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Thursday, March 01, 2012

Answer To Anon PA

Update: BEA personal income and outlays for Jan 2012: Brief summary - personal disposable income (real) -0.1 Nov, +0.3 December, -0.1 January. PCE (real) 0.0 all three months. In short, no, things are not changing - they are in fact flattening out Amy provides soundtrack, and Howard provides color. End update.

Anon PA asked if there were enough have-nots to drag down the haves. Is there space for continued expansion in any form?

The answer is not much. There is a structural difference between what we are seeing now and a normal recession. I have been writing this for years, but abruptly that structure took over, largely because of the Fed's mistake last year. They appear to have learned from that mistake, but they are not in control of the globe, and now the ECB is picking up where the Fed left off. This suggests that we will not get the necessary space to escape the Japanese doom.

To explain, we'll start with several graphs of US total wages disbursements adjusted for CPI:

I apologize for the business of this graph, but I opted for completeness.

This shows the 1, 2, 3 & 5 year changes in wages adjusted for CPI-W. That's total wages, not wages per capita.

This would look horrific if I did it per capita. Maybe I will if I can find some good dope or a good shrink to keep me from jumping off a building after I see the result, but it's probably too dangerous to post anyway. I'd hate to go down in history as the blog that killed the most people measured by death percentage among readership.

Now, because that graph is really too cluttered and because we are most interested in the 3 to 5 numbers, here's a lighter version:

Please open this up in another window or tab.

Post the GD, the US has seen nothing like this. Worse yet, things were improving until the Fed got frisky in the last quarter of 2010. Then the 3&5 headed down again. Oops!

The mistake most financial analysts (especially government/Fed analysts) are making is not using a long enough sequence. As long as that five year is going up, you are okay and you don't mess with success. You have real underlying recovery, and the pricing system is beginning to work again.

Note that the private sector is still worse than the public sector.

I have a bunch of other graphs saved down to show you how I got to this, but the longer this post becomes the less likely anyone will read it. So I'll try to keep this short by advancing a bunch of propositions:

1) Because government revenues change mostly with real per capita incomes from jobs (absent a surge in investment income), we have no chance of closing the fiscal gap without continuing to shrink government employment. This inevitably reduces total wages.

2) The ability to raise taxes on most of the population is highly limited - this graph only shows wage disbursements without any correction for taxes. As real wages per capita drop, naturally income taxes drop. That's the nature of a progressive tax system.

3) The shortfall for state and local governments is immense and growing. They have just begun to deal with the massive retirement spending crunch. It continues to get worse for two decades in many cases. Cutting the base paying in to these plans makes it harder to fund the pensions anyway.

4) Before the Fed got frisky, the five year and the three year changes were correcting, with the five year percent change moving above zero. At the end of last year, the five year private change was below -5%. This implies that the Fed can do little or nothing to redress matters. It only has space to act when real deflation threatens - it cannot increase real wages by its actions. If the Fed launches QE3 these curves will become worse.

5) Since the beginning of 2010, wages are inflated by 2% from the payroll tax cut. The "real" five year change is more like -7%. That's in the depression bracket.

6) Any belief that we can cut the base-level elements of social spending is delusional in the extreme. We can cut frivolities, such as subsidizing high-end housing, BS funding for electric cars that don't go anywhere on electricity, BS funding for solar panel manufacturers, BS funding for climate scientists that model worse than economists, BS funding for tax breaks for GE & AIG and their ilk, BS funding for educational grants and loans for worthless college degrees, etc. We cannot cut food stamps and the basic SS.

What we have going for us is that private employment is still expanding somewhat, and we could, if we wanted to take the lid off, greatly correct our energy import imbalance by expanding native energy production. This would generate a long-term positive upward lift.

Only addressing our current account deficit can possibly give us a way out. There is a unity relationship between current account deficits, the private deficit (net cumulative private borrowing), and the government deficit. For a long while we corrected our ever-growing current account deficit by jacking up private borrowing and government borrowing. The private borrowing came to an end, and then the government stepped in to try to keep it going. Malinvestment is still growing, and this must cease.

