7/2/20: Mapping Real Economic Debt 2019

A neat summary map of the real economic debt as a share of the national economies, via IIF, with my addition of Ireland's benchmark relative to its more accurate measure of the national income than GDP:

Yep, it is unflattering... albeit imperfect (there is some over-estimate here on the corporate debt side).

20/2/19: Crack and Opioids of Corporate Finance

More addictive than crack or opioids, corporate debt is the sand-castle town's equivalent of water: it holds the 'marvels of castles' together, util it no longer does...

Source: https://twitter.com/lisaabramowicz1/status/1098200828010287104/photo/1

Firstly, as @Lisaabramowicz correctly summarises: "American companies look cash-rich on paper, but average leverage ratios don't tell the story. 5% of S&P 500 companies hold more than half the overall cash; the other 95% of corporations have cash-to-debt levels that are the lowest in data going back to 2004". Which is the happy outrun of the Fed and rest of the CBs' exercises in Quantitive Hosing of the economies with cheap credit over the recent years. So much 'excessive' it hurts: a 1 percentage point climb in corporate debt yields, over the medium term (3-5 years) will shave off almost USD40 billion in annual EBITDA, although tax shields on that debt are likely to siphon off some of this pain to the Federal deficits.

Secondly, this pile up of corporate debt has come with little 'balancesheet rebuilding' or 'resilience to shocks' capacity. Much of the debt uptake in recent years has been squandered by corporates on dividend finance and stock repurchases, superficially boosting the book value and the market value of the companies involved, without improving their future cash flows. And, to add to that pain, without improving future growth prospects.

15/2/19: Still Drowning in Love [for Debt]...

Debt... Sovereign debt... and Valentines...

A decade post-GFC, we are still shedding love to our overly-indebted sovereigns... so nothing can ever go wrong, again...

15/2/19: Nothing to Worry About for those Fiscally Conservative Republicans

H/T to @soberlook:

U.S. Federal deficit was up $192 billion y/y in December 2018. Nothing to worry about, as fiscal prudence has been the hallmark of the Republican party policies since... well... since some time back...  That, plus think of what fiscal surplus will be once Mexico pays for the Wall, and Europeans pay for the Nato.

Soldier on, Donald.

21/1/18: FT Warns on Credit Cards Delinquencies: High or Hype?

The FT are reporting a 20% rise in credit cards delinquencies across major U.S. banks in 2016, compared to 2017 (see here: https://www.ft.com/content/bafdd504-fd2c-11e7-a492-2c9be7f3120a). Which sounds bad. Although, of course, neither new nor completely up-to-date. That is because the NY Fed give us the same figures (for all U.S. households) through 3Q 2017.

So here is the analysis of the Fed figures:

• Credit Card delinquencies rose to 6.33% of total balances in 3Q 2017, up from 5.15% a year ago and from 5.45% in 3Q 2015. So, in fact, instead of a 20% jump, y./y for 3Q figures, there was a drop in 2016 compared to 2015, but a big jump in 2017 on 2016.
• One can expect a more significant jump in 2-3Q 2018, as new credit issuance glut of 4Q 2017 works its way into defaults (see link here: http://trueeconomics.blogspot.com/2018/01/19118-tears-over-qe-us-household-debt.html).
• Besides this, as noted here http://trueeconomics.blogspot.com/2018/01/19118-tears-over-qe-us-household-debt.html, credit card debt is rising and rising fast, with overall debt levels now 4.8% ahead of 2005-2007 average.

Despite these worrying dynamics, the levels of delinquencies are still low. In 2007-2008, credit card delinquencies rates were around 9.34% and 10.84%, respectively. In 2006, these were 8.54%. In fact, current running average for 1Q-03Q 2017 is 6.14% or lower than for any year between 2003 and 2012. 

As the chart below shows, the real crisis is currently unfolding not in the credit cards debt, but in Student Loans with 10.05% average delinquency rate for 2017 so far. Credit crds delinquencies are only fourth in terms of severity. 

In terms of total volumes of debt in delinquency, 3Q 2017 data shows credit cards with USD12.3 billion, against mortgages at USD88.56 billion, student loans at USD 30.16 billion and auto loans at USD 17.05 billion. 

Even in terms of transition from shorter-term delinquency (30 days-89 days) to longer-term delinquency (90days and over), credit cards are not as prominent of a problem as student loans:

In summary, thus, the real crisis in the U.S. household debt is not (yet) in credit cards or revolving loans, and not even (yet) in mortgages. It is in student debt, followed by auto loans.

16/8/17: Year Eight of the Great American Recovery: Household Debt

U.S. data for household debt for 2Q 2017 is out at last, and the likes of Reuters and there best of the official business media are shouting over each other about the ‘record debt levels’ warnings. As if the ‘record debt levels’ is something so refreshingly new, that no one noticed them in 1Q 2017.

So with that much hoopla in your favourite media pages, what’s the data really telling us?

Quite a bit, folks. Quite a bit.

Let’s start from the top:

Debt levels are up. Almost +4.5% y/y. All debt categories are up, save for HE Revolving debt (down 5.44% y/y). Increases are led by Auto Loans (+7.89% y/y) and Credit Cards (+7.54%). High growth is also in Student Loans (+6.75%). Mortgages debt is rising much slower, as consistent with lack of purchasing power amongst the younger generation of buyers.

As you know, I look at this debt from another perspective, slightly different from the rest of the media pack. That is, I am interested in what is happening with assets-backed debt and asset-free debt. So here it is:

Yes, debt is up again. Mortgages debt share of total household debt has shrunk (it is now at 67.7%) and unsecured debt share is up (32.3%). Unsecured debt was $3.925 trillion in 2016 Q2 and it is now $4.148 trillion. Why this matters? Because although cars can be repossessed and student loans are non-defaultable even in bankruptcy, in reality, good luck collecting many quarters on that debt. Housing debt is different, because with recent lending being a little less mad than in 2004-2007, there is more equity in the system so repossessions can at least recover meaningful amounts of loans. So here’s the thing: low recovery debt is booming. While mortgages debt is still some $600 billion odd below the pre-crisis peak levels.

