Monday, April 24, 2017

The Debt Monster is Slowly, Steadily Devouring Us

“To contract new debt is not the way to pay old ones.” - George Washington

“To preserve our independence, we must not let our rulers load us with perpetual debt. We must make our election between economy and liberty, or profusion and servitude.” - Thomas Jefferson

“Debt is the fatal disease of republics; the first thing and the mightiest to undermine governments and corrupt the people.” - Wendell Phillips

Our next financial and/or economic crisis (one will lead to the other) will most surely be sparked by our unhealthy and unsustainable debt levels. The size of our various debts is practically incomprehensible. Numbers in the trillions just don’t square in the minds of most people.

For starters, one trillion is one-thousand billion. The physical size of $1 trillion is absolutely stunning. This infographic really helps put things in perspective (click on image to enlarge):

The total public debt reached $19.98 trillion by the end of 2016, which equalled 106 percent of gross domestic product. In essence, the nation’s debt is bigger than our entire economy.

To get some perspective on what $20 trillion looks like, check out this infographic:

It’s truly mind boggling, isn’t it?

Governments pay their debts with their income, in the form of tax revenues. That means we, the people, are on the hook for all government debts. The government will increase our taxes, if necessary, to pay those debts. Or, the government will inflate (and thereby devalue) the currency to make its debts more manageable.

However, taxpayers are also consumers, who have their own debts… and they are sizable.

Total consumer debt reached a record high of $12.68 trillion in 2008, which nearly tanked the economy. After a period of deleveraging, consumer debt is once again on the rise, as if nothing was learned. Total household debt increased by $460 billion last year — the largest increase in almost a decade — bringing the total to $12.58 trillion.

Yes, we are dangerously close to the whopping debt total that crippled the economy nine years ago, the after shocks of which are still resonating. Yet, the New York Fed expects household debt to reach its previous 2008 peak sometime this year.

When you combine the national debt (aka, total public debt) with consumer debt and all other forms of debt, things become really freaky.

Total credit market debt, which includes all forms of debt — financial sector debt, government debt (federal, state, local), household debt and corporate debt — has reached a staggering $66.1 trillion, according to the Federal Reserve’s latest Flow of Funds report. The total was $63.5 trillion at the end of 2015.

According to the latest BEA revision, nominal 2016 GDP was $18.86 trillion, an increase of $632 billion from 2015. However, total credit grew by $2.511 trillion last year. In essence, $2.5 trillion of credit/debt was issued to achieve just $632 billion in economic growth. As Zero Hedge points out, that means it “cost” $4 in new debt to generate just $1 in new economic growth in 2016!

These debt numbers have become so freakishly gigantic due to what is known as exponential growth, in which the amount being added to the system is proportional to the amount already present: the bigger the system is, the greater the increase. In the simplest terms, exponential growth means runaway expansion. Exponential growth can start off slowly but result in enormous sums rather quickly.

For example, many economists and professors have long viewed a budget deficit of 3 percent as manageable and sustainable. Budget deficits are reflected as a percentage of gross domestic product. However, 3 percent of our $19 trillion GDP amounts to a $475 billion deficit. In other words, the government is now adding nearly $1 trillion to the debt every two years.

It's a situation that’s quite worrisome and problematic.

Another reason these numbers have grown to be so outlandish is that debt (aka, credit) is the foundation of our economic system. Without debt, there can be no growth because all money is issued as debt.

It’s a bizarre system in which some very bad outcomes are baked into the cake. Economic growth depends on credit/debt expansion, yet that expansion is outstripping growth by a 4-1 ratio. Maintaining the current system is mathematically impossible, yet we are plowing forward, headlong into the abyss.

As if the $20 trillion national debt and the $12.58 trillion consumer debt aren’t scary enough, there’s an even bigger, freakier number out there.

The federal government’s total of unfunded obligations — the gap between revenue and spending commitments — has reached a record $84 trillion.

Yes, you read that correctly — the U.S. government has $84 trillion in future obligations and it doesn’t have the funds to pay them. These unfunded commitments include programs like Medicare and Social Security.

The federal debt only includes what the government owes to Treasury holders. It doesn't take into account what's owed to seniors, veterans and retired government employees.

Even if we were only talking about the $20 trillion national debt and blindly dismissing these massive, unfunded liabilities, there is a big problem with manner in which it is discussed.

Many economists and analysts refer to our debt-to-GDP ratio, which is misleading since no country pays its debt with its entire economy. Debts can only be paid with revenues, or taxes. A country with high taxes can afford more debt than a low tax country. Debt to GDP does not account for that.

Forbes examined the debt-to-government tax revenue for the thirty-four OECD countries (the world’s developed economies), “Since that is the government’s income.” The U.S. is in third place (after Japan and Greece), with a debt to income measure of 408 percent.

As Forbes noted, “Only three developed countries in the world are in the red zone for national debt to income. The U.S. is one of those three.”

Forbes also noted the following:

"This does not factor the several trillion dollars owed to Social Security, yet it includes the Social Security taxes collected. If Social Security taxes are not counted, the U.S.’s debt to income ratio rises to 688 percent (still in third place). This tells you something about the likelihood of increasing Social Security taxes in conjunction with declining Social Security benefits.”

Despite these problems and these numbers being quite public, our elected leadership in Washington does nothing to address them.

The 2016 federal budget saw revenues of $2.99 trillion, with spending of $3.54 trillion, leading to a deficit of $552 billion.

The 2017 federal budget has revenues of $3.21trillion, with spending of $3.65 trillion, leading to a deficit of $443 billion.

In essence, the government collects $3 trillion annually in taxes, yet somehow that still isn’t enough.

As previously noted, economists have long argued that the U.S. could run annual deficits of 3 percent because our economy historically grew by about 3.28 percent annually. The annual economic growth made the additional deficit spending a wash.

However, there are two problems with this line of reasoning:

1. The U.S. economy no longer grows at a 3 percent-annual clip. Since 2001, GDP has reached at least 3 percent in just two years: 2004 (3.8 percent) and 2005 (3.4 percent). In every other year, through 2016, GDP failed to crack 3 percent, a number that was once considered customary. In 2016, the economy grew just 1.6 percent.

