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Archive for the ‘Debt’ Category

Education and Student Debt

Posted by Steve Markowitz on August 26, 2016

Marshall McLuhan“The reason universities are so full of knowledge is that the students come in with so much and leave with so little.”  Marshall McLuhan

 

Republicans and Democrats attempt to differentiate themselves via their views of the government’s role in the economy.  With close examination, it is hard to find real differences between them.

Those on the Right promote the benefits of “true” capitalism that allows markets to set prices via supply and demand.  Those on the Left share the view that capitalism is too harsh and that the government needs to step in and smooth out inequities created by markets.  At the extreme Left, socialism is promoted, irrespective of its history of failure.

At the macro-economic level there is little difference between Republicans and Democrats.  Crony capitalism is rampant within both parties.  Republicans typically support large industries and those in the military industrial complex.  Democrats promote social programs that benefit industries including education, social services, medical services, and trial lawyers.  The result of crony capitalism has been a significant increase in governmental spending and a surging United States’ debt over the past 50 years.  This debt is in part responsible for the economic malaise that has been inflicted on the country over the past decade.

An example of crony capitalism and the damage it has done is the educational industry.  Through the US Department of Education, as well as at the state and municipal levels, the funds spent on primary education have been skyrocketing as indicated by the charts below.

Total Educational Spending

Spending Per StudentSat Scores

 

 

 

 

However, the increased spending has not resulted in improved education.  The chart shows how poorly our students are doing in basic reading comprehension.

Student DebtThe problem is more significant at the college level.  The educational industry, with support of the US government and its loan programs, has created the false narrative that all Americans require and deserve a college education, irrespective of whether or not it improves their economic well-being.  As a result, the amount of student debt now exceeds $1 trillion and a significant portion of college graduates cannot make an income level that would allow them to pay off the debt in a reasonable period of time.  Many have been forced to move back into their parents’ houses.

While a market-based economy can be a cruel arbitrator of scarce resources, crony capitalism has proven to be catastrophic to those who have been cajoled into inappropriate economic decisions based on government programs.  It is a major cause of the growing wealth disparity between the ultra-rich and average Americans.

Yes, both Hillary Clinton and Donald Trump have prospered under crony capitalism.  The same cannot be said for most Americans.

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California Taxing and Regulating Itself into Bankruptcy

Posted by Steve Markowitz on October 26, 2015

Victor Davis Hanson published a piece in the nationalreview.com titled “Can California be Saved?”.  This article offers a clear indication that California is a canary in the mine for the social and economic decay in America.  Hanson shares the following facts for the State:

  • Los Angeles’s violent crime is up nearly 21% for the first half of 2015 with an 11% increase in property crimes. One cause is California’s Proposition 47 passed in 2014 that released thousands of prisoners.  Proposition 47 was an attempt by California to its costs for the prison system.  Costs may be down, but crime is skyrocketing.
  • California is in the fifth year of a significant drought. This could be alleviated had the State followed through with a new reservoir system approved under California Water Project.  Lack of funding caused projects to be unfinished.
  • California’s traffic accidents have increased by 13% during in last three years. A significant cause is deteriorating roads that are not properly maintained.  It is hard to imagine why a state that includes some of the highest taxes in the country cannot repair its own roads.
  • California is awash with natural resources, yet its gasoline and electricity costs are amongst the highest in the country. Progressive policies inflicted by wealthy liberals who can bear these expenses are the cause.  However, these high costs devastate lower income brackets, a typical unintended consequence of Progressive policies.
  • Approximately 33% of America’s welfare recipients reside in California with nearly 25% of the State’s residents falling below the poverty line. This is unconscionable considering where that state was economically just a few decades ago.

Who is responsible for this sad state of California’s economics?  It is politically expedient to blame the wealthy or nasty conservatives.  However, given that many of the wealthy in California are liberals and all major government offices in the State are controlled by Democrats, this dog just doesn’t hunt.

