22/5/17: U.S. Autoloans Market: Careless Lending, Defaulting Buyers

Auto loans are now coming through as a growing concerns area in terms of U.S. household credit. Auto loans originations have risen, in total volume from $123.9 billion in 1Q 2016 to $132.4 billion in 1Q 2017, an all-time high for 1Q period on record. Total volume of auto loans debt outstanding is at $1,167 billion, up on $1,071 billion in 1Q 2016 and at an all-time record. Year on year growth in auto loans is at 9%.

However, origination has been more subdued in 1Q 2017 for subprime loans, with issuance for credit score below 620 falling to $25.9 billion in 1Q 2017 compared to $26.9 billion a year ago. Likewise, near-sub-prime originations (credit scores 620-659) also declined, from $16.1 billion in 1Q 2016 to $15.6 billion in 1Q 2017.

However, owing to rapid growth in recent years in sub-prime originations, auto loans currently exhibit third highest rate of delinquencies across all forms of household debt, with 3.82 percent of all auto loans currently 90+ days delinquent, the highest since 1Q 2013 and up on 1Q 2016 reading of 3.52 percent.

As noted in a recent Bloomberg article (see https://www.bloomberg.com/news/articles/2017-05-22/subprime-auto-giant-checked-income-on-just-8-of-loans-in-abs), much of the problem arises from sloppy, or outright careless, origination by some key lenders. 

10/8/2014: Inflating Away the Public Debt? Not so fast...

There is a lot of talk amongst Irish and european policymakers about the big great hope for deflating public debts across euro area periphery: the prospect of inflation taking chunks out of the real debt burdens. This hope is based on a major misunderstanding of history. In many a cases, in the presence of debt overhang, higher inflation does help erode the real value of debt. Alas, "While across centuries and countries, a common way that sovereigns have paid for high public debt is by having higher, and sometimes even hyper, inflation, this rarely came without some or all of fiscal consolidation, financial repression, and partial default (Reinhart and Rogoff, 2009)." This quote starts the new NBER paper, titled "Inflating Away the Public Debt? An Empirical Assessment" by Jens Hilscher, Alon Raviv, and Ricardo Reis )NBER Working Paper No. 20339, July 2014)

In other words, it remains to not entirely clear just how effective inflation can be in current environment, given there are no defaults and there are no direct and aggressive financial repression measures implemented in the majority of the advanced economies, yet.

The NBER paper takes on the issue from the U.S. debt perspective. Per authors, "…with U.S. total public debt at its highest ratio of GDP since 1947, would higher inflation be an effective way to pay for it?"

"Providing an answer requires tackling two separate issues:

1. "The first is to calculate by how much would 1% unanticipated and permanently higher inflation lower the debt burden. If all of the U.S. public debt outstanding in 2012 (101% of GDP) were held in private hands, if it were all nominal, and if it all had a maturity equal to the average (5.4 years), then a quick back-of-the-envelope answer is 5.5%.1 However, we will show that this approximation is misleading. In fact, we estimate that the probability that the reduction in U.S. debt is as large as 5.5% of GDP is below 0.05%. The approximation is inaccurate since the underlying assumptions are inaccurate. The debt number is exaggerated because large shares of the debt are either held by other branches of the government or have payments indexed to inflation and the maturity number is inaccurate because it does not take into account the maturity composition of privately-held nominal debt."
2. "The second issue is that assuming a sudden and permanent increase in inflation by an arbitrary amount (1% in the above example) is empirically not helpful. After all, if the price level could suddenly jump to infinity, the entire nominal debt burden would be trivially eliminated. It is important first to recognize that …if investors anticipated sudden infinite inflation, they would not be willing to hold government debt at a positive price. Second, the central bank does not perfectly control inflation, so that even if it wanted to raise inflation by 1% it might not be able to. Moreover, there are many possible paths to achieving higher inflation, either doing so gradually or suddenly, permanently or transitorily, in an expected or unexpected way, and we would like to know how they vary in effectiveness. Therefore, it is important to consider counterfactual experiments that economic agents believe are possible."

The authors "calculate novel value-at-risk measures of the debt debasement due to inflation, and ...consider a rich set of counterfactual inflation distributions to investigate what drives the results. Using all these inputs, [authors] calculate the probability that the present value of debt debasement due to inflation is larger than any given threshold. The 5th percentile of this value at risk calculation is a mere 3.1% of GDP, and any loss above 4.2% has less than 1% probability. Interestingly, much of the effect of inflation would fall on foreign holders of the government debt, who hold the longer maturities. The Federal Reserve, which also holds longer maturities, would also suffer larger capital losses."

