Debt Deflation in America

While this is all happening, the reality of prime mortgages going under water and defaulting as a business decision is been slowly rammed home. I posted six months ago that this must not happen.

The sub prime disaster has over loaded the housing market and destroyed bank capital curtailing their ability to lend.

The only solution is to make that inventory disappear and abruptly shrink the market. Because it is now devaluing housing backed by prime mortgages and giving the owners a business decision.

You own a house once worth $500,000 with a mortgage of $400,000 and monthly payments of $5000. The house drops to $300,000, if you can find a buyer. You are facing a $100,000 loss if you sell and you have already lost the original $100,000. So you walk. Over the next two years you accumulate $120,000 less whatever you spend on rent and you are back to been whole. If the bank chases you for the loss incurred which is likely approaching $150,000 after everything you offer them $30,000 to settle. Most likely they will take it.

Yes you take a hit on credit, but they were making you pay all those cards off anyway. Since you have a good job, it is no trick at all to be in a new home in a couple of years at a much better price structure. Your friendly mortgage broker will show you how. The point is that you have shed a $100,000 unrealized loss and picked up a $100,000 cash gain and certainly strengthened your real financial position.

Again as I have posted it is possible to turn this titanic around by my previously posted suggestions that no one is ever going to try. Instead we will expand the unsold inventory and let the banks own it all until no defaulters are left.



Debt Deflation in America

What the Jump in the U.S. Savings Rate Really Means

By Michael Hudson

URL of this article: www.globalresearch.ca/index.php?context=va&aid=14153

Global Research, June 29, 2009

Happy-face media reporting of economic news is providing the usual upbeat spin on Friday's debt-deflation statistics. The Commerce Department's National Income and Product Accounts (NIPA) for May show that U.S. “savings” are now absorbing 6.9 percent of income.

I put the word “savings” in quotation marks because this 6.9% is not what most people think of as savings. It is not money in the bank to draw out on the “rainy day” when one is laid off as unemployment rates rise. The statistic means that 6.9% of national income is being earmarked to pay down debt – the highest saving rate in 15 years, up from actually negative rates (living on borrowed credit) just a few years ago. The only way in which these savings are “money in the bank” is that they are being paid by consumers to their banks and credit card companies.

Income paid to reduce debt is not available for spending on goods and services. It therefore shrinks the economy, aggravating the depression. So why is the jump in “saving” good news?

It certainly is a good idea for consumers to get out of debt. But the media are treating this diversion of income as if it were a sign of confidence that the recession may be ending and Mr. Obama's “stimulus” plan working. The Wall Street Journal reported that Social Security recipients of one-time government payments “seem unwilling to spend right away," 1 while The New York Times wrote that “many people were putting that money away instead of spending it.”2 It is as if people can afford to save more.

The reality is that most consumers have little real choice but to pay. Unable to borrow more as banks cut back credit lines, their “choice” is either to pay their mortgage and credit card bill each month, or lose their homes and see their credit ratings slashed, pushing up penalty interest rates near 20%! To avoid this fate, families are shifting to cheaper (and less nutritious) foods, eating out less (or at fast food restaurants), and cutting back vacation spending. It therefore seems contradictory to applaud these “saving” (that is, debt-repayment) statistics as an indication that the economy may emerge from depression in the next few months. While unemployment approaches the 10% rate and new layoffs are being announced every week, isn't the Obama administration taking a big risk in telling voters that its stimulus plan is working? What will people think this winter when markets continue to shrink? How thick is Mr. Obama's Teflon?

We are living in the wreckage of the Greenspan bubble

As recently as two years ago consumers were buying so many goods on credit that the domestic savings rate was zero. (Financing the U.S. Government's budget deficit with foreign central bank recycling of the dollar's balance-of-payments deficit actually produced a negative 2% savings rate.) During these Bubble Years savings by the wealthiest 10% of the population found their counterpart in the debt that the bottom 90% were running up. In effect, the wealthy were lending their surplus revenue to an increasingly indebted economy at large.

