60 Minutes offers a glimpse of our real national economic reality (below), while New York and Washington remain wrapped in the insulation of Fed and federal money. Most national commentators remain inside that cocoon -- only vaguely aware of the actual economic reality beyond their circles (though some correspondents are more in touch with the actual America). We hear much commentary from those that rely on numbers or ideology that tells them little about the real dynamics of the economy. Those surprised at the housing collapse will be surprised again in the new decade, but this will be only one of several fundamental surprises for this class of talking heads.
The predominate economic theories are inadequate -- all of them. An Argentine-like future is likely, but there are many unknowns (what will happen with the Chinese currency peg? with tariffs?). Worse fates can happen -- Argentina is a nice country and its people seemed down to earth and friendly when I visited for 5 weeks in 2003. America is in for a major reset of its values.
Some of this reset is already clear -- many people have begun to look for better ways of living.
This will be a true recovery of a better kind.
Watch CBS News Videos Online
Showing posts with label recession. Show all posts
Showing posts with label recession. Show all posts
December 31, 2009
June 13, 2009
Why Federal Borrowing Does Not Crowd Out Private Investment Now...Again
Lately we are hearing various commenters worry that the recent rise in Treasury yields suggests some fundamental market insight that we are on a wrong course. But they are forgetting what is normal. Current rates are more a return to normal. We are a ways yet from rates that are high enough to be threatening. Worrying about these more normal rates is similar to noticing a light breeze after an period of calm, and rushing to close the storm shutters.
Martin Wolf correctly lays out the current situation in a recent FT column.
Readers of this blog will already know this central point made here back in January:
Still, it seems we need to be reminded of the fundamental situation, and it's nice to hear the same central point from another writer, in different language, for clarity.
Martin Wolf correctly lays out the current situation in a recent FT column.
...Economists who believe in “Ricardian equivalence” – after the early-19th-century economist David Ricardo – argue fiscal policy is ineffective, because households will offset any government dis-saving with their own higher savings.Economists disagree fiercely on these points. My approach is “Keynesian”: in extreme moments, the excess of desired savings over investment soars. Again, monetary policy, while important, becomes less effective when interest rates are zero. It is then wise to wear both monetary belt and fiscal braces.
A deep recession proves there is a huge rise in excess desired savings at full employment [Hal here: I'd word this more clearly -- simply that people want to save a lot now and for now that is excess savings], as Prof Krugman argues. At present, therefore, fiscal deficits are not crowding the private sector out. They are crowding it in, instead, by supporting demand, which sustains jobs and profits.
Readers of this blog will already know this central point made here back in January:
...crowding out [which itself leads to higher interest rates]...certainly does happen when an economy is running at or near full steam, so that resources (machines, workers, money) are being fully or almost fully utilized, so that all new output of the economy requires new investment dollars. In that situation, private investment competes for those new dollars with government. But when an economy has much slack, as ours does now, so that more money is sitting in money market accounts and short term treasury bills, there is plenty of available money for government borrowing and investing, and still plenty left for any private borrowing and investing the private sector chooses.
Still, it seems we need to be reminded of the fundamental situation, and it's nice to hear the same central point from another writer, in different language, for clarity.
June 7, 2009
Marketplace Steps Up on Debt and Reality
Marketplace's weekend program stepped up it's game this week to something I'd actually recommend.
Most of the program is focused on debt, savings, and living in the New Reality.
The New Reality (one nice description) and what to do about it were addressed here on this blog.
This New Reality is finally starting to become visible to more people than only a small minority.
Most of the program is focused on debt, savings, and living in the New Reality.
The New Reality (one nice description) and what to do about it were addressed here on this blog.
This New Reality is finally starting to become visible to more people than only a small minority.
May 19, 2009
Usury is OK, and Guns in Parks...
The Senate passed its version of credit card reform today. Several current tricks of credit card issuers will be out of bounds...in the future....eventually...when the rules finally come into effect. But if your card issuer just hiked your rate in a big way, well....
Current usurious rates aren't even on the table. 18%, 25% or 29.99% are all just fine.
One article mentioned that about 1/5 of card holders pay over 20%. Was that data from today?
One of our rate hike notices, which arrived a few weeks back, will raise one card of ours from 12% to about 19%. While these hikes won't affect us much at our house, it's quite easy to imagine the effect on other households. But compare this to the above seemingly reassuring statistic. Our new rate will be below 20%, and isn't in effect yet.
In 6 months, we may find that the above statistic of 1/5 has increased....
The elephant in the room is the question of the rate hikes that have just recently occurred or are on the way, since the card industry could see the new rules coming for miles. Card rate hikes are on the way, notices already sent, and these will slow the economy.
You can check out how your own Senators voted on the question of how many more of your dollars should go to the card industry right now, instead of, for instance, to local businesses where you live. If you are just now starting to pay an extra $40 or $80 a month in interest (a 12 percentage point rise in interest rate on an $8000 balance costs $80/month), will you spend the same amount on local goods and services that you have recently?
If you pay $40 a month more in interest now, will you tip the waiter the same amount? For that matter, will you cut back on eating out even further?
But, while usurious rates are OK with Congress, it's still up in the air whether the guns we need in parks can be loaded:
Current usurious rates aren't even on the table. 18%, 25% or 29.99% are all just fine.
One article mentioned that about 1/5 of card holders pay over 20%. Was that data from today?
One of our rate hike notices, which arrived a few weeks back, will raise one card of ours from 12% to about 19%. While these hikes won't affect us much at our house, it's quite easy to imagine the effect on other households. But compare this to the above seemingly reassuring statistic. Our new rate will be below 20%, and isn't in effect yet.
In 6 months, we may find that the above statistic of 1/5 has increased....
The elephant in the room is the question of the rate hikes that have just recently occurred or are on the way, since the card industry could see the new rules coming for miles. Card rate hikes are on the way, notices already sent, and these will slow the economy.
You can check out how your own Senators voted on the question of how many more of your dollars should go to the card industry right now, instead of, for instance, to local businesses where you live. If you are just now starting to pay an extra $40 or $80 a month in interest (a 12 percentage point rise in interest rate on an $8000 balance costs $80/month), will you spend the same amount on local goods and services that you have recently?
If you pay $40 a month more in interest now, will you tip the waiter the same amount? For that matter, will you cut back on eating out even further?
But, while usurious rates are OK with Congress, it's still up in the air whether the guns we need in parks can be loaded:
One amendment attached to the Senate bill by Senator Tom Coburn, Republican of Oklahoma, would restore a Bush administration policy allowing loaded guns in national parks. That provision is not in the House version, so there may be discussions between the two chambers over the issue.
May 15, 2009
Check to See How Your Senators Voted on Credit Card Reform (Updated)
Here is the first vote to check:
A Yes vote supported a 15% cap on credit card interest rates, limiting usury. A No vote was against the 15% limit on credit card interest. (note that this vote was on whether to include amendment 1062 in HR 627)
Senate Vote on H.R.627: Motion to Waive CBA Sanders Amdt. No. 1062; To establish a national consumer credit usury rate.
People, let's hold them accountable. Let's pay attention. Let's know how they voted, and let's remember and tell our friends.
---------Somehow it doesn't occur to all our Senators that 20% or 25% interest is a bad thing.
Bad for the nation.
One can imagine the lobbying arguments they heard, probably carefully targeted to individual Senators, depending on their temperament and beliefs.
Here are a couple I can imagine:
For a Senator that is a "staunch" "free enterprise" "pro-market" person, but doesn't really understand the basic necessities of markets or enterprise (non-finance enterprise) -- the necessity of having enough potential customers with disposable income left over to buy your product(!) -- an effective pitch could go:
"We gave them a low introductory rate, and planned our business on the premise that the rate later would be higher. Now that defaults are up everywhere, we need higher rates."