The paper also "…explores the role of an active policy tool that interacts with inflation and is often used in developing countries: financial repression. It drives a wedge between market interest rates and the interest rate on government bonds, and acts as a tax on the existing holders of the government debt. We show that extreme financial repression, where bondholders are paid with reserves at the central bank which they must hold for a fixed number of periods, is equivalent to ex post extending the maturity of the debt. Under such circumstances inflation has a much larger impact, such that if repression lasts for a decade, permanently higher inflation that previously lowered the real value of debt by 3.7% now lowers it by 23% of GDP."

In short, there is no miracle inflationary resolution of the U.S. debt conundrum. And similarly, there is probably none for the euro area sovereigns stuck with debts in excess of 90-100% of GDP. The pain of inflation alone is simply not enough to magic away debts. Instead, the pain of inflation will have to be coupled with the added pain of financial repression, and in the euro area case, this pain will befall more domestic investors and savers, than in the U.S. case simply due to differences in debt holdings. While no one expects the financial repression in the euro area to match that deployed in Greece and Cyprus, one can expect the financial repression measures (higher taxation in general, higher taxation of savings and overseas investments, higher rates of cash extraction from consumers via public sector pricing and higher concentrations in the financial services sector to increase rates of cash extraction by the banks) are here to stay and to most likely get worse before things can improve a decade later.

The myth of higher inflation as a (relatively) painless salvation to our debt ills is getting thinner and thinner...

6/1/2013: Houston, we've got a (US) problem?..

2013 biggest Grey Swan might be not China's slowdown or Euro area's continued debt crisis (although both are pretty much still on the books, although the former is less likely than the latter). It might not even be the Japanese economic implosion (albeit Japan is sick beyond any repair)... oh, no... the real Grey Swan of 2013 might be the markets starting to take a closer look at the US.

This might sound bizarre during the weekend following Friday, when the VIX index collapsed 39.1% - more than in any other trading day in its history, and when the US markets have ended the first week of the year with total gains almost equivalent to what some are projecting for the entire 2013... and yet... as some would say: "Houston, we've got a problem!"

The problem is best illustrated in the following three sets of chart, all comparing US fiscal performance to the peers.

Structural Deficits:

As two charts above highlight, the US Government structural deficits are massive. Since 2011, these are shallower than those of Japan (and Japan's figures in charts above are likely to become even worse following the latest Government appointment and their commitment to debase/in-debt the Japanese economy out of existence) but they are the worse in the entire G7 group save for Japan. More ominously:

• The IMF is predicting the structural deficit to worsen once again starting in 2015
• The above projections by the IMF do not reflect the disastrous consequences of the 'Fiscal Cliff' deal struck on December 31, 2012 (see here).
• In 2013, US structural deficit is projected to be around 5.49% of GDP against the G7 average of 3.04%
• In 2010-2017, according to the IMF projections, the US cumulated structural deficits will add up to 44.84% of GDP - against Japan's 58.53% and the G7 average of 24.97%. For 2013-2017, the same figures are: US 21.43%, Japan 33.31% and G7 average 10.48%. In other words, things are going to get worse in the US compared to G7 average in 2013-2017 than they were in 2010-2012. They will be worse still in Japan, but everyone expects Japan to remain the sickest member of G7, so there is little surprise or repricing that can be expected before the US risks are repriced.

Primary Deficits:

Ugly picture for the US vis G7 counterparts continues with primary deficits as well. Per above:

• The US is the second weakest link in G7 in terms of primary deficits
• In 2010-2017 period, the US is expected to generate cumulated primary deficits amounting to 37.65% of GDP and this is against Japan's 52.42%, but G7 average of 15.99%. In the period from 2013 though 2017, the US cumulated primary deficits are expected to come in at 14.21% of GDP against the G7 average of 3.54% of GDP and Japan's 25.73% of GDP. Once again, relative to G7 average, the US performance is expected to worsen in 2013-2017 compared to 2010-2012.