California can be considered one of the great experiments for American Progressives.  Liberal politicians promised to fix societal ills with all sorts of interventions.  The fact that these ills are larger today than when the liberals started their experimentation and have spent trillions implementing the policies is proof they failed.  In addition, a significant portion of these poorly spent funds were but a form of crony capitalism, benefiting the social services, education and other industries

Adding insult to injury, Progressive policies distorted the economic diversity of the State.  Those considering starting businesses are likely to leave California in search of more business friendly environments.  Those wanting to build wealth for their families moved to states with less aggressive tax policies.  In addition, immigrants found California’s easy to obtain social benefits and naturally matriculated to this environment.  The result; California is top-heavy with those who being pulled in the cart then those pulling it.  The cart is now being bogged down in a quagmire.

California needs to change its political and economic ways if it is to remain solvent.  Before a plan can be created to implement change, it is necessary that the State become introspective and ask why and how California has deteriorated so much over the past five decades.  The answer will be painful for many.

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Posted by Steve Markowitz on October 21, 2015

Macro-Economic Consequences of Excessive Debt

During the past three and half decades the United States and other countries have been on a debt binge.  At an increasing rate the Country has used debt not to finance needed infrastructure or future growth, but instead to increase the lifestyle and wealth of the current generation, most notably Baby Boomers.  Examples include the United States running significant deficits to fund its social programs and crony capitalism.

DebtIn the private sector, individuals and corporations now use a similar philosophy for debt.  Instead of using debt in the traditional role of financing growth, companies use it to increase distribution to executives, employees and shareholders.  Similarly, individuals who in previous generations used debt mainly to fund the purchase homes, vehicles and other big-ticket necessities, now use it to purchase any product that offers instant gratification.  Debt is also used, with governmental support, to fund higher education that no longer offers income growth.  The significant increase in worldwide debt is depicted in the chart.

Although politically incorrect to state in today’s world, excessive debt has consequences.  On the consumer side it often leads to bankruptcies and loss of assets.  A more insidious problem occurs when debt is sovereign, the consequences that we are now seeing in the lethargic economic growth that is occurred since the end of the recession nearly 6 years ago.

Dr. Lacy H. Hunt, Ph.D has published a lengthy report on issues created by excessive debt in the Hoisington Quarterly Review and Outlook – 3Q2015.  This report advises investors to stay in long-term government bonds given the likelihood of long-term \ continued low interest rates.  The report also includes reasons why the debt has been, and will continue to be, a drag on economic growth.  Hunt’s conclusions include:

  • Future business activity will reflect two economic realities: 1) the over-indebted state of the U.S. economy and the world; and 2) the inability of the Federal Reserve to initiate policies to promote growth in this environment.” Translation – The Fed’s easy money policies have not and will not fix the economic problems brought on by excessive debt.
  • S. government debt now stands at 103% of GDP. If private debt is included, the ratio climbs to about 370% of GDP.  Scholarly studies indicate that real per capita GDP growth should slow by about one-quarter to one-third from the long-run trend when the total debt-to-GDP ratio rises into the range between 250% and 275%.  Since surpassing this level in the late 1990s, real per capita GDP has grown just 1% per annum, much less than the 1.9% pace from 1790 to 1999.”  Translation – Excessive debt has led to lower economic growth.
  • These results indicate that the relationship between debt and economic growth is non-linear, or progressively negative, as debt advances to higher levels, a pattern confirmed by academic research (Chart 2). The latest information further supports this relationship.  The current expansion began in 2009, and since then real per capita GDP growth has been 1.3%, less than half the 2.7% average growth in all expansions from 1790 to 1999.”  Translation – This recovery is different and historically weak and seems related to the growing debt.
  • The Bank of International Settlements released a report last month stating that total public and private debt relative to GDP for the entire global economy stands at 265%, up from 219% at the peak of the prior credit cycle. Additionally, the global rate of growth is decelerating significantly while debt levels are continuing to rise, indicating an increasing debt drag. Researcher Chris Martenson calculated that since 2008 total public and private debt rose by $60 trillion while GDP gained only $12 trillion.”  Translation – While the huge deficit spending by governments have not led to proportional economic improvement.
  • Despite the unprecedented increase in the Federal Reserve’s balance sheet, growth in M2 over the first nine months of this year fell below its average rate of growth over the past 115 years, a time when the growth in the monetary base was stable and quite modest (Chart 3).” ….  “The drop in velocity to a six decade low is consistent with a misallocation of capital and an increase in debt used for either unproductive or counterproductive purposes.”  Translation – While the Fed has increased its balance sheet significantly, it has not led to a real increase in the money supply, a requirement for economic growth.
  • The current zero interest rate policy has rendered mass distortions in the allocation of capital and mispricing of risk assets. Such repressed interest rates have contributed to more excess capacity that, in turn, has reduced inflation.  The ZIRP policy allows low quality borrowers access to debt markets, creating untenable balance sheet exposure when economic activity slows”  Translation – The fed’s policies are leading to imbalances in the markets that will ultimate have to rebalance, which always involves pain.
  • An extended period of negative interest rates would lead to many adverse unintended consequences just as with QE and ZIRP. The initial and knockoff effects of negative interest rates would impair bank earnings.  Income to households and small businesses that hold the vast majority of their assets with these institutions would also be reduced.  As time passed a substantial disintermediation of funds from the depository institutions and the money market mutual funds into currency would arise.  The insurance companies would also be severely challenged, although not as quickly.  Liabilities of pension funds would soar, causing them to be vastly underfunded.”  Translation – The coming consequences of the Fed’s policies will not be pretty.