For a Senator that is more realistic and down-to-earth, perhaps he'd hear:
"Senator, we'd really like to help you again during your next campaign, but we need your help now."
The 2nd hardly needs any further examination here, but the first pitch is worth batting down.
If a credit card issuer cannot make enough profit at 15% even with a background default rate rising towards 8%-11% for instance (some credit issuers are more careful than others), if that company cannot make it on a 4%-7% spread, then....that isn't a well run company. For issuers that fold at a 15% cap (if any would), we should pleased to let the free market run them out of business and replace them with a company that can live on a 5% or 7% spread of interest (more if the issuer is prudent), which the market would indeed quickly do, in only months. Prohibiting 20%+ interest credit card rates is similar to outlawing an addictive substance that is harmful to health.
---------
Let's illustrate how 20% or 25% interest is ruinous.Consider a typical family carrying a commonplace level of household credit card debt of about $7,000 who then suffer a few (commonplace) financial hits -- too many major expenses at one time, such as multiple large auto repairs in a few months, and some expensive dental work and all of this just after a major replacement expense for a quality refrigerator or money sent to help a kid or relative. (Of course some households could have a previous balance on their cards from items such as furniture before the new expenses...but less discretionary expenditures are also common in debt ramp-ups.) It could easily be the case that after some bad luck for a few months they could end up carrying a significant credit card balance, perhaps even as much as 40% of their annual income for instance.
Let's suppose a family with a household income of $50,000 ended up with a temporary balance on their credit cards of $20,000. Otherwise they are quite average, with a house costing $160,000 at purchase (just a bit over 3 times their annual income) which they bought with 10% down and a good prime mortgage at a nice low fixed 30-year rate of 5.25%.
In other words, a financially responsible family that pays their bills, with excellent credit, who just had some large bills all at once, and not really more than they could handle over time...
...given a normal, reasonable interest rate, such as they expected they would have, due to the advertising of the credit card issuers.
Normally, a credit-worthy family could expect to carry such a balance on a few cards and at an interest rate in the range of 11%-14%.
First, clearly the credit card companies are making a nice, fat profit on balances carried at 12% or 14% interest that are paid over time (account holders that pay on significant balances without defaulting are very profitable for card issuers). In fact, you'll see that shortly.
Do the credit card companies need a higher rate here? Can the family handle a significant rate hike on this existing balance, a practice that is now commonplace according to the news.
So, let's imagine the outcome for this family financially if the $20,000 is carried at 12% in one scenario, and at 22% (21.99%) in the alternative scenario.
What will happen?
Suppose our responsible family with excellent credit spends quite carefully during the next few years, and even gives up their previous plan for a ski trip, settling for a much less expensive trip to SeaWorld once a year.
So, the family is cutting back, paying what they can.
What will happen?
Let's see.
A plan that reduces financial risk is to aim to pay back a high balance like this in around 4 years, because it is likely there will eventually be further expenses, and the family needs to be making real progress reducing debt before those unpredictable future expenses hit.
Putting our balance of $20,000 into the calculator for a 4-year payoff at 12% and 22% yields the following monthly payments:
12% -- $527/month
22% -- $630/month
So, only a difference in our scenario of $103/month more. Is that enough to matter?
Let's see, over 4 years, the roughly $103/month extra adds up to about $4,944 in extra payments (all interest).
Leaving aside for a moment what that $4,944 could have bought, such as two years of $2,470 contributions to an IRA, or $4,944 put into a 529 plan for college for the kids, while the years until college are still enough to earn some returns on the contribution, or....say a replacement used car when the old wagon goes.
Well....the last isn't a trivial example (though neither are the first). Because, in our example this frugal and responsible family has already chosen to repair their old car instead of buying a replacement, because the repair was still cheaper than buying another used-car as replacement....but, in several years, that old car is going to need some more repair, or replacement finally with a newer used car.
hmmm.....
So, there is already a danger this budget difference could put the family on a "crash" course.
But, let's go ahead and look at the budget numbers carefully.
For their monthly mortgage payment on the house described above with $2000 in annual property taxes and a quality $700/year homeowners insurance policy, and PMI (loan to value is 90%) of about $60/month, we arrive at a monthly house payment of $1,080/month.
Let's suppose our family has 1 child, 2 cars, one with a payment of $420/month for another 2 years, and the other older car paid off.
While both parents work, they pay $500/month for daycare for their 3 year-old.
While neither employer provides health insurance, the family has a good quality blue cross policy with a $3500 deductible for which they pay $750/month. To cover their deductible in case of a major medical expense (their regular office visits are covered at a $25 co-pay and no deductible), they funded an traditional IRA last year with $2500, as an emergency fund for medical care (IRA withdrawals are allowed for medical expenses).
For comparison note that the national average health insurance cost for a family is $12,000/year. This family is carefully aiming at a lower cost, but using a significant deductible, for which they have saved up money to help cover.
This is a frugal, money-careful family.
Normally, they contribute $2000/year to a Roth IRA, and this is the only retirement savings they have.
Being an old hand at Turbotax, I ran through all of this family's 2008 tax year. They were able to itemize deductions, due to the costs of medical insurance and home mortgage interest.
With only 5 $25 office visits during 2008, the family had no major medical expenses other than just the basic cost of health insurance. They are healthy and lucky, and don't have significant health costs other than the braces they just had to get for their kid's teeth.
Turbotax revealed they received $600 for their child tax credit, and also a significant child-care tax credit of $1,000, which was a major help, reducing their family federal taxes from about $2800 down to under $1200.
We'd like to list the federal income taxes in our budget, so to figure the family take home pay, we'll subtract only FICA taxes (social security and medicare taxes), and nothing else. All other expenses -- income taxes, health insurance, and retirement will not be withheld, but paid in our budget below.
Take home pay after FICA for our family is then $46,175 or $3848/month.
Also, our lucky family lives in a state with no income tax.
Nice. So this careful, prudent family, who are in many ways lucky and who Uncle Sam has treated very well in 2008, how will things turn out for them financially?
So, with all these advantages, with all these favorable basic facts, but with a few typical large expenses all at once of $20,000, will our family make it financially???
Let's suppose the family doesn't mind sweating some in the summer and is lucky enough to choose a low-cost electricity plan at only 10 cents/KwH. Nice. Their electric bill will average out over a year to only $120/month.
This is a careful, conservative, prudent family, remember?
So here are the budget results (on a few items like gasoline I just use some commonplace amounts):
Monthly Expenses before Credit Card Payments:
Housing Payment: $1080
Health Insurance: $750
Roth IRA Savings: $167
Auto Payment: $420 (5-yr, 6% auto loan for a car just under $22K)
Auto Insurance: $80 (they have good $100K/$300K insurance but comprehensive on 1 car).
Auto tags/inspections: $12 (about $140/year)
Child Care: $500
Federal Taxes: $100
Electric Utility: $120 (average over year)
Gas Utility: $35 (average over year)
Trash/sewer/water: $65
Grocery Budget: $600
Eating Out: $80 (yes, that's only $80 for a whole month -- they cook a lot at home)
Gasoline: $110
Phone and Internet: $75 (our frugal family forgoes cable TV and uses an antenna)
HOA fees: $20
Cell Phones: $65 (this may seem low, but these people are frugal)
Movie Rentals: $15 (cheap entertainment)
Clothing: $35 (some work clothes, some GoodWill clothes)
Dog food: $30 (most families have a pet)
Haircuts, cosmetics, toiletries: $45
Life Insurance: $50 (both parents, prudent, are insured with term life insurance)
Health Club: $20 (they have a deal!)
Babysitter: $25 (obviously, this is about 1 night's worth, again: think frugal)
Ok....let's see where we are at with this very basic, frugal family budget
-----------------------------------------------
Basic Frugal Budget $4499
....