On the surface, mortgages originations are improving in terms of credit scores. In practice, of course, credit scores are superficially being inflated by all the debt being taken out. Yes, that’s the perverse nature of the American credit ratings system: if you have zero debt, your credit rating is shit, if you are drowning in debt, you are rocking…

Still, here is the kicker: mortgages credit ratings at origination are getting slightly stronger. Total debt written to those with a credit score <660 2016.="" 2016="" 2017="" 2q.="" 2q="" also="" auto="" billion="" buyers="" class="Apple-converted-space" credit="" down="" fell="" from="" good="" improving:="" in="" is="" issuance="" loans="" news.="" origination="" quality="" score="" span="" sub-660="" to="" which=""> 

Bad news:

Severely Derogatory and 120+ delinquent loans are still accounting for 3% of total loans, same as in 2Q 2016 and well above the pre-crisis average of 2.1%. Total share of delinquent loans is at 4.77%, slightly below 1Q 2017 (4.83%) and on par with 4.79% a year ago. So little change in delinquencies as a result of improving credit standards at origination, thus. Which suggests that improving standards are at least in part… err… superficial.

And things are not getting better across majority of categories of delinquent loans:

As the above clearly shows, transition from lesser delinquency to serious delinquency is up for Credit Cards, Student Loans and Auto Loans. And confirming that the problem of reading Credit Scores as improvement in quality of borrowers are the figures for foreclosures and bankruptcies. These stood at 308,840 households in 2Q 2017, up on 294,100 in 1Q 2017 and on 307,260 in 2Q 2016. Now, give it a thought: over the crisis period, many new mortgages issued went to households with better credit ratings, against properties with lower prices that appreciated since issuance, and under the covenants involving lower LTVs. In other words, we should not be seeing rising foreclosures, because voluntary sales should have been more sufficient to cover the outstanding amounts on loans. And that would be especially true, were credit quality of borrowing households improving. In other words, how does one get better credit scores of the borrowers, rising property prices, stricter lending controls AND simultaneously rising foreclosures?

Reinforcing this is the data on third party debt collections: in 2Q 2017, 12.5% of all consumers had outstanding debt collection action against them, virtually flat on 2Q 2016 figure of 12.6%. 

In simple terms, in this Great Recovery Year Eight, one in eight Americans are so far into debt, they are getting debt collectors visits and phone calls. And as a proportion of consumers facing debt collection action stagnates, their cumulative debts subject to collection are rising. 

Things are really going MAGA all around American households, just in time for the Fed to hike cost of credit (and thus tank credit affordability) some more. 

26/7/17: Credit booms, busts and the real costs of debt bubbles

A new BIS Working Paper (No 645) titled “Accounting for debt service: the painful legacy of credit booms” by Mathias Drehmann, Mikael Juselius and Anton Korinek (June 2017 http://www.bis.org/publ/work645.pdf) provides a very detailed analysis of the impact of new borrowing by households on future debt service costs and, via the latter, on the economy at large, including the probability of future debt crises.

According to the top level findings: “When taking on new debt, borrowers increase their spending power in the present but commit to a pre-specified future path of debt service, consisting of interest payments and amortizations. In the presence of long-term debt, keeping track of debt service explains why credit-related expansions are systematically followed by downturns several years later.” In other words, quite naturally, taking on debt today triggers repayments that peak with some time in the future. The growth, peaking and subsequent decline in debt service costs (repayments) triggers a real economic response (reducing future savings, consumption, investment, etc). In other words, with a lag of a few years, current debt take up leads to real economic consequences.

The authors proceed to describe the “lead-lag relationship between new borrowing and debt service” to establish “empirically that it provides a systematic transmission channel whereby credit expansions lead to future output losses and higher probability of financial crisis.”

How bad are the real effects of debt?

From theoretical point of view, “when new borrowing is auto-correlated [or put simply, when today’s new debt uptake is correlated positively with future debt levels] and debt is long term - features that are present in the real world - we demonstrate two systematic lead-lag relationships”:

• “debt service peaks at a well-specified interval after the peak in new borrowing. The lag increases both in the maturity of debt and the degree of auto-correlation of new borrowing. The reason is that debt service is a function of the stock of debt outstanding, which continues to grow even after the peak in new borrowing.” It is worth noting a well-known fact that in some forms of debt, minimum required repayment levels of debt servicing (contractual provisions in, say, credit cards debt) is associated with automatically increasing debt levels into the future.

• “net cash flows from lenders to borrowers reach their maximum before the peak in new borrowing and turn negative before the end of the credit boom, since the positive cash flow from new borrowing is increasingly offset by the negative cash flows from rising debt service.”

Using a panel of 17 countries from 1980 to 2015, the paper “empirically confirm the dynamic patterns identified in the accounting framework… We show that new borrowing is strongly auto-correlated over an interval of six years. It is also positively correlated with future debt service over the following ten years. In the data, peaks in debt service occur on average four years after peaks in new borrowing.” In other words, credit booms have negative legacy some 16 years past the peak of new debt uptake, so if we go back to the origins of the Global Financial Crisis, European household debts new uptake peaked at around 2008, while for the U.S. that marker was around 2007. The credit bust, therefore, should run sometime into 2022-2023. In Japan’s case, peak household new debt uptake was back in around 1988-1989, with adverse effects of that credit boom now into their 27 years duration.