A table to summarise the above two sets of charts on a longer time horizon scale:

Government Debt:

The US is positioned as the third weakest G7 economy in terms of levels of Government debt it carries - after Japan and Italy. However, this analysis neglects the fact that according to the IMF projections, the US debt situation is expected to continue worsening through 2016 (when US debt is expected to peak at 114.19% of GDP), while Italian situation is expected to improve from 2013 peak of 127.85% of GDP into 2017. Similarly, compared to G7 average, the US debt dynamics post-2013 are unpleasantly convergent to the higher G7 average (driven by Japan's debt levels).

Stripping out Japan from debt analysis:

• In 2001, US debt to GDP ratio stood at 11.83 ppt below G7 (ex-Japan) average. By 2012 this number has reversed into US debt overshoot of G7 average by 10.06 ppt. By 2017 the same overshoot is expected to rise to 19.57 ppt.

Table below summarises the long-range view of the charts above:

To summarise the above evidence, the US debt levels are not sustainable in the long run, even though current growth (above debt financing costs) and funding costs (exceptionally low yields on Government bonds and the printing press effect on these yields) are delivering short-term sustainability. However, as shown above, the US primary deficit ius huge and not abating fast enough. This implies debt to GDP ratio will be rising into 2016, if not after. Which, in turn, implies rising susceptibility of the US to risk-repricing in the markets.

It is worth contrasting the US case with that of Italy and Japan. In Italy's case, there is significant surplus on the primary balance and overall deficit due to high cost of funding even higher debt, compounded by economic growth well below the cost of funding the state debt pile. In Japan - there are severe problems across all parameters: high primary deficits, growth well below the cost of debt funding, and debt pile so large that structural deficits are alarming.

All of which means that all three economies can be severely tested by the markets. As long as global economic environment remains that of subdued economic activity, so that risk aversion remains high and monetary policies remain extremely accommodative, the US is out of the investors' crosshairs and Italy is in. Should these environments change, all bets are off for the US - at least in the medium- to longer-term.

2/1/2013: The Bitter ATRA Fudge

Some say never shall one let a good crisis go to waste... US Fiscal Cliff 'deal' of December 31st is an exact illustration. Here is the list of pork carriages attached to the Disney-styled 'train' of policies the US Congress enacted.

Have a laugh: http://www.nakedcapitalism.com/2013/01/eight-corporate-subsidies-in-the-fiscal-cliff-bill-from-goldman-sachs-to-disney-to-nascar.html

And to summarise the farcical output of the Congressional effort:

• The American Taxpayers Relief Act (ATRA) has raised taxes on pretty much everyone. Taxes up means growth down. Now, recall that the US economy is not exactly in a sporting form to start with (link here).
• The payroll taxes cuts are not extended into 2013 so every American is getting whacked with some 2% reduction in the disposable income, taking out $115 billion per annum (the largest revenue raising measure in the ATRA) out of households savings, investment and consumption, or under 1% of annual personal consumption.
• The super-rich (or just filthy-rich, take your pick, but defined as those on joint incomes at or above $450K pa) will see income tax rising to 39.6% and will have to pay an additional 0.9% in Medicare tax to cover that which they will not be buying - the Obamacare. They (alongside anyone earning above $250K pa) will also pay 3.8% additional tax on 'passive' income - income from capital gains and dividends for same Obamacare.
• Dividends and CGT are raised from 15% to 20% (again for joint earners above $450K pa).

Meanwhile, the US has already breached the debt ceiling and the ATRA has done virtually nothing to address the deficit overhang. So in a summary, the 'deal' is a flightless dodo flopping in the mud of politics. There are no real cuts on the expenditure side, there are loads of tax hikes that are likely to damage demand and investment and lift up the cost of capex funding for the real economy. And there is simply more - not less - uncertainty about the future direction of policy, as the White House and the Congress are going to be at loggerheads in months to come dealing with the following list of unaddressed topics:

1. Spending cuts
2. Budget deficit
3. Further tax hikes
4. Debt
5. Reforms of the entitlements system
6. Growth-retarding effects of ATRA and Obamacare.

Obamanomics have delivered fudged recovery, fudged solutions to structural crises and real, tangible increases in taxation. The latter is the 'first' since 1993.

21/09/2011: Fed's QE3 and why it will fail

Markets catalysts for today (barring unexpected news from the euro area) will be the US Fed statement expected at 19.15. Following the FOMC two-day meeting consensus expectation is for the FED to announce new, but relatively modest - compared against QE1-2, easing measures labeled in the media Operation Twist.

These will attempt to boost consumer and corporate borrowing and spending, as well as ease longer-term debt constraint for the Feds and local authorities (states and municipalities). The Fed is likely to attempt flattening the longer-term yield curve in a hope that restarting borrowing will cut US elevated 9.1% unemployment rate.

