23/2/20: Fake Data or Faking Data? Inflation Statistics

As economists and analysts, almost all of us are trying - at one point or another - make sense of the, all too often vast, gap between the reality and the economic statistics. I know, as I am guilty of this myself (here's a recent example: https://trueeconomics.blogspot.com/2020/02/18220-irish-statistics-fake-news-and.html).

An interesting and insightful paper from Oren Cass of the Manhattan Institute dissects the extent of and the reasons for the official inflation statistic failing to capture the reality of the true cost of living changes in the U.S. over recent years (actually, decades) here: https://www.manhattan-institute.org/reevaluating-prosperity-of-american-family). It is a must-read paper for economics students, analysts and policymakers.

His key argument is that: "Economists and families see three things differently:

• Quality Adjustment. Products and services that rise substantially in price but in proportion to measured quality improvements can become unaffordable, while having no effect on inflation.
• Risk-Sharing. New products and services can increase costs for the entire population yet deliver benefits to only a very small share, while having no effect on inflation.
• Social Norms. Society-wide changes in behaviors and expectations can alter the value or necessity of a good or service, while having no effect on inflation."

In other words, over time, official inflation starts to measure something entirely different than the real and comparable across time consumption expenditure. As the result, you can have a paradox of today: low inflation is associated with falling affordability of life. 

An example: "In 1985, ... it would require 30 weeks of the median weekly wage to afford a three-bedroom house at the 40th percentile of a local market’s prices, a family health-insurance premium, a semester of public college, and the operation of a vehicle. By 2018, ... a full-time job was insufficient to afford these items, let alone the others that a household needs."

To address some of the shortcomings of the inflation measures, Cass offers a different metric, called COTI - Cost of Thriving Index - which basically amounts to the number of weeks that a given line of expenditure requires in terms of median income. Or "Weeks of Income Needed to Cover Major Household Expenditures". Two charts below illustrate:

And here is a summary table:

Excluding food, other necessities and looking solely at Housing, Health Insurance, Transport and College Education, the number of weeks of work at an overall median wage required to cover the basics of the necessary expenditure is now in excess of 58.4 weeks. For female workers' median wage, the number is 65.6 weeks. 

Which means that even before you consider other necessities purchases, and before you consider taxes, you are either dipping massively into debt or require a second income to cover these. 

Note: these do not account for income taxes, state taxes, property taxes, dental insurance. These numbers do not cover payments for water, gas, electricity. There is no mandatory car insurance included. No allowances for deductibles coverage savings (e.g. HSAs). No childcare, no children expenditures, no food purchases, and so on.

And even with all these exclusions, median income cannot afford the basics of living in today's America. 

A word from Fed, anyone?

16/5/19: Identifying Debt Bubble 4.0

Having just posted on the debt supercycle-related comments from Gundlach (https://trueeconomics.blogspot.com/2019/05/16519-gundlach-on-us-economy-and-debt.html), here is a chart identifying these super-cycles in the U.S. economy:

The periods of significant leverage in the U.S. economy have been identified as follows:

• First, I took nominal GDP growth rates (q/q) snd nominal total non-financial debt growth rates (also q/q) for the entire period of data coverage for which all data points are available (since 1Q 1966). 
• Second, I adjusted nominal non-financial debt growth rates to reflect the evolving ratio of debt to U.S. GDP.
• Third, I subtracted adjusted debt growth rates from nominal GDP growth rates to arrive at change in leverage risk direction. This is the difference figure shown in the chart below. Positive numbers reflect quarters when GDP growth rate exceeded growth in GDP-ratio-adjusted debt and are periods of deleveraging in the economy, and negative periods correspond to the situation where GDP growth rate was exceeded by GDP-ratio-adjusted growth rate in debt.
• Fourth, I calculated 99% confidence interval for historical average difference (shown in the chart below).
• Fifth, I identified three regimes of debt evolution: Regime 1 = "Deleveraging" corresponds to the Difference variable being non-negative (periods where the gap between growth rate in GDP and growth rate in debt is non-negative); Regime 2 = "Non-significant leveraging up" corresponds to periods where the gap (difference) between GDP growth rate and debt growth rate is between zero and the lower bound of the confidence interval for historical average difference; and Regime 3 = "Significant Leveraging up" corresponds to the periods where statistically-speaking, the negative gap between growth in GDP and growth in debt is statistically significantly below the historical average.