When it comes to assessing the implications of credit booms for the real economy, the authors establish three key findings:

1) “…new household borrowing has a clear positive impact, and its counterpart, debt service, a significantly negative impact on output growth, both
of which last for several years. Together with the lead-lag relationship between new borrowing and debt service this implies that credit booms have a significantly positive output effect in the short run, which reverses and turns into a significantly negative output effect in the medium run, at a horizon of five to seven years.”

2) “…we demonstrate that most of the negative medium-run output effects of new borrowing in the data are driven by predictable future debt service effects.” The authors note that these results are in line with well-established literature on negative impact of credit / debt overhangs, including “the negative medium-run effect of new borrowing on growth is documented e.g. by Mian and Sufi (2014), Mian et al. (2013, 2017) and Lombardi et al. (2016). Claessens et al. (2012), Jorda et al. (2013), and Krishnamurthy and Muir (2016) document a link between credit booms and deeper recessions.” In other words, contrary to popular view that ‘debt doesn’t matter’, debt does matter and has severe and long term costs.

3) “…we also show that debt service is the main channel through which new borrowing affects the probability of financial crises. Consistent with a recent literature that has documented that debt growth is an early warning indicator for financial crises, we find that new borrowing increases the likelihood of financial crises in the medium run. Debt service, on the other hand, negatively affects the likelihood of crises in the short turn.”

In fact, increases in probability of the future crisis are “nearly fully” accounted for by “the negative effects of the future debt service generated by an increase in new borrowing”.

The findings are “robust to the inclusion of range of control variables as well as changes in sample and specification. Our baseline regressions control for interest rates and wealth effects. The results do not change when we control for additional macro factors, including credit spreads, productivity, net worth, lending standards, banking sector provisions and GDP forecasts, nor when we consider sub-samples of the data, e.g. a sample leaving out the Great Recession, or allow for time fixed effects. And despite at most 35 years of data, the relationships even hold at the country level.”

So we can cut the usual arguments that “this time” or “in this place” things will be different. Credit booms are costly, painful and long term.

26/7/17: Panic... Not... Yet: U.S. Student Debt is Cancerous

Reuters came up with a series of data visualisations and brief analytics pieces on the issue of student loans in the U.S. These are ‘must read’ materials for anyone concerned with both the issues of debt overhang (impact of real economic debt, defined as household, non-financial corporate and government debts, on economic activity), demographic and socio-political trends (e.g. see my analysis linking - in part - debt overhang to current de-democratization trends in the Western electorates https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2993535), as well as issues of social equity.

The first piece presents a set student loans debt crisis charts and data summaries: http://fingfx.thomsonreuters.com/gfx/rngs/USA-STUDENTLOANS-MORTGAGES/0100504C09N/index.html. Key takeaway here is that although the size of the student loans debt market is about 1/10th of the pre-GFC mortgages debt overhang, the default rates on student loans are currently well above the GFC peak default rates for mortgages:

The impact - from economic point of view includes decline in home ownership amongst the younger demographic.

But, less noted, the impact of student debt overhang also includes behavioural and longer-term cross-generational implications:

1. Younger cohorts of workers are saddled with higher starting debt positions that cannot be resolved via insolvency/bankruptcy, which makes student loans more disruptive to the future life cycle incomes, savings and investments of the households;
2. Behaviourally, early-stage debt overhang is likely to alter substantially life cycle investment and consumption patterns, just as early age unemployment and longer-term unemployment do with future career outcomes and choices;
3. Generational transmission of wealth is also likely to suffer from the student debt overhang: as older generations trade down in the property markets, the values of their properties are likely to be lower than expected due to younger generation of buyers having lower borrowing and funding capacity to purchase retiring generations' homes;
4. The direct nature of student loans collections (capture of wages and social security benefits for borrowers and co-signers on the loans) implies unprecedented degree of contagion from debt overhang to household financial positions, with politically and socially unknown impact; and
5. The nature of interest rate penalties, combined with severe lack of regulation of the market and a direct tie in between Federally-guaranteed student loans and the fiscal authorities implies higher degree of uncertainty about the cost of future debt service for households.

On the two latter matters, another posting by Reuters worth reading: https://www.reuters.com/investigates/special-report/usa-studentloans/.  Student loans debt is now turning the U.S. into an expropriating state, with the Government-sanctioned coercive, and socially and economically disruptive capture of household incomes.

One thing neither article mentions is that student loans are a form of investment - investment in human capital. And as all forms of investment, these loans are set against the expected future returns. These returns, in the case of student loans, are generated by increases in life cycle labor income - wages and other associated forms of income - which is, currently, on a downward trend. In other words, just as cost of student loans rises and uncertainty about the future costs of legacy loans is rising too, returns on student loans are falling, and the coercive power of lenders to claim recovery of the loans is beyond any other form of debt.

We are in a crisis territory, even if from traditional systemic risk metrics point of view, the market for student loans might be smaller.

20/2/17: The Effect of GFC on Italian Non-Performing Loans Overhang

In yesterday’s post I covered some interesting current numbers relating to NPLs in the European banking sector. And sitting, subsequently, in the tin can of an airplane on my way back to California, I remembered about this pretty decent paper from Banca d’Italia, published in September 2016.

Titled “The evolution of bad debt in Italy during the global financial crisis and the sovereign debt crisis: a counterfactual analysis” and authored by Alessandro Notarpietro and Lisa Rodano (Banca d’Italia Occasional Paper Number 350 – September 2016), the paper looked at the evolution (dynamics) of Italian banks’ NPLs since the start of the Global Financial Crisis and the twin recessions that hit Italy since 2008. Actual data is compared against “the counterfactual simulations". "A ‘no-crises scenario’ is built for the period 2008-2015. The counterfactual dynamics” generate a comparative new bad debt rate, which “depends on macroeconomic conditions and borrowing costs.”

