– Christopher Swann is a Reuters columnist. The views expressed are his own –People can be divided into three classes, it has been said: the haves, the have-nots and the have-not-paid-for-what-they-haves. The prevalence of the third category may be the biggest single source of vulnerability for the U.S. recovery.A stress test of the consumer could reveal more distressing results than the one conducted on the banking system.Debt is at high levels — 130 percent of disposable income, or more than twice its peak in the late 1980s. A slide in net wealth has reduced the collateral Americans can draw upon for emergency loans. Finally, it is now harder to borrow money for new consumption or to roll over existing debt.Like a compromised immune system, this weakness makes consumers extremely susceptible to further shocks. Traumatic as the recent bout of retail restraint may have felt, worse may be in store. After all, consumption rose by 18.5 percent in the seven years to 2008. So far it has only fallen back by less than 2 percent.There are several potential mishaps that could swiftly undermine consumer spending and set the recovery back to square one.Among the most likely problems would be a continued slide in house prices. Even on the conservative measures used by the Federal Reserve, the value of residential real estate has fallen 18 percent since 2006.With signs of recovery still tentative, a further 10 percent slide is well within the realm of possibility — inflicting a further blow on the balance sheet and sense of well-being of American households. (If nervousness over swelling government debt pushes up bond yields, the outcome could be still worse.)Homeowner’s equity, already down to 40 percent from close to 60 percent, would plunge to 35 percent. This would send household wealth down to its lowest level since the mid-1980s. While Americans can’t immediately rebuild the $12 billion of net worth lost over the past 2 years — equivalent to more than a year’s worth of consumption — further losses will heighten their sense of caution.A second threat is also looking increasingly likely — wage cuts. Fifteen percent of employers surveyed by the Society for Human Resource Management reduced pay in the past six months, a threefold increase from earlier this year. It is no longer implausible to imagine nominal wages starting to decline on a nationwide basis.The Employment Cost Index is already rising at its slowest rate since the early 1980s. Wage deflation would make it even harder for Americans to repay the $10.5 trillion of mortgage debt they hold or the $2.5 trillion of consumer credit.Martha Olney, a professor at Berkeley, envisages disproportionate cuts in spending if wages dip. “For households that are paying 60 percent of their income in mortgage and credit payments a 10 percent pay cut does not mean a 10 percent fall in disposable income,” she says. “It’s a 25 percent fall.” This is the danger of leverage.Even under a rosy scenario it could take years for American consumers to repair their finances. If the savings rate rises to 8 percent of disposable income — about $860 billion a year — it will now take four years for debt to return to its 2002 level. This steady drain alone is equivalent to almost 10 percent of consumer spending.After such a substantial loss of wealth, Americans will be pressed to be even more frugal. Along the way American will be hyper-sensitive to any jolts from weaker than expected employment, house prices or financial markets.Consumer spending may not merely stagnate as most economists expect. It could yet decline more sharply. And like the banks, consumers will almost certainly need more support from the central bank and government before this economic malaise is over.
The pace of decline slowed to just 0.56 percent in April. But as last year confirmed, house prices are heavily seasonal. During the busy spring and summer period, the speed of the slide more than halved in 2008.
Ponzi schemes are not always such a bad investment.
Typically they offer such high rates of return that at least a portion of investors end up winning. Tamar Frankel, a professor at the University of Boston, who has made a study of Ponzi schemes believes that it is not unusual for around a third of participants to come out ahead. The eponymous Charles Ponzi offered rates of about 10 percent a month at a time when banks were offering 5 percent a year. Mike Calozza’s scheme benefited about a quarter of those who invested.
Madoff’s scheme may have been more pernicious than either. This is firstly because his rates of return – between 10-17 percent a year – were somewhat parsimonious by the standards of most confidence tricksters. Many investors were loyal enough to stay with Madoff long enough to recoup the equivalent of their principal – in many cases just six or seven years. Sadly, due to the kind of investor that Madoff attracted, Frankel argues, many would plough returns right back into his funds rather than withdrawing them. Part of Madoff’s talent was to attract savers rather than speculators. Rates of return were attractive but not absurdly suspicious.