I highlighted in the above chart four periods of significant, persistent leveraging up, identified as Debt Bubbles 1-4. There is absolutely zero (statistical) doubt that the current period of economic recovery is yet another manifestation of a Debt Bubble. And, given the composition of the debt increases since the end of the Global Financial Crisis, this latest Bubble is evident across all three components of non-financial debt: the households, corporates and the U.S. Federal Government. 

4/4/2019: Debt Relief for Households: It Turns Out to be a Great Idea, Folks

The question of debt relief for households during the periods of financial crises has been a pressing one in the aftermath of the 2008 Global Financial Crisis. I have written a lot on the topic in topic in the past, but to sum the arguments here in a brief format:

• Argument in favour of debt relief: households carrying unsustainable debt burden during the crisis are likely to substantially reduce current and future consumption and investment, including long term investment in education, health and other activities. The resulting decline in the aggregate demand is likely to be prolonged and extensive, with a positive correlation to the crisis-triggered recession. Thus, debt relief via direct debt forgiveness and/or generous bankruptcy writedowns can help ameliorate adverse shocks to employment, demand and investment during large scale crises;
• Argument against debt relief: debt relief can lead to the emergence of moral hazard (inducing greater leveraging by households post-crises), and adversely impact balancesheets of the lending institutions.

I favour the first argument, based on my view that the economy is crucially dependent on households' financial health, and that moral hazard consideration does not apply ex post the crisis, but only ex ante, which means that policymakers can tackle adverse effects of moral hazard after debt forgiveness in the wake of the structural crises.

A new paper by Auclert, Adrien and Dobbie, Will and Goldsmith-Pinkham, Paul S., titled "Macroeconomic Effects of Debt Relief: Consumer Bankruptcy Protections in the Great Recession" (CEPR Discussion Paper No. DP13598: https://ssrn.com/abstract=3360065) tries to settle the debate.

The paper argues that "the debt forgiveness provided by the U.S. consumer bankruptcy system helped stabilize employment levels during the Great Recession." The authors "document that over this period, states with more generous bankruptcy exemptions had significantly smaller declines in non-tradable employment and larger increases in unsecured debt write-downs compared to states with less generous exemptions. We interpret these reduced form estimates as the relative effect of debt relief across states,... [showing that] the ex-post debt forgiveness provided by the consumer bankruptcy system during the Great Recession increased aggregate employment by almost two percent."

More specifically, the model of debt forgiveness effects developed by the authors "implies that ex-post debt relief had positive effects on employment in ...sectors and in ...regions. Ex-post debt relief directly increases spending and employment in both sectors [tradables and non-tradables] in the high--[debt]-exemption region, which increases tradable employment in the low-[debt]-exemption region through a demand spillover effect. The increase in tradable employment in the low-exemption
region then increases non-tradable spending and employment in that region. Calibrating the model
to the observed path of debt write-downs during the financial crisis, we find that average employment across regions in the second half of 2009 would have been almost 2 percent lower in both the
non-tradable and the tradable sector in the absence of the ex-post debt forgiveness provided by the
consumer bankruptcy system."

Furthermore, the authors "conclude by using the model to conduct three policy counterfactuals.

• First, we ask how the effect of ex-post debt relief changes in normal times when the zero lower bound does not bind. We find that even with a relatively aggressive monetary policy response, debt relief continues to have positive effects in both regions and in both sectors. 
• Second, we ask how the effect of debt relief changes with the size of the relief provided to borrowers. We find that the debt relief multiplier is initially invariant to the size of the relief provided to borrowers, but eventually falls as the size of debt relief grows large due to the concavity of borrowers’ consumption functions. [see chart]
• Finally, we ask how the effect of ex-post debt relief changes with the location of the savers that pay for the relief provided to borrowers. We find that the debt relief multiplier is invariant to the location of these savers, as savers smooth consumption in response to wealth transfers no matter where they are located."

9/1/19: Student Debt Bubble Adjusted for Wages and Employment Costs Growth

Student loans debt has been steadily rising in recent years, at rates far in excess of the rates of growth in overall credit to the U.S. households. However, the data shows conclusively, that the degree of leverage risk implied by growing student debt is now out of control. Here are two charts, referencing the levels of student debt to earnings and employment costs since 1Q 2005:

Source: Bloomberg

Source: my own calculations based on data from Fred database

In very simple terms, adjusting for labor compensation to college graduates, student debt growth rates since 1Q 2005 have exceeded the growth rates in returns to college degrees. The rate of this excess, cumulated from 2005-2006 period is around 2.5 times. In other words, student debt has grown 2.5 times more than the growth rate in college degree-holder's labour compensation.

