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Tuesday, October 27, 2009

Next Installment Of The Hopium Blues

It's all about incomes, really. And the implication of declining incomes for tax receipts, entitlement programs, the needs of the population, etc. Without starting from the fundamentals, it is hard to design workable social or economic stimulus programs.

First, we need some perspective. See Census data here and here for the following.
Click on this for a larger image. What you see here is total housing units from 2000 on, from Census. These are estimates, but pretty good, and no matter how much one discounts these estimates, the fact is that total housing units rose by over 12.5 million from 2000 to 2008.

And what did incomes do? Yes, we have another clickable table, also from Census:
This table gives you ten years of income history by household income quintile in 2008 dollars. That's 1998-2008. The first column is total households. The next four are upper limits by 5th, and the last is the lower limit of the top 5%. US incomes are much flatter than most people want to believe, which is why cutting taxes on everyone but the top 5% is such a futile proposition.

Note the following over this decade:
Note that all income brackets are off their ten year high.
I have discussed tax receipts in 2009 with some thoroughness, and if you have read those posts I think you'll agree that all of these brackets are still falling.

To some extent we are seeing demographics here. As people enter their later 50s, the incomes of those in private industry tend to level off and then start declining. Only government workers maintain their jobs and their income levels.

Another factor is that the incomes of the top brackets were heavily intertwined with the asset bubble. and the grossly disproportionate government/private compensation premiums. See 2006 summary of federal ratios. Over this decade, wages and benefits paid to government workers grew whereas private incomes fell. This last, is, btw, the reason why the WIET declines are so tightly linked to the government wage and salary job losses. Government job losses over the course of this recession have been hugely concentrated toward recent months.

But government jobs are going to continue to decline. This has major implications for financial assets, because as these jobs decline, retirement benefits are going to grow hugely, but the ability to shift money into the retirement funds is declining. So 401k and pension plan benefit stimulus for stocks and bonds is going to erode.

Somewhat obviously, housing values are going to continue to decline for a few years. All the money dumped into housing credits is basically being wasted. As incomes fall and mortgages shift toward actual repayment plans instead of eternal borrowing plans, housing values must fall to compensate. One can shift the adjustment timing a bit by spending all this money, but the end point will be tied not to interest rates, but to incomes.

So the best real stimulus for housing is to concentrate on generating private sector jobs.

If you will look at the second table again, you'll see that incomes for all these brackets declined following the 2001 recession, which really extended into 2003. The income bottoms are centered on 2004, with only the lowest quintile troughing in 2003. You will see a similar pattern on this recession, even if we do not tip into a second cycle of contraction; incomes are going to bottom several years after NBER's official recession end date.

Somewhat obviously, household formation is constrained by lack of income. With the great increase in housing units since 2000, rents will fall until we reach an equilibrium between incomes and rents that allows new household formation. Housing values are highly related to rent, and thus to household incomes.

There are less obvious implications which have strong economic implications. The distortion between government/private incomes is not tolerable. Here we will go back to Table A-5 from the last employment release. As is normal in recessions, the ratio of public/private employment rose from 18.85% in Sept 08 to 19.6% in Sept 09. However private incomes are falling too far and too fast to support taxation levels that can support our government employment. This will either be corrected by public policy or by a hard turn to the right, which is why conservative Ds and conservative Rs are abruptly beginning to sound so much alike. Recovery largely depends on some highly boring and not very marketable adjustments, plus a hefty dose of realism. The Rs have to drop the tax-cutting mantra, and the Dems have to drop the spending mantra. We are living in an era of sharp constraints.

The other obvious implication is that we simply cannot continue to shift costs from government-paid insurance onto those on private insurance. That is why the protests against the current health care "reform" bills have legs and persistence and are coming from both the right and the left. Whether you are a progressive or a hidebound conservative, reforms which promise government subsidies but do not attack the genesis of the problem are not reforms, but cosmetics that will induce sharper future cuts. Since everyone wants to be able to access medical care, this is a rising concern. Since medical costs in the private sector are rising while incomes are falling, it is an acute concern.