– Christopher Swann is a Reuters columnist. The views expressed are his own –Optimism has been all but extinguished from the U.S. housing market.The number of Americans lining up for new home loans is shrinking again, according to Wednesday’s release from the Mortgage Bankers Association, and the best that can be said of homebuilding is that it has stabilized at almost 80 percent below its peak.With no end in sight to falling prices, perhaps we should look on the bright side. Indeed, there are three good reasons why sliding prices are not such a bad thing.Falling house prices are usually seen as wealth destruction. But they can also be seen as wealth transfer. The next generation of homebuyers will benefit from our loss. Those young homebuyers who have been able to cling onto their jobs are already reaping the advantage. The American dream of home ownership can now be achieved at bargain basement prices.Take San Francisco. If you earned the median wage in San Francisco at the peak of the housing market in 2006, you would have needed to devote 75 percent of your income to meet mortgage payments on the average home. Now people will pay just 35 percent of their income, according to Ian Morris, chief U.S. economist at HSBC.It would no longer be any surprise if prices remained stagnant for a decade – spreading the benefit of cheap housing for at least 13 million new households.Americans may also reflect that much of their temporary housing wealth was illusory anyway. Since house prices in a given area tend to rise in tandem, the only way to cash out was to borrow against equity, or move to a cheaper area or smaller space, or die.A second consolation is political. Tumbling prices have exposed the flaws in the American government’s efforts to subsidize housing.It is now clear that these efforts did more harm than good. More thoughtful U.S. politicians must now question the mortgage interest tax deduction. The benefit of this tax was heavily skewed towards high earners since they paid a stiffer tax rate. Instead of fostering broad home ownership, the deduction encouraged rich Americans to borrow more and build bigger homes.This is bad financial and even worse environmental policy. At the very least, Congress should now cap this deduction at $500,000.The third source of solace is macroeconomic. For several years America borrowed money from abroad to make an investment that did nothing to expand its productive capacity or its ability to export. Residential construction in 2005 reached 6.3 percent of US national income — its highest level since 1951.A more sober level can be gauged from the average since 1980, which is 4.5 percent. Rampant home building went far beyond the actual housing needs of Americans. Over the past five years around 8.9 million housing units were built and just 6.7 million new households were created, according to Harvard economics professor Edward Glaeser. The number of vacation homes jumped from 3.6 million in 2002 up to 4.8 million now.An ever-growing number of U.S. homes were also vacant, as investors waited for tenants or buyers. Not only did houses become more numerous, they also got bigger. The average square footage of a U.S. family home expanded from 2,200 to 2,500 over the past eight years. “Mistaken beliefs about housing may have crowded out more productive investments,” argues Glaeser.Since two-thirds of Americans own their homes, falling prices are never likely to inspire street parades. The economic loss has certainly outweighed the gains and the banking system may take years to fully recover. Even so, our loss is a hidden accounting gain for the next swath of homeowners. A more balanced economy and housing policy may now emerge. For more philosophically minded Americans, this is a cloud with a silver lining.
– Christopher Swann is a Reuters columnist. The views expressed are his own –The Federal Reserve is putting on a brave face about the rise in Treasury yields.At the moment, the Fed can afford to put off bringing out the big cannons for a little while. If market optimism is overdone, a few weak economic releases would soon send interest rates plunging again. If the market is right, then higher rates are justified and the economy will cope.But Fed policymakers, who next meet in two weeks, should be getting the artillery ready. They have already promised to buy as much as $300 billion of Treasuries before September.Unless rates come down swiftly, this limit should be increased substantially.So far, the Fed has managed to confound the skeptics of their unconventional monetary policy.Fed intervention breathed life back into the commercial paper market and the program appears to be winding down. The purchase of mortgage securities has driven the spread between 30-year mortgages and Treasury yields down to pre-Lehman levels. The result was a spurt of mortgage refinancing.Thursday’s rally in Treasuries notwithstanding, the recent run-up in yields is now threatening this great achievement.Refinancing of home loans has already halved over the last two months and may grind to a halt. Around $3 trillion of Fannie and Freddie debt has a coupon of more than 5 percent.With rates on a 30-year mortgage rising above 5.5 percent, it no longer makes sense to refinance. Mark Zandi of Moody’s Economy.com had expected Americans to save up to $30 billion in 2009 by locking in lower rates. This would require the fixed-rate mortgage to stay under 5 percent.The rise in rates will also damage several federal programs aimed at kick-starting the housing market. The Homeowners Affordability and Stability Plan was created to allow those with very limited home equity to refinance. There will be few takers at current rates.Similarly, the $8,000 tax credit for new homeowners expires on December 1 and will be largely wasted unless rates decline.Against these possible outcomes, an additional round of Treasury purchases by the Fed poses relatively modest risks. The threat of an adverse market reaction — with nervous creditors dumping Treasuries and the dollar — is overdone as is the fear of inflation.So far the Treasury Inflation Protected Securities suggest that investors have confidence in the Fed’s ability to keep inflation in check.Even if the Fed buys its full quota of $300 billion in Treasuries it will still own less than 5 percent of the $6.6 trillion of outstanding market.It can afford to buy much more before suggestions that it is monetizing the debt are to be taken seriously. After all the Fed is planning to buy $1.25 trillion in mortgage-backed securities by the end of the year — leaving it with up to a quarter of the total, according to Louis Crandall, chief economist at Wrightson.The Fed still has great credibility, accumulated in the decades since it vanquished inflation under Paul Volcker. Now is the time to spend some of this credibility.