Per authors, “the analysis suggests that, in the absence of the two recessions – and of the economic policy decisions that were taken to combat their effects – non-financial corporations’ bad debts at the end of 2015 would have reached €52 billion, instead of €143 billion."

Chart above plots the evolution of two time series of debt: actual and ex-crisis counterfactual, for non-financial corporates, showing the crisis-related debt overhang of around EUR 90 billion. More precisely: “In the absence of the two crises – and of the economic policy decisions that were taken to contrast their effects – the stock of non-financial corporations’ bad debts at the end of 2015 would have reached €52 billion, instead of €143billion. In the counterfactual scenario, the level at the end of 2015 is only 1.7 times larger than the one observed at the end of 2007; in actual data, the observed level was almost 5 times as large. As a share of total outstanding loans to non-financial corporations, bad debts rose at about 17.9 per cent at the end of 2015; had the two crises never occurred, it would have been around 5 per cent, roughly in line with the pre-crisis level.”

While the numbers may appear to be relatively small, given the size of the Italian real economic debt pile, provisioning on this bad debt overhang would amount to a serious dosh. Per the authors’ and previous estimates, roughly 13 percentage points was lost in Italian GDP (once public debt is accounted for). In other words,  through 2015, Italian economy has lost some 13.5 percent of GDP in potential output due to debt overhang. Of this, near 7 percentage points were lost due to sovereign debt-related losses and 6.5 percentage points due to corporate bad debt overhang.

17/1/17: Government Debt in the Age of Austerity

The fact that the world is awash with debt is hard to dispute (see data here and here), but it is quite commonly argued that the aggressive re-leveraging happening in the corporate and household sectors runs contrary to the austerity trends in the public debt segment of the total economic debt. The paradox of the austerity arguments is, of course, that whilst debt is rising, public investment is falling and public consumption remains either stagnant of rising slowly. This should see public debt either declining or remaining static. Of course, banks bailouts in a number of advanced economies would have resulted in an uplift in public debt during the early years of the Global Financial Crisis and the Great Recession, but these years behind us, we should have witnessed the austerity translating into moderating debt levels in the global economy when it comes to public debt.

Alas, this is not the case, as illustrated in the chart below:

Here's a tricky bit:

• In the 5 years 2012-2016 (post-onset of the recovery) Government debt around the world rose 11.4% in level terms (USD), and 14.51 percentage points as a share of GDP per capita. During the crisis years of 2007-2011, Government debt rose 72.7% in dollar terms and was down 4.39 percentage points as a share of GDP.
• In the advanced economies, Government debt rose 67.6% in dollar terms in 2007-2011 period, up 4.7 percentage points, before rising 5.44% in dollar terms over subsequent 5 years (up 26.65 percentage points in terms of debt to GDP ratio). 
• In the euro area, Government debt was up 57.4% in dollar terms and up 0.51 percentage points in GDP ratio terms over the period of 2007-2011, before falling 6.9 percent in dollar terms but rising 24.8 percentage points relative to GDP in 2012-2016 period.
• And so on...

As the above chart shows, globally, total volume of Government debt was estimated to be USD63.2 trillion at the end of 2016, up USD6.46 trillion on the end of 2011. That is almost 84.1% of the world GDP today, as opposed to 78% of GDP at the end of 2011. More than half of this increase (USD3.91 trillion) came from the Emerging and Developing Economies, and USD2.3 trillion came from G7 economies. Meanwhile, euro area Government Debt levels declined USD815 billion, all of which was due solely to changes in the exchange rate and the rollover of some debt into multinational organisations' (e.g. ESM) and quasi-governmental (e.g. promissory notes) debt. Worse, over the said period of time, only one euro area country saw reduction in the levels of debt: Greece (down EUR34.46 billion due to restructuring of debt). In fact, in Euro terms, total euro area government debt rose some EUR1.36 trillion over the span of the 2011-2016 period.

All in, global pile of Government debt is now USD27.84 trillion (or 78.7%) up on where it was at the end of 2007 and the start of the Global Financial Crisis.

So may be, just may be, the real economy woe is that most of the new debt accumulated by the Governments in recent years has flown into waste (supporting banks, financial markets valuations, doling out subsidies to politically favoured sectors etc), instead of going to fund productive public investments, including education, skills training, apprenticeships and so on. Who knows?..

17/9/16: The Mudslide Cometh for Your Ladder

One chart that really says it all when it comes to the fortunes of the Euro area economy:

And, courtesy of these monetary acrobatics, we now have private corporates issuing debt at negative yields, nominal yields...  http://blogs.wsj.com/moneybeat/2016/09/15/negative-yielding-corporate-debt-good-for-your-wealth/.

The train wreck of monetarist absurdity is now so far out on the wobbly bridge of economic systems devoid of productivity growth, consumer demand growth and capex demand that even the vultures have taken into the skies in anticipation of some juicy carrion. With $16 trillion (at the end of August) in sovereign debt yielding negative and with corporates now being paid to borrow, the idea of the savings-investment link - the fundamental basis of the economy - makes about as much sense today as voodoo does in medicine. Even WSJ noted as much: http://www.wsj.com/articles/the-5-000-year-government-debt-bubble-1472685194.

Which brings us to the simple point of action: don't buy bonds. Don't buy stocks. Hold defensive assets in stable proportions: gold, silver, land, fishing rights... anything other than the fundamentals-free paper.

