By Simon Grey, on December 15th, 2011
Researchers with the Federal Reserve Bank of New York found that investors who used low-down-payment, subprime credit to purchase multiple residential properties helped inflate home prices and are largely to blame for the recession. The researchers said their findings focused on an “undocumented” dimension of the housing market crisis that had been previously overlooked as officials focused on how to contain the financial crisis, not what caused it.
More than a third of all U.S. home mortgages granted in 2006 went to people who already owned at least one house, according to the report. In Arizona, California, Florida and Nevada, where average home prices more than doubled from 2000 to 2006, investors made up nearly half of all mortgage-backed purchases during the housing bubble. Buyers owning three or more properties represented the fastest-growing segment of homeowners during that time.
“This may have allowed the bubble to inflate further, which caused millions of owner-occupants to pay more if they wanted to buy a home for their family,” the researchers noted.
Investors defaulted in large numbers after home values began to drop in 2006. They accounted for more than 25 percent of seriously delinquent mortgage balances nationwide, and more than a third in Arizona, California, Florida, and Nevada from 2007 to 2009.
Sweet Keynes but the banksters just do not have a clue. Somehow, the FRB of New York has come to the hilarious conclusion that somehow, mysteriously, those who “flip” houses are the root cause of the recession. Talk about clueless.
The question that the NY FRB is apparently too stupid to ask is: Why would some people suddenly decide to “flip” houses? Answer: because it’s generally profitable due to the increased demand for houses as a result of a)artificially low interest rates from The Fed, b) massive fraud among the banks in regards to loan application, c) the Federal Government’s willingness to subsidize market risk, and thus eliminate moral hazard, through the agencies Freddie Mac and Fannie Mae, and d) the general tendency of the government to encourage and subsidize home ownership through, among other things, federal income tax breaks. Basically, the government as at the root of most of the problem here, and the Federal Reserve played a major role.
Of course, the FRB is not going to admit to wrongdoing, particularly since greedy businessmen make for a more compelling villain in this narrative. But blaming people for responding to incentives at the margin, as clearly happened in this case, is indicative of just how worthless mainstream macroeconomic analysis clearly is. Quite simply, it takes an astonishing amount of either dishonesty or short-sightedness to come to the conclusion that greedy businessmen are to blame for the current recession instead of the incentive system in which they operated.
The shallowness of this analysis, if honest, is simply evidence that those who are currently in charge are simply too stupid to merit the power with which they’ve been entrusted. If, on the other hand, they are liars, the case for their removal from power is not in any way diminished. In sum, there is no excuse for those presumed to be intelligent, and thus deserving of power, to be offering analysis this putridly vapid; they must be summarily dismissed and the system must be dispatched with.
* Cf. Dr. Sowell’s book Applied Economics.
By Simon Grey, on November 9th, 2011
Seriously, what’s so difficult about allowing student loans to be discharged in bankruptcy? Today, President Obama is effectively giving college students and their parents his middle finger. Whereas Jobs’ prank was harmless and symbolic, the President’s plan to bail out student loans will derail the entrepreneurial dreams and financial security of countless young people. [Ed. - this claim is utter bulls**t.Bailing out student loans will increase their financial security because they will no longer be slaves to the banks. And, with less debt, they can actually become entrepreneurs.]
By executive order, the President’s unconstitutional “We Can’t Wait – Pay As You Earn” plan modifies the existing Income-Based Repayment Plan so that, effective in 2012, graduates may cap their loan payments at 10percent instead of 15 percent of their discretionary income. Anything remaining after 25 years (formerly 20 years) becomes fundamentally the taxpayers’ responsibility. And, if a student wants to become a public servant (i.e. work for George Soros) his loan will be forgiven after just 10 years.
Obviously, Obama is playing for political points with this plan, presumably to mollify the OWSers, so I understand outrage for that reason. But what I don’t understand is how anyone thinks that student loans weren’t already the taxpayers’ responsibility. The government guaranteed student loans a long time ago, which is one of the reasons there’s a college bubble—private lenders face virtually no risk on the loans. In fact, the government guarantee of repayment is why default was taken off the table as an option: the government didn’t want taxpayers to take it in the shorts.
Neo-con bomb-lobbing aside, Obama’s plan is pretty terrible. It shouldn’t wreck the economy(at least no more than seeding a college bubble would), and it’s better than a jubilee for the loans, but there is still a much better solution available: the federal government should stop guaranteeing student loans and allow them to be discharged in bankruptcy. This way, college student wannabes won’t be as inclined to pursue worthless degrees and banks won’t be as inclined to fund the pursuit of worthless degrees. You don’t need bailouts, you don’t need special debt laws, all you need is the ability to discharge student debt during bankruptcy. Problem solved.
