Debt, Deflation, and Debacle Presentation to the GIC Richmond, Virginia April 9, 2013
The Raging Debate Between Stimulus and Austerity on Public Debt Debate tends to omit discussion of private debt
Debt to GDP 300
250
200 Blue — Federal Debt Red — Private Debt
150
100
50
0 1945
2011
Rapid Increase in Private Debt Caused the Great Recession U.S. Home Mortgages as a percent of GDP (in percent) 80
$2.5 trillion in excess mortgages vs trend line
RUNAWAY LENDING! 68% growth in ten years and 46% growth in six years
70
60
50
Average 16% growth in previous four decades
Higher asset values not a mitigant, true constraint is income Mortgage Loans/GDP Mortgage Loans if Continued 16% Trend
40
30
Inevitable spate of non-payment after a period of binge lending brought the Great Recession
20
10
1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
0
3
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
2011 Comparison of Economic Categories (in billions) $30,000
$9 trillion growth in the last ten years
$25,000
$20,000
$15,000
$10,000
$5,000
$0 GDP
Non-Financial Private Debt
Total Public Debt
Money Supply
Trade
Tax Receipts
5
GDP growth correlates more to private debt growth than government debt growth U.S. Growth in GDP, Private Debt, and Public Debt 1970-2011
Japan Growth in GDP, Public Debt, and Private Debt 1990-2010 12% 10% 8%
-5% -10%
Also correlates more than consumer or business separately, M2, trade imbalance levels
2010
2008
2006
-2% -4% -6% -8%
2004
1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009
0%
2002
Growth in Public
2000
5%
Growth Public Debt 1998
Growth in Private
1996
Growth in GDP
10%
Growth GDP
6% 4% 2% 0% 1994
15%
1992
20%
1990
25%
Growth Private Debt
If runaway private lending caused the Great Recession, did it also lead to the Great Depression?
Nominal Private Debt Totals 1919-1935 (in billions)
Private Debt to GDP Trends prior to the Great Depression and Great Recession (in percent)
$180
66% growth 1919-1929
200
Runaway Lending: 40% Private Debt to GDP Growth
$160 180 $140 $120
160
$100 140
$80
Private Debt/GDP 1920-1930
$60
120 Private Debt/GDP 1997-2007
$40 100
$20
1919 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935
$0 80 1
2
3
4
5
6
7
8
9
10
11
8
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?
2009
2006
2003
2000
1997
1994
1916
1991
1988
1985
1982
1979
1976
1973
1970
1967
1964
1961
1958
1955
1952
1949
1946
1943
1940
1937
1934
1931
1928
1925
1922
1919
1916
KEY GRAPH: Private Debt and Public Debt to GDP 1916-2011
250 (in percent)
2011
200
150 Private/GDP
100 Public Debt/GDP
50
0
Only Three Periods with Very High Debt Growth Private Debt to GDP 1916-2011
250
Only three periods of private debt to GDP growth of 40%
(in percent)
200
Only two periods with 150+% absolute private debt to GDP
PREDICTIVE! Only Two Periods With Both 150
Private Debt to GDP 100
50
2009
2006
2003
2000
1997
1994
1991
1988
1985
1982
1979
1976
1973
1970
1967
1964
1961
1958
1955
1952
1949
1946
1943
1940
1937
1934
1931
1928
1925
1922
1919
1916
0
11
• 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?
Nominal U.S. GDP, Private Debt, and Public Debt 1920-1939 (in billions)
$180 $160 $140 $120
Private Debt $100
GDP Public Debt
$80 $60 $40 $20 $0
1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939
• 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%
Nominal U.S. GDP, Private Debt, and Public Debt Trends 1998 to 2011 (in billions)
30000
25000
20000
Private Debt 15000
GDP Public Debt
10000
Private Debt/GDP has declined 10% from crisis peak, but is 15% above 2000 and 53% above 1980 5000
0 1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
•
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.
Almost all countries are on this steep path of increased leverage Total Debt to GDP of Select Countries 1980-2010 400% Italy
350%
France
300%
Germany
250%
China 200%
Brazil
150%
United States
100%
Japan 2010
2007
2004
2001
1998
1995
1992
1989
1986
1983
1980
50% 200%
Debt Net of Deposits 1980-2010
180% 160% 140% 120% 100%
80%
US Japan Germany France Italy Spain
60% 40% 20% 0% 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
• 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?
Dr. Robert C. Hockett
Post-Bust Home Price Cyclicality 20-City Composite Case Shiller Home Price Index July 2006 to May 2012 1.50% 3-Month Moving Average Change In 20-City Composite Case Shiller Home Price Index
225.00
August 2009 June 2010
July 2011
215.00
1.00%
205.00
0.50%
195.00
0.00%
185.00
-0.50%
175.00
-1.00%
165.00
-1.50%
155.00
-2.00%
145.00
-2.50%
135.00
-3.00% 125.00 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
3 Month Moving Average Change in HPI
20-City Composite HPI
20-City Composite Case Shiller Home Price Index
2.00%
Regional Concentration of High LTV Underwater Mortgages CoreLogic Negative Equity
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 Employment-to-Population Ratio, 1960-2012 65%
66% 64%
60%
62% 55%
60%
50%
58% 56%
45%
54% 40% 35% 1960
52% 50% 1965
1970
1975
1980
1985
1990
1995
2000
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
2005
2010
Labor Force Participation Rate Trendline
Labor Force Participation Rate 1960-2012 Seasonally Adjusted 68.0 66.0 64.0 62.0 60.0 58.0 56.0 54.0 52.0 1960
1965
1970
Source: Bureau of Labor Statistics
1975
1980
1985
1990
1995
2000
2005
2010
Lease Swap A Owns Date 1 A/B Negative Equity
Date 2
B Owns
A Resides
B Resides
B Resides
A Resides
A Resides
B Resides
A/B Bankruptcy
Date 3 A/B Positive Equity
Structure of Modification Transaction via Eminent Domain
Overlapping Membership
• Investors: Private &/or Federal
$
Current MBS Holders
Bad Loans
Good Loans
$
$
Eminent Domain Trusts
$
States/ Subunits
New Obligation
$
New Lending
HomeOwners
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.
PLS Trusts