As I recently quipped to an asset manager I used to work with:

"A mudslide off this mountain of debt will have to happen in order to correct the excesses built up in recent years. There is too much liquidity mass built into the markets devoid of investment demand, and too weak of an economy holding it. Everywhere. By fundamental metrics of value-added growth and organic demand expansion potential, every economy is simply sick. There is no productivity growth. There is no EPS growth, even with declining S down to waves of buy-outs. There is debt growth, with no capex & no EPS growth to underwrite that debt. There is a global banking system running totally on fumes pumped into it at an ever increasing rate by the Central Banks through direct monetary policies and by indirect means (regulatory shenanigans of ever-shifting capital and assets quality revisions). There is no trade growth. There is no market growth for trade. Neither supply side, nor demand side can hold much more, and countries, like the U.S., have run out of ability to find new lines of credit to inflate their economies. Students - kids! - are now so deep in debt before they even start working, they can't afford rents, let alone homes. Housing shortages & rents inflation are out of control. GenZ and GenY cannot afford renting and paying for groceries, and everyone is pretending that the ‘shared economy’ is a form of salvation when it really is a sign that people can’t pay for that second bedroom and need roommates to cover basic bills. Amidst all of that: 1% is riding high and dragging with it 10% that are public sector ‘heroes’ while bribing the 15% that are the elderly and don't give a damn about the future as long as they can afford their prescriptions. Take kids out of the equation, and the outright net recipients of subsidies and supports, and you have 25-30% of the total population who are carrying all the burden for the rest and are being crushed under debt, taxes and jobs markets that provide shit-for-wages careers. Happy times! Buy S&P. Buy penny stocks. Buy bonds. Buy sovereign debt. Buy risk-free Treasuries… Buy, Buy, Buy we hear from the sell-side. Because if you do not 'buy' you will miss the 'ladder'... Sounds familiar, folks? Right on... just as 2007 battle cry 'Buy Anglo shares' or 2005 call to 'Buy Romanian apartments' because, you know... who wants to miss 'The Ladder'?.."

12/9/16: Fiscal Policy in the Age of Debt

In recent years, there has been lots and lots of debates, discussions, arguments and research papers on the perennial topic of fiscal stimulus (aka Keynesian economics) on the recovery. The key concept in all these debates is that of a fiscal multipliers: by how much does an economy expand it the Government spending rises by EUR1 or a given % of GDP.

Surprisingly, little of the debate has focused on a simple set of environmental factors: fiscal stimulus takes place not in a vacuum of environmental conditions, but is coincident with: (a) economies in different stages of fiscal health (high / low deficits, high/low debt levels etc) and (b) economies in different stages of business cycle (expansion or contraction). One recent paper from the World Bank decided to correct for this glaring omission.

“Do Fiscal Multipliers Depend on Fiscal Positions?” by Raju Huidrom, M. Ayhan Kose, Jamus J. Lim and Franziska L. Ohnsorge (Policy Research Working Paper 7724, World Bank) looked at “the relationship between fiscal multipliers and fiscal positions of governments” based on a “large data-set of advanced and developing economies.” The authors deployed methodology that “permits tracing the endogenous relationship between fiscal multipliers and fiscal positions while maintaining enough degrees of freedom to draw sharp inferences.”

The authors report three key findings:

“First, the fiscal multipliers depend on fiscal positions: the multipliers tend to be larger when fiscal positions are strong (i.e. when government debt and deficits are low) than weak.” In other words, fiscal expansions work better in case where sovereigns are in better health.

“For instance, our estimates suggest that the long run multiplier can be as big as unity when the  fiscal position is strong but it can turn negative when the fiscal position is weak. A weak fiscal position can undermine fiscal multipliers even during recessions. Consistent with theoretical predictions, we provide empirical evidence suggesting that weak  fiscal positions are associated with smaller multipliers through both a Ricardian channel and an interest rate channel.”

By strong/weak fiscal position, the authors mean low/high sovereign debt to GDP ratio. And they show that fiscal expenditure uplift for higher debt ratio states results in economic waste (negative multipliers) in pro-cyclical spending cases (when fiscal expansion is undertaken at the times of growing economy). Which is important, because most of the ‘stimuli’ take place in such conditions and majority of the arguments in favour of fiscal spending increases happen on foot of rising economic growth (‘spend/invest while you have it’).

“Second, these effects are separate and distinct from the impact of the business cycle on
the fiscal multiplier.” Which means that debt/GDP ratio has an impact in terms of strengthening or weakening fiscal policy impact also regardless of the business cycle. Even if fiscal expansion is counter-cyclical (Keynesian in nature, or deployed at the time of a recession), fiscal multipliers (effectiveness of fiscal policy) are weaker whenever the debt/GDP ratio is higher. In a way, this is consistent with the issues arising in the literature examining effects of debt overhang on growth.

“Third, the state-dependent effects of the fiscal position on multipliers is attributable to two factors: an interest rate channel through which higher borrowing costs, due to investors’ increased perception of credit risks when stimulus is implemented from a weak initial fiscal position, crowd out private investment; and a Ricardian channel through which households reduce consumption in anticipation of future fiscal adjustments.”

What this means is that low interest rates (accommodative monetary policy) may be supporting positive effects of fiscal expansion, but at a cost of reducing private investment. In a sense, public investment, requiring lower interest rates, crowds out private investment. Now, no medals for guessing which environment we are witnessing today.

Some charts

First, median responses to increased Government spending

Once you control for debt/GDP position with stimulus taking place during recessions:

“Note: The graphs show the conditional fiscal multipliers during recessions for different levels of fiscal position at select horizons… Government debt as a percentage of GDP is the measure of fiscal position and the values shown on the x-axis correspond to the 5th to 95th percentiles from the sample. …Fiscal position is strong (weak) when government debt is low (high). Solid lines represent the median, and dotted bands are the 16-84 percent confidence bands.”