By Simon Grey, on November 8th, 2011
If you weren’t sure about the existence of a college bubble, here’s proof:
When the number of psychology majors increase by 135% over25 years, you can be reasonably sure that there’s a college bubble because a) psychology is not a science, it’s a form of bovine fecal matter and b) economies don’t need psychologists in order to grow and thrive. In essence, more than doubling the number of psychologists in the economy is not going to cause massive growth.
So why are there so many psychology majors? Simple: The ease of obtaining student loans makes it appear that there is more demand for psychologists than actually exists. And why do current students believe there is more demand for psychologists than actually exists? Again, simple: the government has incentivized the extension of student loans by guaranteeing repayment thereof. When a student defaults, the government pays the lender then goes to collect the remaining debt. Sometimes the government uses the banks’ collections agencies to collect the loan, which then makes defaulting on student debt a very attractive proposition for the bank that originated the loan.
So how do we know that the increase in psych majors proves there’s a college bubble? Easy: the government’s involved, and is actively encouraging the pursuit of a college education. Plus, does anyone think that so many would pursue a psych degree if they couldn’t finance it so easily?
By The Gold Report, on November 3rd, 2011
 Exponential debt increases coupled with limited natural resources mean that we are in a predicament. This is the message The Crash Course Author Chris Martenson delivered at the Casey Research/Sprott Inc. summit, “When Money Dies.” As an economic researcher, Chris considers the “Three E’s” that shape our future: Economy, Energy and the Environment. In the below presentation, “Unfixable,” Chris explains to Energy Report readers why these indicators suggest a global economic slowdown. Read on.
The next 20 years are going to be completely unlike the last two decades. How the world works, how stocks grow, the very nature of investing and how our economy functions—all of these are due for fundamental, earth-shaking change. As investors, we have to adjust the way we look at the world.
We want growth. We need economic growth. It’s all you hear about when the treasury secretary talks about how we are going to get the economy growing again or when the president talks about jobs. When our money system is growing, things are reasonably happy. When it is not growing, things are very unhappy. As long as everything is growing, our economy functions reasonably well. And when it stops growing, it throws giant fits and gets into trouble. That is why we are always chasing growth. And there is a reason for that: Money. But what is money?
I don’t care what color it is or whose picture is on it or what counterfeiting measures you have in place. All money in the world today shares one characteristic: it is loaned into existence. It seems like a simple enough statement, but this has enormous implications. Because it is borrowed, we pay interest on it. That interest drives a peculiar feature in our money system (by “our” I’m referring to all fiat currencies in the world because all of them operate by this same loaning principle). When you loan money into existence, you have to pay both the principal and the interest back. That means there is always more debt than money in the system.
We are constantly growing our money supply because our population is growing. In the past, we had a seemingly endless supply of resources, energy and land to occupy—all of that has been OK. But we are coming to a point where it’s not OK anymore.
Consider a chart of total credit market debt. It tops out at about $52 trillion (T). Each of those big, blue, upside-down triangles mark a doubling of credit market debt. From 1970 to about 1977, total credit market debt doubled. It doubled again by 1983. Then it doubled again and again and again. Over four decades, we had five doublings of our credit market debt. In order for the next 20 years to look like the last 20 years, we would need two complete doublings of credit market debt. Let me put those numbers in: $52T to $104T to $208T. That is an absolutely obscene amount of credit growth. This is not how our economy is supposed to function. It was a result of the abandonment of the gold standard, and it is not sustainable.
The second thing I want to point out is the blue line. That is a curve fit. It is an attempt to mathematically model what is going on with that red credit market debt line. It shows that our money system, our credit system, has been growing nearly perfectly exponentially.
Debt:GDP Explosion
Another way to evaluate the economy is by looking at the debt:GDP ratio, because if you have a lot of income, it is OK to have a lot of debt: GDP is our income. Something really unusual is happening: The ratio is skyrocketing in an unprecedented range, with the exception of a blip during the Great Depression when manufacturing dived. We are in the middle of a very interesting experiment in this country. We can’t dig through the data series and say, “Oh, the last time we did that, this is how it turned out.” We don’t have any historical examples of any country in history getting out from under a debt:GDP load this high without going through some kind of a massive currency adjustment. There is one example from 1815 to 1900 where England got out from under 260% debt:GDP load, and it did that by cutting war spending after the Napoleonic Wars with help from the Industrial Revolution. Nothing on our horizon indicates that we are going to cut spending or increase our overall economic output by huge amounts. So we have to ask the question: How do we get out from under that? This debt:GDP imbalance is a global phenomenon. It is not just a U.S. problem.
