debt, deflation, and debacle
DESCRIPTION
by Richard Vague, managing partner of Gabriel Investments, and Robert Hockett, professor of law at Cornell University Law SchoolTRANSCRIPT
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1945 2011
Debt to GDP
The Raging Debate Between Stimulus and Austerity
on Public Debt
Blue — Federal Debt
Red — Private Debt
Debate tends to omit discussion of private debt
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U.S. Home Mortgages as a percent of GDP
(in percent)
Mortgage Loans/GDP
Mortgage Loans if Continued 16% Trend
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Average 16% growth in previous four decades
RUNAWAY LENDING! 68% growth in ten years and 46% growth in six years
$2.5 trillion in excess mortgages vs trend line
Inevitable spate of non-payment after a period of binge lending brought the Great Recession
Higher asset values not a mitigant, true constraint is income
Rapid Increase in Private Debt Caused the Great Recession
Why Does High Debt to GDP Matter?
• If a home or business owner has high levels of debt, reduced capacity for additional spending and investment
• In aggregate, a country’s capacity for growth is constrained if its citizens and businesses collectively are operating at high leverage
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GDP Non-FinancialPrivate Debt
Total Public Debt Money Supply Trade Tax Receipts
2011 Comparison of Economic Categories (in billions)
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$9 trillion growth in the last ten years
GDP growth correlates more to private debt growth than government debt growth
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U.S. Growth in GDP, Private Debt, and Public Debt
1970-2011
Growth in GDP
Growth in Private
Growth in Public
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Japan Growth in GDP, Public Debt, and Private Debt
1990-2010
Growth GDP
Growth Public Debt
Growth PrivateDebt
Also correlates more than consumer or business separately, M2, trade imbalance levels
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Nominal Private Debt Totals 1919-1935 (in billions)
66% growth 1919-1929
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Private Debt to GDP Trends prior to the Great Depression and Great Recession
(in percent)
Private Debt/GDP 1920-1930
Private Debt/GDP 1997-2007
Runaway Lending: 40% Private Debt to GDP Growth
If the 1920s and 2000s had 40% private debt growth, how many
OTHER times in the last century has private debt growth been 40% in a
single decade?
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KEY GRAPH: Private Debt and Public Debt to GDP 1916-2011
(in percent)
Private/GDP
Public Debt/GDP
1916 2011
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Only Three Periods with Very High Debt Growth Private Debt to GDP 1916-2011
(in percent)
Private Debt to GDP
Only three periods of private debt to GDP growth of 40%
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Only two periods with 150+% absolute private debt to GDP
PREDICTIVE! Only Two Periods With Both
• GOOD NEWS: we now have a tool for predicting — and preventing — the next major crisis of this magnitude
• But how did we miss something so obvious?
• Because many prevailing economic theories and forecasting models ignore debt as “net zero”
• False comfort from low interest rates
• In addition, we missed it because it is widely held that loan growth is always bullish
• WE ARE STILL WELL ABOVE 150% PRIVATE DEBT TO GDP — and growth is harder when you have high debt
• SO HOW WOULD YOU ADVISE DECREASING OUR HIGH RATIO OF DEBT?
– Paying down debt?
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Nominal U.S. GDP, Private Debt, and Public Debt 1920-1939 (in billions)
Private Debt
GDP
Public Debt
• Bank runs precipitated loan liquidation
• Attitude of times: Treasury Secretary Mellon said “liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate … it will purge the rottenness out of the system. … Enterprising people will pick up from less competent people.”
• Mellon advocated weeding out “weak” banks
• The single biggest lesson of the Great Depression for economists was to AVOID major debt pay down — a “liquidity crunch”
• Thus, in the 2000s, we again had runaway lending, but no massive debt pay down after the crisis point, so instead of private debt contraction of 25% and unemployment of 25%, it was 3% and 9%
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Nominal U.S. GDP, Private Debt, and Public Debt Trends 1998 to 2011
(in billions)
Private Debt
GDP
Public Debt
Private Debt/GDP has declined 10% from crisis peak, but is 15% above 2000 and 53% above 1980
• We avoided Depression, but we have a NEW DILEMMA,
– deleveraging contracts GDP, while
– re-leveraging promotes growth, but increases the structural precariousness of the economy and dampens future growth
• EUROZONE CRISIS is also about runaway private debt
• Runaway lending happened in Japan in 1991 — almost 40% private debt growth in ten years then a stock and real estate crash. But no private debt or GDP contraction for 5 years and private debt still at 150% of GDP over 20 years later.
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Total Debt to GDP of Select Countries 1980-2010
Italy
France
Germany
China
Brazil
United States
Japan
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Debt Net of Deposits 1980-2010
US
Japan
Germany
France
Italy
Spain
Almost all countries are on this steep path of increased leverage
• SO HOW WOULD YOU ADVISE DECREASING OUR HIGH LEVELS OF DEBT? – Paydown — causes economic contraction
– Getting government debt under control — a must at some point, but does create short-term GDP pressure and does not address private debt levels
– Growth or Inflation – takes 15 to 20 years or more — and bumps up against the dampening effect of debt on growth
– Debt restructuring — obstacle of moral hazard and objections regarding wealth transfer — but a trillion in restructuring is better than a trillion in new stimulus
– Live with it — don’t we always?
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Jul-06 Dec-06 May-07 Oct-07 Mar-08 Aug-08 Jan-09 Jun-09 Nov-09 Apr-10 Sep-10 Feb-11 Jul-11 Dec-11 May-12
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20-City Composite Case Shiller Home Price IndexJuly 2006 to May 2012
3 Month Moving Average Change in HPI 20-City Composite HPI
August 2009
June2010
July2011
Post-Bust Home Price Cyclicality
Sampling of High LTV Zip Code Areas
ZIP Code City State % Underwater % Price Decline
92301 Adelanto CA 64% -70%
93501 Mojave CA 65% -71%
93505 California City CA 72% -71%
33035 Homestead FL 68% -69%
33127 Miami FL 57% -70%
33142 Miami FL 62% -66%
30274 Riverdale GA 85% -71%
30296 Riverdale GA 84% -66%
30297 Forest Park GA 81% -72%
89030 North Las Vegas NV 77% -76%
89101 Las Vegas NV 75% -76%
89106 Las Vegas NV 72% -71%
89115 Las Vegas NV 77% -72%
Employment-to-Population Ratio Trendline
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Employment-to-Population Ratio, 1960-2012
Women's Labor Force Participation (left)
Full-time Employment to Population Ratio (right)
Full-time and Part-time Employment-to-Population Ratio (right)
Source: Bureau of Labor Statistics
Labor Force Participation Rate Trendline
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Labor Force Participation Rate 1960-2012 Seasonally Adjusted
Source: Bureau of Labor Statistics
Lease Swap
A Resides
B Resides
A Resides
A Resides
B Resides
B Resides
Date 1
Date 2
Date 3
A Owns B Owns
A/B Negative Equity
A/B Bankruptcy
A/B Positive Equity
Structure of Modification Transaction via Eminent Domain
• Investors:
Private &/or Federal
Current MBS
Holders
Eminent
Domain
Trusts
States/
Subunits
PLS Trusts
Overlapping Membership
Good Loans Bad Loans
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$
$ $
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New Obligation New Lending
Home-
Owners
Note: The double-headed arrow represents class overlap rather than a flow. The two vertical arrows crossing the dotted line represent a
detour between the “bad loan” and “good loan” arrows.