16/11/18: Student Debt Hits Another High in 3Q 2018

Bloomberg @business just now posted that the student loans debt in the U.S. has increased USD37 billion to USD1.44 trillion at the end of 3Q 2018:

And, Flows of student debt into serious delinquency - 90 or more days - rose to 9.1% from 8.6% in 2Q.

This is somewhat at odds with the Fred database which shows Student Loans debt at USD1.5636 trillion in 3Q 2018, up ca USD33.23 billion on 2Q 2018:

While the NY Fed report is already alarming in both delinquencies rates dynamics and overall debt dynamics, the FRED data that includes securitized debt volumes is even more worrying.

By its very nature, student loans debt impacts the segment of the population (younger workers) who are in the need to fund their housing needs just as their careers are only starting (with associated lower earnings). These younger households also need financial resources to achieve sufficient mobility to better match jobs offers and career prospects to their abilities and needs. Student loans fall heavily onto the shoulders of younger families with growing housing needs, healthcare demand and funding calls from childcare. In other words, student loans debt is potentially crippling those households that are demographically going through the period when enhanced mobility and financial resilience are necessary to secure better life-cycle employment and family outcomes.

1/8/18: Household Debt and the Cycle

So far, lack of huge uplift in household debt in the U.S. has been one positive in the current business cycle. Until, that is, one looks at the underlying figures in relevant comparative. Here is the chart from FactSet on the topic:

What does this tell us? A lot:

1. Nominal levels of household debt are up above the pre-crisis peak. 
2. Leverage levels (debt to household income ratio) is at 17 years low.
3. Mortgage debt is increasing, and is approaching its pre-crisis peak: mortgage debt stood at $10.1 trillion in 1Q 2018, just 5.7% below the 2008 peak. 
4. Consumer credit has been growing steadily throughout the 'recovery' period, averaging annual growth of 5.2% since 2010, bringing total consumer debt to an all-time high of nearly $14 trillion in early 2018. 
5. While leverage has stabilized at around 95%, down from the 124% at the pre-crisis peak, current leverage ratio is still well-above the 58% average for 1946-1999 period.
6. The above conditions are set against the environment of rising cost of debt carry (end of QE and rising interest rates). In simple math terms, 1% hike in interest rates will require (using 95% leverage ratio and 25-30% upper marginal tax brackets) an uplift of 1.19-1.24% in pre-tax income for an average family to sustain existent debt carry costs. 

The notion that the U.S. households are financially non-vulnerable to the cyclical changes in debt costs, employment and asset markets conditions is a stretch, even though the current levels of risks in leverage ratios are not exactly screaming a massive blow-out. Just as the U.S. Government has low levels of slack in the system to deal with any forthcoming shocks, the U.S. households have little cushion on assets side and on income / savings balances to absorb any significant changes in the economy.

As we say in risk management, the system is tightly coupled and highly complex. Which is a prescription for a disaster. 

19/1/18: Tears over QE & U.S. Household Debt Problem

As (some) White House-linked (or favouring) economists lament the Fed's QE (and there are reasons to lament it), one thing is clear: the unprecedented monetary policies of the recent years have achieved two things:

1. The Fed QE has fuelled an unprecedented boom in risky assets (bonds, equities, property, cryptos, you name it); and
2. The Fed QE sustained a dangerous explosion of personal household debt

Which, taken together, means that the rich got richer, and the middle classes and the poor got poorer. Because debt is not wealth. Worse, the policies past have set the stage for a massive unraveling of the credit bubble to come, if the Fed were to attempt to seriously raise rates.

Note: the figures below are not reflective of a reportedly massive jump in consumer credit in 4Q 2017 (see: https://www.marketwatch.com/story/consumer-credit-growth-surges-in-november-by-most-in-16-years-2018-01-08?siteid=bnbh). 

Here is the latest data on personal household debt:

\And here is the aggregate data (also through 3Q 2017) from the NY Fed:

Year on year, 3Q 2015 growth in total household debt in the U.S. stood at 3.03%. This fell to 2.36% in 2016, before rising to 4.90% in 2017, the highest annual rate of growth for the third quarter period since Q3 2007.