In the two charts above, notice that the range of public debt/GDP ratios for positive growth effect (multiplier > 1) of fiscal policy is effectively at or below 25%. At debt levels around 67%, fiscal expansion turns really costly (negative multipliers) in the long run. How many advanced economies have debt levels below 67%? How many below 25%? Care to count? Five  economies have debt levels below 25% (Estonia, Hong Kong, Macao, Luxembourg and San Marino). For 67% - nineteen out of 39 have debt levels above this threshold. Not exactly promising for fiscal expansions...

Overall, the paper is important in: (1) charting the relationship between fiscal policy effectiveness, and debt position of the sovereign; (2) linking coincident fiscal and monetary expansions to weaker private investment; and (3) showing that in the long run, fiscal expansion has serious costs in terms of growth and these costs are more pronounced for countries with higher debt levels. Now, about that idea that Greece, or the rest of PIGS, should run up public investment to combat growth crisis…

19/4/16: Leverage and Equity Gaps: Italy v Rest of Europe

Relating to our previous discussions in the MBAG 8679A: Risk & Resilience: Applications in Risk Management class, especially to the issue of leverage, recall the empirical evidence on debt distribution and leverage across the European countries corporate sectors.

Antonio De Socio and Paolo Finaldi Russo recently contributed to the subject in a paper, titled “The Debt of Italian Non-Financial Firms: An International Comparison” (February 25, 2016, Bank of Italy Occasional Paper No. 308: http://ssrn.com/abstract=2759873).

Per authors, “In the run-up to the financial crisis Italian firms significantly increased their debt in absolute terms and in relation to equity and GDP.” This is not new to us, as we have covered this evidence before, but here are two neat summaries of that data:

What is of greater interest is more precise (econometrically) and robust estimate of the gap in leverage between Italian firms and other European corporates. “The positive gap in firms’ leverage between Italy and other euro-area countries has widened in recent years, despite the outstanding debt of Italian firms has decreased since 2011.”

Another interesting insight is the source of this gap. “We find that, controlling for several firm-specific characteristics (i.e. age, profitability, asset tangibility, asset liquidity, turnover growth), the leverage of Italian firms is about 10 percentage points higher than in other euro area countries. Differences are systematically larger among micro and small firms, whereas they are small and weakly significant for firms with assets above 300 million euros.”

But equity gap, defined as “the amount of debt to be transformed into equity type funds in order to fill the leverage gap with other countries”, is not uniform over time.

“…in order to reach the same average level as other euro-area countries, Italian firms should transform about 230 billion euros of financial debt into equity type finance, corresponding to 18 per cent of their outstanding debt. The gap is largest, at around 28 per cent of outstanding debt, for small firms and micro firms with over 1 million euros of assets.”

Authors note one influential outlier in the data: “A large part of the estimated corrections is due to the comparison with French firms, which on average have one of the lowest levels of leverage in Europe. Excluding these companies, the equity gap would drop to 180 billion euros.”

Dynamically, “the results indicate that the gap has widened somewhat since 2009, from about 180 to 230 billion euros”.

Given the EU-wide (largely rhetorical) push for increasing capital structure gearing toward equity, “the Italian Government recently put in place some incentives to encourage recourse to equity financing by reducing the debt tax shield: a cap on the amount of interest expense that could be deducted from taxable income and tax deductions linked to increases in equity (according to the Allowance for Corporate Equity scheme). Similarly, other measures have also been aimed at strengthening the supply of risk capital for Italian firms. The results of our analysis suggest that Italian firms still need this kind of incentives to strengthen their financial structure.”

18/4/16: Leverage Risk, the Burden of Debt & the Real Economy

Risk of leverage has been a cornerstone of our recent lectures concerning the corporate capital structure decisions in the MBAG 8679A: Risk & Resilience:Applications in Risk Management class at MIIS. However, as noted on a number of occasions in both MBAG 8679A and other courses I teach at MIIS, from macroeconomic point of view, corporate leverage risks are just one component of the overall economic leveraging equation. The other three components are: household debt, government debt, and the set of interactions between the burden of all three debt sources and the financial system at large.

An interesting research paper by Mikael Juselius and Mathias Drehmann, titled “Leverage Dynamics and the Burden of Debt” (2016, Bank of Finland Research Discussion Paper No. 3/2016: http://ssrn.com/abstract=2759779) looks that both leverage risk arising from the U.S. corporate side and household side.

Per authors, “in addition to leverage, the debt service burden of households and firms is an important link between financial and real developments at the aggregate level. Using US data from 1985 to 2013, we find that the debt service burden has sizeable negative effects on expenditure.” This, in turn, translates into lower economy-wide investment and consumption - two key components of the aggregate demand. Debt “interplay with leverage also explains several data puzzles, such as the lack of above-trend output growth during credit booms and the depth and length of ensuing recessions, without appealing to large shocks or non-linearities. Using data up to 2005, our model predicts paths for credit and expenditure that closely match actual developments before and during the Great Recession.”

With slightly more details: the authors found that “the credit-to-GDP ratio is cointegrated with real asset prices, on the one hand, and with lending rates, on the other. This implies that the trend increase in the credit-to-GDP ratio over the last 30 years can be attributed to falling lending rates and rising real asset prices. The latter two variables are, moreover, inversely related in the long-run.”

In addition and “more importantly, we find that the deviations from the two long-run relationships - the leverage gap and the debt service gap henceforth - have sizeable effects on credit and output. …real credit growth increases when the leverage gap is negative, for instance due to high asset prices. And higher credit growth in turn boosts output growth. Going beyond the existing evidence, we find that the debt service gap plays an additional important role at the aggregate level that has generally been overlooked: it has a strong negative impact on consumption and investment. In addition, it negatively affects credit and real asset price growth.”