That is why the economy must grow. In order to be happy, in order to service those debt loads, it must grow. Exponential growth, the kind that starts out nice and easy in a linear fashion and then shoots up suddenly, is what I am really worried about. It is everywhere. Human population grew rather sedately for a long period of time and, recently really accelerated. Oil consumption has increased on the same model. Starting in the early 1940s, it really turned up. The more we produce, the more we use. The same is true on the environmental side; water use, forest loss, species extinction, fisheries exploited—all of this turned up aggressively in in the 1940s and 1950s. We could look at miles of roads paved, numbers of McDonald’s hamburgers served; it doesn’t matter. We are surrounded by all of these nonlinear, very J-shaped curves. This is really critical if you believe in boundaries. There is only so much arable land. There is a limit to how much water is in an aquifer. There is a limit to how much oil is in the ground. We can argue about whether we are close to those limits, but we can’t argue about the fact that the limits exist. So we need to understand how we are using these things.
I like to use a thought exercise to explain exponential growth. I have this magic eyedropper. A drop of water from this thing is going to double every minute. So one drop will become two drops in one minute. In another minute it will be four drops. After about six minutes, it will be enough to fill a thimble. If we started this experiment at noon on the pitcher’s mound of Yankee Stadium and you are handcuffed to the highest row of the bleacher seats, how long would you have to escape from your handcuffs? By 12:50 that same day, the park would be completely overrun with water. In fact, at 12:45 this is still 97% empty space with a little water in the infield. You have 45 minutes to sort of fool around, but the next five minutes are critical. That is the power of exponential increases. If you have that sense that world events are speeding up, you are right. They absolutely are.
A Peak Problem
Dating back three million years from the australopithecine humanoid precursors to 1960, we put 3 billion people on the planet. It took 40 years for the next 3 billion to arrive. Someone who is 22 years old today has been alive when half of all the oil in the world that has ever been burned has been burned. We are burning oil at roughly 2–3% more per year than when we were in a healthy economy. This is a predicament.
Do you know the difference between a problem and a predicament? A problem has solutions. A predicament has inevitable outcomes that have to be managed. If you are in a predicament seeking solutions, you are wasting time. A lot of our efforts at the national level right now are centered around seeking solutions to predicaments. That concerns me greatly because it means we are actually wasting our time, wasting resources and not looking at things the right way.
Our predicament right now concerns energy. U.S. oil production peaked in 1970 and has never returned to its former days of glory—and it never will. As a result, we import two-thirds of our liquid petroleum needs to run our society. No matter how much we drill at this point, there is absolutely no chance that we are going to return to our former production highs. In fact, out of the 54 oil-producing countries, we have about 45 that have gone past peak. No country has ever managed to get back to a former peak and exceed it.
World Discovery by Decade
 Source: Chris Martenson
The peak year for oil discover was 1964. The green in the chart represents history. The red is projections for what we think we might find going forward. There could be some wiggle room, but I think it would be a stretch to think that we are ever going to get back to that peak that we saw in the 1960s.
Here is the thing about oil: If you want to produce it, you have to find it. Our finds were 40 years ago. Interesting fact: The U.S. peaked in its domestic discoveries in 1930 and hit a production peak in 1970, a 40-year gap. World oil discovery peaked in 1964 and world oil production for conventional oil peaked in 2005, 41 years after its find peak. It has not yet been exceeded. It might, but it hasn’t, even though oil prices have tripled. If there is ever an incentive to get your oil out of the ground, it’s when prices triple. That’s what market theory tells us. Somehow, we haven’t done it.
The U.S. Energy Information Administration issued a shocking statement in its 2008 World Energy Outlook. It said that oil from currently producing fields peaked in 2006. It factored in natural gas, non-conventional oil and crude oil yet to be found and developed as possibilities for filling the country’s growing energy needs. The problem is that in order to get energy out of the ground, you have to put energy into the equation. If we take a barrel to find a barrel, then all we are doing is using energy to go explore and get energy out of the ground—there is none left over to go into our gas tanks. There is none left over to grow food, or for anything else. By the time you are using one barrel to find one barrel, you are spinning your wheels.