UH OH
(it seems paying the full cost of health insurance has shot this family's budget)
....
It seems our family can't quite....live....this basic budget on $50,000/year.
OK, let's suppose the parents have been working quite hard at their jobs, and are great at them, and they just got BIG raises....(perhaps in part due to their employers canceling health insurance benefits).
Let's revise the family income upwards to a very average family level of $60,000
$10,000 is a nice raise, yes?
But...we'll keep that credit card debt unchanged at $20,000, now about 1/3 annual income.
Federal taxes increase (TurboTax says) to about $232/month.
Take home pay after FICA withholding only is now increased to $55,410 or $4618/month.
The basic budget though is increased by only the new income tax increase, or another $132/month:Basic Frugal Budget $4631
whew....not so good...
It seems $60,000 is not enough for our "frugal budget" above.
Notice that some or several of the items are *less* than your own family spends?
Ok, let's cut costs to the bone, and put on a 2nd job for dad.
Of course, some families don't have a $420/month auto payment.
Let's give them a cheaper car there.
Let's cut that car payment to $350/month -- they bought a cheaper car to begin with, say. This cuts the basic Budget by $70/month.
Dad is now working 55/hours week (40hrs + 15 hours on the 2nd job at $9/hour) and brings in an extra $6750/year now in 50 weeks.
The little boy sees less of dad now, but....life is sometimes hard (and sometime made harder by decisions of other people though), and that's a reality.
Of course, another job will require a little more gasoline, and probably the family will need fast food a few times also, being too exhausted to cook sometimes. Let's suppose $20 more for gasoline, and $25 more for fast food.
This brings home another 6233/year after FICA, or $520/month, for a total of $5,137/month. Federal taxes increase by another $91 to $323/month now. Against the increase of $91/month in taxes we decrease the car payment by $70, then add $45 for more fast food and gasoline for a net increase of $66 in the budget:
Basic Frugal Budget $4697/month
Ok, now with 3 jobs and a cheaper car the family is bringing in enough for their basic frugal budget and will have
$440/month left to pay on... credit cards.
hmmm.....
remember this payment amount on the $20,000?:
12% -- $527/month
22% -- $630/month
We are still not making it here...
ok, we have to be somehow more favorable, less desperate. Let's say that that credit card balance for those unexpected expenses all at once was only $15,000.
We are now under 1/4th of family income from that expensive, unlucky 4 months.The new 4-year payment amounts (on $15,000) are:
12% -- $395/month
22% -- $473/month
Ok, now we've made it. The family can pay the credit cards. Sort of.
They can pay about $400/month at 12% interest. Or with the help of Congress, they can pay more, about $470/month, lining the pockets of bank executives and investors. Perhaps they can save somewhere else in the budget to close that $33 a month gap needed to make the $473 payment when the interest rate is 22%.
Is one scenario better for the economy than the other?
I'm not just being rhetorical with that question. The $78 more each month the family has available under the lower interest rate is sustainable (non-credit) money that will be spent, sooner or later (more later if saved first), in the ordinary economy -- giving a waitress an extra tip, or buying a little iPod. It's discretionary money like this that ultimately provides you and I with our jobs. If that is sent off instead as extra interest, it can go to investors overseas, or into an U.S. high-wealth portfolio of securities somewhere, and be socked away for decades.
-----------
Update: A helpful reader pointed out that the example of buying a couch (in addition to medical and repair bills) suggested the example family wasn't prudent enough, so I substituted an equally realistic example without a couch. But ultimately the issue wasn't what a family chose to buy in piling up debt, so much as just simple usury, and worse usury after the fact.
I liked this metaphor from Austan Goolsbee in a NYTimes article on the credit card reform bill to describe the practice of raising rates exorbitantly on existing balances:
A Yes vote supported a 15% cap on credit card interest rates, limiting usury. A No vote was against the 15% limit on credit card interest. (note that this vote was on whether to include amendment 1062 in HR 627)
Senate Vote on H.R.627: Motion to Waive CBA Sanders Amdt. No. 1062; To establish a national consumer credit usury rate.
People, let's hold them accountable. Let's pay attention. Let's know how they voted, and let's remember and tell our friends.
---------Somehow it doesn't occur to all our Senators that 20% or 25% interest is a bad thing.
Bad for the nation.
One can imagine the lobbying arguments they heard, probably carefully targeted to individual Senators, depending on their temperament and beliefs.
Here are a couple I can imagine:
For a Senator that is a "staunch" "free enterprise" "pro-market" person, but doesn't really understand the basic necessities of markets or enterprise (non-finance enterprise) -- the necessity of having enough potential customers with disposable income left over to buy your product(!) -- an effective pitch could go:
"We gave them a low introductory rate, and planned our business on the premise that the rate later would be higher. Now that defaults are up everywhere, we need higher rates."
For a Senator that is more realistic and down-to-earth, perhaps he'd hear:
"Senator, we'd really like to help you again during your next campaign, but we need your help now."
The 2nd hardly needs any further examination here, but the first pitch is worth batting down.
If a credit card issuer cannot make enough profit at 15% even with a background default rate rising towards 8%-11% for instance (some credit issuers are more careful than others), if that company cannot make it on a 4%-7% spread, then....that isn't a well run company. For issuers that fold at a 15% cap (if any would), we should pleased to let the free market run them out of business and replace them with a company that can live on a 5% or 7% spread of interest (more if the issuer is prudent), which the market would indeed quickly do, in only months. Prohibiting 20%+ interest credit card rates is similar to outlawing an addictive substance that is harmful to health.
---------
Let's illustrate how 20% or 25% interest is ruinous.Consider a typical family carrying a commonplace level of household credit card debt of about $7,000 who then suffer a few (commonplace) financial hits -- too many major expenses at one time, such as multiple large auto repairs in a few months, and some expensive dental work and all of this just after a major replacement expense for a quality refrigerator or money sent to help a kid or relative. (Of course some households could have a previous balance on their cards from items such as furniture before the new expenses...but less discretionary expenditures are also common in debt ramp-ups.) It could easily be the case that after some bad luck for a few months they could end up carrying a significant credit card balance, perhaps even as much as 40% of their annual income for instance.
Let's suppose a family with a household income of $50,000 ended up with a temporary balance on their credit cards of $20,000. Otherwise they are quite average, with a house costing $160,000 at purchase (just a bit over 3 times their annual income) which they bought with 10% down and a good prime mortgage at a nice low fixed 30-year rate of 5.25%.
In other words, a financially responsible family that pays their bills, with excellent credit, who just had some large bills all at once, and not really more than they could handle over time...
...given a normal, reasonable interest rate, such as they expected they would have, due to the advertising of the credit card issuers.
Normally, a credit-worthy family could expect to carry such a balance on a few cards and at an interest rate in the range of 11%-14%.
First, clearly the credit card companies are making a nice, fat profit on balances carried at 12% or 14% interest that are paid over time (account holders that pay on significant balances without defaulting are very profitable for card issuers). In fact, you'll see that shortly.
Do the credit card companies need a higher rate here? Can the family handle a significant rate hike on this existing balance, a practice that is now commonplace according to the news.
So, let's imagine the outcome for this family financially if the $20,000 is carried at 12% in one scenario, and at 22% (21.99%) in the alternative scenario.
What will happen?
Suppose our responsible family with excellent credit spends quite carefully during the next few years, and even gives up their previous plan for a ski trip, settling for a much less expensive trip to SeaWorld once a year.
So, the family is cutting back, paying what they can.
What will happen?
Let's see.
A plan that reduces financial risk is to aim to pay back a high balance like this in around 4 years, because it is likely there will eventually be further expenses, and the family needs to be making real progress reducing debt before those unpredictable future expenses hit.