Lacy concludes by saying: “History, economic studies and practicality of politics suggest this is just another red herring trying to solve over-indebtedness with more debt.”  In normal times the obviousness of this conclusion would be laughed at.   But these are not normal times for the world’s economies.

Hoisington Quarterly Review and Outlook – 3Q2015

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Economic Imbalances Connected to Central Bankers’ Policies

Posted by Steve Markowitz on September 25, 2015

In 2008 the worldwide economy seemed at a precipice.  Politicians and economists demanded action that resulted in significant governmental interventions.  It is not possible in hindsight to argue with the policies given the fears at that time.  It is also impossible to determine if we would we would have gone off the economic cliff without the by central banker actions.

We have been taught there is no such thing as a free lunch.  It seems this lesson has been lost in recent decades, especially when it comes to policy and economic decisions.  The interventions made by central banks including the Federal Reserve since 2008 are historic.  Banks have purchased their countries’ debt, in essence printing money.  While so far the negative economic consequences have not been catastrophic, there will indeed be consequences.

There are two general problems typically arising from excess money supply.  The first is inflation.  Inflation has historically been across the board with increased prices for many categories of goods and services during these periods.  This type of inflation has yet to occur.

Another issue arising from an oversupply of money is bubble creation in certain asset categories. This is basically a different type of inflation and it is a growing problem.  Initially the asset bubbles occurred in commodities with prices of oil, gold, and other metals significantly increasing.  These bubbles have already burst with negative consequences affecting exporting countries.  This includes oil-producing countries such as Venezuela, Saudi Arabia and Iraq.  It is also damaged Canada and Australia who initially benefited from the overvalued commodities being purchased by China.

More recently, Chinese and other countries have significantly cut back on commodity purchases as their economies’ have slowed.  Ups and downs are a normal part of business cycles.  However, the uptick since 2008 has not been normal, but instead has been artificially created by various countries’ cheap money policies and deficit spending.

The popping of the commodity bubbles has brought consternation to equity markets that have shown increased volatility.  This is of significant concern because these equity valuations are one of the few remaining mega bubbles.  When this equity bubble pops, the consequences will be ugly. Read the rest of this entry »

Posted in Bubbles, Debt | Tagged: | 1 Comment »

Government Pursues Bad Mortgage Policies with Veterans

Posted by Steve Markowitz on July 17, 2015

Various policies and practices led to the 2008 financial meltdown that nearly took down the world’s economic order.  Many were related to the inappropriate use of debt.

Beginning in the mid-1990s, the Federal Reserve began aggressively using low interest rate policies to offset economic downturns.  This included the Asian markets’ turmoil in the late 1990s, the Datacom and Dot com busts, as well as the economic downturn caused by 9/11.  While these low interest rate policies offered short-term benefits, in the long term they created significantly damage to the economy.