The link between leverage gap and debt service gap:

In summary, “The leverage and debt service gaps hold the key for explaining the divergence of credit and output in recent decades. For instance, in the late 1980s and mid 2000s both gaps were negative boosting credit and asset price growth. This had a positive effect on output, but not one-to-one with credit, which caused the credit-to-GDP ratio to rise. This in turn pushed the debt service gap to positive values, at which point it started to offset the output effects from high credit growth so that output growth returned to trend. Yet, as the leverage gap remained negative, credit growth was still high, ie we observed a “growthless” credit boom. This continued to increase the debt-service gap, which had a growing negative effect on asset prices and expenditure, driving the leverage gap into positive territory. And once both gaps became positive they worked in the same direction, generating a sharp decline in output even without additional
large shocks or crises-related non-linearities. The subsequent downturns were deep and protracted, as the per-period reduction in credit had to be faster than the per-period decline in output in order to lower the credit-to-GDP ratio and thereby close the two gaps. This also implied that the recovery was “creditless”.”

Highly intuitive and yet rather novel results linking leverage risk to debt financing costs.

14/1/16: Two Charts to Sum Up Global Growth Environment

SocGen recently produced some interesting charts looking into 2016 trends. Two caught my eye, as both relate to long running themes covered on this blog throughout 2015.

The first one is that of a decline in global trade flows as the driver for growth. Per SocGen: "Global trade growth has been anchored below its historical average since the Great Recession, offering further evidence of tepid world economic recovery. Decreasing global demand, especially due to slowing emerging markets, weighs on the outlook for world trade."

http://uk.businessinsider.com/societe-generales-charts-of-the-global-economy-in-2016-2016-1


Another relates to the second drag on global economic progress - debt overhang. SocGen focuses on Emerging Markets’ debt, saying: "Zero interest policies in the developed world have bolstered debt issuance from EM corporates. Only a fraction of EM countries are immune to the current adverse conditions requiring a cautious approach to these markets."

Both do not offer much optimism when it comes to both cyclical (interest rates forward) and structural (capex and demand capacities) drivers for global growth. And both suggest that 2016 is unlikely to be more robust year for the world’s economy than 2015.

20/11/15: U.S. Households' Deleveraging: Painful & Long

An interesting set of charts plotting trends in U.S. household credit arrears over time, courtesy of the @SoberLook

Three things stand out in the above. 

Per first chart, credit cards debt is the only form of credit that saw arrears drop below pre-crisis levels. It also happens to be the form of debt that is easiest to resolve - largely unsecured and easily written down. Mortgages debt arrears - while declining significantly from crisis peak - still remain at levels above pre-crisis averages. Ditto for all other forms of household debt. 

Also per first chart, improving labour markets conditions are doing zilch for student loans arrears. These remain on an upward trend and close to historical highs.

Thirdly, from the second chart, new volumes household credit in arrears in 3Q 2015 are broadly consistent with the situation in the same quarter in 2014, with new arrears falling to 4Q 2007 levels, but still running at levels well above 2003-2006 levels.

This, in an economy characterised by more robust labour markets than those of Europe and by personal insolvency regimes and debt resolution systems more benign than those in Europe. In simple terms: deleveraging out of bad debt is a painful, long-term process. Good luck to anyone thinking that raising rates will do anything but delay it even longer and make the pain of it even greater.

27/7/15: IMF Euro Area Report: Debt's a Mean Bitch…

The IMF today released its Article IV assessment of the Euro area, so as usual, I will be blogging on the issues raised in the latest report throughout the day.

The first post looks at debt overhang.

Per IMF, low inflation environment in the Euro area is "pushing up real rates, more in countries with higher debt burdens"

And here's a handy chart from the Fund:

Note: Net debt is the total economy’s financial liabilities minus assets.

Broadly-speaking, with annual expected inflation at or below 1%, we have serious pressure on Portugal and Spain, where Government borrowing costs (and by some proximity, banks funding costs) have not declined as dramatically as in, say, Ireland. The second sub-group at risk are countries with lower debt ratios, but still high enough funding costs - Slovenia and Italy. Ireland is in a separate category, having enjoyed significant declines in cost of funding, without a corresponding improvement in debt ratios. In other words, for Ireland, so far, the challenge is less of day-to-day funding of debt, but the quantum of debt outstanding. Short-run sustainability is fine, but longer run sustainability is still problematic.

The problematic nature of debt carried across the euro area goes well beyond the sovereign cost of funding and into the structure of European banks balance sheets.

Per IMF: "A chronic lack of demand, impaired corporate and bank balance sheets, and deeply-rooted structural weaknesses are behind the subdued medium-term outlook:

• Insufficient demand. Business investment continues to lag the cycle, remaining well below pre-crisis levels, reflecting weak demand, as well as high corporate debt, policy uncertainty, and tight credit. While overall unemployment has begun to recede, it remains above 11 percent, with long-term and youth unemployment near historic highs. Fiscal policy is broadly neutral, but is not providing offsetting support.
• Weak balance sheets. The ECB’s comprehensive assessment (CA) found that banks had raised capital, but also saw NPLs continuing to rise, reaching systemic levels in some countries. High levels of NPLs and debt have held back bank lending and investment, limiting the pass-through of easier financial conditions. Europe’s experience contrasts sharply with that of the U.S. recently and Japan in the 2000s where, after their financial crises, aggressive NPL resolution helped support a faster recovery in credit.
• Low and divergent productivity. Progress on structural reforms has been piecemeal and uneven across countries, as highlighted by the slow implementation of Country-Specific Recommendation (CSR) reforms under the European Semester. Productivity remains well below pre-crisis levels and lags the U.S., especially in important sectors such as information technology and professional services."

Note, I wrote extensively on the three factors holding back credit cycle before and recently testified on the subject at the Joint Committee on Finance, Public Expenditure and Reform, the Houses of the Oireachtas: http://trueeconomics.blogspot.ie/2015/07/8715-ecb-qe-strong-monetary-weak-real.html

Here is a chart highlighting the state of NPLs across the Euro area, U.S. and Japan which shows just how dire are the conditions in European banking really are:

Even by provisions measure, Europe is a total laggard. Which means there is plenty more delve raging left in the system.