Putting our balance of $20,000 into the calculator for a 4-year payoff at 12% and 22% yields the following monthly payments:
12% -- $527/month
22% -- $630/month
So, only a difference in our scenario of $103/month more. Is that enough to matter?
Let's see, over 4 years, the roughly $103/month extra adds up to about $4,944 in extra payments (all interest).
Leaving aside for a moment what that $4,944 could have bought, such as two years of $2,470 contributions to an IRA, or $4,944 put into a 529 plan for college for the kids, while the years until college are still enough to earn some returns on the contribution, or....say a replacement used car when the old wagon goes.
Well....the last isn't a trivial example (though neither are the first). Because, in our example this frugal and responsible family has already chosen to repair their old car instead of buying a replacement, because the repair was still cheaper than buying another used-car as replacement....but, in several years, that old car is going to need some more repair, or replacement finally with a newer used car.
hmmm.....
So, there is already a danger this budget difference could put the family on a "crash" course.
But, let's go ahead and look at the budget numbers carefully.
For their monthly mortgage payment on the house described above with $2000 in annual property taxes and a quality $700/year homeowners insurance policy, and PMI (loan to value is 90%) of about $60/month, we arrive at a monthly house payment of $1,080/month.
Let's suppose our family has 1 child, 2 cars, one with a payment of $420/month for another 2 years, and the other older car paid off.
While both parents work, they pay $500/month for daycare for their 3 year-old.
While neither employer provides health insurance, the family has a good quality blue cross policy with a $3500 deductible for which they pay $750/month. To cover their deductible in case of a major medical expense (their regular office visits are covered at a $25 co-pay and no deductible), they funded an traditional IRA last year with $2500, as an emergency fund for medical care (IRA withdrawals are allowed for medical expenses).
For comparison note that the national average health insurance cost for a family is $12,000/year. This family is carefully aiming at a lower cost, but using a significant deductible, for which they have saved up money to help cover.
This is a frugal, money-careful family.
Normally, they contribute $2000/year to a Roth IRA, and this is the only retirement savings they have.
Being an old hand at Turbotax, I ran through all of this family's 2008 tax year. They were able to itemize deductions, due to the costs of medical insurance and home mortgage interest.
With only 5 $25 office visits during 2008, the family had no major medical expenses other than just the basic cost of health insurance. They are healthy and lucky, and don't have significant health costs other than the braces they just had to get for their kid's teeth.
Turbotax revealed they received $600 for their child tax credit, and also a significant child-care tax credit of $1,000, which was a major help, reducing their family federal taxes from about $2800 down to under $1200.
We'd like to list the federal income taxes in our budget, so to figure the family take home pay, we'll subtract only FICA taxes (social security and medicare taxes), and nothing else. All other expenses -- income taxes, health insurance, and retirement will not be withheld, but paid in our budget below.
Take home pay after FICA for our family is then $46,175 or $3848/month.
Also, our lucky family lives in a state with no income tax.
Nice. So this careful, prudent family, who are in many ways lucky and who Uncle Sam has treated very well in 2008, how will things turn out for them financially?
So, with all these advantages, with all these favorable basic facts, but with a few typical large expenses all at once of $20,000, will our family make it financially???
Let's suppose the family doesn't mind sweating some in the summer and is lucky enough to choose a low-cost electricity plan at only 10 cents/KwH. Nice. Their electric bill will average out over a year to only $120/month.
This is a careful, conservative, prudent family, remember?
So here are the budget results (on a few items like gasoline I just use some commonplace amounts):
Monthly Expenses before Credit Card Payments:
Housing Payment: $1080
Health Insurance: $750
Roth IRA Savings: $167
Auto Payment: $420 (5-yr, 6% auto loan for a car just under $22K)
Auto Insurance: $80 (they have good $100K/$300K insurance but comprehensive on 1 car).
Auto tags/inspections: $12 (about $140/year)
Child Care: $500
Federal Taxes: $100
Electric Utility: $120 (average over year)
Gas Utility: $35 (average over year)
Trash/sewer/water: $65
Grocery Budget: $600
Eating Out: $80 (yes, that's only $80 for a whole month -- they cook a lot at home)
Gasoline: $110
Phone and Internet: $75 (our frugal family forgoes cable TV and uses an antenna)
HOA fees: $20
Cell Phones: $65 (this may seem low, but these people are frugal)
Movie Rentals: $15 (cheap entertainment)
Clothing: $35 (some work clothes, some GoodWill clothes)
Dog food: $30 (most families have a pet)
Haircuts, cosmetics, toiletries: $45
Life Insurance: $50 (both parents, prudent, are insured with term life insurance)
Health Club: $20 (they have a deal!)
Babysitter: $25 (obviously, this is about 1 night's worth, again: think frugal)
Ok....let's see where we are at with this very basic, frugal family budget
-----------------------------------------------
Basic Frugal Budget $4499
....
UH OH
(it seems paying the full cost of health insurance has shot this family's budget)
....
It seems our family can't quite....live....this basic budget on $50,000/year.
OK, let's suppose the parents have been working quite hard at their jobs, and are great at them, and they just got BIG raises....(perhaps in part due to their employers canceling health insurance benefits).
Let's revise the family income upwards to a very average family level of $60,000
$10,000 is a nice raise, yes?
But...we'll keep that credit card debt unchanged at $20,000, now about 1/3 annual income.
Federal taxes increase (TurboTax says) to about $232/month.
Take home pay after FICA withholding only is now increased to $55,410 or $4618/month.
The basic budget though is increased by only the new income tax increase, or another $132/month:Basic Frugal Budget $4631
whew....not so good...
It seems $60,000 is not enough for our "frugal budget" above.
Notice that some or several of the items are *less* than your own family spends?
Ok, let's cut costs to the bone, and put on a 2nd job for dad.
Of course, some families don't have a $420/month auto payment.
Let's give them a cheaper car there.
Let's cut that car payment to $350/month -- they bought a cheaper car to begin with, say. This cuts the basic Budget by $70/month.
Dad is now working 55/hours week (40hrs + 15 hours on the 2nd job at $9/hour) and brings in an extra $6750/year now in 50 weeks.
The little boy sees less of dad now, but....life is sometimes hard (and sometime made harder by decisions of other people though), and that's a reality.
Of course, another job will require a little more gasoline, and probably the family will need fast food a few times also, being too exhausted to cook sometimes. Let's suppose $20 more for gasoline, and $25 more for fast food.
This brings home another 6233/year after FICA, or $520/month, for a total of $5,137/month. Federal taxes increase by another $91 to $323/month now. Against the increase of $91/month in taxes we decrease the car payment by $70, then add $45 for more fast food and gasoline for a net increase of $66 in the budget:
Basic Frugal Budget $4697/month
Ok, now with 3 jobs and a cheaper car the family is bringing in enough for their basic frugal budget and will have
$440/month left to pay on... credit cards.
hmmm.....
remember this payment amount on the $20,000?:
12% -- $527/month
22% -- $630/month
We are still not making it here...
ok, we have to be somehow more favorable, less desperate. Let's say that that credit card balance for those unexpected expenses all at once was only $15,000.
We are now under 1/4th of family income from that expensive, unlucky 4 months.The new 4-year payment amounts (on $15,000) are:
12% -- $395/month
22% -- $473/month
Ok, now we've made it. The family can pay the credit cards. Sort of.
They can pay about $400/month at 12% interest. Or with the help of Congress, they can pay more, about $470/month, lining the pockets of bank executives and investors. Perhaps they can save somewhere else in the budget to close that $33 a month gap needed to make the $473 payment when the interest rate is 22%.
Is one scenario better for the economy than the other?