2. Even if the government reduced its deficit spending to match the lower economic growth, or even if it eliminated the deficit entirely, it would do nothing to address the underlying $20 trillion national debt. It would only stop adding to it. That would be a start, but it wouldn’t be a solution to this massive predicament.

Many Americans are entirely unaware of the scope of these problems and even those who are feel powerless to do anything about them. But these debts will eventiually, undoubtedly, blow up in our faces. Many of the things we take for granted will go away in the next crisis. Millions of jobs and homes will be lost. I believe the next crisis will make 2008 look like a dress rehearsal.

The best thing you can do is get out, and stay out, of debt. If the government won’t live within its means, at least we can.

And when the next crisis strikes, don’t expect the government to bail us out. Instead, expect them to demand that we bail them out.

Friday, April 07, 2017

The Fed is About to Perform a High Wire Balancing Act With No Net

During the 2008 financial crisis, the Federal Reserve took the dramatic step of initiating quantitative easing, or QE, after determining that dropping its key interest rate to zero wasn’t sufficient.

Following three successive rounds of these Treasury and mortgage bond purchases, the Federal Reserve’s balance sheet ballooned to $4.5 trillion. That amounted to a fourfold increase from late 2008 to late 2014.

However, minutes from the Fed’s March meeting reveal that the central bank now plans to start selling off some of those assets this year, which is expected to drive up long-term interest rates.

The Fed has never done anything remotely like this before; it is in uncharted waters. There is no map for unwinding $4.5 trillion. No central bank has ever attempted anything so audacious and grand.

Though the Fed says the reductions will be “gradual and predictable,” and will be accomplished by “phasing out” reinvestments (meaning it won’t abruptly stop reinvesting these assets when they mature), its actions will undoubtedly send shock waves through markets.

While the Fed hasn’t actively increased its portfolio since ending QE3 in 2014, it has continued to roll over maturing Treasuries and reinvest principal payments from the mortgage-backed securities. If the Fed simply ceases to reinvest the payments it earns on these securities as they mature, that would automatically shrink its balance sheet.

The Fed raised its key rate, the federal funds rate, a quarter point in March, as well as in each of the last two Decembers (2015 & 2016). As of April 5, the funds rate stood at 0.91 percent. It had been stuck at a range of 0-0.25 percent from December 2008 to December 2015.

The federal funds rate — an overnight lending rate between banks — affects short term rates. Adjusting it higher or lower is the lever the Fed exercises to affect other short-term interest rates.

Though short-term rates are the most sensitive (or reactive) to changes in the funds rate, longer term interest rates can ultimately be affected as well, most especially in this instance.

Federal Open Market Committee members say they expect to make two more hikes in 2017 and three in 2018. But the Fed may not have to engage in any further increases to the funds rate if the unwinding of its balance sheet begins to tighten, as expected.

Releasing its long-term securities to the public would push down their prices and drive up their yields (bond prices and yields move in opposite directions).

The Federal Reserve does not typically control long-term interest rates. The market forces of supply and demand determine the pricing for long-term bonds, which set long-term interest rates. However, when the Fed begins to unload some of its long term bonds, that will begin increasing long-term interest rates.

To be clear, though the Fed doesn’t usually control long-term rates, the shrinking of its balance sheet will surely increase the yields of government bonds with longer maturities. When there is copious supply, prices fall and yields rise.

“The Fed’s portfolio includes $426 billion of Treasury securities set to mature in 2018, and $352 billion more that will mature in 2019,” reports Bloomberg, which is on top of the $164 billion of securities that will mature this year.

The Fed will attempt to manage this process as smoothly, cautiously and predictably as it possibly can. But shrinking its balance sheet could prove to be uneven and cumbersome.

When the Fed finally ended QE in October 2014, it did so in a measured and predictable manner, gradually lowering its bond purchases by $10 billion per month. When the central bank began to “taper” in December 2013, it was buying a whopping $85 billion of securities per month. By October 2014, those purchases had ended.

Similarly, the Fed will need to publicly commit to reducing its balance sheet by a certain dollar amount each month.

However, in order to do so, the economy must continue to at least hold steady, if not improve. An economic downturn would send the process into disarray and, ultimately, reversal.

In the meantime, when the biggest buyer of Treasuries and mortgage securities exits the market, mortgage rates are sure to rise. So will the borrowing costs of the federal government.

Additionally, when the Fed stops rolling over its securities, the Treasury will have to raise cash to pay back the Fed for those maturing securities.

That will cost the American taxpayers hundreds of billions of dollars.

Wednesday, March 29, 2017

Fed's Easy Money Policy Enriches Big Banks, Creating Bubble That Will Result in Crisis

When you hear news that the Federal Reserve is “raising interest rates” (which occurred just weeks ago), the Fed is, in reality, raising just one interest rate: the federal funds rate.

The federal funds rate is the interest rate at which banks and credit unions (depository institutions) lend the funds they keep at the Federal Reserve to other depository institutions overnight. In essence, it is an overnight lending rate from one bank to another.

As of this week, the federal funds rate was yielding 0.91 percent. Just six months ago, it was 0.30 percent. Meanwhile, the 10-year Treasury currently yields 2.42 percent. That arbitrage is a really sweet deal for the Big Banks. The Fed prints money and essentially gives it to the Big Banks, who then loan it back to the government at a much higher interest rate. What a racket!

Since late 2008, the nation’s biggest banks have been receiving enormous sums of money from the Federal Reserve at near-zero interest rates. They are then able to invest this essentially free money in government bonds, collecting massive returns in the process. This results in pure profit, which is one hell of a business model.

Yes, the Big Banks are in the supreme and enviable position of getting virtually free money from the Federal Reserve, which they then loan out at interest.

It's no coincidence that the stock market took off like a rocket when the Fed initiated its zero-interest-rate policy, along with three successive rounds of quantitative easing. The S&P 500 doubled in value from November 2008 to October 2014, coinciding with the Federal Reserve's asset purchasing program.