Aggregate household debt in 3Q 2017, relative to 2005-2007 average was:

• 11.8% higher in 3Q 2017 for Mortgages;
• 23.4% lower for HE Revolving;
• 51.9% higher for Auto Loans;
• 6.6% higher for Credit Cards;
• 201.2% higher for Student Loans;
• 6.5% lower for Other forms of debt; and
• 19.7% higher for Total household debt

In current environment, a 25 bps hike in Fed rate, if fully passed through to household credit markets, will increase the cost of household credit by USD32.4 billion per annum. The same shock five years ago would have cost the U.S. household USD 28.3 billion per annum. Now, put this into perspective: current markets expectations are for three Fed rate hikes (and increasingly, the markets are factoring a fourth surprise hike) in 2018. Assuming the range of 3-4 hikes moves to raise rates by 75-100 basis points, the impact on American households of the QE 'normalization' can be estimated in the region of USD98-130 billion per annum. Since much of this will take form of the non-deductible interest payments, the Fed 'unwinding' risks wiping out the entire benefit from the recent tax cuts for the lower-to-upper-middle class segments of population. 

Now, let's cry about the QE... 

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.

20/7/17: Euro Area's Great non-Deleveraging

A neat data summary for the European 'real economic debt' dynamics since 2006:

In the nutshell, the Euro area recovery:

1. Government debt to GDP ratio is up from the average of 66% in 2006-2007 to 89% in 2016;
2. Corporate debt to GDP ratio is up from the average of 72% in 2006-2007 to 78% in 2016; and
3. Household debt to GDP ratio is down (or rather, statistically flat) from the average of 58.5% in 2006-2007 to 58% in 2016.

The Great Austerity did not produce a Great Deleveraging. Even the Great Wave of Bankruptcies that swept across much of the Euro area in 2009-2014 did not produce a Great Deleveraging. The European Banking Union, and the Genuine Monetary Union and the Great QE push by the ECB - all together did not produce a Great Deleveraging. 

Total real economic debt stood at 195%-198% of GDP in 2006-2007 - at the peak of previous asset bubble and economic 'expansion' dynamism, and it stands at 225% of GDP in 2016, after what has been described as 'robust' economic recovery. 

17/07/17: Debt Relief v Payments Relief: A Lesson Ireland Should Have Learned

An interesting study looked into two sets of debt relief measures:

1. Immediate payment reductions to target short-run liquidity constraints and 
2. Delayed debt write-downs to target long-run debt constraints.

It is worth noting that the first measure was roughly similar to the majority of 'sustainable debt resolution' measures introduced in Ireland (e.g. temporary relief on payments, split mortgages, etc) that temporarily delay repayments at the full rate. Even worse, in Irish case, policy instruments that delay repayments are generally associated with roll up of unpaid debt and in some cases, with interest on the unpaid debt, thus increasing life-cycle level of indebtedness. 

The second set of measures used in the NBER study are broadly consistent with debt forgiveness measures, where actual debt reduction took place at both the principal and interest levels.

So what did NBER study find?

"We find that the debt write-downs significantly improved both financial and labor market outcomes despite not taking effect for three to five years. In sharp contrast, there were no positive effects of the more immediate payment reductions. These results run counter to the widespread view that financial distress is largely the result of short-run constraints."

In other words, it appears that empirical evidence supports debt relief, as opposed to temporary payments reductions. Irish banks and authorities, in continuing to insist on preferences for temporary relief measures are simply driven by pure self interest - protecting banks' balancesheets - not by a desire to deliver a common good, such as speedier recovery of the heavily indebted households. 

Study link here: http://www.nber.org/papers/w23545.

Specifically, for debt relief: "For the highest-debt borrowers, the median debt write-down in the treatment group increased the probability of finishing a repayment program by 1.62 percentage points (11.89 percent) and decreased the probability of filing for bankruptcy by 1.33 percentage points (9.36 percent). The probability of having collections debt also decreased by 1.25 percentage points (3.19 percent) for these high-debt borrowers, while the probability of being employed increased by 1.66 percentage points (2.12 percent). The estimated effects of the debt write-downs for credit scores, earnings, and 401k contributions are smaller and not statistically significant. Taken together, however, our results indicate that there are significant benefits of debt relief targeting long-run debt overhang in our setting".

