Uh oh. FHA negative reserves…Say it ain’t so!

[CA renter]

[quote=dumbrenter]

CAR,
I fail to see the relationship between asset prices and unemployment insurance extensions. For you everything seems to be about unions and globalization.
If the asset prices are maintained for the rich, then you the poor unions/middle class can force their hands by reverting to simple living, not buying their stuff and maybe not even paying taxes. Paying taxes can be avoided if poor simply barter goods/services with each other.
If the union folks and middle class default things and default big time, the asset prices are bound to fall. However, they will never get that next ipad or the smart phone on credit.

But going back to my original question, the drop in asset prices will affect the rich most. The unions and middle class had nothing to begin with other than being sold some “dreams” and “told” about things.
The question is: how will the creditors react when they find out they have lost a chunk of their asset values and very little to claim against it?[/quote]

Asset prices (receivables and the value of that debt) can remain artificially high if the Fed/govt maintains the ability of the working/middle class to pay off their debts. We can “extend and pretend” for much longer, and during this time, much of that privately held debt can be sold off to the govt (think: refinancing privately-held mortgages to govt-backed GSE/FHA mortgages, etc.).

For as long as payments are being made, the value of the debt held by “the rich” can remain higher than if all debtors were to default en masse, which is exactly what would have happened if we didn’t get all the interventions.

[spdrun]

Participation has fallen to a low, though picked up a bit recently. Food and energy inflation is pinching. I’m not convinced that the average American is maintaining their power to pay off debts, or will be able to long-term.

Add to this the prospect of $6+/gal gas across the USA if the Middle East blows up.

[davelj]

[quote=CA renter][quote=livinincali]

The problem is that all the growth in the economy for the past 20-30 years has come from increases in debt. If you back out the debt the economy has been shrinking. [/quote]

Yep. Good post, livinincali.[/quote]

Well, not exactly. Roughly 1/3 of the annual growth over the last 30 years has been a result of debt accumulation. The problem, of course, is that if you keep building up debt at small incremental rates over a long period of time – say three decades – you eventually find yourself over-leveraged. As Dickens pointed out, “Annual income £20, annual expenditure £19 and six pence, result happiness. Annual income £20, annual expenditure 20 and six pence, result misery.”

It’s not that all of the growth has been fantasy… it’s just that a very small part of it has been fantasy over a long period of time such that now the cost of servicing that fantasy (resulting from prior debt) is (finally) dragging down our ability to grow.

[livinincali]

[quote=davelj]
Well, not exactly. Roughly 1/3 of the annual growth over the last 30 years has been a result of debt accumulation. The problem, of course, is that if you keep building up debt at small incremental rates over a long period of time – say three decades – you eventually find yourself over-leveraged. As Dickens pointed out, “Annual income £20, annual expenditure £19 and six pence, result happiness. Annual income £20, annual expenditure 20 and six pence, result misery.”

It’s not that all of the growth has been fantasy… it’s just that a very small part of it has been fantasy over a long period of time such that now the cost of servicing that fantasy (resulting from prior debt) is (finally) dragging down our ability to grow.[/quote]

Maybe I’m just arguing semantics, or maybe we’re looking at different data sources but this is what I see. In 1980 the total outstanding debt was right around 5 trillion dollars, this includes public and private debt (Look up the Fed z1 for 1980). That total is now right around 55 trillion. Essentially > 10 fold increase in total debt.

The nominal GDP in 1980 was 2.788 trillion. Today’s it’s around 14.5 trillion. So the economy grew about 5 times in that same period. What I don’t see is any real GDP growth in excessive of debt. In essence we don’t have any example of total debt producing a positive return on investment as a whole. Certainly there are successful businesses that took on debt and produced a real rate of return, but in aggregate there’s been more failures than successes.

If there was real growth in excess of debt then we should be looking at an economy where GDP is well over 30 trillion.

[davelj]

[quote=livinincali][quote=davelj]
Well, not exactly. Roughly 1/3 of the annual growth over the last 30 years has been a result of debt accumulation. The problem, of course, is that if you keep building up debt at small incremental rates over a long period of time – say three decades – you eventually find yourself over-leveraged. As Dickens pointed out, “Annual income £20, annual expenditure £19 and six pence, result happiness. Annual income £20, annual expenditure 20 and six pence, result misery.”