Today, homeowners no longer can re-finance their mortgages and compensate for their wage squeeze by borrowing against rising prices for their homes. Payback time has arrived – paying back bank loans, whose volume has been augmented to include accrued interest charges and penalties. New bank lending has hit a wall as banks are limiting their activity to raking in amortization and interest on existing mortgages, credit cards and personal loans.

Many families are able to remain financially afloat by running down their savings and cutting back their spending to try and avoid bankruptcy. This diversion of income to pay creditors explains why retail sales figures, auto sales and other commercial statistics are plunging vertically downward in almost a straight line, while unemployment rates soar toward the 10% level. The ability of most people to spend at past rates has hit a wall. The same income cannot be used for two purposes. It cannot be used to pay down debt and also for spending on goods and services. Something must give. So more stores and shopping malls are becoming vacant each month. And unlike homeowners, absentee property investors have little compunction about walking away from negative equity situations – owing creditors more than the property is worth.

Over two-thirds of the U.S. population are homeowners, and real estate economists estimate that about a quarter of U.S. homes are now in a state of negative equity as market prices plunges below the mortgages attached to them. This is the condition in which Citigroup and AIG found themselves last year, along with many other Wall Street institutions. But whereas the government absorbed their losses “to get the economy moving again” (or at least to help Congress's major campaign contributors to recover), personal debtors are in no such favored position. Their designated role is to help make the banks whole by paying off the debts they have been running up in an attempt to maintain living standards that their take-home pay no longer is supporting.

Banks for their part are slashing credit-card debt limits and jacking up interest and penalty charges. (I see little chance that Congress will approve the Consumer Financial Products Agency that Mr. Obama promoted as a flashy balloon for his recent bank giveaway program. The agency is to be dreamed about, not enacted.) The problem is that default rates are rising rapidly. This has prompted many banks to strike deals with their most overstretched customers to settle outstanding balances for as little as half the face amount (much of which is accrued interest and penalties, to be sure). Banks are now competing not to gain customers but to shed them. The plan is to offer steep enough payment discounts to prompt bad risks to settle by sticking rival banks with ultimate default when they finally give up their struggle to maintain solvency. (The idea is that strapped debtors will max out on one bank's card to pay off another bank at half-price.)

The trillions of dollars that the Bush and Obama administration have given away to Wall Street would have been enough to buy a great bulk of the mortgages now in default – mortgages beyond the ability of many debtors to pay in the first place. The government could have enacted a Clean Slate for these debtors – financed by re-introducing progressive taxation, restoring the full capital gains tax to the same rate as that levied on earned income (wages and profits), and closing the tax loopholes that effectively free finance, insurance and real estate (FIRE) sector from income taxation. Instead, the government has made Wall Street virtually tax exempt, and swapped Treasury bonds for trillions of dollars of junk mortgages and bad debts. The “real” economy's growth prospects are being sacrificed in an attempt to carry its financial overhead.

Banks and credit-card companies are girding for economic shrinkage. It was in anticipation of this state of affairs, after all, that they pushed so hard from 1998 onward to make what finally became the 2005 bankruptcy laws so pro-creditor, so cruel to debtors by making personal bankruptcy an economic and legal hell.

It is to avoid this hell that families are cutting their spending so as to keep current on their debts, against all odds that they can avoid default in today's shrinking economy.

Working off debt = “saving,” but not in liquid form

People are putting more money away, but not into savings accounts. They are indeed putting it into banks, but in the form of paying down debt. To accountants looking at balance sheets, savings represent the increase in net worth. In times past this was indeed the result mainly of a buildup of liquid funds. But today's money being saved is not available for spending. It merely reduces the debt burden being carried by individuals. Unlike Citibank, AIG and other Wall Street institutions, they are not having their debts conveniently wiped off the books. The government is not nice enough to buy back their investments that had lost up to half their value in the past year. Such bailouts are for creditors and money managers, not their debtors.

The story that the media should be telling is how today's post-bubble economy has turned the concept of saving on its head. The accounting concept underlying balance sheets is that a negation of a negation is positive. Paying down debt liabilities is counted as “saving” because one owes less.

