economy

by

Have we reached a transformational point in the consumer driven economy?

The most popular post on the Wall Street Journal today is, “Wiping Out $90,000 in Student Loans in 7 Months”.  Mihalic’s methods for reducing his costs are creative. He shows a gazelle like fear of debt that is emotionally necessary to paying debt down early and most importantly he is on the road to being completely debt free. Anyone who has lived no else for seven months probably has a plan for paying off his mortgage, too. This type of debt repayment would make Dave Ramsey proud but it does present some interesting questions about the economy. If this is the most popular post on the Wall Street Journal today, what does that say about the popularity of consumer debt? Has debt reduction become cool and has the America subconsciously picked a new socially acceptable debt level? I speculated in a previous post that it makes a lot of sense for America to pay down its credit card debt to a level much lower than today. If the new level for socially acceptable consumer debt is a number that is much lower than in the previous fifty years, what does it say about our consumer driven economy over the next couple of years if the consumer is diverting some of their spending power to reduce debt?

Here are some of tricks he used to pay his debt down early.

Mihalic said he spent months taking a flask of liquor to bars so he could continue to go out drinking with friends without running up a tab. (Be warned: this is typically illegal.) Instead of the movies, he took dates out hiking, or for bagels and coffee. He ate protein bars packed from home and walked several miles to the city, to save a few bucks on transportation, during a trip to Michigan. He got two roommates to rent out his house.

Mihalic also took steps that financial advisers typically say are a no-no: He liquidated his individual retirement account, drawing a tax penalty, and stopped contributing to his 401(k), even though his employer offers a matching contribution.

by

Job Creation Performance and Unemployment Rates for Wisconsin and Ohio

Everyone seems to be talking about state budgets and governors performance. I guess Menzie started things out with this post. Joe Wiesenthal followed up with this post. Although the job creation performance of Governor Walker in Wisconsin and Governor Kasich in Ohio are not resounding successes they are not complete failures either. In a recent post I found both states showed a dramatic improvement in business environment over the last two years according to ChiefExectutive.net. Unfortunately popularity with chief executives does necessarily translate into jobs. The optimism of chief executives is not echoed in the 2012 State Business Tax Climate Index report by Tax Foundation. Wisconsin is number 43 on the list and Ohio is number 39.

Since Menzie pursued the job creation angle, I decided to use Fredgraph to create an unemployment graph for Wisconsin, Ohio, Illinois, and the United States, http://research.stlouisfed.org/fredgraph.png?g=7eN. Looking at the graph I am not sure I would be complaining too much if I lived in Wisconsin. It could be worse. The job situation is much more precarious in Illinois. Although Menzie correctly points out that the job creation in in Wisconsin is pretty anemic, both Wisconsin and Ohio unemployment rates are below the national average. This is pretty good job performance considering how poorly they rank in business tax climate. Unfortunately most of the future job gains in Wisconsin and Ohio will probably come from job losses in other states such as Illinois. If Illinois’s unemployment rate remains above the average, their government financing remains a mess, and if either Wisconsin or Ohio can improve their business tax climate to a Illinois’s level, then Wisconsin and Ohio should be successful at poaching jobs from Illinois. This should be a major part of any jobs plan along with new jobs created by green industries and shale gas.

by

The Dilemma of the Quantitative Easing

On Friday the economic statistic I was most interested in was the revolving credit in the Federal Reserve Consumer Credit report. Considering the returns we are experiencing in the stock market, bond market, housing market, and certificate of deposits, the best return for your investment is to pay down your credit card debt which is typically over 18%. Would the average American be the pragmatic investor? The answer continues to be yes.

The next question I had was how long would the average American continue this trend? So I did a few graphs of revolving credit over time to see if disposable income or inflation could explain how far it would fall. Then it struck me. I could not explain the rise in credit card debt. If we look at the graph we can see that the explosion in credit card debt is relatively new way to extract wealth from the middle class.

Total Revolving Credit Outstanding -20110407

 

If you believe like Dave Ramsey that to road to personal wealth starts by getting debt free, our country’s goal for revolving credit should be approximately zero. Even if you believe there is a good reason to carry some credit card debt, the pragmatic decision for the average American will be to continue to pay down their credit card debt. The only attractive alternative to paying down your credit cared is mortgage refinancing. If the mortgage refinancing gig is about over, then the credit card repayment trend should accelerate this year since there are no better investment alternatives. Then we can move onto the next financial bubble, student loans. For the short and medium term continued deleveraging is the logical choice. It is ironic that quantitative easing program whose primary focus was to encourage spending and investment, has caused businesses and households to reduce their borrowing and focus on ways to create their own sustainable financial future. In a way this lack of trust response is a condemnation of the big government model of governing and it makes it much more difficult to grow out of our financial mess. The market may be telling us that we are in the process of establishing a new normal for the way we buy things and the way we govern ourselves or it might be as simple as we are just returning to the old way we bought things. If the private sector and businesses are unwilling to take the risk by increased spending and investments, the local and state governments will not see tax revenue growth. Although higher taxes can help a little bit, most proposals generate too little tax revenue to be significant. Over the years we created a variety of budget gimmicks but eventually state and local governments have to match up revenue, spending, and unfunded liabilities.  As we phase out the budget gimmicks we will once again return to the old ways of running local and state governments. The big four blue states, California, Illinois, New York, and New Jersey, who have large budget deficits and unfunded liabilities are at the most risk to reduced growth prospects. They desperately need businesses in their state to start earning a significant portion of new profits from unit growth if the “grow out of their mess” strategy is going to work. Unfortunately this is easier said than done. Most of the recent NFIB surveys show that increased government regulations are making it harder rather easier to start up and run a business. The bad news is that if these four states cannot grow out of their mess, the country cannot grow out of its mess either. Hmm, maybe we need to listen to what the market is actually telling us and develop a plan that works for this market.