It’s not that all of the growth has been fantasy… it’s just that a very small part of it has been fantasy over a long period of time such that now the cost of servicing that fantasy (resulting from prior debt) is (finally) dragging down our ability to grow.[/quote]

Maybe I’m just arguing semantics, or maybe we’re looking at different data sources but this is what I see. In 1980 the total outstanding debt was right around 5 trillion dollars, this includes public and private debt (Look up the Fed z1 for 1980). That total is now right around 55 trillion. Essentially > 10 fold increase in total debt.

The nominal GDP in 1980 was 2.788 trillion. Today’s it’s around 14.5 trillion. So the economy grew about 5 times in that same period. What I don’t see is any real GDP growth in excessive of debt. In essence we don’t have any example of total debt producing a positive return on investment as a whole. Certainly there are successful businesses that took on debt and produced a real rate of return, but in aggregate there’s been more failures than successes.

If there was real growth in excess of debt then we should be looking at an economy where GDP is well over 30 trillion.[/quote]

Nope, you’re not arguing semantics – it appears that the difference between an income statement and a balance sheet is eluding you.

But before I get to that, as I’ve explained many times here, the Fed’s measure of total debt is calculated incorrectly by any rational person’s way of thinking. That is, it includes securitized debt, which double-counts the vast majority of residential mortgages in this country, among many other things. Having said that, we still have WAY too much debt even after the adjustment, just not as much as it appears. Now, I know what you’re thinking: “If the Fed’s been doing that since time immemorial then the stats over time are comparable.” This is incorrect because securitizations only really came into vogue during the 1980s and then grew like wildfire to where they are today. So, prior to the 1990s the Fed’s debt figures are reasonably accurate; today they’re way off. I have discussed this with a Fed economist and his response, after checking into it (he didn’t even know about the double-counting), was: “Yeah, we don’t know when or if that will ever get corrected.” My response was, “Well, congratulations on a job… done.”

Now, to the larger issue… GDP is essentially an income statement item. Total debt is a balance sheet item. So, merely comparing how large an income statement item (which is not cumulative by nature) is at Year X with a balance sheet item (which IS cumulative) at Year X doesn’t prove your point. Instead what you’d need to do is add up EACH year’s GDP and then compare it to the cumulative amount of debt (using the correct figure, of course) that had built up. (I’m too lazy to do this, but in my head I can see that you’re going to reach a very different conclusion.)

Yes, debt has been growing at a much faster rate than GDP, so we know that it has had a positive impact on GDP (in the past). Now we’re at the point where debt is so large that it has a negative impact on GDP (too much to service). We have too much debt – there’s no question about that. But… you’re dramatically overstating your case when you suggest that there hasn’t been ANY economic growth ex-debt over the last 30 years; this is empirically incorrect. In fact, there’s been a bit of research done on this subject and most of it concludes that about 50-100 bps of annual GDP growth over the last 30 years has been the result of incremental debt.

[dumbrenter]

[quote=davelj]
Yes, debt has been growing at a much faster rate than GDP, so we know that it has had a positive impact on GDP (in the past). Now we’re at the point where debt is so large that it has a negative impact on GDP (too much to service). We have too much debt – there’s no question about that. But… you’re dramatically overstating your case when you suggest that there hasn’t been ANY economic growth ex-debt over the last 30 years; this is empirically incorrect. In fact, there’s been a bit of research done on this subject and most of it concludes that about 50-100 bps of annual GDP growth over the last 30 years has been the result of incremental debt.[/quote]

Would it be correct to say that the debt service payments will be a short-term liability (i.e. in current portion of liability) while the same debt used productively will be having a positive effect on the revenue portion of the income statement?

[no_such_reality]

[quote=dumbrenter]
Would it be correct to say that the debt service payments will be a short-term liability (i.e. in current portion of liability) while the same debt used productively will be having a positive effect on the revenue portion of the income statement?[/quote]

Let me think.

A school district is doing 30 year bonds to finance long and short term issues, including technology spending on neat-o stuff like iPads. Those iPads are being planned to be in service with the students for 5 years.

The debt, or at least, portion of the debt will be being paid for 30 years.

The iPads will be planned for use for 5 years. If they are still in use after 5 years, how useful will they be?