This is not what people expected a half-century ago. Economists wrote about how technology would raise productivity levels, people would be living in near utopian conditions by the time the year 2000 arrived. They expected a life of leisure and prosperity. Needless to say, this is far from materializing. The textbooks need to be rewritten – and in fact, are being rewritten.3

Keynesian economics turned inside-out

Most individuals and companies emerged from World War II in 1945 nearly debt-free, and with progressive income taxes. Economists anticipated – indeed, even feared – that rising incomes would lead to higher saving rates. The most influential view was that of John Maynard Keynes. Addressing the problems of the Great Depression in 1936, his General Theory of Employment, Interest, and Money warned that people would save relatively more as their incomes rose. Spending on consumer goods would tail off, slowing the growth of markets, and hence new investment and employment.

This view of the saving function – the propensity to save out of wages and profits –viewed saving as breaking the circular flow of payments between producers and consumers. The main cloud on the horizon, Keynesians worried, was that people would be so prosperous that they would not spend their money. The indicated policy to deter under-consumption was for economies to indulge in more leisure and more equitable income distribution.

The modern dynamics of saving – and the increasingly top-heavy indebtedness in which savings are invested – are quite different from (and worse than) what Keynes explained. Most financial savings are lent out, not plowed into tangible capital formation and industry. Most new investment in tangible capital goods and buildings comes from retained business earnings, not from savings that pass through financial intermediaries. Under these conditions, higher personal saving rates are reflected in higher indebtedness. That is why the saving rate has fallen to a zero or “wash” level. A rising proportion of savings find their counterpart more in other peoples' debts rather than being used to finance new direct investment.

Each business recovery since World War II has started with a higher debt ratio. Saving is indeed interfering with consumption, but it is not the result of rising incomes and prosperity. A rising savings rate merely reflects the degree to which the economy is working off its debt overhead. It is “saving” in the form of debt repayment in a shrinking economy. The result is financial dystopia, not the technological utopia that seemed so attainable back in 1945, just sixty-five years ago. Instead of a consumer-friendly leisure economy, we have debt peonage.

To get an idea of how oppressive the debt burden really is, I should note that the 6.9% savings rate does not even reflect the 16% of the economy that the NIPA report for interest payments to carry this debt, or the penalty fees that now yield as much as interest yields to credit-card companies – or the trillions of dollars of government bailouts to try and keep this unsustainable system afloat. How an economy can hope to compete in global markets as an industrial producer with so high a financial overhead factored into the cost of living and doing business must remain for a future article to address.

Notes

1 Kelly Evans, “Americans Save More, Amid Rising Confidence,” Wall Street Journal, June 27, 2009.
2 Jack Healy, “As Incomes Rebound, Saving Hits Highest Rate in 15 Years,” The New York Times, June 27, 2009.
3 Four years ago at a post-Keynesian “heterodox economics” conference at the University of Missouri at Kansas City (on whose faculty I have been for some years now), I outlined the shift from over-saving to debt deflation. Michael Hudson, “Saving, Asset-Price Inflation, and Debt-Induced Deflation,” in L. Randall Wray and Matthew Forstater, eds., Money, Financial Instability and Stabilization Policy (Edward Elgar, 2006):104-24.

FICO Gamed

FICO is the credit scoring system that tracks credit worthiness. Anyone using credit eventually gets exposed to it and what has happened in the financial business is that the industry has shifted more and more of the decision making process onto automatic systems. This has opened the door to aggressive and abusive gaming of the system by the lenders.

Here is an example of apparent practice. A credit card holder discovered that an error had occurred in his statement. It was a modest error that had the effect of delaying a posting. This dropped his FICO score by two hundred points. This triggered the interest rate to be reset from a very low rate well under 10% to the maximum of 29%. I believe his whole credit card debt was instantly affected. This all took place over a couple of days. Pretty efficient obviously.