For repayment relief: "we find no positive effects of the minimum payment reductions targeting short-run liquidity constraints. There was no discernible effect of the payment reductions on completing the repayment program... The median payment reduction in the treatment group also increased the probability of filing for bankruptcy in this sample by a statistically insignificant 0.70 percentage points (6.76 percent) and increased the probability of having collections debt by a statistically significant 1.40 percentage points (3.56 percent). There are also no detectable positive effects of the payment reductions on credit scores, employment, earnings, or 401k contributions. In sum, there is no evidence that borrowers in our sample benefited from the minimum payment reductions, and even some evidence that borrowers seem to have been hurt by these reductions."

Why did payment relief not work? "The payments reductions increased the length of the repayment program in the treatment group by an average of four months and, as a result, increased the number of months where a treated borrower could be hit by an adverse shock that causes default (e.g., job loss)."

Now, imagine the Irish authorities arguing that no such shocks can impact over-indebted households over 10-20 years the repayment relief schemes, such as split mortgages or temporarily reduced repayments, are designed to operate. 

21/6/17: BusinessInsider: The Most Important Charts in the World

My contribution to the BusinessInsider "The most important charts in the world from the brightest minds on Wall Street" is out. See my chart here: http://www.businessinsider.com/most-important-charts-markets-finance-chartbook-2017-6?op=0#/#constantin-gurdgiev-52 and the full deck of charts here: http://www.businessinsider.com/most-important-charts-markets-finance-chartbook-2017-6.

21/5/17: Student Loans Debt: The Bubble is Still Inflating

Having covered the latest news on the U.S. household debt continued explosion (see http://trueeconomics.blogspot.com/2017/05/19517-us-household-debt-things-are-much.html) and the ongoing deepening of the long term insolvency within the U.S. Social Security system (here: http://trueeconomics.blogspot.com/2017/05/19517-reminder-social-security-is-only.html), let’s take a look at the second largest source of household debt (after mortgages): Student Loans.

According to the data from the New York Federal Reserve, 1Q 2017 total volume of student loans outstanding in the U.S. was USD1.344 trillion, up on USD 1.310 trillion in 4Q 2016, marking the highest level of Student Loans debt in history. However, the Fed methodology does not include some of the more predatory types of loans extended to students.  This means that other sources report student debt at the end of 2016 to be between USD 1.44 trillion and USD 1.5 trillion (see for example https://studentloanhero.com/student-loan-debt-statistics/).

Setting aside the issues relating to data reporting, even by the official U.S. Fed standards, student loans debt is almost double the U.S. households’ credit cards debt, and is more than 10 percent higher than combined credit cards and HE revolving debt volumes.

Crucially, default rates on Student Loans are currently higher (at 11%) than for any other form of debt (credit cards defaults, second highest, are at around 7.45%).

With an average debt load of over USD36,000 per student, the expected Fed rates hikes through 2017 alone are likely to take some USD 270.00 per annum from household budgets already under severe strain from low income growth, and sky high and rising rents.

Meanwhile, the U.S. bankruptcy code now excludes Student Loans from protection, courtesy of 2005 Congressional decision, presided over by Joe Biden. Of course, Biden’s political machine was supported by one of largest student loans underwriter, the MBNA. President Obama promised to undo Biden’s changes to the bankruptcy code, but in the end did absolutely nothing to keep his promise and, in fact, made matters worse (https://www.bloomberg.com/news/articles/2015-10-14/obama-administration-hits-back-at-student-debtors-seeking-relief).  Subsequently, during his Presidential election campaign, Donald Trump said “That's probably one of the only things the government shouldn't make money off -- I think it's terrible that one of the only profit centers we have is student loans.”  Since election, however, the Trump Administration is yet to do anything on the issue.

In simple terms, American students have no friends in high places… but legislators like Joe Biden can roam free across campuses and events extolling own ethical virtues… for a fee... often paid for by students' tuitions.

19/5/17: U.S. Household Debt: Things are Much Worse Than Headlines Suggest

Those of you who follow this blog know that I am a severe/extreme contrarian when it comes to median investor perceptions of the severity of leverage risks. That is to say, mildly, that I do not like extremely high levels of debt exposures at the macroeconomic level (aggregate real economic debt, which includes non-financial corporations debt, household debt and government debt), at the financial system levels (banking debt), at the microeconomic (firm) level, and at the level of individual investors own exposure to leverage.

With this in mind, let me bring to you the latest fact about debt, the fact that rings multiple bells for me. According to the data from the U.S. Federal Reserve, household debt in the U.S. has, as of the end of 1Q 2017, exceeded pre-2008 peak levels and hit an all-time high by the end of March.