Downturns are a necessary part of economic cycles.  They are often caused when supply and demand of goods and/or services go out of balance.  During downturns excess goods and services are sold off and depressed prices, which ultimately leads to rebalancing supply and demand and then economic growth as more goods and services are required.

The low interest rate Fed policies, along with governmental bailouts, led to huge imbalances including the housing bubble.  With historically low interest rates and lax lending practices, housing prices appreciated on an unsustainable path.  Then, when appreciation turned to depreciation, millions could no longer pay their mortgages leading to the collapse of 2008.

Under typical conditions an economic calamity as encountered in 2008 suffices to “teach” a generation to avoid unsound economic practices.  However, these are not normal times. After 2008 Federal Reserve and central banks doubled down on the low interest rate policies.  While they tempered the effect of the meltdown in the short term, there are responsible for the lackluster recovery, the slowest since the Great Depression.

Pied PiperThe American government often uses interest rate policies to implement social manipulation pursued by Progressives.  The 2008 housing bubble was fed by the government promoting mortgages to income brackets that could not afford to make the monthly payments.  Millions then lost their homes and any equity in them. They would have then better served not purchasing the houses in the first place, but were cajoled into doing so by governmental intervention.  However, even this lesson has not been learned.

Once again the government is promoting imprudent mortgage policies, this time to veterans.  The company NewDay USA promotes as a benefit in one of the headings on its website newdayusa.com states: We’re a Different Kind of Lender.  As a Veteran, You Can Borrow Up to 100% of the Value of Your Home, Not Just 80%.”  NewDay USA goes on to say: ”With up to 100% of your home’s value available, including mortgage balance, you could qualify for thousands of dollars more from NewDay USA.”

NewDay USA could not make this offer without the backing and support of the US government.  This crony capitalism not only benefits the stakeholders at NewDay USA, but also places at risk their customers, veterans who served their country.  It is imprudent for any homeowner to not have at least 20% equity in their home.  This equity cushion not only helps ensure that their mortgage payments will be set at a reasonable level given their income, but it will make it more likely that their homes’ value will remain above the market price during inevitable downturns.

Some politicians back imprudent policies with good intentions, but little understanding of economics; the fools.  Others promote such policies for less benign reasons including crony capitalism; the greedy.  Neither serve the country well.

New Day

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Greek Banks Close for a Week as Crisis Grows

Posted by Steve Markowitz on June 29, 2015

The Wall Street Journal reported that Greece has ordered that its banks remain closed for the next week to the stem panicked cash withdrawals by depositors.  This drastic move indicates that the five year long Greek debt crisis is coming to an end game.

After the financial meltdown occurred in 2008, the economic folly of Europe’s single currency, the Euro, became apparent.  The European Union was created in an effort by Europeans to create a political climate that would lessen the likelihood of future wars on their continent.  This desire was a reaction to the carnage that inflicted on Europe during two world wars in the 20th century.  While the political idea was noble, little thought was given to the economic consequences that a central currency would lead to.  Those consequences are now playing out.

The Euro was destined to create an economic calamity because the political union was not accompanied by a truly economic union.  European countries maintain their own banking systems and Euro central bank was weak.

After the European Union and the Euro were created, the more efficient and stronger economies of North Europe, specifically Germany, obtained the lion share of benefit created by the Union. With nearly all European countries having a single currency, less efficient countries had their cost of labor increased in relation to more efficient ones.  As a result, the poorer countries had a artificially strong currency that enabled them to consume increased amounts of the more efficient countries’, i.e. Germany.  Through the Euro, Greece had to access to relatively cheap borrowing via an overall European credit rating that did not reflect the realities of individual countries.  As a result, Greece and other Southern European countries borrowed more funds than they could afford to pay back and use these funds to purchase imports from Germany and other exporting countries.

When the recession hit, Greece and other countries were unable to make payment on their debt.  This led to a battle between the creditor countries such as Germany and debtors like Greece.