Because we are essentially faced with problems of social "fairness", the electoral map is biased toward Democrats. But if the solutions chosen continue to suppress growth, the electoral map will abruptly shift towards Republicans. It is no accident that taxation and employment policies which grossly favor government workers over private workers were those that formed the basis of last year's national elections, and it is no accident that large industries with heavy government lobbying power are managing to get the government to give them hundreds of billions of dollars. The big companies - insurance companies, auto companies, energy companies, financial companies - have all been very successful at getting federal handouts since the Clinton era, and current proposals amount to a huge shift toward handing out more money to relatively prosperous segments. This cannot continue - it will not continue, because the price of its continuance is dollar deflation and a vastly lower standard of living for most Americans.

We'll find a new balance somewhere. None of this is impossible, but the transition to a economy that is capable of growth is going to require a new kind of electoral calculus. Just as CA has been forced to start cutting benefit programs and government spending, the federal government is now faced with the same choice. Every time we pay T. Boone Pickens to build another windmill, we are in effect handing a good portion of that bill to Americans with very moderate incomes, who are already overburdened by their own debts.

Median household income in 2008 (see 2008 Census release) was $50,303. Mean (average) household income was $68,424. Median income for owner-occupation households was $62,082.

While household incomes did not increase for a decade for most households, here is what happened to household debts:

Obviously that correction is not over either. A lot of that is mortgage debt. Let's look at consumer credit outstanding, which is composed largely of CC debt and things like auto loans, student loans, etc. The historical tables for SA consumer debt are here:

In 1998, outstanding consumer credit SA ended at 1.42 trillion. In 2008 consumers ended the year with 2.56 trillion, which we have since paid down to 2.46 trillion. Stated in current dollars, in 1998 the upper income limits for the middle fifths (2/5ths and 3/5ths) of households by income were 30,408 and 48,337. Which makes things look better, but the truth is that consumer debt is paid always in constant dollars from disposable income, which has only declined over that period. It's pretty clear that US consumers compensated for lower incomes with more debt - for a while, until marginal debt repayments increased more than marginal increases in incomes, which then pushed us over into contraction.

This is the signal I picked up in stores this spring, which is only increasing in strength. Inflation cannot rescue us from our debt crisis, because inflation is dependent on rising incomes. Nor can lending more rescue us; this thing toppled on bad lending when people increasingly became unable to repay their loans.

This post is now way too long. I was going to go on to discuss credit cards and the current rumors, but that will have to come later.

Did you see the story floating around that The CC Companies were trying to get delinquent borrows to settle for 50 cents on the dollar?

A great post; one of your best. Now who would like to break the news to the US that their standard of living has peaked and is on the way down? I am sure that will get a great reception. This has ominous implications for a lot of underfunded pension plans. Now if only Summers, Geithner, and Obama could understand it. They seem hell bent on taking us on the Japanese path. You do some of your best work when you are feverish and on meds!
CF - it is a lot better than they'll get if they go BK.

One of the differences in this recession is the very long period of unemployment. The theory used to be that CC balances would go up during a period of unemployment and then that would be good money for a few years. This time, the balances go up and then go to default.

But the most recent impetus was the passage of the law to move the CC changes effective date up to Dec 1st. Total effing panic. Running and screaming in the streets. Pretty much you have to hike everyone's rate this month, and switch everyone to variable this month. A whole lot of expense, a whole lot of aggrieved customers, and the big players were deeply involved in trying to figure out what the traffic would bear, and now aren't going to get a chance to figure it out.

They have no damned idea how to make money on good customers any more. Not at these rates, and you can't offer good rates if you can't adjust them upward when the risk goes up.

It's like the banker pay initiative. The moment that went through, all the money Bernanke had dumped in to the banks to try to prevent credit from contracting was gone from the economy - now every bank is going to pay that back.

We lurch from bad to worse. Crazy Congress Critters have done much evil in their day, but this time they've outdone themselves.
My compliments on a fine piece of analysis.
The T.Boone Pickens line made my day. It should serve as a banner headline of the zeitgeist.
Thanks very much for the education.
PS: I hope your family has put the flu(?) behind?
I bumped into a guy today that negotiated a $7000 pay-off on a $26000 CC balance with BoA. He had some help in that a paralegal friend of his did the negotiating for him, but I was surprised at the size of that write down.

According to him, the capital was "only" 20k. The 6k in interest and fees is automatically excluded per Obama's legislation. (Is that true?) So they started with a 50% write-down on the principle and then got a couple more percent forgiven because the guy was laid-off and disabled. In then end, they negotiated four monthly payments $500, $500, $3000, $3000. He's made three, one more payment to go. No bankruptcy, no court, no collection agency, M2(?) $14k lighter.
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