I'm not just being rhetorical with that question. The $78 more each month the family has available under the lower interest rate is sustainable (non-credit) money that will be spent, sooner or later (more later if saved first), in the ordinary economy -- giving a waitress an extra tip, or buying a little iPod. It's discretionary money like this that ultimately provides you and I with our jobs. If that is sent off instead as extra interest, it can go to investors overseas, or into an U.S. high-wealth portfolio of securities somewhere, and be socked away for decades.
-----------
Update: A helpful reader pointed out that the example of buying a couch (in addition to medical and repair bills) suggested the example family wasn't prudent enough, so I substituted an equally realistic example without a couch. But ultimately the issue wasn't what a family chose to buy in piling up debt, so much as just simple usury, and worse usury after the fact.
I liked this metaphor from Austan Goolsbee in a NYTimes article on the credit card reform bill to describe the practice of raising rates exorbitantly on existing balances:
Austan Goolsbee, an economic adviser to President Obama, said that while the credit card industry had the right to make a reasonable profit as long as its contracts were in plain language and rule-breakers were held accountable, its current practices were akin to “a series of carjackings.”“The card industry is giving the argument that if you didn’t want to be carjacked, why weren’t you locking your doors or taking a different road?” Mr. Goolsbee said.
May 8, 2009
The Best of the Week
As a regular feature I'll be posting on the weekend a Best of the Week, which will occasionally be updated on Sundays also (if not posted on Sunday to begin with). Work is proceeding on the final draft of the book I've been working on (see my profile).
This week a couple of pieces stood out for drama:
Charlie Rose had an interview with Neel Kashkari (notes below):
some interesting moments (times):
9-11 minutes: house prices, loan modifications, what will end the "housing crisis"
17-23 minutes: the $700 billion, the crisis, the changes, the reasoning
24: "Nationalize (sic) the banks" vs. reality
...
And not to be over-shadowed, Adam Davidson, whom is usually fun to listen to, ended up going overboard on Elizabeth Warren, finally resorting to labels and pigeonholes. Of course, such don't fit so well. If Elizabeth Warren is "left", then the left is smaller than I thought, and we'll be needing a new label (or not) for what used to be "left". If you listen, here are a few economists Adam forgot when he said no economists agree that the problem of household debt is a central, primary problem on par with fixing banks (and I'm including any public/blog/interview statement to the effect that consumer/household debt is central and a main source of the problems banks face):
Ken Rogoff
Timothy Geithner
Nouriel Roubini
There are more (for instance Krugman has suggested this a few times lately), but these three could suffice. (Still if readers want to suggest more or offer links, I'll include them).
Notice these three don't fit in a common pigeonhole, unless it's "realist".
Ok, here's the link for that interview.
We hope Adam will re-balance. Sometimes a person has to make a mistake in order to find their own next step.
Update: After Adam's apology Monday, Planet Money posted the full unedited interview on Tuesday, which really is a lot more interesting.
...
One broad point I'd like to make: No one really knows the economic future. We have profound insights such as from Irving Fisher, but even standing on the high platforms of insights such as these don't afford a clear view through the fog of all the ever-changing decisions and efforts that together will sum and multiply and modify each other into true complexity.
One insight I can offer: ultimately our economy is a joint decision of all of us. We can indeed decide to move up, down, or in a new direction, and the mass decision of tens of millions moving together in response to the bully pulpit is no small matter. It could be decisive.
This week a couple of pieces stood out for drama:
Charlie Rose had an interview with Neel Kashkari (notes below):
some interesting moments (times):
9-11 minutes: house prices, loan modifications, what will end the "housing crisis"
17-23 minutes: the $700 billion, the crisis, the changes, the reasoning
24: "Nationalize (sic) the banks" vs. reality
...
And not to be over-shadowed, Adam Davidson, whom is usually fun to listen to, ended up going overboard on Elizabeth Warren, finally resorting to labels and pigeonholes. Of course, such don't fit so well. If Elizabeth Warren is "left", then the left is smaller than I thought, and we'll be needing a new label (or not) for what used to be "left". If you listen, here are a few economists Adam forgot when he said no economists agree that the problem of household debt is a central, primary problem on par with fixing banks (and I'm including any public/blog/interview statement to the effect that consumer/household debt is central and a main source of the problems banks face):
Ken Rogoff
Timothy Geithner
Nouriel Roubini
There are more (for instance Krugman has suggested this a few times lately), but these three could suffice. (Still if readers want to suggest more or offer links, I'll include them).
Notice these three don't fit in a common pigeonhole, unless it's "realist".
Ok, here's the link for that interview.
We hope Adam will re-balance. Sometimes a person has to make a mistake in order to find their own next step.
Update: After Adam's apology Monday, Planet Money posted the full unedited interview on Tuesday, which really is a lot more interesting.
...
One broad point I'd like to make: No one really knows the economic future. We have profound insights such as from Irving Fisher, but even standing on the high platforms of insights such as these don't afford a clear view through the fog of all the ever-changing decisions and efforts that together will sum and multiply and modify each other into true complexity.
One insight I can offer: ultimately our economy is a joint decision of all of us. We can indeed decide to move up, down, or in a new direction, and the mass decision of tens of millions moving together in response to the bully pulpit is no small matter. It could be decisive.
April 6, 2009
Poll: 70% Have Cut Back on "Luxuries", 40% on Necessities
Forty percent said they had cut spending on luxuries, and 10 percent said they had cut back on necessities; 31 percent said they had cut both. -- New York Times/CBS PollOf course, if 40% have cut back on luxuries, and another 31% on both luxuries and necessities, then 71% have cut back on luxuries.
But the stark number is the total of about 40% that have cut back on necessities.
This leaves open the question of whether eating out is considered a luxury or a necessity by respondents. But if eating out is a luxury for many now, then what necessities might be cut by as many as 40% of Americans? Variety of food eaten at home might be one necessity that could be cut back on. Auto maintenance might be another. Health care is certainly being cut back on by many.
We can only hope that the necessity of good nutrition is not being cut back too much by too many.
Americans took on an additional $5 trillion in mortgage debt from 2001 to 2007. Since roughly 51 million homes had mortgages at the end of 2008, this amounts to roughly $100,000 more mortgage debt owed on the average home than in 2001. Even at a favorable mortgage rate of 5.25% for instance, that $100,000 costs about $550/month in extra mortgage payments vs. payments levels of 2001, for an average home. Of course, some owe the same payment as in 2001 (not having moved or refinanced or taken money out), but many owe an extra amount considerably more than this average.
The interest cost of $5 trillion at 5.25% is some $260 billion per year.
That $260 billion per year (eased down a small bit with every foreclosure) is money that could have been spent in the economy on other goods and services, resulting in diverse and lasting employment for many millions of Americans.
This extra mortgage interest over just 3 years is about as large as the stimulus package.
This is what we are up against.
But there is one form of great relief and source of new strength for the U.S. economy in this dark reality.
With as many as 8 million foreclosures by 2012 (one estimate), possibly as much as $2 trillion of this debt burden could be removed from households (who become renters at typically much lower monthly costs).
Such a large amount of debt-relief (monthly living cost relief) would help the economy immensely.
We have a ways to go yet, as only 1.4 million foreclosures have accumulated since July 2007.
But Congress, which appears at times in thrall to vested interests or under the spell of clever lobbyists, does not appreciate the crucial economic stimulus foreclosure debt-relief brings to the U.S. economy. House prices return back to normal levels sooner due to foreclosures, allowing a recovery in buying (and eventually building) sooner.
We need a clearing, a chance for people to get out of homes far too expensive for them. We need these Americans back -- back in the economy -- able to live in a more economically participating way: with money to spend on more than only a gigantic mortgage payment (any payment more than around 1/3 of income). We have yet to see whether large numbers will benefit from Obama's foreclosure prevention plan to ease payments down to 31% of income. But many underwater home owners would often be better off, and the economy in turn, to let go of a home that is too expensive, lowering their monthly shelter costs even further, and have more money to spend on the other parts of life.