For five years the Greece debt crisis has been a can kicked down the road.  Creditors including, Germany, have been unwilling to forgive Greece’s debt, even though Greece is not a position to repay it.  Had Greece continued to have its own currency, it would have devalued versus the German currency making its exports cheaper and more likely that it would have been able pay back its debt obligations.  The single currency has curtailed this natural rebalancing mechanism of sovereign debt.

Greece has been operating under an austerity program for some years in an effort to pay down its debt obligations.  That effort was doomed to fail since austerity does not address Greece’s uncompetitive position.  Its current efforts to stop the panicked withdrawals At the Greek banks will also fail since this radical step will only create more panic in Greece and other southern European countries.

It is difficult to determine how the next few days will play out with the Greek crisis.  There are basically two long-term solutions 1) Greece drops out of the European Union and reverts back to its own currency, while at the same time defaulting on its debt, or 2) Greece’s creditors, mainly Germany, writes off the loans.  Either scenario has very painful economic consequences.  Either would require a realignment of the Euro and the European Union to correct the economic deficiencies of this unnatural union.

Greece is a relatively small economy.  Had it not been for the Euro, its default would have had only minor consequences for the world economy.  However, similar to international banks that were allowed to become too big to fail, the European Union’s single currency has made the consequences of even smaller economies European countries defaulting too big to fail.

Given the hard choices for Europe, look for the politicians and bankers to do whatever is possible to kick the can down the road.  This means that it is likely they will give Greece more loans to continue the illusion that the country is not defaulting on its loan obligations.  However, that bit of alchemy would only push the crisis off for a short period of time.

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Government Again Pushing Mortgages to Those Who Cannot Afford Them

Posted by Steve Markowitz on May 18, 2015

In 2008 the world economies encountered the worst financial crisis since the Great Depression.  In a supposedly effort to repair the economies, governments transformed them through huge stimulus spending, low interest rate policies and bailouts.  These interventions have contributed to the ongoing weakness in economic recovery since.

The main cause of the 2008 meltdown was the subprime mortgage lending practices that led to loans being hustled to millions who could not afford to pay them back.  When the housing market slowed leading to depreciated housing values, homeowners could no longer refinance, further eroding housing demand that led to many homeowners owing more on the homes than they were worth.  Many walked away from the loans leading to the meltdown, putting at risk nearly most of the world’s largest financial institutions.

Given 2008 is only eight years ago, logic would dictate that we learned a lesson about imprudent financial behavior, at least for a generation.  However, once governments intervene, logic and economic reality take a backseat.  In fact, we are currently traveling down the same road, again fermented by governmental policies.

News.investors.com reported that the US government is again cajoling financial institutions to give mortgages to those that cannot afford them.  Specifically, the Consumer Financial Protection Bureau warned (threatened) lenders that they would be investigated for discriminatory practices if they do not count government assistance payments to lower income individuals as real income.  In announcing this policy, Bureau Director Richard Cordray used the following incredible logic:

The bureau has become aware of one or more institutions excluding or refusing to consider income derived from the Section 8 HCV Homeownership Program during mortgage loan application and underwriting processes.”  …. “Consumers should not be put at a disadvantage just because they receive public assistance.”

So, using the government’s logic, individuals who need governmental payment assistance are worthy of obtaining mortgages.

Once again politicians and bureaucrats are manipulating economic practices and reality in order to further social goals.  Prudent financial practices not only protect financial institutions, but also borrowers.  Instead, the government is placing people in mortgages they are unlikely to be able to repay.  In addition, this policy leads to bad investments decisions for some consumers when housing prices depreciated in the future.  If this occurs on a large enough scale, it will create another housing bubble and melt down mirroring that which occurred in 2008.

There is a flaw in the premise used by the Consumer Financial Protection Bureau.  Inherent in this policy is the view that lending institutions discriminate on people based on noneconomic factors, which is economic lunacy.  Those in the mortgage industry make money offering mortgages.  The more they write the higher the profits, assuming that the mortgages are prudent.  Forcing lenders to make imprudent mortgages will improve the short-term profitability of the mortgage industry, but ultimately hurt those that invest in buying these assets on the secondary market; i.e. pension funds, etc.   That is precisely what in the meltdown of 2008.