He then proceeded to attempt to correct the error. Then he discovered that he had to send a letter outlining the complaint by snail mail and that a full three months or so may elapse before it would be addressed. Realistically this procedure would delay satisfaction for at least six months. The customer would have to be totally anal to suffer through this sort of abuse. This clearly is a deliberate gaming of the system that curiously is typical of an account driven system that has lost touch with its customers. I hate to recall how many times I squabbled with the type who thinks they are doing you a favor.

The point I am making is that the industry is obviously been run by sharps who have now forced the creation of new legislation to protect consumers from abusive practice. Anyway, this is the tip of the iceberg of what has happened to our formerly robust financial system.

What makes it particularly stupid, unless someone shows me different, is that the credit industry cannot go to the courts to successfully collect at all. Thus if credit card holders went of a mass revolt, the industry would not be able to ever recover. It is very much in their interest to coddle their customers who actually enjoy the service and will work hard to keep it in good order.

For what it is worth, a trip to the court house means a discovery process in which you make the credit card company document each and every item creating the claim. To do that invariably generates hundreds of man hours of accounting and copying. Just do not admit any memory of a particular transaction and insist on proof.

Of course, the simple solution is to pass a law in which defaulted credit is converted to a simple low interest loan based on the principle alone. This penalizes the company for lending to bad credit risks and permits a reasonable pay down of the loan and eventual restoration of credit.

Will creditors take advantage of this? Of course, but the negatives are a lot less than bankruptcy, and a restored customer really means he has a new job, and in most cases is back in business.

The point I want to make is that no business funded on high interest loans is inherently stable. The credit industry is now trying to gouge the disappearing creditors as they hastily exit the party. In the process, their business will violently contract and it is certainly not the customer’s fault

Economic Floor and Rick Cook

We are in what should be and actually needs to be the floor of this economic down swing. Most commentators have now bought into the trend line and are all making the classic mistake of projecting its continuance. It is correct to say that it is very ugly and that everyone has had to reevaluate their financial position.

I am calling it a floor for a very simple reason. Asset pricing is now such that it is impossible for the lender to take possession and realize significant recovery. Instead he realizes both a loss and a hit on capital. The hit on capital impacts his lending ability by at least ten times the loss. At best he is unable to replace the asset.

If the only possible solution is a work out that somehow limits the immediate effects of the capital loss, then willy-nilly that is the way it will go. That means that entire inventory is not really in the market. So it is possible to slowly rebuild our way up out of this from the current floor using the programs now going into place.

This article catches the flavor of the times and certainly encourages a massive lowering of expectations. That is now happening a little more directly in the US auto industry. Today it is reported that the auditors saw that they must stick in the chapter 11 warning into the GM financials.

Again no one is getting it. Yes, the banking system needs a massive influx of cash to make up the reduction in their lending multiple and to replace money never to be recovered. That prevents fire sale liquidation of their assets and the total destruction of the economy.

What is also needed is a replacement of credit card debt with cheap term debt, perhaps with a government guarantee and the IRS as enforcer. That begins to free up the individual. After that we need to implement a government sponsored mortgage restructuring program so that the homeowner can ultimately pay off the property and that there is some chance of the government recapturing its investment.

It can be done that simply and that smoothly. Do you hear anyone else saying this?

http://www.globalresearch.ca/index.php?context=va&aid=12512

[“The Last Picture Show” was a 1971 film depicting the decay of small town America . It took place in the fictitious town of Anarene , Texas .]

We hear a distant tune reminiscent of America ’s high and lonely places and the sound of a dry wind blowing. It’s March 2010 in the tiny West Texas town of Anarene . Nothing much happens here any more. The last business shut down a couple of years ago. It was a cement plant that went broke after the housing bubble burst and the banks stopped lending. The kids out of high school drive their jalopies from one end of Main Street to the other past boarded-up storefronts.

Some of the grown-ups carpool to low-wage jobs in a city 50 miles down the road. The elderly have had their Social Security eaten up by the high price of food but still get by on Spam and Kool-Aid. There used to be a movie theater, but it too closed a few months ago. Not a single person went to the “Last Picture Show.”