Let's crunch some numbers.

• Total Household Debt in the U.S. stood at USD 12.725 trillion at the end of 1Q 2017, up on USD 12.576 trillion in 4Q 2016. Previous record, reached in 3Q 2008 was USD 12.675, while the pre-Global Financial Crisis average was USD 10.112 trillion.
• During pre-crisis period, Mortgage Debt peaked at USD 9.294 trillion in 3Q 2008. In 1Q 2017 this figure remained below this peak levels at USD 8.627 trillion. As flimsy as house price valuations can be, this means that there is no 'hard' asset underlying the new debt peak. If anything, the new overall household debt mountain is written against something far less tangible than real estate.
• Student loans are up on previous peak (4Q 2016 at USD 1.310 trillion) at USD 1.344 trillion, as consistent with continued growth in the student loans crisis in the U.S.

Chart below illustrates the trends for total household debt:

Another key trend in household debt relates to debt defaults and risks. Here too 1Q 2017 data is far from encouraging. Pre-Global Financial Crisis average delinquencies (120 days or more overdue loans and Severely Derogatory delinquencies) average 2.07 percent of total debt outstanding. In 1Q 2017, some 29 quarters of deleveraging later, the comparable percentage is 3.0 percent. This is bad. Worse, take together, all household debt that was in delinquency in 1Q 2017 was 4.8 percent, which is still above 4.56 percent average for pre-2008 period. 

While overall delinquencies are not quite at problematic levels, yet, we must keep in mind the underlying conditions in which these delinquencies are taking place. Prior to the onset of the Global Financial Crisis, interest rates environment was much less benign than it is today toward higher levels of debt exposures: debt origination costs (direct cash costs) and debt servicing costs (income charge from debt) were both higher back in the days of the pre-2008 boom. Today, both of these costs are lower. Which should have led to lower delinquencies. The fact that delinquencies still run above pre-2008 levels implies that we are witnessing poorer underlying household fundamentals against which the debt is written.

Sadly, you won;t read this view of the current debt and debt burden issues from the mainstream media and analysts.

29/12/16: Drowning in Debt

Recently, I posted about the return - with a vengeance - of one of the key drivers of the Global Financial Crisis and the Great Recession, the rapid rise of the debt bubble across the global economy. The original post is available here: http://trueeconomics.blogspot.com/2016/12/161216-root-of-2007-2010-crises-is-back.html

There is more evidence of the problem reaching beyond corporate finance side of the markets for debt. In fact, in the U.S. - the economy that led the de-risking and deleveraging efforts during the early stages of the recovery - household debt is now once again reaching danger levels.

Chart 1 below shows that, based on data from NY Federal Reserve through 3Q 2016, full year 2016 average household debt levels are likely to exceed 2005-2007 average by some 3 percent. In 3Q 2016, total average household debt was around USD98,312, a level comparable to USD98,906 in 2006.

And Chart 2 shows that overall, aggregate levels of household debt and per capita levels of household debt both are now in excess of 2005-2007 averages.

Finally, as Chart 3 below indicates, delinquencies rates are also rising, despite historically low interest rates and booming jobs markets. For Student Loans and Car Loans, 3Q 2016 delinquencies rates are 1 percentage points and 3.8 percentage points above the 2005-2007 average delinquency rates. For Mortgages, current delinquency rates are running pretty much at the 2005-2007 average. Only for Credit Cards do delinquency rates at the present trail behind the 2005-2007 average, by some 2 percentage points.

Now, consider the market expectations of 0.75-1 percentage increase in Fed rates in 2017 compared to 3Q 2016 (we are already 0.25 percentage points on the way with the most recent Fed decision). Based on the data from NY Fed, and assuming average 2015-2016 growth rates in credit forward, this will translate into extra household payments on debt servicing of around USD1,085-USD1,465 per annum depending on the passthrough rates from policy rate set by the Fed and the retail rates charged by the banks.

Given the state of the U.S. household finances, this will be some tough burden to shoulder.

So here you have it, folks:
1) Corporate debt bubble is at an all-time high
2) Government debt bubble is at an all-time high
3) Household debt bubble is at an all-time high.
Meanwhile, equity funding is slipping even for the usually credit-shy start ups.

And if you want another illustration, here is total global Government debt, based on IMF data:

We’ve learned no lessons from 2008.