Such as the necessities.
March 18, 2009
"We're on New Ground"
This is quite a discussion from Charlie Rose, and even people in a hurry would not want to miss anything after around 28 minutes into the program, such as Meredith Whitney for instance. I especially recommend what Hank Greenberg says towards 32 1/2 minutes onwards.
While the whole video is really worth it, here's an excerpt of Hank Greenberg at that point for those who want to see it in print (my transcript):
This is indeed truly new ground.
What was before is crashing like a huge freight train going off the rails. Bernanke has brought out the Big Guns today (printing money and buying securities) to try to reverse this. It will help. It won't change what Hank says.
While the whole video is really worth it, here's an excerpt of Hank Greenberg at that point for those who want to see it in print (my transcript):
"I think...it's global, it's not just here. We haven't confronted what we're living with now in our lifetime. There's nothing like this experience in our lifetime...
"People are not going to spend...the consumer is not going to spend as he did before. They're going to be far more cautious. People have been hurt dramatically, and they're going to be far more conservative in what they do going forward. So we are not going to have anything like the kind of growth that we experienced in the past. It's going to be a long time before people feel comfortable again. Their lives have changed, and it's not just here, it's worldwide.
"It's not as dramatic in other countries, because Europe has had safety nets and social programs that pick up some of the slack. We have not had that here, the same way.
"We're on new ground."
This is indeed truly new ground.
What was before is crashing like a huge freight train going off the rails. Bernanke has brought out the Big Guns today (printing money and buying securities) to try to reverse this. It will help. It won't change what Hank says.
February 6, 2009
Consumer Credit Shows a New Trend
Perhaps unnoticed by many in the swirl of news comes some data of great import. AP reports a larger than expected (though not to readers of this blog) drop in consumer credit use:
The full significance of this drop is that this includes households that needed to increase credit use due to layoffs. This means those with jobs are cutting back on card use even more than the aggregate result.
For the entire 4th quarter, the Federal Reserve reports that
It was a sudden, step-like shift. Like someone hit a switch.
Sound familiar? Consider the analysis of exactly what happens in response to a housing price bubble here.
"The Federal Reserve said Friday that consumer borrowing dropped...
"The weakness in December reflected a big 7.8 percent decline in the category that includes credit card debt..."
The full significance of this drop is that this includes households that needed to increase credit use due to layoffs. This means those with jobs are cutting back on card use even more than the aggregate result.
For the entire 4th quarter, the Federal Reserve reports that
Starting in November, consumers cut credit card use sharply."Revolving credit decreased at an annual rate of 5-1/2%"
It was a sudden, step-like shift. Like someone hit a switch.
Sound familiar? Consider the analysis of exactly what happens in response to a housing price bubble here.
January 26, 2009
The Tax Rebate & TARP Worked Better Than Advertised Against The "Greater Depression"
One of several memes we've heard over and over now to the point of becoming conventional wisdom is that "the tax rebates didn't work".
Now, before you think I'm simply on one side of a partisan debate, let me say first I think taking sides itself a mental error that leads to further errors. I'm not on any side, unless it turns out Obama keeps doing everything right as we go along. I think most of the large publicized pieces of spending in the stimulus proposal are good ideas, and good together as a large package (though not bringing enough timely stimulus in 2009, see why speed matters). My view is that A) we need many different kinds of stimulus, both government spending and tax cuts, but that B) the stimulus, however large, will not suddenly bring us into a roaring recovery, that C) the deep recession is likely to last for years in terms of feeling like we are in a recession. In certain ways, all of this is beside the point. There are fundamental reasons why America cannot have another golden age where it is always wealthier than other nations. And worse, it's even likely that the unemployment and economic challenges we face cannot be fixed completely through most kinds of government stimulus -- that the temporary setup where China grew rapidly while holding down American inflation and interest rates (by providing cheap goods and exporting their excess savings to us also) has played out to an end, bringing back more normal economic turbulence. Only special, unique conditions like those of the 1950s or 1990s can create economic ease, and only temporarily. (I'll post about this interesting question later.)
But today, it's popularly understood we are under threat of another Great Depression. Some even speculate we may face a Greater Depression, due to the profound debt overhang weighing on our economy.
This housing price bubble was more pronounced than any before, implying a deeper fall and heavier than normal fallout. Arrayed against this danger is a more knowledgeable and aggressive Federal Reserve and Federal Government than in the 1930s.
Most people now understand there is a feedback loop of job losses increasing fear -- which in turn leads to further pullbacks in consumer spending, creating more job losses.
So the public at large widely understands that this recession could deepen and keep deepening without intervention.
And while the two sides of the debate argue about what kind of stimulus will "work", the real picture is both more complex and more simple than commonly presented by major columnists, news reports and economists.
It's more simple in that ultimately all the financial crisis is one simple process -- the inevitable fallout of an enormous decades-long world-wide credit bubble. Another element in the popular view of what is happening -- "letting Lehman Brothers fail worsened the crisis" -- is also false. The whole picture of a "credit crisis" worsened by "letting Lehman fail" presumes we could always have grown debt, ever more and more -- more mortgage debt, higher debt to income ratios, more consumer spending and less saving, without limit. Thinking that allowing Lehman to fail caused more crisis implies that if Lehman was saved, the crisis might pass, and things could continue as before the crisis. In this view, a "crisis" or "shock" happened which should and could have been contained. So the story goes, or went, with the support of some prominent voices.
Nevertheless, there is more and more recognition spreading that we had a more genuine problem of a true out-of-control bubble -- that the housing bubble is part of a more fundamental story.
The implication of having a real bubble is that it will indeed eventually burst and collapse, and that falling house prices are not just caused by foreclosures or psychology alone -- are not merely a by-product of some other chance financial events.
Saving Lehman Brothers would have been like patching one significant hole in a slow motion bursting bubble -- it would not stop other from holes opening and growing in the ever thinner bubble surface.
So the story is more simple than often portrayed -- we ran up debts much faster than our average incomes grew, leading to an inevitable hitting-the-wall moment.
By late 2004, there were no actions by the Fed, by the Federal Government, by regulators, by anyone, that could have made any difference. House prices had already become out of reach of average families with conventional mortgages in too many places.
If it hadn't been New Century Financial hitting the wall first, it could have been American Home Mortgage Investment Corp. If it hadn't been Bear Stearns collapsing before Countrywide, it would have been Countrywide collapsing before Bear Stearns.
If Lehman had been saved, at you and your children's expense, instead of at the expense of various investors, that would not have saved Washington Mutual (as an independent bank), IndyMac, Wachovia, Merrill Lynch, etc.
One of the more disturbing political processes I've seen up close is the evolving political story of the TARP. At this point the story has evolved to say the initial phase of TARP under Hank Paulson failed and was opaque. But Paulson originally presented TARP as a way to stop the ongoing crisis of banks failing and our financial system appearing in danger of collapse. This was not something that could be easily talked about -- even if more Congressmen understood the real picture, it tends to increase panic for many leaders to talk of most well-known banks failing. Instead Paulson had to warn simply of a general financial crisis intensifying. TARP, then, was easy to re-define into the ultimate political football. When Paulson flailed about at first due to the impossible contradictions of his initial plan of buying bad mortgage securities, and then later finally followed the mainstream advice of most economists to inject funds directly into banks -- the plan that was actually used -- he gave a characteristically brief announcement, perhaps presuming it would be understood.
But while his announcement made sense to economists and well-read followers of the situation, how many average people understood the whys and hows of the new plan? While Paulson efficiently and effectively shored up the surviving banks -- and did so openly and in full view -- it seemed to me everyone would be pleased the best possible plan had been enacted. The best possible outcome to that moment had been found.
But Paulson's actions were subsequently portrayed as opaque ("lacking transparency") and against the will and intent of Congress!