This has led to massive speculation and malinvestment, such as the recent Snapchat IPO, for example.

What’s particularly amazing is that the Big Banks are using this nearly-free Fed money to buy billions worth of Treasury bonds, redirecting this money right to the federal government for its deficit spending.

"Including federally guaranteed mortgage-backed securities, banks now own $2.4 trillion of government bonds, which would be the most since the central bank began compiling data in 1973," Bloomberg reported in October. Obviously, that total has only grown in the ensuing months.

Yet, those bonds are eventually paid back, at interest, with taxpayer money. The Big Banks enjoy massive returns while doing zilch. They have done nothing and created nothing. They are simply riding the gravy train at taxpayer expense.

Think about that; billions of dollars are being loaned to the biggest banks, essentially for free. Those Big Banks then use all that nearly-free money to purchase Treasuries that currently pay 2.42 percent - 3.00 percent (30-year), resulting in huge gains for the Big Banks.

What borrower doesn’t love near-zero percent loans?

The government also loves this arrangement because it provides a buyer for hundreds of billions in Treasuries. It's a pretty cozy relationship, don't you think? It's kind of like your dad loaning you money so that you can spend it in his store and boost his sales.

It’s also called insanity.

The Fed’s cheap money policy has enabled the inexpensive financing of speculative, levered positions by Wall St. In short, the Fed has been financing concurrent stock, bond and housing bubbles, the likes of which flattened the economy in 2008-2009. And we're still trying to recover from that. All bubbles eventually burst, usually with devastating consequences.

Near-zero interest rates for the better part of the last decade have crushed savers, compelling many to chase the higher yields found in the equities markets. Low rates have also spurred a new housing bubble, sending home prices soaring above the levels that led to the last crash. This is largely keeping Millennials and other first-time buyers out of the housing market.

Of course, the stock markets are called “risk markets” for a reason. The hunt for yield has created “irrational exuberance” among investors and ballooned markets that will inevitably encounter a pin.

Investor optimism is now at its highest level since 2000, according to the latest Wells Fargo/Gallup Index survey. The herd mentality has taken hold, which is always the time to run for the exits. Unfortunately, not everyone will fit through the door, and the losses will be enormous.

During the current bull market, which began in March 2009 and is the second longest in history, the Dow Jones has more than tripled. This won’t go on indefinitely. We’re long overdue for much more than a mere correction. When this bubble inevitably pops, the resulting blast will feel like a Category 5 hurricane.

As the old saying goes, pigs get fat and hogs get slaughtered. The Fed is leading the hogs right into the slaughterhouse and the Big Banks will profit from the massacre.

Monday, March 20, 2017

Outsized Defense Budget Poised to Become Even More Bloated

Let me state this up front: I’m glad the U.S. has the biggest, baddest military in the world and I hope it always stays that way. I have no problem with the U.S. being the top dog and the top spender, militarily.

The U.S. spends more money on its military, by far, than any other nation in the world. We’ve been No. 1 since the end of World War II and, in my estimation, that’s a good thing. I think we should always strive to remain No. 1.

However, I’m also in favor of fiscal prudence and responsibility. That’s why I’m concerned about Donald Trump’s call for a $54 billion increase in military spending in his recent Congressional address. Trump's new federal budget proposal calls for defense spending to jump 10 percent above its already world-leading level.

This increase would "push the Pentagon spending, already well beyond the Cold War average used to keep the now-defunct Soviet Union at bay, even higher,” writes National Security Analyst Mark Thompson.

The U.S. spent $596 BILLION on its military in 2015, according to the Stockholm International Peace Research Institute.

That was more than the next seven countries (China, Saudi Arabia, Russia, United Kingdom, India, France and Japan) COMBINED.

Yet, in fiscal year 2017, US military spending is budgeted for an increase to $617.0 BILLION. Additionally, veterans' spending is budgeted at $180.8 billion and foreign policy / foreign aid spending is budgeted at $55.8 billion. All together, total U.S. government spending for defense is budgeted at $853.6 BILLION.

If that seems like a lot of money, it's because it is.

U.S. military spending in inflation-adjusted terms is higher than it has been since World War II, according to Miriam Pemberton, a research fellow and defense expert at the Institute for Policy Studies.

Here’s the rub: the national debt recently topped $20 TRILLION, and it is growing daily.

"The most significant threat to our national security is our debt," former Joint Chiefs of Staff Chairman Adm. Michael Mullen famously declared in 2010. When the nation’s top military man said this, the national debt was just over $13 trillion.

Yet, the federal budget deficit is projected to add nearly $10 trillion to the federal debt over the next 10 years, according to projections from the nonpartisan Congressional Budget Office.

Congressional Republicans, who have long sworn their allegiance to fiscal prudence and responsibility, will have to find a way to explain, endorse and rationalize a surge in military spending at the same time they are pledging large tax cuts for individuals and corporations, as well as huge cuts to much smaller budget programs.

Aside from the deficit, tepid economic growth is also a concern. Over the next 10 years, real economic output is projected to grow at an annual rate of 1.9 percent. No country can continually grow its debts faster than its economy, without leading to economic crisis.

The Defense Dept. knows that the military budget is bloated and wasteful. Everyone in Washington knows it.

The Pentagon commissioned a study, released in January 2015, which discovered $125 billion in bureaucratic waste.

However, the Pentagon quickly buried the study because it feared “Congress would use the findings as an excuse to slash the defense budget,” according to the Washington Post.

"Pentagon leaders had requested the study to help make their enormous back-office bureaucracy more efficient and reinvest any savings in combat power. But after the project documented far more wasteful spending than expected, senior defense officials moved swiftly to kill it by discrediting and suppressing the results.

"For the military, the major allure of the study was that it called for reallocating the $125 billion for troops and weapons. Among other options, the savings could have paid a large portion of the bill to rebuild the nation’s aging nuclear arsenal, or the operating expenses for 50 Army brigades.