Sources for data:
https://www.nerdwallet.com/blog/average-credit-card-debt-household/
https://www.newyorkfed.org/microeconomics/data.html
http://www.imf.org/external/pubs/ft/weo/2016/02/weodata/index.aspx

16/12/16: The Root of the 2007-2010 Crises is Back, with a Vengeance

There are several fundamental problem in the global economy, legacies of the past 20 years - from the mid 1990s on - that continue to drive the trend toward secular stagnations (see explainer here: http://trueeconomics.blogspot.com/2015/07/7615-secular-stagnation-double-threat.html).

One key structural problem is that of excessive reliance on credit (or debt) to drive growth. We have seen the devastating effects of the rapidly rising unsustainable levels of the real economic debt (debt that combines government obligations, non-financial corporate debt and household debt) in the case of 2008 crises.

And we were supposed to have learned the lesson. Supposed to have, because the entire conversation about structural reforms in banking and capital markets worldwide was framed in the context of deleveraging (reduction of debt levels). This has been the leitmotif of structural policies reforms in Europe, the U.S., in Australia and in China, and elsewhere, including at the level of the EU and the IMF. Supposed to have, because we did not that lesson. Instead of deleveraging, we got re-leveraging of economies - companies, households and governments.

Problem Case Study: U.S. Corporates

Take the U.S. corporate bonds market (that excludes direct loans through private lenders and intermediated loans through banks) - an USD8 trillion-sized elephant. Based on the latest research of the U.S. Treasury Department, non-banking institutions - plain vanilla investment funds, pension funds, mom-and-pop insurance companies, etc are now holding a full 1/4 of U.S. corporates bonds. According to the U.S. Treasury, these expanding holdings of / risk exposures to corporate debt are now "a top threat to stability" of the U.S. financial system. And the warning comes at the time when U.S. corporate debt is at an all-time high as a share of GDP, based on the figures from the Office of Financial Research.

And it gets worse. Since 2007, corporate debt pile in the U.S. rose some 75 percent to USD8.4 trillion, based on data from the Securities Industry and Financial Markets Association - which is more than USD8 trillion estimated by the Treasury. These are long-term debt instruments. Short term debt obligations - money market instruments - add another USD 2.9 trillion and factoring in the rise of the value of the dollar since the Fed meeting this week, closer to USD3 trillion. So the total U.S. corporate debt pile currently stands at around USD 11.3 trillion to USD 11.4 trillion.

Take two:

1. Debt, after the epic deleveraging of the 2008 crisis, is now at an all-time high; and
2. Debt held by systemic retail investment institutions (insurance companies, pensions funds, retail investment funds) is at all time high.

And the risks in this market are rising. Since the election of Donald Trump, global debt markets lost some USD2.3 trillion worth of value. This reaction was driven by the expectation that his economic policies, especially his promise of a large scale infrastructure investment stimulus, will trigger inflationary pressures in the U.S. economy that is already running at full growth capacity (see here: http://trueeconomics.blogspot.com/2016/12/151216-us-economic-policies-in-era-of.html). Further monetary policy tightening in the U.S. - as signalled by the Fed this week (see here: http://trueeconomics.blogspot.com/2016/12/151216-long-term-fed-path-may-force-ecb.html) will take these valuations down even further.

Some estimates (see https://www.bloomberg.com/news/articles/2016-12-16/republican-tax-reform-seen-shrinking-u-s-corporate-bond-market) suggest that the Republican party corporate tax reforms (that might remove interest rate tax deductibility for companies) can trigger a 30 percent drop in investment grade bonds valuations in the U.S. - bonds amounting to just under USD 4.9 trillion. The impact would be even more pronounced on other bonds values. Even making the estimate less dramatic and expecting a 25 percent drop across the entire debt market would wipe out some USD 2.85 trillion off the balancesheets of the bonds-holding investors.

As yields rise, and bond prices drop, the aforementioned systemic retail investment institutions will be nursing massive losses on their investment books. If the rush to sell their bond holdings, they will crash the entire market, triggering potentially a worse financial meltdown than the one witnessed in 2008. If they sit on their holdings, they will be pressed to raise capital and their redemptions will be stressed. It's either a rock or a hard place.


Problem Extrapolation: the World

The glut of U.S. corporate debt, however, is just the tip of an iceberg.

As noted in this IMF paper, published on December 15th, corporate leverage (debt) has been on a steady march upward in the emerging markets (http://www.imf.org/external/pubs/ft/wp/2016/wp16243.pdf).