I wonder if many of our elected representatives realize that many average people are not fooled at all by the political rhetoric. Many more people than they realize are quite aware this was the Big One, and more banks were heading to the chopping block. More people than they'd guess have paid attention to the fact the big bank failures stopped after TARP, at least those with names everyone knew, the kind that kept everyone on edge.
The initial TARP money stopped the accelerating large bank failures (Washington Mutual and Wachovia were the last for a while), and reduced the panic, just as it was proposed to do.
TARP was initially proposed to "stabilize the financial system." TARP indeed did so, to the extent possible with that amount of money. But "stabilize the financial system" is too vague a term it turns out, and has been re-defined quite easily to mean things other than what close observers understood.
Often we'll hear a bit on a newscast of someone who wonders why TARP didn't stop the financial difficulties entirely. Some even believed TARP was meant to also save homeowners near foreclosure. This was certainly a communications mess.
The initial TARP was successful in a sense that mattered. A panic that threatened to escalate to complete collapse of all large banks was averted, along with the psychological damage that would have added against already weakening confidence.
TARP so far has been similar to strapping parachutes onto the passengers (banks) falling out of the disintegrating airplane of banks-that-took-risky-bets.
Those with parachutes are still drifting downward of course, but for now they are still breathing. Some banks receiving funds weren't in that shaky airplane, but rather stood safely on the ground, with few risky bets, and are in far better shape.
Ideally those sounder banks could actually buy out the weaker, poorly-managed banks at low prices, resulting in the best possible outcome for the nation.
But some in Congress actually objected to the beneficial effect of well-managed banks using TARP funds for acquisitions!
Does it occur to many in Congress that their political rhetoric is part of why the level of trust for Congress is so low? Even when we don't know exactly what the political misdirections are, we intuitively sense we often aren't hearing the real story.
Much of Congress played the blame game -- trying to make it appear the other partisan side was responsible for what few wanted to admit was inevitable.
It's estimated that American banks would need more than $1T (that's trillion, and some estimate more than $2T) to be effectively re-capitalized to the level of being able to do significant lending without worrying about failing in the next few years. (see George Soros on this)
Why so much? Because the realistic losses from the credit bubble (mortgages, credit cards, commercial real estate lending, etc) are expected to be this much or more when we aren't pretending things are better than they are. But the jobs of the Fed chairman, Treasury Secretary, and other public officials are to instill confidence. They must acknowledge things are only as bad as we can see in the rear view mirror, and by the way -- don't panic.
The gigantic losses of banks and across the economy are the result of the end of a decades-long credit bubble.
------------------------
So....the tax rebates of summer 2008... Seems like a while ago, doesn't it?
Consider this graph from the Minneapolis Fed of The Recession in Perspective (our current recession is in red):
Notice something?
Yes, it seems this recession didn't drop off as steeply in its early months as normal. During the Summer of 2008 (months 5-8 in the graph), when things should have deteriorated more rapidly....the pace of the downturn was somehow slowed....business failures were slowed, bankruptcies were slowed, bank withdrawals (runs) were slowed, mortgage defaults were slowed, housing sales held up a little better....
What we know is the powerful recession we are in acted like a mild recession for many months, quite different from the typical pattern.
Did the tax rebate anticipation and arrival hold off the real power of this recession for many months? If so, did this slowing of the downturn help the "crisis"?
Well, the recession, like all recessions is in part psychological, and depends on confidence. The crisis is in part fear, and fear is the most powerful force in it, able to stop consumers, businesses, banks and jobs in their tracks.
Fear tends to feed on itself. The unusual staying power of confidence in the first 7 months of the recession held off a lot of effects. By slowing the downturn, the level of fear was held lower than it would have been and the "crisis" unfolded more slowly, giving the Fed and the Treasury and the FDIC more time to plan and act and learn.
We know the powerful driver of the recession is the collapsing housing bubble, and the associated consumer debt bubble and commercial real estate bubbles. The gasoline price spike added a powerful drag during the summer, and without rebate checks to offset the high prices, would likely have collapsed consumer spending much faster during the summer. The other powerful factor in any recession is the level of confidence. Consumers felt more confident for many months than is typical in a strong recession like this one.
Why? Well confidence is a combination of expectations and news and popular stories about what is happening. Consumers were told the stimulus was coming and it was thought it would help. Both the tangible reality of extra cash in our pockets and the belief it would help buoyed confidence.
The Tax Rebate of 2008 was the cause of the gentleness of this recession for months, in spite of the other huge forces that would make it a powerful recession, as is now evident.
We are also told the tax rebate failed because most of it was saved.
Consumers, instead of spending like nothing was happening, chose to pay down part of their credit card debts or save a good part of their rebates. Because they saved more, they've felt a little less pressure and a little safer ever since (than they would have at without that extra savings). Because we all have a little more money at hand still, it's likely we choose to eat out or buy discretionary items just a little more often than we would otherwise.
Put another way, as we have cut back spending, we haven't cut back as much as we would have without that extra in our pockets (or lower card balance).
Do the particular theoretical "multipliers" for different categories of stimulus spending favored by those opposed to tax cuts measure the effect of reducing fear and adding residual extra spending months later? If your guess is no, I bet you are right.
Having saved more, many of us now are spending a little more, supporting each others' jobs just a little better than we would have without that summer 2008 rebate.
Now....do you really think the Tax Rebate of 2008 didn't work?
Now, before you think I'm simply on one side of a partisan debate, let me say first I think taking sides itself a mental error that leads to further errors. I'm not on any side, unless it turns out Obama keeps doing everything right as we go along. I think most of the large publicized pieces of spending in the stimulus proposal are good ideas, and good together as a large package (though not bringing enough timely stimulus in 2009, see why speed matters). My view is that A) we need many different kinds of stimulus, both government spending and tax cuts, but that B) the stimulus, however large, will not suddenly bring us into a roaring recovery, that C) the deep recession is likely to last for years in terms of feeling like we are in a recession. In certain ways, all of this is beside the point. There are fundamental reasons why America cannot have another golden age where it is always wealthier than other nations. And worse, it's even likely that the unemployment and economic challenges we face cannot be fixed completely through most kinds of government stimulus -- that the temporary setup where China grew rapidly while holding down American inflation and interest rates (by providing cheap goods and exporting their excess savings to us also) has played out to an end, bringing back more normal economic turbulence. Only special, unique conditions like those of the 1950s or 1990s can create economic ease, and only temporarily. (I'll post about this interesting question later.)
But today, it's popularly understood we are under threat of another Great Depression. Some even speculate we may face a Greater Depression, due to the profound debt overhang weighing on our economy.
This housing price bubble was more pronounced than any before, implying a deeper fall and heavier than normal fallout. Arrayed against this danger is a more knowledgeable and aggressive Federal Reserve and Federal Government than in the 1930s.
Most people now understand there is a feedback loop of job losses increasing fear -- which in turn leads to further pullbacks in consumer spending, creating more job losses.
So the public at large widely understands that this recession could deepen and keep deepening without intervention.
And while the two sides of the debate argue about what kind of stimulus will "work", the real picture is both more complex and more simple than commonly presented by major columnists, news reports and economists.
It's more simple in that ultimately all the financial crisis is one simple process -- the inevitable fallout of an enormous decades-long world-wide credit bubble. Another element in the popular view of what is happening -- "letting Lehman Brothers fail worsened the crisis" -- is also false. The whole picture of a "credit crisis" worsened by "letting Lehman fail" presumes we could always have grown debt, ever more and more -- more mortgage debt, higher debt to income ratios, more consumer spending and less saving, without limit. Thinking that allowing Lehman to fail caused more crisis implies that if Lehman was saved, the crisis might pass, and things could continue as before the crisis. In this view, a "crisis" or "shock" happened which should and could have been contained. So the story goes, or went, with the support of some prominent voices.