But there is change in the air! President Barack Obama, who was elected president a couple of years ago, is in the middle of his fiscal year 2010 budget. The 2009 budget had a deficit of $1.75 trillion, a number no fool could even have imagined before the crash of 2008. The projection for 2010 is $1.17 trillion, due to the government’s hopes for an economic recovery. But the jury is out on whether a recovery will ever happen.

Some say the banks are starting to lend again, though no one at the Anarene State Bank knows anything about it. Some say the city down the road is getting a plant to make blades for those new wind turbines. The Anarene high school got funding for an adult training course on writing resumes. The Nightly News says, “ America is coming back.”
I wish!

So what is really going on here?

Well, President Obama’s 2010 budget has attracted a lot of attention. $1.75 trillion? That’s not federal spending. That’s new federal debt!

A good measure of fiscal policy is federal government tax revenues. Revenues for 2010 are projected at $2.19 trillion, off 13 percent from a year ago, due to the recession. With the huge bank bailouts and Obama’s $787 billion economic recovery program, 2010 expenditures are estimated at $3.94 trillion, an increase of 33 percent over 2008.

Then there’s the interest taxpayers must pay on the national debt, which will likely reach $600 billion in 2010. Of course almost 100 percent of all new federal debt is financed by foreigners, mainly China .

But don’t worry, the recovery program will succeed, and the economy will start growing again. THE GOVERNMENT PROMISES! Obama’s budget forecasts such a strong upsurge in economic activity by the end of 2009 that the net for the year will be GDP growth of 1 percent. (Yes, that’s what it says.)

Is it a contradiction that the government is conducting “stress tests” on the nation’s banks in which it is predicting that the recession will last at least until 2011 to see if those banks are strong enough to weather the storm? Yes, it is a contradiction. Even the Federal Reserve does not see recovery coming as quickly as Obama’s budget. Neither do any economists. The budget is not an honest document.

It gets worse. The budget says growth will then continue as far as the eye can see—the projections go out to 2019, when we’ll have a GDP of $22.86 trillion, 61 percent higher than 2008. Happy days will be here again!

So go back to sleep, America . It’s official. The recession we are in right now will end soon and is the last one ever.

This means that the financial industry will soon be fixed, plenty of good jobs will be available, climate change and drought will be overcome, the government budget will be right-sized, and America and the world will be content and at peace. All because of the decisions being made by the Obama administration and approved by Congress during these few critical weeks we’re in the middle of right now.

But there are a whole swarm of flies in the ointment. I’ll mention just two.
One is that according to University of Massachusetts economist Thomas Ferguson, who spoke at last weekend’s Eastern Economic Conference national conference in New York , the Bush/Obama bank bailouts alone will cause a permanent addition of interest payments on the national debt of $100 billion a year forever. That means every American will pay, during the course of his or her lifetime, over $20,000 to rescue the banks from their bad loans. To put that number in perspective, it equates to 2-1/2 years of tuition at a state university that instead will be paid to the government of China or a similar foreign investor.

Yes, America , that is what your elected government just decided you will do.

Another is that the U.S. has had virtually no real economic growth since the early 1970s, because since then we’ve lived in a bubble economy. Look it up. Most of our industrial output has been flat or has declined. Whole industries, such as steel, are shadows of their former greatness. The automobile industry is on life support. We’ve imported huge amounts of foreign capital by selling them our real estate and businesses. As stated on the Economy in Crisis website:

“The United States now no longer controls many of its domestic industries. Over the last 10 years alone foreigners have spent $1.2 trillion to acquire more than 8,000 key US companies. Already as of 2002, foreigners owned fully 20 percent of American manufacturing. In many high-tech and defense-related industries, the proportion is far higher. Such US industries as mining, cement, publishing, engine and power transmission equipment, rubber and plastics, and sound recording and motion pictures are now largely foreign owned. Even in industries like pharmaceuticals, chemicals, industrial machinery, transportation equipment, electronics, metal industries, and coal and petroleum industries, foreign ownership has recently become very high.”