Rhetorical attacks on the dollar’s supremacy occur with monotonous regularity. They usually come from nations with strained political relations with the U.S. who resent the dominance of the greenback. Iran, Venezuela and Iraq (under Saddam Hussein) all took shots against the dollar.
The announcement by the Russian central bank is part of this tradition, even though it was more diplomatically worded.
– Christopher Swann is a Reuters columnist. The views expressed are his own –Obama’s tax cuts were meant to be the first strike force of the stimulus package. The main selling point — other than political popularity — was speed.Higher take-home pay in April and May would be the first evidence many Americans would see of their government’s broad effort to rescue the economy. The hope was that this would prop up spending long before lumbering public work projects could get under way.Yet the financial impact already looks set to be swept away. The recent run-up in gasoline prices and a surge in personal savings have provided an uncomfortable reminder of the diminutive size of the tax cuts.The cuts are just part of a broad government campaign to revive the U.S. economy — along with fresh infrastructure projects, help to the states and bank bailouts.Even so, boosting take home pay has been an important part of the White House strategy to prop up spending.But the “Making Work Pay” deduction in withholding tax will amount to an estimated $116 billion spread over two years.In April — the first month in which Americans would have noticed the extra take-home pay — the annual infusion was just shy of $50 billion. Even if you add a one-time payment to Social Security recipients and extra unemployment benefits, you still only reach about $80 billion over the year.Compare this with the impact of rising prices at the pump. Americans have been spending roughly $240 billion a year to fill up their cars. A 38 percent increase in retail gasoline prices since the first quarter — if sustained — will increase their yearly bill by more than $90 billion.This alone would be enough to swamp the tax element of the stimulus.A second imposing obstacle has been the increasing desire of Americans to save. Early estimates suggested that jittery consumers stashed away two thirds of Bush’s 2008 tax rebate, turning a bazooka for spending into a pea-shooter.Obama’s package was drafted with precisely this danger in mind. Behavioral economists, like Richard Thaler, believe that one-off bonanzas are more likely to be hoarded, while consumers will spend inconspicuous monthly sums.Again, this clever policy making may be overwhelmed by the sheer scale of the problem. Americans are scrambling to pay down debt. In April consumers paid down around $15.7 billion — once again more than double the monthly impact of personal tax cuts.People with any ability to replenish their savings seem keen to do so. Americans squirreled away an extra $130 billion in April compared with March — a total of $620 billion.To be sure, the outlook would be even grimmer were it not for this well-timed help to the consumer. An increase in take-home pay may also have a psychological effect that outweighs its financial impact. But little should be expected from the tax cut portion of the “stimulus package”.Indeed, it might more accurately be called a “damage limitation” package.
The heads of the big investment banks make appealing targets for public opprobrium – even after they have cut their salaries to a dollar a year. It’s been much easier to put a face on this economic downturn than the slump of the 1930s.
Few would dispute that financial mischief was mostly responsible for tripping up the global economy. But the Congressional Budget Office is making the case that we should not discount the importance of a more faceless recession-generator – oil.
The US housing slump has passed an inauspicious milestone. The vertiginous two-year slide has now taken prices back to their 2000 level in real terms, according to the Case-Shiller index. Even in nominal terms we are back to 2002.
Set against the traditional yardsticks of rents and disposable incomes, house prices are now definitively undervalued. The ratio of house prices to disposable income is languishing at almost 20 percent below its average since the data series began in 1987, Capital Economics calculates. Compared to rents, house price are around 10 percent under their long term average.
The handsome margin by which members of Congress voted to clamp down on the credit card companies should send a powerful signal. With their political power eroding fast, card issuers have to do some urgent rebranding. In fact they need to show more than usual moral rectitude in order to rebuild their reputations.
One intriguing way of doing so is proposed by Dan Ariely, professor of behavioral economics at Duke University and author of Predictably Irrational. Ariely envisages a “self-control” credit card – enabling people to restrict their own spending. Impulsive consumers could impose their own limits on how much they could pay out at a particular store, on a particular category of goods or over a certain time period. (For example a cardholder might fix a limit of $300 a month on clothing.) They could also select their own punishment for lapses. This could be a simple as the embarrassment of a rejected card or more elaborate slaps on the wrist – such as donations to charity or an automatic email to a judgmental spouse, mother or friend.