We should quit worrying about housing prices. They go where they go, and attempts to prevent that will make the economy worse. We should stop trying to make well-off people wealthier. It's a loser - we're making them poorer, and the lower-income people are being crushed.

Here's one additional graph:

This chart shows all wages (disbursements) adjusted for CPI-W, private sector wages adjusted for CPI-W, and government sector wages adjusted for CPI-W. Government sector wages are INDEXED TO THE RIGHT. They are not that high as a percent of private sector wages, obviously.

As you can see, government is still the outlier. They are now dropping, but only in comparison to the jack-up seen in the recession. You are going to have to get that back in line with private sector wages sooner or later. Small annual adjustments would be the best way.

Look at where the black line is in comparison with 2000. Hardly any increase. Look at where the blue line is in comparison to 2000. Big increase. Sad as it is, that relationship must correct. 100% of government wages are paid by the private sector, and most of that is paid by private sector workers. The taxes government workers pay only correct that to about 70% paid by private sector workers - so you cannot sustain a long term disproportion. That's doing it Greek-style, and the dramatization of the inevitable result will be written by Euripides rather than Aristophanes.

The mistake most financial analysts (especially government/Fed analysts) are making is not using a long enough sequence.

I think they consider that a feature, not a bug.
Good morning and thank you very much MOM, that's quite helpful. Maybe even a bit hopeful...

Regarding your comment Charles, too funny. When looking at all the various governmental actions taken, I have sometimes felt as if I was watching the movie "Dumb and Dumber". Now with MOMA's exposition I feel that way even more. Though I swear, I could hear my inner voice saying "so we still got a chance" as I read near the conclusion of MOMA's post.

I do know the people in charge are not dumb, but they do have various constituencies they have to answer to. Your explanation MOMA helps fill in more of that picture too. Thank you again very much for the answer to my question.

And now...more importantly, who plays you in the movie?

Thanks again... Anon PA
MOMA = Museum of Mama's Arithmetic? Located on Columbus Circle, the future home of exhibitions to include "Late 20th Century Cluelessness" and "I Thought You Said There'd be No Math"
To snark or not to snark? That is the question. Guess which option I'm using.

I found the money that's going to solve all of our problems. Everything is going to be fine. Turns out we mostly shipped it overseas. We just need to ask for it back.

Trade Deficit vs. Money Supply
Neil - The revenge of the math nerds museum? That has to be located in some small bankrupt CA city, heated by wood stoves.

Art Broko?

Maybe we need a new game for the new age - Brokopoly. In that game you buy, sell and trade yourself to riches and fame by buying sovereign bonds at a steep discount and selling them at a slightly less steep discount when the government financing kicks in.
Charles - no, they are trying. It's just that we have formed a mental ghetto in higher education dedicated to pretending that we can always escape gravity if we just flap our arms a little faster.

Modern economics literally does not work because it has evolved to ignore the economy. Fatal mistake.
Anon PA - I think Howard Davidowitz gets the starring role. I know, I know - his habit of genteel understatement would seem to unfit him to portray my rowdier character, but on the big screen, his ability to bulge his eyes when presented with idiocy will be a big asset.

There's a chance.

First you need to round up the economists and make them work for a living. Any of them that can actually make a living running a business for five years can come back and work for government.

Then you take the EPA and do the same....

Then while they are preoccupied, you let the people of the country try to make a living. It could work!
As long as we continue to tax domestic labor/productivity
at higher rates than foreign labor/productivity, jobs will
go overseas and our down hill slope will continue. If we
didn't need imported oil, dollar devaluation would have
been more beneficial. Queue the free trade defenders
in 3,2,1,...
I agree a mental ghetto has been formed. To me that's an indication of NOT trying. Or at best trying to make a political point instead of discovering economic facts.