The same lopsided equation is operational in shale beds. If we decide to switch to natural gas, we will need to retrofit our cars, build filling stations and pipelines. This will take a lot of money and about 10 or 20 years to build out. There are going to be companies that make a lot of money aggressively attempting to expand into that, but we are already behind the eight ball.
When we first started drilling for oil in the 1930s, we were getting 100:1 returns from these little wooden drilling derricks going down maybe 1,000 ft, hitting spindletop. At that point we were putting in one barrel and getting 100 back. In the ’70s, we were getting maybe 25:1 back. In the 1990s, we were getting 18:1 or even 10:1. We were drilling deeper, more remotely. The substance was a little heavier, and more sour. We went after the good stuff first: light, sweet and near the surface. Now, we are drilling in a deep ocean environment. Some of our efforts are down to 3:1. Ethanol will make it even worse. As we fall down this energy cliff and get progressively less and less energy back for our efforts, the amount of energy available to us to run our economy drops rather precipitously.
Natural Erosion
This same dynamic impacts natural resources. Some 150 years ago, we found giant nuggets of copper the size of cars sitting in streambeds. Eventually we went after smaller nuggets. Then we went after copper ore grades of 10%. Now we have huge open-pit mines with ore grades of 0.2%. Regardless of whether copper is $4/lb or $3.50/lb or $35/lb, think about the energy required to take 500 lb of copper ore from the bottom of that pit, haul it up a quarter mile, run it through a crushing machine, smelt and refine it to get that 1 lb of copper out. Would we be doing that if we didn’t have liquid fuels, if we didn’t have diesel to run big trucks? I think the answer is no. And this is after just 150 years. What happens over the next 150 years? How about in 500 years? If we continue to deplete all of our mineral reserves at 2% growth in extraction per year, which has been our 40-year historical run, how long will they last? We might find more, but sources will be more remote, further away from infrastructure needed to extract them, refine them and move them to market. The end product will be more diluted and lower quality, with deeper costs attached.
We have a world where we will face exponentially rising costs if we continue to run our economy in the way it has been running. That is not a great strategy at this point. Our economy must grow by design because of how our money and debt systems operate, but it is connected to an energy system that can’t grow. This is the definition of a predicament. No matter what policies we pursue or how clever our technologies get, there are certain things that we just can’t undo. When you take oil out of the ground and you burn it, it is gone. And we are burning it up at a faster and faster pace.
Coming to terms with this reality has actually been a fairly liberating idea for me. It has allowed me to understand what is important in my life. And it has been very helpful in my overall investing philosophy. Even though it is not a terribly uplifting story for a lot of people at first, I do think that it helps to clarify where we are in the story and what is happening.
This was a summary of Chris Martenson’s presentation. For the complete audio collection of the Casey Research/Sprott Inc. Summit “When Money Dies,” click here.
Chris Martenson is a scientist, financial and economic analyst and writer at www.ChrisMartenson.com. He earned his MBA at Cornell University and a Ph.D. from Duke University. As one of the early econobloggers who forecast the housing market collapse and stock market correction years in advance, he launched a video seminar and later published a book entitled The Crash Course. To learn more about Chris and his work, including the Crash Course, go to chrismartenson.com.
By Simon Grey, on September 26th, 2011
Freakonomics asked if forgiving student loans en masse was a good idea. Here was their conclusion: 1. Distribution: If we are going to give money away, why on earth would we give it to college grads? This is the one group who we know typically have high incomes, and who have enjoyed income growth over the past four decades. The group who has been hurt over the past few decades is high school dropouts.
I guess it would help to define “high income.” Everything I’ve seen suggests that college grads generally start with relatively income when joining the workforce and that it eventually increases over time. And, once you adjust for inflation, grads today are earning less than grads of, say, thirty years ago, on the average. The only way the above claim is true is if one compares the college grads to those with less education. Also note that income growth, though a trend, is not promised to continue indefinitely. Also note that going to college is the recommended course of action, while dropping out of high school is not. In essence, those who have played by the rules, so to speak, are in a tough bind because they have played by the rules. It is cruel to argue that they don’t deserve consideration because they are still better off than those who didn’t follow the rules.
