends and relatives to get a better picture of the economy.
Please ignore my top post commentary as it is for my brother and look at the next one down which is three charts of education, housing, and healthcare costs.
www.niceconstable.blogspot.com
Interesting comment. To date, the Fed has not mentioned IOER in almost any context.
John Cochrane often mentions IOER and much much larger excess reserves. Cochrane advocates converting the entire national debt into bank reserves. I may not go that far, but I see no problem with a large central bank balance sheet - - - and it does eliminate the national debt from the taxpayer point of view.
Benjamin: Is there a primer-type article detailing Cochrane's advocacy of converting the national debt into bank reserves? I'd love to read about the details and such.
Benjamin - Please refer to the New York Fed (link below) for normalization procedures. IOER has to be adjusted. This is a critical interest rate that is not being discussed by very many people but will play a huge part in normalization and subsequent recessionary countermeasures. It could be because it is new. Please see Emergency Economic Stabilization Act of 2008. I hate referencing wikipedia but it gives a decent overview.
Normalization during this cycle will inherently look different than normalization during any other period. That is because of the approx. $2.5 trillion in excess reserves currently held at the Fed. Prior to 2008 the excess reserves were less than 1% of the current number. Not only will normalization look different this go around but the measures of easing monetary policy will also look much different during the next downturn.
M2V will likely pick up significantly during the next downturn if the IOER is significantly cut. The question in my mind is, how will cutting IOER, thus increasing M2V alter inflation expectations. I keep hearing low inflation on the horizon, but it seems with the current Fed toolkit, an overshoot during the next downturn could result in higher than expected inflation. Any thoughts here?
http://www.newyorkfed.org/newsevents/speeches/2014/pot141007.html
https://en.wikipedia.org/wiki/Emergency_Economic_Stabilization_Act_of_2008
Matthew - Please see Japan for how the conversion will occur. Japan is now "monetizing" their entire bond issuance this year. Also see how the BOJ has entered the ETF market, although in a fairly small amount. Also note, QE essentially converts national debt into bank reserves. The Fed purchases longer dated USTs and converts the dollars used to purchase the USTs into excess bank reserves by paying interest on such reserves.
http://www.wsj.com/articles/boj-helps-tokyo-stocks-to-soar-1426065432
I always hear "this time is different" but really this time will be different.
Indeed monetary policy will be different this time around. Before QE1 and IOER, the job of the FOMC was to find the interest rate that kept the supply of bank reserves stable or growing modestly. The Fed funds rate represented the cost to banks of holding reserves, because reserves paid no interest. Holding reserves instead of other assets mean forgoing a rate of return, so banks always wanted to minimize their holdings of reserves.
Now, the FOMC must find the interest rate that convinces banks to hold a substantial quantity of excess reserves. Reserves are now competitive with other assets, since they pay interest. So banks like holding reserves. But if the IOER isn't high enough relative to other assets, then banks would have a strong incentive to increase their lending and thus greatly expand the money supply, something that would eventually lead to higher inflation.
If the economy remains on an even keel and improves slowly, then increasingly banks are going to be more willing to lend, and they have ample reserves on hand to support new lending. The FOMC must keep the IOER at a level which convinces the banks that holding excess reserves is equally attractive, on a risk-adjusted basis, to making new loans.
Different challenges, but in the end the Fed is charged with finding the short-term interest rate which keeps the supply and demand for money in rough equilibrium.
Matthew: I read Cochrane's blog; that is where he advocates. He also made a presentation at a Fed conference with a paper. You should be able to google this stuff up.
When I look at household debt I look at 4 sectors: Student Loans, Vehicle Loans, Revolving Credit, and Mortgage debt. Out of these 4 sectors, only 2 are higher now than 2008. Student Loans and Motor Vehicle Loans.
http://research.stlouisfed.org/fred2/series/SLOAS (student loans)
http://research.stlouisfed.org/fred2/series/MVLOAS (motor vehicle loans)
http://research.stlouisfed.org/fred2/series/REVOLSL (total revolving credit)
http://research.stlouisfed.org/fred2/series/MDOAH (mortgage debt outstanding)
http://research.stlouisfed.org/fred2/series/TCMILBSHNO (total credit market instruments household and nonprofit organizations)
I like looking at leverage as a percentage basis like you referenced Scott. I also like looking at the overall outstanding debt picture. I find it interesting that the student loan and motor vehicle sectors have increased overall debt while the revolving credit and mortgage sectors have decreased overall debt. What does this signify?
In my mind it signifies demographic changes within the US. Younger people are taking on more debt (student loans and auto loans) while older people are paying off debt (mortgage debt and credit cards). I don't have the ability to post demographic charts here, but the US needs the younger generation to enter the housing market. We are seeing the initial signs (http://www.wsj.com/articles/u-s-existing-home-sales-increase-5-1-in-may-1434981986) but first time buyers are still only 32% of the market vs. 40% on a historical basis. This is still up 5% YoY.
Now, to what degree did the federal government allow for higher outstanding loans? Let's look at the Student Loan sector. In 2005, The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 was passed. This made it very difficult to discharge student loans in bankruptcy. The switch to 100% Direct Lending by the Federal Government was effective July 1, 2010 through the passage of the Health Care and Education Reconciliation Act of 2010, through the Student Aid and Fiscal Responsibility Act of 2009. This ended the practice of federally subsidized private loans and made the loans direct from Dept. of Ed. and increased federally held student loans significantly on a YoY basis. See http://research.stlouisfed.org/fred2/series/FGCCSAQ027S
The overall picture I see here is the federal government has significantly increased student loan lending to hold up total credit instruments outstanding. This will likely have longer term effects on the housing sector unless more assistance is given to the younger generation like we have seen through the Pay as You Earn Program.
Any input on demographic analysis of outstanding debt burdens in the US? What about governmental policy encouraging overall debt level increases?
The next bubble to burst will be Student Loans. Since the government became virtually the sole source for student loans, they have exploded. It is ridiculously easy to get a student loan, and millions of students have thereby acquired debts that they will be unable to pay. The easy availability of loans has also allowed colleges and universities to charge prices that students would otherwise have been unable to pay. With little or no price competition, the cost of higher education has soared to unsustainable levels. We are only just beginning to see this whole thing unravel; it has many years yet to play out.
By attempting to make college more affordable, government has succeeded in creating just the opposite. That's they way almost all government programs which interfere with normal market mechanisms end up.
Scott - To what degree is the current recovery due to increased student loan debt? It seems household deleveraging in total credit market instruments is not possible (without a recession) with the current economic reality. Without the increase in student loans offsetting the decrease in mortgage debt and revolving credit debt, would we be where we are today?
We hear a lot about how young adults should not take on the student loans, ect. It seems that without the increasing burden of student loans our current economic recovery would not be where it is today. Maybe we should thank students for taking on higher debt loads to attend higher education?
Increased student loan debt can only contribute to economic growth and prosperity to the extent it increases (via education) the productivity of the student borrowers. I strongly suspect that the increased productivity, collectively, will not be enough to pay for the burden of the debt—which would take the form of a bursting of the student loan bubble. We cannot expect government to redirect the economy's resources to students in willy-nilly fashion, and see a happy ending; only the private sector can lend intelligently. If I'm right, the whole student loan program is at best a modest drag on the economy.
If student loans are so helpful to the economy maybe we can devise a way for young people to take out loans to pay for rent and food. More credit more spending better economic outcomes. Yes, that is the ticket. Increase prices so much they are forced to take out loans.
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