[livinincali]

[quote=davelj]
Yes, debt has been growing at a much faster rate than GDP, so we know that it has had a positive impact on GDP (in the past). Now we’re at the point where debt is so large that it has a negative impact on GDP (too much to service). We have too much debt – there’s no question about that. But… you’re dramatically overstating your case when you suggest that there hasn’t been ANY economic growth ex-debt over the last 30 years; this is empirically incorrect. In fact, there’s been a bit of research done on this subject and most of it concludes that about 50-100 bps of annual GDP growth over the last 30 years has been the result of incremental debt.[/quote]

Fair enough. If you take on a trillion dollars of debt to produce 300 billion of annual production it theoretically does end up producing a positive return at some point. It’s just difficult to see it when you keep increasing debt every year in excessive of the incremental productivity increases. I suppose in our system we should measure yearly servicing cost versus the GDP growth. I.e. 1.2 trillion @ 4% is right around 70 billion in servicing costs for 30 years. We get about 280 billion in what we assume is permanent growth from that debt.

Certainly in a world with a growing population and growing energy usage there is growth. It’s just that we chose to measure it something that has a variable meaning. A dollar today in terms of productive output is different than a dollar 2 years ago.

[davelj]

[quote=dumbrenter][quote=davelj]
Yes, debt has been growing at a much faster rate than GDP, so we know that it has had a positive impact on GDP (in the past). Now we’re at the point where debt is so large that it has a negative impact on GDP (too much to service). We have too much debt – there’s no question about that. But… you’re dramatically overstating your case when you suggest that there hasn’t been ANY economic growth ex-debt over the last 30 years; this is empirically incorrect. In fact, there’s been a bit of research done on this subject and most of it concludes that about 50-100 bps of annual GDP growth over the last 30 years has been the result of incremental debt.[/quote]

Would it be correct to say that the debt service payments will be a short-term liability (i.e. in current portion of liability) while the same debt used productively will be having a positive effect on the revenue portion of the income statement?[/quote]

This is an interesting issue and it’s complicated by politics and the fact that our economy isn’t a corporation, although they share certain similarities. A traditional view of corporate finance suggests that you issue debt and invest in projects so long as the new projects’ expected rate of return is greater than the weighted-average cost of capital (weighting both debt and equity). As debt increases, the individual costs of both equity and debt increase (as the whole enterprise becomes more risky), but the weighted-average cost declines (because debt is cheaper than equity) UP TO A POINT. At a point – and this varies by company – the overall cost of capital starts to increase with each unit of additional debt – this is, in theory, where the “optimal capital structure” lies. To use extreme examples, the optimal debt-to-capital ratio for a tech start-up is zero (as it’s a very risky enterprise). Conversely, the optimal debt-to-capital ratio for a utility is fairly high, as its cash flows are highly predictable.

Which brings us to the US. Aggregate debt, in and of itself, is not a bad thing. And the US doesn’t have a “true” cost of capital because it’s not a corporation (the Federal Reserve can print money, after all). Arguably, however, at the point at which $1 of incremental debt no longer produces $1 of incremental GDP… well, you need to start asking some hard questions. Perhaps that $1 of debt will pay off in the longer term. For example, a corporation doesn’t issue $1 of debt assuming it’s going to generate a like $1 of earnings in year 1 – that’s absurd. But over time… it needs to generate something positive. The problem that we face now, of course, is that $1 of new debt generates about $0.15 of incremental GDP. While I don’t know what the optimal capital structure is for the US (I’d have to really think about that), it’s not what we have currently – we’re over-leveraged. The only reason we can service our debt right now (and for the foreseeable future) is that Mr. Bernanke has fixed interest rates at a very low level.

So, in a corporate context, it’s much easier to determine whether or not an enterprise is over-leveraged. It’s much more difficult when you look at an economy. But I think when you look at the mountain of debt we have today relative to GDP it’s pretty clear we have a problem. The debate is whether it’s a painful, albeit surmountable, problem over the long term or completely insurmountable. The jury’s still out on that question.

[davelj]

[quote=livinincali][quote=davelj]
Yes, debt has been growing at a much faster rate than GDP, so we know that it has had a positive impact on GDP (in the past). Now we’re at the point where debt is so large that it has a negative impact on GDP (too much to service). We have too much debt – there’s no question about that. But… you’re dramatically overstating your case when you suggest that there hasn’t been ANY economic growth ex-debt over the last 30 years; this is empirically incorrect. In fact, there’s been a bit of research done on this subject and most of it concludes that about 50-100 bps of annual GDP growth over the last 30 years has been the result of incremental debt.[/quote]

Fair enough. If you take on a trillion dollars of debt to produce 300 billion of annual production it theoretically does end up producing a positive return at some point. It’s just difficult to see it when you keep increasing debt every year in excessive of the incremental productivity increases. I suppose in our system we should measure yearly servicing cost versus the GDP growth. I.e. 1.2 trillion @ 4% is right around 70 billion in servicing costs for 30 years. We get about 280 billion in what we assume is permanent growth from that debt.

