Households borrow while business stints: James Saft

November 19, 2013

Nov 19 (Reuters) – Households are borrowing like it’s 2008
but businesses simply won’t play along.

That gap, between households which once again are taking on
debt and businesses which can find nothing better to do with
record profits than hand the money back to shareholders, is at
the center of our economic malaise.

Understand the working behind this and you may be able to
parse not just why everything from art to wine is fetching
record prices but why employment and conventional inflation
remain mired at unacceptable levels.

First, let’s describe what’s happening.

On the one hand we have data released last week from the New
York Federal Reserve which seems to show that, far from
deleveraging, households are now avidly adding to their debts.

Household debt jumped by $127 billion in the third quarter,
the biggest increase since the first quarter of 2008. The
increase was across the board, as Americans went into greater
debt to buy everything from houses to cars to schooling.
Household debt is now growing faster than both GDP and
disposable income, returning to the pattern which drove both
economic growth and serial bubbles in the last decade.

But, while corporate profits are at a post-war peak compared
to GDP, business investment, which has recovered a bit from its
steep recession decline, is still about where it was during the
recession before last.

Think of this as a battle of conflicting incentives.

On one side stand households and investors who are
responding to the very strong liquor which the Federal Reserve
is putting in the punch. By buying up bonds and keeping rates
low, the Fed encourages risk taking and drives prices for assets
– real and financial – higher.

That’s leading to record prices for everything from art to
social media companies to Manhattan real estate. This isn’t just
a phenomenon for the rich, though the rich do get the cream.
Real estate is going up fairly strongly in a wide variety of
markets, as are the stocks owned in so many people’s retirement
funds and accounts.

On the other side are corporate executives, who don’t seem
to have read their economics textbooks. Rather than responding
to high profit margins by investing and competing, they seem
happy to milk their cows without adding much to their herds.

Since business investment, and the loans used to generate
it, are key to growth, this leaves us with an economy which
never quite takes off, leaving employment and inflation at
potentially damaging levels.


Economist Andrew Smithers argues, convincingly, in his new
book “The Road to Recovery: How and Why Economic Policy Must
Change”, that much of this investment drought is down to
executive incentives.

Smithers contrasts the early 1970s with today. Then
companies invested about 15 times more in new equipment and
ventures than they returned to shareholders via dividends. Now
the ratio is less than two. As recently as the 1990s, this
number was as high as six.

Why? The change toward ever greater executive pay, doled out
in share options which are highly sensitive to short-term stock
price movements, has changed how CEOs behave.

That, in combination with the market obsession with making
quarterly earnings targets, has resulted in a corporate
landscape in which legitimate long-term projects can’t get a
hearing because they are not in the best interest of those
making the decisions. Why fund a project which will only bear
fruit when you, the CEO, are out of office and no longer getting
huge yearly allocations of shares?

That’s the real irony here – monetary policy is trying to
get households to behave ever more foolishly because companies
are living as if only today and next quarter matter.

Both groups are arguably responding by making increasingly
poor decisions about how to allocate their funds.

Tucked away in the Fed household debt report was the fact
that, while student debt is surging, so is student debt
delinquency. A total of 11.8 percent of all student loans are
now 90 days in arrears or more. That means more student loans
are now in delinquency than existed in total in mid-2001.

That’s a reflection of the increasing desperation of young
people who, faced with a bleak job market, try to stay in school
to either acquire new salable skills or wait out the recovery.

But with business investment low, that recovery seems
forever delayed.

Former U.S. Treasury Secretary Larry Summers recently argued
that this state of affairs is in part a function of demographics
– that some economies have reached the point where only bubbles
can produce enough juice to bring unemployment satisfactorily

It may well be that, rather than bubbles, what is needed is
effective control of corporations by their owners rather than by
top staff.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at and find more columns at

(Editing by James Dalgleish)

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