"But some Pentagon leaders said they fretted that by spotlighting so much waste, the study would undermine their repeated public assertions that years of budget austerity had left the armed forces starved of funds. Instead of providing more money, they said, they worried Congress and the White House might decide to cut deeper.

"So, the plan was killed. The Pentagon imposed secrecy restrictions on the data making up the study, which ensured no one could replicate the findings. A 77-page summary report that had been made public was removed from a Pentagon website."

There are two primary excuses for more and more military spending. One of them is jobs.

Military contractors — such Raytheon, Lockheed Martin, Boeing and Northrop Gruman, for example — almost always build their hardware in multiple states. That way the jobs are spread over multiple congressional districts. Since no politician ever wants to vote to kill jobs, this is a very clever strategy. Creating jobs wins elections, while cutting them is always a losing proposition.

The other rationale/excuse is that, “The bad guys are going to get us.”

The Military-Industrial Complex and its political cronies have always created, and they always will seek to create, international bogeymen to advance their argument for new weapons, new wars and the continual flow of military contracts to weapons makers.

The justification is usually draped in the flag and sold as a matter of patriotism. According to this argument, if you support the military, you support more military spending. That makes you a patriot — a real American. If you don’t support more military spending, you are anti-American and a traitor.

It’s all so irrational, bogus and transparent, yet this argument is continually and reflexively made anyway. Many Americans still fall for it and even endorse it.

However, more spending doesn’t make the military stronger, better or more able.

“The only way to strengthen our national security is not to spend more money,” says Lt. Col. Daniel Davis, “but rather to reform the way the Department of Defense does business."

"It boggles the mind that the DoD cannot account for the hundreds of billions of dollars a year that it spends," says Davis. "A full twenty-six years after a federal law was passed requiring all parts of the federal government to provide Congress with an audit of its spending, there remains only a single government agency that has not complied: the Department of Defense. Even after being publicly rebuked by the Senate in 2013 for this failure—and wasting billions of dollars on failed auditing software—the Pentagon remains noncompliant.”

The U.S. already has the most powerful, most deadly, most advanced military in the history of humanity.

Given this reality, is it reasonable or rational for the US to spend even more money on its military?

I think the obvious answer is “no.”

Thursday, March 16, 2017

Fed Rate Hikes May Create Self-Fulfilling Prophecy

The Federal Reserve announced another quarter-point hike yesterday, following the same move in December. The increase brings the federal funds rate into a range of 0.75 percent to 1 percent.

The Fed said its decision was based on both realized and expected labor market conditions and inflation. Translation: the labor market has tightened to nearly full employment and inflation is finally starting to tick up after years of dormancy.

But beware: there have been 13 Fed rate-hike cycles in the post-WWII era, and 10 landed the economy in recession, according to David Rosenberg, Chief Economist & Strategist, Gluskin Sheff.

The current economic expansion, which began in June 2009, has now entered its 93rd month, surpassing the 92-month expansion of the 1980s. That makes this the third-longest in U.S. history. In records dating back to before the Civil War, only the expansions of the 1990s ('91-'01) and 1960s ('61-'69) were longer.

Throughout U.S. history, the gap between one recession’s end and the next one’s beginning has averaged just under five years. In other words, this expansion is getting really long in the tooth, which is a very uncomfortable reality.

The Fed is playing a very risky game by raising rates right now, with the belief that this expansion will go on indefinitely. It won’t. We are currently in the midst of concurrent stock, bond and housing bubbles, and all bubbles eventually burst. All of them.

The economy surely doesn’t look all that strong at present.

The Atlanta Fed just relowered its Q1 GDP estimate to 0.9 percent from 1.2 percent after seeing the BLS report Friday, as well as consumer spending and CPI data.

Real GDP increased 1.6 percent in 2016, compared with an increase of 2.6 percent in 2015. In other words, the Fed is tightening into an economic slowdown.

The strong dollar is constraining exports, which creates a drag on GDP. Last year the trade deficit once again eclipsed $500 billion, as it has for 12 consecutive years.

Federal Open Market Committee members say they expect to make two more hikes in 2017 and three in 2018.

However, continued rate increases during this time of economic weakness will likely be counterproductive. Don’t be surprised if/when the Fed is forced to reverse course and slash rates once again as the economy stalls or the next recession inevitably begins.

But in order to cut rates in the future, the Fed first had to raise the funds rate above zero, which it started to do in Dec. 2015. Now it at least has some breathing room when trouble eventually rears its ugly head once again.

That’s what this and the two previous rate hikes (in Dec. 2015 and Dec. 2016) were all about. However, they run the risk of creating a self-fulfilling prophecy.

In essence, these hikes could spur the very recession or economic crisis the Fed says it is guarding against. That would be the definition of irony.

Monday, February 06, 2017

Rising Interest Rates Matter to Everyone, Especially the Government

When will the Federal Reserve again raise interest rates? That is the question on the minds of lenders and borrower alike. In reality, the Fed will actually raise just a single interest rate, the federal funds rate, which affects all other short-term rates. Those, in turn, can affect long-term rates, such as mortgages.

The Fed raised the funds rate in Dec. 2016 to its current 0.75 percent, from 0.50 percent. It was just the second increase in a decade, following the one in Dec. 2015. The Fed has penciled in three more quarter-point rate increases this year. Meanwhile, traders expect slightly less than two increases in 2017.

The Fed typically raises or lowers the funds rate in quarter-point increments, meaning the increase from 0.50 to 0.75 percent was the smallest that might occur. However, it still represented an increase of 50 percent. That’s a relatively large climb. Imagine how the markets would tremble if the funds rate jumped from 3 percent to 4.5 percent, or even from 2 percent to 3 percent?

When rates are this low, even relatively small movements have large proportional effects.

Just to provide a little perspective on how historically low the federal funds rate remains — even after hikes in each of the past two Decembers — the rate has averaged 6 percent since 1971. In 2001, it was 6.5 percent. Again, it is presently 0.75 percent, so we are still a long way from normal.

The 10-year Treasury bond yield peaked at 15.84 percent in 1981. There are lots of Americans who have no memory of, and no experience with, such high borrowing costs.