by

FRB: G.19 Release– Consumer Credit — March 7, 2012

Here’s the bottom line. The amount owed the government went up $28 billion and everything else stayed the same or went down. It looks like student loans is the only driver of consumer borrowing.

Consumer credit increased at an annual rate of 8-1/2 percent in January. Revolving credit decreased at an annual rate of 4-1/2 percent, while nonrevolving credit increased at an annual rate of 14-3/4 percent.

FRB: G.19 Release– Consumer Credit — March 7, 2012

by

Was our last economic boom due to consumer debt?

When I read the post, A Deep Look At Revolving Credit, And What It Means For Consumer Spending, the graphs inspired me to try my hand at answering some questions I have been about the importance of consumer debt to our last economic expansion.  So the first thing I did was to create a graph using FRED of the revolving debt versus the S&P 500. To avoid issues with scaling and different units, I told FRED to scale the graph using the latest available data as 100. From the graph I could see that there was a strong relationship between the two lines but I had some other questions. How much of the increased debt was due to the increase in population and inflation? My solution was to create a per capita revolving credit estimate by dividing the revolving credit by the population of wage earners and scaling it to 100 and adding a separate line for the inflation index. Here is the final result.

 

fredgraph_percapita

Now this is an interesting graph. We can see that the S&P 500 and the per capita revolving credit have a close relationship up until the internet boom of 2000. Then things go haywire. We can also see that the per capita rate of revolving debt started to accelerate after 1983. It continued to increase at a rate greater than the inflation rate until 2007 when it started a decline despite a much larger number of wage earners and inflation. This leads me to conclude that the wage earner’s debt was maxed out in 2007.

The next question I had was where does the per capita revolving debt go from here? One way we can make an intelligent guess at the answer is to go from the premise that per capita revolving debt should have grown at the rate of inflation. Using a regressed line of the CPI to provide us with the slope of the line, we would expect that per capita revolving debt still needs to drop another 10% to reach the point that inflation rate would have predicted. Since the wage earner was probably maxed out in 2007 I think the wage earner is unlikely to add more debt any time soon. They are still close to their max debt load. If we assume that wage earner’s tolerance for debt and inflation rates does not change dramatically then it make take another year or two for the wage earner to pay down enough debt and establish enough distance from their max debt level. On the negative side if the wage earner gets panicky about the future of their job and the economy,  there might be some debt repayment overshoot. The logical conclusion is that this new normal for revolving debt will be bad news for the companies whose sales are dependent on revolving debt and make if very difficult for this economy to expand for the next two years.

by

If Social Security is a Ponzi scheme, does that make CalPERS a Ponzi scheme, too?

If Social Security is a Ponzi scheme then all of our defined benefit pension plans such as the California Public Employees’ Retirement System (CalPERS) risk falling into the same category. CalPERS is a $226 billion pension fund with an estimated $240 billion unfunded liability according to a Reuters article. So even if you are willing to concede the point that Social Security and CalPERS are primarily "pay-as-you-go" systems as advocated on the Social Security site, you are confronted with three almost insurmountable problems.

  1. How do you scale back the future benefits in an equitable manner?
  2. How do you convince current contributors to contribute more money at the same time you are scaling back benefits?
  3. In the case of defined benefit programs that are partially advance-funded, who is responsible for investment risk?

This is not a new problem. For many years companies had difficulties managing the funding and benefits of their pension plans. An additional problem was what to do with defined benefit plans for companies that no longer existed. This problem became very apparent when the steel companies disappeared in the 1970’s. In 1974 the government created the The Pension Benefit Guaranty Corporation(PBGC) to take over the defined benefits for pensions for bankrupt companies. The funding for the PBGC came from fees charged on the remaining existing corporate defined benefit plans. This policy seems to have worked. In the following years most private companies converted their pension plans into defined contribution plans and problems with the remaining defined benefit plans diminished considerably. On the other hand public sector fully embraced the defined benefit plans. Part of the allure was that the promise of future benefits was a major issue in collective bargaining agreements. Instead of pay raises they were promised future health and pension benefits.  The long history of problems that the private sector had with funding and managing defined benefit pension plans seems to have been ignored by the public sector. Since the management of defined benefit plans were not being managed differently than the way the private sector managed their plans it is inevitable that they would duplicate the same mistakes. Considering the size and extent of the public sector unfunded pension and health care liabilities, most of these agreements were done in bad faith and led to deliberate mismanagement of pension funding and benefits. It will probably take some form of the PBGC for state and local governments that is funded by the public sector pension funds and has strict funding and benefit rules to clean up the public sector pension mess.