And here is the IMF chart on productivity:

Which really neatly highlights the debacle that is euro area productivity growth: we have a massive uplift in unemployment during the crisis. Normally, rising unemployment automatically induces higher labour productivity through two channels: by destroying more jobs in lower value-added sectors, and by destroying jobs of, on average, less productive workers. In Europe, of course, the former factor did took place, but there was no corresponding retainment of activity in the higher value-added sectors, and the latter factor did not take place because of inflexible labour markets (for example, unions rules preventing lay offs of less productive staff, basing any employment adjustments on superficial criteria of tenure and/or union membership/contracts structures). So net result: jobs destruction (bad) was not even contributive to improved productivity (bad). But things are actually even worse. Chart below shows the distribution of productivity growth by broader sector, comparing euro area and the U.S.:

This is truly abysmal, for the euro area, which managed to post negative growth in productivity in Professional Services, and undershoot U.S. productivity growth in everything, save agriculture (where U.S. already enjoyed significant pre-crisis advantage over the EU, which implies normally lower productivity growth for the U.S.) and Construction (where the U.S. has enjoyed more robust recovery since 2010 against continued decline of activity in the euro area).


Yeah, remember those flamboyantly delightful days of denial, when everyone was keen on repeating the Krugmanite thesis that 'debt doesn't matter'? In reality, debt overhang is such a bitch… especially when it comes to messing up value-added investment and productivity growth. But never mind - Europe is not about these capitalist concepts, with its Knowledge Economy (as measured by IT and Professional Services and Manufacturing) shrinking in both metrics compared to the U.S.

Stay tuned for more excerpts and analysis from the IMF report.

29/5/15: Margin Debt: Another Zombie Hits Town Hall...

So you've seen this evidence of how global real economic debt is now greater than it was before the crisis... and you have by now learned this on how debt levels and debt growth rates are distributed globally. And now, a new instalment in the Debt Zombies Portraits Gallery:

Source: http://www.zerohedge.com/news/2015-05-29/margin-debt-breaks-out-hits-new-record-50-higher-last-bubble-peak

Now, do keep in mind that just this week, ECB ostriches have declared that things are fine in the European financial system because 'leverage is low'.

Yes, Irish Financial Regulator of the Celtic Garfield Era, Pat Neary, would have made the Frankfurt stars-studded team with his knowledge...


Note: hare's China's rising contenders for the above distinction: http://ftalphaville.ft.com/2015/05/18/2129638/does-china-already-have-the-highest-level-of-margins-vs-free-float-in-market-history/ h/t to @TofGovaerts

29/5/15: Large Fiscal Policy Multipliers & Private Debt Overhang

"Private Debt Overhang and the Government Spending Multiplier: Evidence for the United States" by Marco Bernardini, Gert Peersman (March 31, 2015, CESifo Working Paper Series No. 5284) uses "state-dependent local projection methods and historical U.S. data" to show  that government spending multipliers are "considerably larger in periods of private debt overhang."

In low-debt state: there is a "significant crowding-out of personal consumption and investment" in response to fiscal spending stimulus, "resulting in multipliers that are significantly below one."

However, "conversely, in periods of private debt overhang, there is a strong crowding-in effect, while multipliers are much larger than one. In high-debt states, more (less) government purchases also reduce (increase) the government debt-to-GDP ratio." 

These results are robust to controls for the business cycle, government debt overhang and the zero lower bound on the nominal interest rate. Which lead authors to a conclusion that fiscal "spending multipliers were likely much larger than average during the Great Recession."

As a note of caution, the authors posit that "it is not clear what the exact reason is for the different behavior of the private sector in periods of debt overhang. Can it be explained by borrowing constraints or rule-of-thumb behavior of households?.. Is it driven by a much higher marginal propensity to consume of highly-leveraged households?.. Or are there alternative explanations?"

To add to this list, one needs to consider the sovereign capacity to actually undertake fiscal stimulus. In the current crisis, for many states (unlike the U.S.) room for stimulus is severely curtailed by already present public debt overhang. In addition, one has to be careful translating the U.S. results to other, smaller and more open economies, such as euro area states. Finally, the findings need confirmation in a setting with fixed exchange rates.

"Another relevant extension of our analysis is the question whether also tax multipliers are different across private debt states. Our findings also have some relevant policy implications. In particular, the state of private debt seems to be an important indicator for the consequences of fiscal consolidations and stimulus programs. In periods of debt overhang and deleveraging in the private sector, it is probably not a good idea to conduct austerity policies, because it could have dramatic effects on economic activity. In contrast, deficit-financed government purchases policies could significantly stimulate and stabilize the economy in periods when households are deleveraging and depressing aggregate demand. On the other hand, once private debt levels are again below trend, the timing is perfect to conduct fiscal consolidations, having little consequences for economic activity."

Fascinatingly, this evidence lends credence to the latest theory of financial imbalances, known as the "excess financial elasticity" theory, formulated by Borio: https://www.bis.org/publ/work456.pdf on which I have just submitted an article to a U.S. publication (stay tuned for the unedited version to be posted here later next month). I covered Borio's research recently here: http://trueeconomics.blogspot.ie/2015/05/8515-bis-on-build-up-of-financial.html

24/5/15: Markets, Patterns and Catalysts: Irish Growth Story

Some of my slides from last week's presentation at the All-Ireland Business Summit, covering three key themes:

The Current State of the Irish Economy "The Market Section"

The New Normal of rising global risk "The Pattern"

A Policy Path to Growth "The Catalysts"