Americans, and markets, have become accustomed to exceptionally low rates. What were once viewed as anomalies are now considered the norm. For example, the 10-year Treasury yield fell in July, 2016 to 1.367%, while the 30-year fell to 2.141%. Both were record lows. However, the pendulum now appears to be swinging the other way.

Though the Fed has announced plans for three more rate hikes this year, its concurrent aim to reduce its bond holdings will automatically put upward pressure on rates. In other words, the Fed may achieve its objective without having to raise the funds rate any further.

Through its quantitative easing program, which was designed to lower rates and increase lending, the Fed has amassed $4.45 trillion in bond assets, of which $1.75 trillion are in mortgaged-backed securities. When the Fed eventually (and inevitably) starts to unload some of these holdings, rather than reinvesting them, long-term rates will begin to rise. That discussion has now begun and many market watchers expect the slow process of unwinding to begin as soon as this year.

Increasing mortgage rates will likely slow the housing market, reducing demand and prices. The Fed is now the biggest source of demand for U.S. government-backed mortgage debt and owns a third of the market. So, if the Fed stops buying mortgage bonds, it will almost surely lead to further cost increases for home buyers.

Simply put, when the biggest buyer exits the market, demand for mortgage-backed securities will fall and borrowing costs will rise. Who remembers 6 percent 30-year mortgages? It wasn’t very long ago (2008 to be exact) that this was the norm. In 2000, the 30-year mortgage was over 8 percent. Such a reversion would crush the housing market.

The 10-year Treasury presently yields about 2.4 percent, while the 30-year yields about 3 percent; that’s not a big difference. Borrowing money for 30 years should cost a lot more than borrowing for 10 years, yet the costs are quite similar at present.

That could all change this year and next, pushing mortgage costs much higher. Markets are forward looking, anticipating future rate moves. As a result, mortgage rates are already on the rise.

The total value of the U.S. housing stock grew nearly 6 percent last year, according to Zillow. The housing market has finally regained all the value lost during the housing crisis, Zillow found.

Homeowners have once again become accustomed to the value of their homes appreciating considerably each year, but that upward trajectory could now be in jeopardy.

Of course there are two sides in any transaction. For buyers, a price halt, or even retrenchment, would be welcomed.

Lastly, and quite critically, higher borrowing costs will have a very negative effect on the federal government. The national debt has now reached $20 trillion and is steadily rising.

The federal budget deficit is projected to add nearly $10 trillion to the federal debt over the next 10 years, according to the latest projections from the nonpartisan Congressional Budget Office.

Meanwhile, the CBO projects that, under current law, net interest costs will more than double over the next 10 years, soaring from $270 billion in 2017 to $712 billion in 2026 and totaling $4.8 trillion over the period. Interest costs are expected to continue climbing beyond the next 10 years and are projected to be the third largest category in the federal budget by 2028 (after just Social Security and Medicare), the second largest category in 2046, and the single largest category in 2050.

That’s a recipe for disaster and a full-blown economic crisis. It illustrates why rising interest rates are so critical. Borrowing costs matter, not just to car buyers and home buyers, but also to our heavily indebted federal government, which is funded by the taxpayers — meaning you and me.

Saturday, January 21, 2017

The American Middle Class Is No Longer the Majority and That's Dangerous

If you’re still looking for the reason that Donald J. Trump is now the 45th President of the United States, look no further than the tattered remains of the once-proud American middle class. Pocket-book issues are typically the defining issues in most elections, and that was certainly the case in November.

For decades, politicians (mostly Democrats) have focused on the economic woes of America’s large cities. However, the majority of America’s poor no longer reside in inner-cities. They live in the suburbs and rural areas.

A report by the Brookings Institute found that:

"Between 2000 and 2011, the number of poor residents in the suburbs of the nation's largest metropolitan areas grew by 64 percent — more than twice the growth rate in cities. For the first time, suburbs became home to more poor residents than America's big cities. Today, one in three poor Americans — about 16.4 million people — lives in the suburbs."

The plight of millions upon millions of Americans can’t, and shouldn’t, be ignored. Perhaps the politicians are now listening, since the election of Trump has resounded like the shot heard ‘round America.

The suburbs used to be the land of the American middle class. Sadly, that is no longer the reality. In fact, our middle class has become a faded memory.

A Pew Research Center study on the decline of the middle class found that its members no longer make up a majority of Americans. An equal share of us are in the top and bottom tiers.

This has created an enormous drag on our economy. Wage and income stagnation is at the root of our economic problems because ours is a consumption-based system. If the majority has less to spend, there is less overall demand and consumption.

The good news is that nearly twice as many people rose up and out of the middle class as fell downward into the lower tier. Though the share of people in the middle-class group fell by 11 points, half the country is still in that group, while 29 percent are in the upper income tier and 21 percent in the bottom tier.

However, the middle class lost even more wealth than it lost members.

The share of Americans in the middle class dropped from 61 to 50 percent, but their share of wealth dropped more. In 1970, the middle class had 62 percent of income. That dropped to 43 percent in 2014, while the share going to the upper tier rose from 29 percent to 49 percent.

In short, the rich have gotten richer, while the middle class has gotten poorer… to the point that the middle class has shrunk considerably.

Researcher and demographer Harry Dent wrote the following about our predicament:

Our middle class has been shrinking substantially since the 1960s and ’70s. Today, their share of wealth is the lowest in the world, at a mere 19.6%!

Extreme political polarization and income inequality is at the root of this. We’re the highest on both. Today real incomes of the middle class are 5% lower than they were in 1970 and 12.4% lower than in 2000, when they peaked!

When we take the affluent 10% out of the picture, we see that the bottom 90% average only $32,352 in income per year. That top 10% skew the overall average dramatically, so the $55,132 [median household income] you hear about isn’t accurate.

In the meantime, the top 0.1% have seen their share of wealth go up four times since 1975! And, since 1970, the “super elite” 0.01% has seen their incomes grow a whopping 628%!