I will never forget my attempt a few years ago to learn about the US mortgage market of the past. Shouldn't have been too hard, I thought, to find that information. Boy was I wrong! 99% of the information goes back only as far as the 1930's. Well, if there was a housing crash during the Great Depression, what was the state of the mortgage market a few years before the crash? Apparently no in the present economics profession gives a damn.

Modern economists take the 30-year mortgage and the FHA, GSE's, etc. for granted. As if they are economic truths. They certainly didn't prevent the "next" crash. They are either purposely using WWII as a selective endpoint (aka cheating) or they don't think they need to consider anything prior (aka stupid). Either way, it ain't useful.

The 30-year mortgage was a rarity that became the norm. In essence, it was the original "extend and pretend." When Tanta said "We are all sub-prime now" she really should have added "We've all been subprime since WWII."
Charles - much of the economic data we have from the 20s and the 30s is pretty sparse.

As for 30 year mortgages, I disagree.

It's not the term but the terms - a 30 year fixed-rate fully amortizing mortgage for 90% LTV at origination is nothing like a 100% LTV @ O interest-only initial term with sharp jump up in payment in 2 or 3 years, and even less like a funny-money 100% LTV @ O that is negatively amortizing for five years (doesn't require the borrower to even pay all the interest).

One of the reasons we have 30 year mortgages is that half the problem in the great crash was that many of those mortgages were balloon loans (five years or less, interest-only). A lot of people had 50% original downpayment and paid on the loans, but when the banks went belly-up they didn't have the money to extend a new loan when the balloon came due.

The 30 year fully amortizing mortgage was a response to earlier excesses and unnecessary risks.

Here's a bit of history for you.

Note that 30 year fixed-rate mortgages cannot mostly be made by banks. The cost of funds would change too much over the 30 year period (what banks have to pay for deposits). You must have some way to move the loans out onto the market and recover capital in much shorter time frames in order to write long term fixed-rate loans.

Banks can write shorter-term adjustable rate loans. However adjustable rate loans with payment step-ups in 3 (best for banks) or 5 years will cause more defaults in later years and thus have greater risk characteristics.
Also, Charles, NBER has up this selection from an old book which provides urban loan sampling of mortgages at commercial banks in the late 1940s. The vast majority had been originated since 1944, of course.

On page 14 (external):
The sample suggests, first, that there has been a decided shift
since 1920 from the nonamortized to the amortized loan: iii the
1920—34 period, from 40 to 45 percent of all sample loans on one to four-family dwellings were nonamoitized, while only about 5 percent of those made in the period 1940—47 were of this• type However, even before the introduction of insured loans in 1934 about 40 percent of the number of sample loans made were on a partially amortized basis and about 15 percent were fully amortized.

Partial amortization has remained a comparatively common characteristic of loans secured by other than one- to four-family properties, accounting for about 40 percent of the number of sample loans made from 1920 through 1944 and 26 perent of those made in the 1945—47 period. Full amortization was less common in the early years of the period studied: only about 9 percent of the number of those loans made in the 1920—34 period were fully amortized as compared with about 50 percent of those made in 1940—47.

PS again - on page 16 (external) you can see a table of loans by period of origination. The sampling period was later, of course, so the earlier loans remaining on the books were less risky than the original crop. That's for sure. Note that of the remaining crop originated in the 1920s, almost 85% had balloons (non-amortized or partially amortized). Non-amortized loans would have required full interest payments but not repayment of principal during the term. Principal amounts were just rolled unless the borrower could pay down the principal at the balloon (frequently they did pay down whatever they had).

If you look at the early 1930s, you see the highest percentage of non-amortized loans (by original amount compared to percent of loans) - that's because the banks didn't want to foreclose, so if the borrower could pay the interest they would roll the loan forever. Beginning in 1935 the new loan scheme which allowed insuring loans under FHA emerged, and you see the sudden fall-out from the non-amortized and partially amortized categories as banks roll those mortgages over to FHA. Over 40% are now insured. The law was only passed in 1934.

Ain't nuthin' changed. There was a huge bailout back then, for both property owners and banks.
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