Social Security is different from the public pension plans but it shares many of the same mismanagement of funding and benefits problems and a more puzzling style of investing. Considering the size of unfunded liability for Social Security, the funding and benefits have been negotiated in bad faith, too. So although comparing Social Security to a Ponzi scheme may seem too severe, it shares the same bad faith negotiations and plan mismanagement as public sector pension plans. A pension plan relying solely on "pay-as-you-go" financing and funky investing may have been a viable option for my father’s generation but not my son’s generation. The pact between one generation and the next is about to be broken. The future of defined benefit plans in general is in doubt. Defined contribution plans are the preferred option in the private sector but suffer from inadequate savings rate. This problem can be fixed by a relatively simple solution, policies to encourage a higher savings rate. It remains to be seen whether defined benefit plans can overcome their predisposition to bad faith negotiations and mismanagement and create a better pension outcome than those offered by defined contribution plans.

by

Financial Events That Caught My Attention Last Week

Unlike most of the media the debt ceiling debate I thought the debate went as expected. After watching the budget debates in California, Illinois, New Jersey, and Wisconsin I was expecting the debt ceiling debate to be ugly and to satisfy no one. However the most interesting financial result from the debt ceiling agreement was the movement on the 10 year Treasury bond. So while the media pundits were still talking about rising interest rates for consumers, the 10 year bond continued to go in the opposite direction. That left me to conclude that the big financial issue driving the dollar higher and the treasury bond rates lower was the combination of the Eurozone blowing up and the United States economy stalling. It is got to be hard on the Chinese. Their best export market was tanking and their plan of using a basket of currencies to replace the dollar as the reserve currency was going down along with the Italian and Spanish economies. If the world economy is slowing down, the domestic issues confronting the Chinese are likely to heat up. It is likely that the average Chinese worker will think that they got the raw end of the economic boom.

Another weird economic report was the Federal Reserve report on consumer debt, http://www.federalreserve.gov/releases/g19/.  As a fan of Dave Ramsey, http://www.daveramsey.com/home/, I believe that the economic health and wealth of the United States depends on more Americans becoming debt free. It obvious to many people that Americans have too much consumer debt and it is time for the debt pendulum to start swinging back the other direction. Getting our fiscal house in order starts in our own home first. The G19 report by the Federal Reserve was showing that Americans were making some progress in 2009, 2010, and 2011. In 2009 and 2010 the debt went down at rate of ”“4.4% and -1.7% respectively. In 2011 the rate rose at rate that was comparable to our inflation rate, 2.1%. In June our accumulation of debt accelerated to about 7.7 percent from 2.5 percent in May. This drove up the preliminary rate for the second quarter to 4.4% and well above the inflation rate. Both cars and credit card purchases contributed almost equally.

Maybe we will get lucky. The price of crude oil continues to dive as the world economy slows down. It appears that once again we are looking at a mixed bag of inflationary and deflationary indicators. Inflation and deflation continues to be my biggest fears for the United States economy.

by

The Problem with Defined Benefit Plans is the same as the Problem with Defined Contribution Plans

The problem with both the defined benefit and defined contribution plans is that we do not put enough money in them. The primary difference between the plans is who we blame for not having enough funds.

EVEN WITH ROSY ASSUMPTIONS, public pensions are deep in the red. “A 2010 Pew study on public pensions nationwide put the funding gap at about a half-trillion dollars based on states’ own assumptions. But Novy-Marx and North western University’s Joshua Rauh say it’s $3 trillion using a risk-free discount rate.” I think a 4% rate is realistic. But note how bad things look assuming even a 6% return.

EVEN WITH ROSY ASSUMPTIONS, public pensions are deep in the red. “A 2010 Pew study on public pensio…
Glenn Reynolds
Sun, 27 Mar 2011 01:55:48 GMT

by

More evidence implicating consumer credit in the subprime mess

 

SO I’M WATCHING MCCAIN TALK ABOUT THE SUBPRIME CRISIS, and how there may be some “greedy people on Wall Street who need to go to jail.”

But I heard a typically sad-toned NPR story on subprimes tonight, and despite their best efforts to evoke the Joads it was a story of people who “used their houses like ATMs,” taking out home equity loan after home equity loan when they started with a subprime mortgage, only to wind up owing far more than their houses were worth and unable to make the payments. Boo hoo. Shouldn’t there be a price for being an idiot? …

SO I’M WATCHING MCCAIN TALK ABOUT THE SUBPRIME CRISIS, and how there may be some “greedy people on W…
Glenn Reynolds
Thu, 31 Jan 2008 01:34:18 GMT

Don’t get me wrong! I still think that there is a good possibility that there were unscrupulous mortgage brokers who took advantage of prospective home owners. However, the elephant in the room is credit card debt. As I have said in a previous post, our only chance is if the government chooses to scale back the credit card debt problem and tighten the mortgage rules at the same time we rescue these “victims”. If we continue to ignore our addiction to credit card debt, we will repeat this financial crisis again.