Income inequality is higher in the United States than any wealthy nation, and the gap between the top of the bottom is widening. This was a primary theme in Bernie Sanders’ long-shot run for the White House.

Though this problem has made headlines for several years now, inequality in America is steadily worsening.

The mega wealthy — the top 1 percent — now earn an average of $1.3 million a year. That’s more than three times as much as the 1980s, when the rich "only" made $428,000, on average, according to economists Thomas Piketty, Emmanuel Saez and Gabriel Zucman.

Meanwhile, the bottom 50 percent of the American population earned an average of $16,000 in pre-tax income in 1980. Adjusted for inflation, it remains essentially the same more than three decades later.

The wealthy’s share the economic pie wasn’t always so large. In the 1970s, the top 1 percent of Americans earned just over 10 percent of all U.S. income. However, the top 1 percent now take home more than 20 percent of all income.

As you might expect, this corresponded with the rest of us taking home less income. The bottom 50 percent went from collecting over 20 percent of national income during much of the 1970s to about 12 percent today.

What’s perhaps most striking about this trend is that it occurred even as the nation’s economic pie was getting bigger. In other words, there should have been more than enough for everyone, not just the elite few.

As the New York Times wrote:

In 35 years, the U.S. economy has more than doubled, but new research shows close to zero growth for working-age adults in the bottom 50 percent of income.

This group — the approximately 117 million adults stuck on the lower half of the income ladder — “has been completely shut off from economic growth since the 1970s,” the team of economists found. “Even after taxes and transfers, there has been close to zero growth for working-age adults in the bottom 50 percent."

The glaring result is that America is no longer the land of opportunity it once was. If you're born rich, you're likely to stay that way. Sadly, the same is true if you are born poor.

The U.S. now has less economic mobility than Canada and much of Western Europe. In fact, when it comes to economic mobility (the ability to climb the economic ladder), “the United States is very immobile,” according to a report from the Pew Charitable Trusts.

Fewer Americans are earning more income than their parents, which was the norm for past generations. The "American Dream" is dying a long, slow death.

Those born in 1980, or today’s 30-somethings, have just a 50 percent chance of making more money than their parents, according to a research team led by Harvard and Stanford professors.

By contrast, a kid born in 1940 had a 92 percent chance of earning more than their parents at the same age. For kids born in 1950, the likelihood of achieving that version of the American Dream had fallen to 79 percent. By 1960, that figure had dropped further to 62 percent.

This is not an attempt to vilify the top 1 percent of earners. It should be noted that there is a huge difference between the top 1 percent and the top 1/10th of 1 percent.

For example, to be part of the top 1 percent, you’d need to earn at least $450,000 annually, according to Census Bureau data. That's a far cry from the select group of America’s mega wealthy.

The top 9,600, or so, US wage earners make over $10 million per year (2015 is the latest data available); 773 people earn between $20-$50 million annually and 202 Americans earn more than $50 million a year.

So, fewer than 10,000 Americas earn as much as $10 million annually. It's a small and privileged few in a nation of 324 million.

Many experts argue that policies could be enacted to ensure that income is more equitably distributed to all workers, and not continually siphoned off to those at the very top.

Don’t expect that under a Trump administration, which, aside from being headed by a billionaire, is staffed by a horde of millionaires and billionaires. Politico suggested the new president’s team could be worth $35 billion.

The Achilles heel of capitalism is greed. If those in power, and their ultra-wealthy cronies, ignore the needs of the masses for too long, this could all end in tears. It's is how revolutions are started.

As billionaire Nick Hanauer recently warned his fellow plutocrats: Beware, “The pitchforks are going to come for us.”

Sunday, January 08, 2017

What Will Trigger the Next Economic Crisis?

January is the time of year when all sorts of economic forecasts and predications are made for the upcoming year. However, the business of predicting and forecasting future events is notoriously challenging, suspect and, in retrospect, often wrong.

That said, an astute observer can often see trouble coming from a mile away.

Back in March, 2008, I wrote a story, titled “The Perfect Storm,” for, for whom I was at the time a Money Correspondent. In the article, I highlighted the numerous problems plaguing the U.S. economy and how they were like spokes on a wheel, converging in a central hub. I could clearly see an economic disaster unfolding. Given that the financial crisis fully exploded just six months later, my concerns proved to be somewhat prescient.

I must admit that, at the time, I thought we were headed for a second Great Depression. While that outcome didn’t ultimately materialize, the fallout was brutal, with millions of Americans losing their jobs and homes.

More than 800,000 jobs were lost in November, 2008 and again in January, 2009. In total, nearly 9 million jobs were lost during the Great Recession, which lasted from December, 2007 to June, 2009.

More than 9.3 million homeowners went through a foreclosure, surrendered their home to a lender or sold their home via a distress sale between 2006 and 2014, the Wall Street Journal reported.

What we all discovered, after the fact, was that we were officially in recession (which is defined as two consecutive quarters of economic contraction) for nine months before the financial crisis ignited. Though the recession wasn’t officially recognized for much of 2008, millions of Americans intuitively knew that things were not all right. I was one of them.

While I was wrong about a new depression unfolding, there was plenty of panic around the country, even in Washington, DC, where insiders knew just how awful the rapidly unfolding situation was.

In October, 2008, Congressman Brad Sherman of California said that some members of the House were told that martial law would begin within a week if they did not immediately pass the TARP bailout bill:

"The only way they can pass this bill is by creating and sustaining a panic atmosphere. ... Many of us were told in private conversations that if we voted against this bill on Monday that the sky would fall, the market would drop two or three thousand points the first day and a couple of thousand on the second day, and a few members were even told that there would be martial law in America if we voted no.”

So, my concerns at the time were not unfounded. I was not alone in expecting the worst.

Henry Paulson, Treasury Secretary at the time, subsequently wrote the following about the crisis:

"That was just a terrible moment for me. Everyone was waiting for Tim [Geithner} and me to come down and report to them, and I wasn’t quite sure what to say. I was gripped with fear. I called [my wife] and said, “Wendy, you know, I feel that the burden of the world is on me and that I failed and it’s going to be very bad, and I don’t know what to do, and I don’t know what to say. Please pray for me.”