To do this, the Fed will probably sell short-term debt (Treasuries) to buy out longer term debt - in effect the cost of borrowing will rise in the short run, while longer term financing costs will decline. Short-term consumer credit will take a hit, as will less liquid financial services providers. Operating capital for businesses is also likely to become more expensive. Just how exactly this is going to help US economy - anyone's guess, but it will provide some breathing space for the US Government, put pressure on the Republican opposition to debt ceiling hikes (pressing the argument forward that short-term financing is getting relatively more expensive) and will encourage banks to load up on maturity mismatch risk via incentivising shorter bonds loading).

Simultaneous selling of short term maturities and buying of longer term debt will in effect sterilize Fed intervention when it comes to its balance sheet, but it will also encourage cutting back the entire maturity profile of banks asset books.

The core problem, of course, is that these measures are likely to fail to deliver anything meaningful to the economy. The cause of stalled consumer and producer demand for credit is not the cost of financing - especially in the short run, since mortgage rates are currently at historically low levels. The real cause is the fact that the US is suffering from debt overhang.

Back in 1980, US Household, Corporate and Government debt as percentage of nominal GDP amounted to 151% - 3rd lowest in G7. By 1990 this rose to 200% - 4th lowest. With Bill Clinton's (or rather Republican Congress) heroic efforts to cut that, 2000 level of debt was 198% - the lowest in G7. In 2010, the US combined public and private non-financial debt was 268% - the second lowest in G7.

Meanwhile, household debt rose from 52% of GDP in 1980 to 95% of GDP in 2010. Thus US households have gone from being 4th most indebted in G7 back in 1980 to being second most indebted in 2010. In the mean time, corporate debt remained relatively low, compared to G7 states - rising from 53% in 1980 (3rd lowest) to 76% of GDP in 2010 (lowest in G7).

Public sector debt rose from 46% of GDP (3rd lowest in G7) in 1980 to 71% of GDP in 1990 (3rd highest in G7), declined to 58% of GDP in 2000 (second lowest) and rose to 97% of GDP in 2010 (3rd lowest in G7).

In a recent paper, presented at Jackson Hole, WY meeting this year, S. G. Cecchetti, M. S. Mohanty and F. Zampolli (paper titled "The real effects of debt") reported that thresholds for debt levels that are damaging to economic growth (under the baseline case that covers presence of the financial crisis) are:

• 96% for Government debt to GDP ratio (US was already at 97% in 2010)
• 73% for Corporate debt to GDP ratio (US was at 76% in 2010) and
• 84% for Household debt to GDP ratio (US was at 95% in 2010)

Spot the problem, folks, for Ben clearly can't see it. (Hint: of all three debt heads, household debt is further out of trigger range).

Thus, the only meaningful stimulus the US Government can put forward is the set of measures to deliver meaningful reductions in household debt. About the only tool for that is a broad-based middle and upper-middle classes income tax cut.

Everything else, including Ben's financial re-engineering of the yield curve, is not much different from what the EU is doing with Greece. Kicking the can down the road is not the proverbial elephant the Fed is ignoring. The can itself - household debt - is.

01/08/2011: Should President Obama play a harder ball with the Republicans?

In the wake of the US debt 'deal' pre-announcement, I have been seeing comments, including that from Paul Krugman in the NYT today (here) which appear to suggest that President Obama's agreement to accept parts of the Republican's proposals represents a surrender of the presidential authority and, more improtantly, such a limit on presidential authority is somehow a bad signla concerning consistency of macroeconomic policy in the US.

In particula, Prof Krugman states: "In fact, if I were an investor I would be reassured, not dismayed, by a demonstration that the president is willing and able to stand up to blackmail on the part of right-wing extremists. Instead, he has chosen to demonstrate the opposite."

Now, this argument would be fine, if Mr Obama had a record worth taking a stand on. He does not. Here are two charts on US debt based on IMF WEO database.

So both in terms of debt to GDP ratio and absolute current dollar denominated debt levels, Mr Obama might do well running away from his previously established record. Whether he did this via the latest debt deal or not is a separate issue altogether, but Mr Krugman's statement that President Obama should have exhibited more intransigence as the means for encouraging investors confidence in his administrative abilities is bizarre, to put it mildly. Mr Obama has no record worth defending. He has a record worth abandoning.