Posted in Debt, Mortgages | Tagged: , , , | 1 Comment »

New Consumer Credit Scores Promote Risky Lending

Posted by Steve Markowitz on April 5, 2015

The Wall Street Journal reported the most often used creator of consumer credit scores, Fair Isaac Corporation (FICO), is introducing a new metric for rating consumer credit worthiness.  These metrics will use consumers’ payment history for items like utility bills and how often they have changed their address.  Previously, FICO scores have been created from information obtained by the major credit reporting firms.

In making the announcement, FICO indicated that over 50 million Americans who currently do not have acceptable FICO lending scores would be able to obtain them under the new system.  This fact alone should raise significant concern as to the motivation behind FICO’s change.  However, for those that need more convincing, the FICO’s rating changes come as a result of significant pressure from lending institutions and the real estate industry.  These self-interest groups do not seek change for any other reason than a desire for greater profits.  In the past, relaxing lending standards has resulted in significant economic damage to the greater society.

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Subprime Auto Loans Increase

Posted by Steve Markowitz on September 27, 2014

USA Today reported on the growing number of subprime auto loans being made in the United States. Such loans are made to high-risk borrowers with poor credit scores.  According to USA Today:

  • Since 2009 the number of auto loans made to high risk borrowers with credit scores below 660 has doubled.
  • In the past year the repossession rate for automobiles has increased by 70%.
  • The amount of interest paid by consumers for auto loans is staggering. For those purchasing automobiles on credit in 2009, an aggregate interest of nearly $26 billion will be paid on those loans.
  • In most states more than one half of the consumers have some form of subprime credit.

It is remarkable that only six years after the subprime mortgage fiasco caused a worldwide economic meltdown, similar high- risk loans practices are gaining momentum. In addition, subprime auto loans are being bundled by Wall Street into risky securities and sold to naïve investors.

While the size of the subprime auto loan market is significantly smaller than that of the subprime mortgage loans, a significant amount of failure amongst these loans will damage the overall economy to some extent.

The subprime mortgage market and the bubble it created were a result of governmental and Fed policies that included artificially low interest rates. The current subprime auto loan market is being created by similar policies.  Once again, artificially low interest rate policies promoted by the Federal Reserve support predatory lending practices to those who should not be given loans.  In addition, this low interest rate environment offers fertile ground for the sale of the securitized loan portfolios to investors seeking higher returns through risk.

In addition, the moral hazard has been damaged by the government’s bailouts that saved imprudent lenders and banks from disaster in 2008/2009. These lenders and their investors expect the government to cover their backs during the next meltdown, even if caused by their imprudent lending practices.

Both political parties avoid discussion of debt the damage it causes. This is by political necessity given the ever-expanding debt financing used by the US government.  Debt is inappropriate if used to create wealth today at the expense of tomorrow’s economic growth potential.  It becomes a tragedy when such debt is promoted by imprudent governmental policies.

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Corporate Bonds at Record Levels

Posted by Steve Markowitz on August 28, 2014

The Wall Street Journal reported that corporations are issuing US bonds, i.e. taking on debt, at record levels.  This is the third consecutive year for a record.  So far for 2014 the issued bonds are just shy of $1 trillion.

When corporations sell bonds, typically this is done to raise funds to be used for future expansion.  Such expenditures are usually productive and can be beneficial to the economy as a whole.  However, these are not normal economic times.

With interest rates remaining at record lows for years, companies are taking advantage of this abnormality, issuing debt to refinance previous loans, or merely holding cash with the belief that interest rates will rise in the future.  This hoarding of cheap cash creates economic imbalances with consequences to play out in the future.

The Fed’s low interest rate policies have not created an environment for a sustained economic recovery.  It can be argued that these policies have in fact delayed the recovery by not allowing supply and demand to meet their natural levels.  In addition, many who rely on fixed incomes, such as the elderly, are being hurt as their incomes decrease.  Finally, the artificially low interest rates have led to equity valuations that are now in bubble territory.  The world got a taste of the downside of bubbles in 2008.

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