“It seemed like there was a good chance Morgan Stanley could go down, and if it did that could take Goldman down. If that had happened, it would have been all she wrote for the American economy."

Yeah, for those who didn’t know it at the time, it was that bad.

Yet, many of the problems that led to the Great Recession have not gone away; in some cases they have festered and worsened. I am still highly concerned.

While I steer clear of outright predictions, especially when it comes to timelines, I won’t be at all surprised when the next crisis rears its head — even if it occurs this year. Recessions are inevitable and the Federal Reserve is often to blame for creating the business cycles that invariably lead to recessions.

Regardless of what triggers the next recession and/or financial crisis (one will likely lead to the other), there are more than enough combustibles at present to spark and then feed the fire.

As Paulson also said:

"I get asked all the time, “What’s the likelihood of another financial crisis?” And I begin by saying it’s a certainty. As long as we have markets, as long as we have banks, no matter what the regulatory system is, there will be flawed government policies. Those policies will create bubbles. They will manifest themselves in a financial system no matter how it’s structured and how it’s regulated.”

With that in mind, I will attempt to briefly outline below what I see as the most likely potential triggers of the next crisis:

High debt levels of all kinds (government, business, household)

The following chart comes from Hoisington Investment Management:

From 1980 to 2013, total credit/debt grew by 8 percent per year, compounded. This is remarkable because anything growing by 8 percent per year will double every 9 years.

As a result, total Credit Market Debt, which measures all forms of debt in the U.S. — including corporate, state, federal, and household borrowing — now stands at a whopping $64 trillion!

Staggering levels of debt prevent investment and consumption. This chokes off future economic growth, which is one reason our economy has endured such struggles over the past decade. Simply put, annual economic growth below 3 percent cannot support annual debt growth of 8 percent.

Hoisington Investment Management wrote the following in its November, 2016 newsletter:

"In the latest statistical year, debt of the four main domestic non-financial sectors increased by $2.2 trillion while GDP gained only $450 billion. Debt of these four sectors (household, business, Federal and state/local) surged to a new high relative to GDP. This will serve as a restraint on growth for years to come.”

Slow growth makes it harder for a nation to pay off its debts. As it stands, debt service is already the fifth largest piece of the federal budget, following Social Security, Medicare, Medicaid and military spending.

Last year the federal government spent $432.6 billion servicing the debt, according to the Treasury Dept. That’s more than was spent on education, science and medical research, transportation, infrastructure, NASA and food and drug safety — combined!

Huge amounts of debt needed to achieve economic growth

Since about 1980, debt has been growing much faster than GDP. In fact, the public debt has grown at 2.6 times GDP since 2008. But it is not possible to perpetually grow debts faster than income.

Total Credit Market Debt rose to a new record high of $64.1 trillion in the first quarter of 2016, according to the Federal Reserve. This was an increase of $645 billion from the previous quarter. It means that in the first quarter, it “cost” $10 in new debt to generate just $1 in new economic growth!

Our entire economic system is predicated on debt to achieve growth. That is hugely problematic… and suicidal.

Persistently slow economic growth

This is a theme I’ve covered many, many times through the years. Despite the huge debt loads incurred annually, growth is becoming ever harder to come by. Debt is choking off growth, as stated above.

Historically, from 1947 through 2016, the annual GDP growth rate in the US has averaged 3.23 percent.

However, since 2001, GDP has reached at least 3 percent in just two years: 2004 (3.8 percent) and 2005 (3.4 percent). In every other year, through 2015, GDP failed to crack 3 percent, a number that was once considered customary.

There are many reason for this, not the least of which is that $64 trillion in total Credit Market Debt discussed above, which is acting as a ball and chain on our economy.

But there's also the matter of stagnant incomes. Though median household income finally rose in 2015, it is still 1.6 percent lower than in 2007, before the Great Recession. It also remains 2.4 percent lower than the peak reached in 1999.

Yet, Americans pay more today for needs like health care and higher education than they did in 1999.

Rents, health insurance, prescription drug costs and tuition have all risen — and are still rising — much faster than the general rate of inflation and, more importantly, much faster than median family income.

Even worse, median earnings for men working full-time are still lower than they were in the 1970s, according to Sheldon Danziger, president of the Russell Sage Foundation, a research group focusing on social issues.

Then, of course, there’s also the fading financial strength of the Baby Boomers, who have passed their peak spending years and are in, or preparing for, retirement. Meanwhile, the Millennials do not have the financial strength (due to low-paying jobs and huge student debts) to fill the void created by the Boomers.

Nearly 40 percent of 18- to 34-year-olds are now living with their parents — the highest percentage since 1940, the end of the Great Depression. That really says it all.

Little productivity growth, despite the technology boom

The working age population in the US (and across the world) is in decline and the number of people past retirement age continues to grow. This is a major headwind and it is already hurting productivity growth, as well as economic growth. Older people aren’t more productive; they’re less productive.

Bureau of Labor Statistics data indicates that U.S. productivity growth from 2010-15 averaged just 0.4 percent per year, down from 1.9 percent during the 1990-2010 period and way down from 2.6 percent during the 1950-1970 period. Historically, productivity gains have been an important engine for wage increases as well as GDP growth.

In his book “An Extraordinary Time," economist and journalist Marc Levinson says the good times are over for good, or at least for the foreseeable future. The economic boom from 1948 to 1973 was extraordinary. What we have now, he asserts, is “the return of the ordinary economy.”

Inventions since 1970, including the internet, don’t live up to the innovations that powered growth from 1870 to 1970, such as refrigerators, cars, telephones, and aircraft. Levinson quotes productivity expert John Fernald of the Federal Reserve Bank of San Francisco, who says, “It is the exceptional growth,” not the slowdown since, “that appears unusual.”

Slow population growth

One of the keys to economic growth is population growth.

However, the population growth rate in the United States has sunk to 0.6 percent, a historic low. According to a December 23 Brookings Institution survey, the rate is at its lowest point since 1936, during the Great Depression.