Certainly in a world with a growing population and growing energy usage there is growth. It’s just that we chose to measure it something that has a variable meaning. A dollar today in terms of productive output is different than a dollar 2 years ago.[/quote]

I’d have to really think about how to measure the utility of each incremental dollar of debt. That’s probably not an easy thing to do because the cost of capital issue looms large and is difficult to quantify. I think we have too much debt and it seems self-evident because if you normalized interest rates, debt service would be a huge issue. But so long as rates remain low, to paraphrase Chuck Prince, “Everyone keeps dancing.”

[dumbrenter]

[quote=davelj][quote=dumbrenter][quote=davelj]
Yes, debt has been growing at a much faster rate than GDP, so we know that it has had a positive impact on GDP (in the past). Now we’re at the point where debt is so large that it has a negative impact on GDP (too much to service). We have too much debt – there’s no question about that. But… you’re dramatically overstating your case when you suggest that there hasn’t been ANY economic growth ex-debt over the last 30 years; this is empirically incorrect. In fact, there’s been a bit of research done on this subject and most of it concludes that about 50-100 bps of annual GDP growth over the last 30 years has been the result of incremental debt.[/quote]

Would it be correct to say that the debt service payments will be a short-term liability (i.e. in current portion of liability) while the same debt used productively will be having a positive effect on the revenue portion of the income statement?[/quote]

This is an interesting issue and it’s complicated by politics and the fact that our economy isn’t a corporation, although they share certain similarities. A traditional view of corporate finance suggests that you issue debt and invest in projects so long as the new projects’ expected rate of return is greater than the weighted-average cost of capital (weighting both debt and equity). As debt increases, the individual costs of both equity and debt increase (as the whole enterprise becomes more risky), but the weighted-average cost declines (because debt is cheaper than equity) UP TO A POINT. At a point – and this varies by company – the overall cost of capital starts to increase with each unit of additional debt – this is, in theory, where the “optimal capital structure” lies. To use extreme examples, the optimal debt-to-capital ratio for a tech start-up is zero (as it’s a very risky enterprise). Conversely, the optimal debt-to-capital ratio for a utility is fairly high, as its cash flows are highly predictable.

Which brings us to the US. Aggregate debt, in and of itself, is not a bad thing. And the US doesn’t have a “true” cost of capital because it’s not a corporation (the Federal Reserve can print money, after all). Arguably, however, at the point at which $1 of incremental debt no longer produces $1 of incremental GDP… well, you need to start asking some hard questions. Perhaps that $1 of debt will pay off in the longer term. For example, a corporation doesn’t issue $1 of debt assuming it’s going to generate a like $1 of earnings in year 1 – that’s absurd. But over time… it needs to generate something positive. The problem that we face now, of course, is that $1 of new debt generates about $0.15 of incremental GDP. While I don’t know what the optimal capital structure is for the US (I’d have to really think about that), it’s not what we have currently – we’re over-leveraged. The only reason we can service our debt right now (and for the foreseeable future) is that Mr. Bernanke has fixed interest rates at a very low level.

So, in a corporate context, it’s much easier to determine whether or not an enterprise is over-leveraged. It’s much more difficult when you look at an economy. But I think when you look at the mountain of debt we have today relative to GDP it’s pretty clear we have a problem. The debate is whether it’s a painful, albeit surmountable, problem over the long term or completely insurmountable. The jury’s still out on that question.[/quote]

Thanks.
So going to back to what I am trying to figure out:
A debt issued by government is very different from that of a corporation.
Additionally, while the interest rate on a bond issued by a corporation is dependent on market, the US government at this time can choose the interest it wants to pay on its debt.

To make things even interesting, the US can not only choose the interest rate, but the debt is denominated in paper that the US can print at will.
So where exactly is the problem? How can we be over-leveraged when we get to control the rate AND the denomination in which the debt is serviced?

We can keep issuing debt till there is no buyer at which point we cannot issue debt anymore which means there is no more debt problem.
OR we will reach a point of exchange rates / devaluation / inflation where it will become cheaper to make things here instead of making them overseas and shipping them here. Which means more jobs here and a vibrant economy.
Looks like folks holding dollar or dollar denominated assets will win in either case. Or so it seems to this dumb renter.