Nevertheless, there is more and more recognition spreading that we had a more genuine problem of a true out-of-control bubble -- that the housing bubble is part of a more fundamental story.
The implication of having a real bubble is that it will indeed eventually burst and collapse, and that falling house prices are not just caused by foreclosures or psychology alone -- are not merely a by-product of some other chance financial events.
Saving Lehman Brothers would have been like patching one significant hole in a slow motion bursting bubble -- it would not stop other from holes opening and growing in the ever thinner bubble surface.
So the story is more simple than often portrayed -- we ran up debts much faster than our average incomes grew, leading to an inevitable hitting-the-wall moment.
By late 2004, there were no actions by the Fed, by the Federal Government, by regulators, by anyone, that could have made any difference. House prices had already become out of reach of average families with conventional mortgages in too many places.
If it hadn't been New Century Financial hitting the wall first, it could have been American Home Mortgage Investment Corp. If it hadn't been Bear Stearns collapsing before Countrywide, it would have been Countrywide collapsing before Bear Stearns.
If Lehman had been saved, at you and your children's expense, instead of at the expense of various investors, that would not have saved Washington Mutual (as an independent bank), IndyMac, Wachovia, Merrill Lynch, etc.
One of the more disturbing political processes I've seen up close is the evolving political story of the TARP. At this point the story has evolved to say the initial phase of TARP under Hank Paulson failed and was opaque. But Paulson originally presented TARP as a way to stop the ongoing crisis of banks failing and our financial system appearing in danger of collapse. This was not something that could be easily talked about -- even if more Congressmen understood the real picture, it tends to increase panic for many leaders to talk of most well-known banks failing. Instead Paulson had to warn simply of a general financial crisis intensifying. TARP, then, was easy to re-define into the ultimate political football. When Paulson flailed about at first due to the impossible contradictions of his initial plan of buying bad mortgage securities, and then later finally followed the mainstream advice of most economists to inject funds directly into banks -- the plan that was actually used -- he gave a characteristically brief announcement, perhaps presuming it would be understood.
But while his announcement made sense to economists and well-read followers of the situation, how many average people understood the whys and hows of the new plan? While Paulson efficiently and effectively shored up the surviving banks -- and did so openly and in full view -- it seemed to me everyone would be pleased the best possible plan had been enacted. The best possible outcome to that moment had been found.
But Paulson's actions were subsequently portrayed as opaque ("lacking transparency") and against the will and intent of Congress!
I wonder if many of our elected representatives realize that many average people are not fooled at all by the political rhetoric. Many more people than they realize are quite aware this was the Big One, and more banks were heading to the chopping block. More people than they'd guess have paid attention to the fact the big bank failures stopped after TARP, at least those with names everyone knew, the kind that kept everyone on edge.
The initial TARP money stopped the accelerating large bank failures (Washington Mutual and Wachovia were the last for a while), and reduced the panic, just as it was proposed to do.
TARP was initially proposed to "stabilize the financial system." TARP indeed did so, to the extent possible with that amount of money. But "stabilize the financial system" is too vague a term it turns out, and has been re-defined quite easily to mean things other than what close observers understood.
Often we'll hear a bit on a newscast of someone who wonders why TARP didn't stop the financial difficulties entirely. Some even believed TARP was meant to also save homeowners near foreclosure. This was certainly a communications mess.
The initial TARP was successful in a sense that mattered. A panic that threatened to escalate to complete collapse of all large banks was averted, along with the psychological damage that would have added against already weakening confidence.
TARP so far has been similar to strapping parachutes onto the passengers (banks) falling out of the disintegrating airplane of banks-that-took-risky-bets.
Those with parachutes are still drifting downward of course, but for now they are still breathing. Some banks receiving funds weren't in that shaky airplane, but rather stood safely on the ground, with few risky bets, and are in far better shape.
Ideally those sounder banks could actually buy out the weaker, poorly-managed banks at low prices, resulting in the best possible outcome for the nation.
But some in Congress actually objected to the beneficial effect of well-managed banks using TARP funds for acquisitions!
Does it occur to many in Congress that their political rhetoric is part of why the level of trust for Congress is so low? Even when we don't know exactly what the political misdirections are, we intuitively sense we often aren't hearing the real story.
Much of Congress played the blame game -- trying to make it appear the other partisan side was responsible for what few wanted to admit was inevitable.
It's estimated that American banks would need more than $1T (that's trillion, and some estimate more than $2T) to be effectively re-capitalized to the level of being able to do significant lending without worrying about failing in the next few years. (see George Soros on this)
Why so much? Because the realistic losses from the credit bubble (mortgages, credit cards, commercial real estate lending, etc) are expected to be this much or more when we aren't pretending things are better than they are. But the jobs of the Fed chairman, Treasury Secretary, and other public officials are to instill confidence. They must acknowledge things are only as bad as we can see in the rear view mirror, and by the way -- don't panic.
The gigantic losses of banks and across the economy are the result of the end of a decades-long credit bubble.
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So....the tax rebates of summer 2008... Seems like a while ago, doesn't it?
Consider this graph from the Minneapolis Fed of The Recession in Perspective (our current recession is in red):
Notice something?
Yes, it seems this recession didn't drop off as steeply in its early months as normal. During the Summer of 2008 (months 5-8 in the graph), when things should have deteriorated more rapidly....the pace of the downturn was somehow slowed....business failures were slowed, bankruptcies were slowed, bank withdrawals (runs) were slowed, mortgage defaults were slowed, housing sales held up a little better....
What we know is the powerful recession we are in acted like a mild recession for many months, quite different from the typical pattern.
Did the tax rebate anticipation and arrival hold off the real power of this recession for many months? If so, did this slowing of the downturn help the "crisis"?
Well, the recession, like all recessions is in part psychological, and depends on confidence. The crisis is in part fear, and fear is the most powerful force in it, able to stop consumers, businesses, banks and jobs in their tracks.
Fear tends to feed on itself. The unusual staying power of confidence in the first 7 months of the recession held off a lot of effects. By slowing the downturn, the level of fear was held lower than it would have been and the "crisis" unfolded more slowly, giving the Fed and the Treasury and the FDIC more time to plan and act and learn.
We know the powerful driver of the recession is the collapsing housing bubble, and the associated consumer debt bubble and commercial real estate bubbles. The gasoline price spike added a powerful drag during the summer, and without rebate checks to offset the high prices, would likely have collapsed consumer spending much faster during the summer. The other powerful factor in any recession is the level of confidence. Consumers felt more confident for many months than is typical in a strong recession like this one.
Why? Well confidence is a combination of expectations and news and popular stories about what is happening. Consumers were told the stimulus was coming and it was thought it would help. Both the tangible reality of extra cash in our pockets and the belief it would help buoyed confidence.
The Tax Rebate of 2008 was the cause of the gentleness of this recession for months, in spite of the other huge forces that would make it a powerful recession, as is now evident.
We are also told the tax rebate failed because most of it was saved.
Consumers, instead of spending like nothing was happening, chose to pay down part of their credit card debts or save a good part of their rebates. Because they saved more, they've felt a little less pressure and a little safer ever since (than they would have at without that extra savings). Because we all have a little more money at hand still, it's likely we choose to eat out or buy discretionary items just a little more often than we would otherwise.
Put another way, as we have cut back spending, we haven't cut back as much as we would have without that extra in our pockets (or lower card balance).
Do the particular theoretical "multipliers" for different categories of stimulus spending favored by those opposed to tax cuts measure the effect of reducing fear and adding residual extra spending months later? If your guess is no, I bet you are right.
Having saved more, many of us now are spending a little more, supporting each others' jobs just a little better than we would have without that summer 2008 rebate.
Now....do you really think the Tax Rebate of 2008 didn't work?
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