William H. Frey, a fellow with Brookings wrote:

"It is likely that some of the reduced fertility in recent years is attributable to recession-related delays in family formation among young adult millennials; this trend could reverse in the near future as the economy continues to grow. But higher death rates are likely to continue due to the long-term aging of the population, a phenomenon contributing to projected declines in U.S. growth rates, which could drop as low as 0.5 percent in 2040.”

Huge, persistent trade deficits

The U.S. has run an annual trade deficit every year since 1976 — yes, for four decades.

Half-a-trillion dollar annual trade deficits have been the norm for many years and we surely reached that figure once again in 2016.

As I noted in 2013:

The U.S. has consistently run a gaping trade deficit for decades because we import more than we export. In fact, the U.S. has led the world in imports for decades and is also the world's biggest debtor nation.

Countries with big, persistent trade deficits have to continually borrow to fund themselves. The problem for the U.S. is that we don't export nearly enough to continue paying for all those cheap foreign goods that we've grown so accustomed to.

Year after year, the trade deficit sucks hundreds of billions of dollars, and millions of jobs, out of the U.S. as we continually buy products from overseas that could instead be made here at home.

No nation can continually buy more from abroad than it sells. It's simple arithmetic. Where will the money for all these purchases come from?

It’s a very basic logic: You can't indefinitely buy more than you sell.

New housing bubble

The median price of an existing home reached $234,900 in November, while the median price of a new home rose to $305,400. Remember that median household income remains 2.4 percent lower than the peak reached during 1999. How the hell are people paying higher home prices if incomes remain stuck at 1999 levels?

Back in 1999, the median price of an exiting home was $133,300, while median price of a new home was $164,800 that December.

So, the median price of an existing home has risen by about $100,000 since 1999 and the median new home price has increased by $138,000. Meanwhile, median income remains the same. This simply doesn’t add up. People are being financially squeezed into submission.

National home prices in 2016 finally crossed the previous peak set in 2006. Prices rose every month last year (through October), with a 5.61% increase nationally. Remember, unsustainably high home prices and the associated debt sparked the last housing crisis, which in turn created the broader financial crisis. Yet, prices have now surpassed the 2006 highs. This is reason for genuine concern.

Meanwhile, worker pay had an annual gain of just 2.9% in 2016, which was the fastest increase since the recovery began in mid-2009.

This is further evidence that home-price increases and pay increases are mismatched and have created an uneasy disequilibrium. Homes simply are not affordable for most people and that will likely get many of them in trouble sooner or later. That will create huge problems for all taxpayers, even renters.

Today about 90 percent of all new mortgages are insured by the government through Fannie Mae or Freddie Mac. The taxpayers are backstopping all of these mortgages.

A report by the Social Security Administration had some rather stunning findings.

In 2014, 38% of all American workers made less than $20,000; 51% made less than $30,000; 63% made less than $40,000; and 72% made less than $50,000.

This is likely why there are fewer homeowners now than at any time in the last two decades.

The US homeownership rate fell to 63.5 percent in the third quarter of 2016, the lowest level since early 1995.

Stock market bubble

This is the third-longest bull market in 80 years. There is bound to be a significant correction. As the Romans once implored, “caveat emptor." Or, in today’s parlance, “Buyer Beware."

Equities are very expensive right now. Near-zero interest rates for the past eight years have driven many investors out of bonds, CDs and savings accounts into higher-yielding stocks. But equities are called "risk assets" for a reason. Trillions of dollars are now at stake.

The stock market’s wild advance over the past seven years has been nothing less than a fraud.

A 2016 HSBC research report revealed that virtually all of Wall Street’s gains since 2009 are the result of corporate buybacks. S&P 500 companies have bought a staggering $2.1 trillion worth of their own stock since 2010.

So, individual investors and pension funds haven’t contributed anything to the market’s surge in that span. Almost all of the market’s increases are due simply to corporate buybacks!

Remarkably, this is legal, even though it is outright market manipulation.

Stock buybacks aren't a good use of capital. In fact, they're wasteful. That money would be better allocated to R&D, equipment or other capital improvements. Buybacks don't increase revenues or profits, or even improve future growth. They are a gimmick used to increase earnings per share, but not actual earnings. Buybacks are a fraud.

Buybacks allow companies to spike their earnings per share because they reduce the number of outstanding shares. It’s phony earnings growth. It has nothing to do with demand for a company’s product or services. And buybacks do nothing to promote innovation. It’s all just financial engineering.

Too big too fail banks are now even bigger and more concentrated

The financial crisis only served to make the Big Banks even bigger.

The five largest U.S. banks – JP Morgan Chase Bank, Bank of America, Citibank, Wells Fargo Bank, and US Bank – control nearly half of all assets in the U.S. banking sector.

These five banks collectively held $6.9 trillion in assets as of the third quarter, 2015.

Since 1992, the total assets held by the five largest U.S. banks has increased by nearly fifteen times! Back then, the five largest banks held just 10 percent of the banking industry total.

The mergers and acquisitions that occurred during the financial crisis only exacerbated the problem. The assets held by the five largest banks totaled $4.6 trillion in 2007, meaning they increased by more than 150 percent in just eight years.

This has created even greater systemic risk to the financial sector and the nation as a whole. Such concentration of banking assets is dangerous for our economy and raises the systemic threat to the entire banking sector during the next, inevitable crisis.

Taxpayers are always on the hook for the failures of private banks. Profits are privatized, while losses are socialized


There are more than enough reasons that the U.S. could/will experience another economic or financial crisis. I’ve listed nine of them above, and some of them are inter-related. That makes these predicaments even more pernicious and potentially systemic. I’m sure that some of you reading this may conjure other critical problems as well.

These quandaries are quite easy to see; our elected “leaders” and government officials are fully aware of them, yet nothing is done to address these critical matters. There is no course correcting; there is only finger crossing and keeping their heads firmly planted in the sand… or their asses.

These troubles are not secrets and there should be no surprise when all of this eventually, and inevitably, blows up quite spectacularly. The only question is whether it happens in 2017, or later.