[livinincali]

[quote=dumbrenter]
To make things even interesting, the US can not only choose the interest rate, but the debt is denominated in paper that the US can print at will.
So where exactly is the problem? How can we be over-leveraged when we get to control the rate AND the denomination in which the debt is serviced?

We can keep issuing debt till there is no buyer at which point we cannot issue debt anymore which means there is no more debt problem.
OR we will reach a point of exchange rates / devaluation / inflation where it will become cheaper to make things here instead of making them overseas and shipping them here. Which means more jobs here and a vibrant economy.
Looks like folks holding dollar or dollar denominated assets will win in either case. Or so it seems to this dumb renter.[/quote]

The problem is that real wealth is the promise of future productivity. We put that debt in terms of dollars but a dollar in itself has almost zero tangible value. When you print too much and people lose faith in actually getting paid back in productive output and instead bags full of paper money you get hyper inflation.

[dumbrenter]

[quote=livinincali][quote=dumbrenter]
To make things even interesting, the US can not only choose the interest rate, but the debt is denominated in paper that the US can print at will.
So where exactly is the problem? How can we be over-leveraged when we get to control the rate AND the denomination in which the debt is serviced?

We can keep issuing debt till there is no buyer at which point we cannot issue debt anymore which means there is no more debt problem.
OR we will reach a point of exchange rates / devaluation / inflation where it will become cheaper to make things here instead of making them overseas and shipping them here. Which means more jobs here and a vibrant economy.
Looks like folks holding dollar or dollar denominated assets will win in either case. Or so it seems to this dumb renter.[/quote]

The problem is that real wealth is the promise of future productivity. We put that debt in terms of dollars but a dollar in itself has almost zero tangible value. When you print too much and people lose faith in actually getting paid back in productive output and instead bags full of paper money you get hyper inflation.[/quote]

Given the demand for dollar now, I question if we are anywhere close to a point where people lost faith in USD. Our experiences in 2008 and 2011 show that as crisis hits, dollar becomes more expensive relative to other currencies. So, relative to other currencies, USD does have tangible value and each time we have a crisis, it seems to even appreciate in value (i.e. opposite of hyperinflation).
Based on this experience, this non-economist dumb renter questions if US even has a debt crisis.

This write up makes sense when putting USD in terms of demand and supply : http://www.zerohedge.com/news/2012-11-18/guest-post-understanding-exorbitant-privilege-us-dollar

None of the rules that applied to other economies, currencies throughout our history apply here anymore, so we have no history to look back to.
In my view, we are all actually sitting very pretty and need to thank our good fortune that folks outside our shores have an insatiable appetite for our paper. The only risk is when major commodities / goods will be priced in currencies other than USD. Unlikely to happen for grain and agriculture related ones since US still dominates that trade as an exporter. So that only leaves out oil or in general any energy source. As long as they are priced in USD, all is good.

[livinincali]

[quote=dumbrenter]
None of the rules that applied to other economies, currencies throughout our history apply here anymore, so we have no history to look back to.
In my view, we are all actually sitting very pretty and need to thank our good fortune that folks outside our shores have an insatiable appetite for our paper. The only risk is when major commodities / goods will be priced in currencies other than USD. Unlikely to happen for grain and agriculture related ones since US still dominates that trade as an exporter. So that only leaves out oil or in general any energy source. As long as they are priced in USD, all is good.[/quote]

In my eyes history has shown that a fiat currency crisis happens suddenly and violently. The USD will be unquestioned until it finally is and by then it will be to late. Usually in a currency crisis the hard currency does perform better than leveraged assets but not much better. I.e. Iceland saw a 95% reduction in the stock market but only a 50% reduction in the currency value, relative to other currency values.

Of course I’ve been thinking about the economy without currency because currency is just a medium of exchange. What’s really important is the total goods and services available and the competition between people to consume those goods and services.

Americans have had an extremely large competitive advantage compared to the rest of the world, but we aren’t doing things to maintain that competitive advantage. That’s why the average is falling behind the previous standard of living. They are losing to outside competitive forces. In all honesty what competitive advantage does your average baby boomer retiree have in this world economy. Those that have no skills or no desirable assets are going to have a tough time competing.

[kev374]

well, since the Obama administration has no qualms about printing as much money is required, money will be printed to make the FHA whole and continue their practices ad-infinitum.

And since the American public are onboard with the money printing (they re-elected the fellow after all!) why is this even an issue?

[Author]

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