And in its Fiscal Monitor for October 2016, the Fund notes that "At 225 percent of world GDP, the global debt of the nonfinancial sector—comprising the general government, households, and nonfinancial firms—is currently at an all-time high. Two-thirds, amounting to about $100 trillion, consists of liabilities of the private sector which, as documented in an extensive literature, can carry great risks when they reach excessive levels." (see http://www.imf.org/external/pubs/ft/fm/2016/02/pdf/fm1602.pdf)

Yes, global real economic debt now stands at around USD152 trillion or 225 percent of world GDP.

Excluding China and the U.S. global debt levels as percentage of GDP are close to 2009 all time peak. Much of the post-Crisis re-leveraging took place on Government's balancehseets, as illustrated below, but the most ominous side of the debt growth equation is that private sector world-wide did not sustain any deleveraging between 2008 and 2015. In fact, Advanced Economies Government debt take up fully replaced private sector debt growth rates contraction. Worse happened in the Emerging Markets:

So all the fabled deleveraging in the economies in the wake of the Global Financial Crisis has been banks-balancesheets deleveraging - Western banks dumping liabilities to be picked up by someone else (vulture funds, investors, other banks, the aforementioned systemic retail investment institutions, etc).

And as IMF analysis shows, only 12 advanced economies have posted declines in total non-financial private debt (real economic debt) as a share of GDP over 2008-2015 period.  Alas, in the majority of these, gains in private deleveraging have been more than fully offset by deterioration in government debt:

Crucially, especially for those still believing the austerity-by-cuts narrative presented in popular media, fiscal uplift in debt levels in the Advanced Economies did not take place due to banks-rescues alone. Primary fiscal deficits did most of the debt lifting:

In simple terms, across the advanced economies, there was no spending austerity. There was tax austerity. And on the effectiveness of the latter compared to the former you can read this note: http://trueeconomics.blogspot.com/2016/12/10122016-austerity-three-wrongs-meet.html. Spoiler alert: tax-based austerity is a worse disaster than spending-based austerity.

In summary, thus, years of monetarist activism spurring a massive rise in corporate debt, coupled with the utter inability of the states to cut back on public spending and the depth of the Global Financial Crisis and the Great Recession have combined to propel global debt levels past the pre-crisis peak to a new historical high.

The core root of the 2007-2010 crises is back. With a vengeance.

7/5/16: Households Over-Indebtedness in the Euro Area

An interesting assessment of Italian household debt levels in the context of over-indebtedness by D'Alessio, Giovanni and Iezzi, Stefano, (paper “Over-Indebtedness in Italy: How Widespread and Persistent is it?”. March 18, 2016, Bank of Italy Occasional Paper No. 319. http://ssrn.com/abstract=2772485).

Using the Eurosystem’s Household Finance and Consumption Survey (HFCS) the authors also compare the over-indebtedness of Italian households with that of other euro-area countries (Ireland, as usual, nowhere to be found, presumably because we don’t have data).

Here is a summary table for euro area households over-indebtedness:

Several things can be highlighted from this table:

1. There is severe over-indebtedness in Spain (14.1%) and Slovenia (10%); serious over-indebtedness in the Netherlands (8.8%), Luxembourg (8.4%), and Portugal (8.2%)
2. Demographically, those under 50 are the hardest hit. This would be normal, if the incidence of higher debt amongst younger generations was consistent with demographic profile of the country (younger countries - more over-indebtedness amongst younger generations). This is not the case. 
3. Overall, worst cross-country over-indebtedness problem occurs in 31-40 age group - the group of the most productive households who should be able to fund their debts from growing incomes.
4. In 9 out of 13 countries covered, highest or second highest level of over-indebtedness accrues in “University Degree” holding sub-population.
5. Self-employed are disproportionately hit by over-indebtedness problem compared to those in employment.

In simple terms, the above evidence can be consistent with sustained, decade-long transfers of wealth (via debt channel) from younger and middle-age generation to older generation (>50 years of age). System of taxation that induces higher volatility to incomes of self-employed compared to those in traditional employment might be another contributing factor.

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.

2/1/16: QE for the People 2016

Back in March 2015, I have signed a group petition in support of the QE for the People idea of using monetary policy to directly inject funding into the economy via households' budgets. Since then the idea continued to gain traction and in December 2015 the campaign issued an in-depth analysis of the idea, and a renewed call for public and professional engagement.