Until the last year, the biggest growth industry within the U.S. had been the financial sector, producing profits of over $500 billion as late as 2006. In other words, the U.S. has replaced working for a living with the manipulation of money and the extraction of interest, either by lending it or by brokering the lending and investment by foreigners. In order to enrich themselves, the financiers, with a lot of help from the government, created the merger/buyout bubble of the 1980s, the dot.com bubble of the 1990s, and the housing/equity/hedge fund/derivative bubble of the 2000s.
All this time, the federal, state, and local governments have tried to keep up by taxing every financial transaction they can get their hands on, including by raising property taxes on the inflated value of family homes. But now, with the last of the bubbles deflating, the tax base is vanishing. So governments, along with the private sector economy, which has been living on capital gains in the absence of job income for all but the very rich, have gone into the tank as well.

President Barack Obama’s economic recovery program, along with the budget just released, is an attempt to substitute a federal government bubble for the failed private sector ones. Like the private sector bubbles, this one is also based on debt. This is because debt is the only way anyone in the U.S. can any longer think of when it comes to creating a national money supply. It includes the president’s proposed $5 billion federal infrastructure bank for lending to state and local governments. This bank will probably offer better interest rates than the bond markets, but it’s still debt.

There was a time in U.S. history when other ways were known to create money; for instance, during the Civil War, when Congress authorized the Lincoln administration to spend Greenbacks directly into existence. The banks hated the Greenbacks, of course, so they got Congress to pass the National Banking Acts of 1863-64, which were the prelude to the Federal Reserve Act of 1913. Today, Greenback-type funding for the federal government is one of the chief provisions of the American Monetary Act drafted by the American Monetary Institute (www.monetary.org).

Another way to introduce debt-free money into the economy is through a dividend, such as the Alaska Permanent Fund, which in 2008 paid every resident $3,269 tax-free out of the state’s resource revenues. There is no good reason why such a dividend could not be paid by every state or by the federal government.

Greenbacks and programs like the Alaska Permanent Fund are part of what I call Dividend Economics. It’s why I’ve proposed the “Cook Plan,” which would be a system of vouchers for the necessities of life in the amount of $1,000 a month for any adult citizen who applied. A smaller amount would be provided as an allowance for children. The vouchers would be taxed like any other income and would supplement other entitlements such as unemployment compensation, Social Security, etc. But taxes would be low for those who would use the vouchers as a main source of income. Under the plan, the vouchers would then be accepted as deposits at a new network of community savings banks that would lend at one percent interest to consumers, students, small businesses, local manufacturing establishments, and family farms.

This would introduce over $2.5 trillion of debt-free money into the economy over the next year, because under the “Cook Plan,” the dividend would be paid directly by the U.S. Treasury without borrowing or taxation. It would not be inflationary, because it would replace money from public bank lending and would result in new goods and services being created within the U.S. producing economy. In fact, we would see a renaissance of local and regional economic activity that would eventually transform the national economy as well.

You may ask, should we just be “giving away money?” My answer is that if the banks can create trillions of dollars in credit out of thin air for lending, why can’t the government create it for the people? The same goes with the trillions the government is borrowing to pay to the banks to reinflate the bubble economy. Give it to the people instead. Look at Obama’s economic recovery program that equates to $225,000 for each new job it hopes to create and probably won’t. Give that to the people too. Let them use the money as a dividend to live on during this emergency and create new jobs as well. Right now there is nothing further from the minds of President Obama and his advisers than such ideas. That’s why his new bubble budget is America ’s “Last Picture Show.”

Richard C. Cook is a former U.S. federal government analyst. His book on monetary reform, We Hold These Truths: The Hope of Monetary Reform, is now available at http://www.amazon.com. He is also the author of Challenger Revealed: An Insider’s Account of How the Reagan Administration Caused the Greatest Tragedy of the Space Age. He can be contacted through his website at http://www.richardccook.com.

Richard C. Cook is a frequent contributor to Global Research. Global Research Articles by Richard C. Cook