2. Macroeconomics: This is the worst macro policy I’ve ever heard of. If you want stimulus, you get more bang-for-your-buck if you give extra dollars to folks who are most likely to spend each dollar. Imagine what would happen if you forgave $50,000 in debt. How much of that would get spent in the next month or year? Probably just a couple of grand (if that). Much of it would go into the bank. But give $1,000 to each of 50 poor people, and nearly all of it will get spent, yielding a larger stimulus. Moreover, it’s not likely that college grads are the ones who are liquidity-constrained. Most of ‘em could spend more if they wanted to; after all, they are the folks who could get a credit card or a car loan fairly easily. It’s the hand-to-mouth consumers—those who can’t get easy access to credit—who are most likely to raise their spending if they get the extra dollars.
Can we get rid of this whole nonsensical stimulus thinking? All money circulates. Ceteris parabis, the money will be spent at some point. The only concern is over timing, not necessarily net effect. And there is no objective reason to prefer immediate results to delayed results. This point, though technically true, is irrelevant.
3. Education Policy: Perhaps folks think that forgiving educational loans will lead more people to get an education. No, it won’t. This is a proposal to forgive the debt of folks who already have an education. Want to increase access to education? Make loans more widely available, or subsidize those who are yet to choose whether to go to school. But this proposal is just a lump-sum transfer that won’t increase education attainment. So why transfer to these folks?
This is simply asinine. No one thinks that forgiving loans makes education more desirable. People think that the student loan system is fraudulent (i.e. people were talked into loans under false pretenses). The reason most people support loan forgiveness is because they see it as a reasonable redress to the outrages of the system. Also, note that the current system does a remarkable job of subsidizing marginal students, which is the problem in the first place.
4. Political Economy: This is a bunch of kids who don’t want to pay their loans back. And worse: Do this once, and what will happen in the next recession? More lobbying for free money, rather than doing something socially constructive. Moreover, if these guys succeed, others will try, too. And we’ll just get more spending in the least socially productive part of our economy—the lobbying industry.
Don’t or can’t? How many grads have to take on subpar jobs because they can’t afford to wait for better jobs or undertake risky ventures? These kids have been sold a lie, and many they have no recourse (and I mean this literally as they can’t even default out of their loans). The government guaranteed repayment of student loans, and, in order to prevent getting hit in the shorts, has made it impossible to discharge this debt through bankruptcy. As such, banks have little incentive to ensure the loan’s recipient’s ability to repay. In short, the government has created the mess, under the guise of helping the underprivileged. They have turned the underprivileged into slaves. Shouldn’t the slaves be able to lobby their master? Or is that too much to ask?
5. Politics: Notice the political rhetoric? Give free money to us, rather than “corporations, millionaires and billionaires.” Opportunity cost is one of the key principles of economics. And that principle says to compare your choice with the next best alternative. Instead, they’re comparing it with the worst alternative. So my question for the proponents: Why give money to college grads rather than the 15% of the population in poverty?
This is simply stupid. The 15% of the population in poverty already receives money. To the tune of billions of dollars per year. How much more do they need? You’d think hundreds of billions of dollars would be enough to cure poverty, but apparently the federal government sucks worse at charity than it does at disaster relief in a chocolate city after a hurricane.
This is nothing more than a grossly ignorant appeal to emotion. The poor already get money from the federal government. And why are corporations more deserving of billions of dollars? The government has already lined the pockets of their Wall Street cronies through student loans. Shouldn’t this be redressed?
Conclusion: Worst. Idea. Ever.
More like: Worst. Rebuttal. Ever.
However, I don’t find the idea of student loan forgiveness all that appealing, in part because students still deserve to face the consequences of their (admittedly stupid) decision to go to college instead of getting a real job. In order for a lie to work, one party must tell it and another party must believe it. If you believe a lie, you need to live with the consequences. But if you take advantage of those who have believed a lie, then you deserve the consequences thereof as well.
My proposal, then, is very simple: allow grads to default on their student loans. Grads’ credit scores will take a hit, which is a reasonable consequence t their decision to essentially waste four years of their life. And banks would be forced to write a bunch of bad loans, killing their profits, which is a reasonable consequence to their decision to loan money to people that didn’t deserve it.
The current system is broken and remarkably unfair to those it purports to help. Correcting this problem doesn’t require forgiving all students of their loans. Allowing grads who find that a college degree is worthless to default on their loans should be sufficient to clear the market.
By B.P.T., on September 16th, 2011
With increases in college tuition showing no signs of slowing down, despite the recession, students are being required to borrow more and more money to fund their education. Since a report from the US Census values a bachelor’s degree at about $900,000 in additional salary earned when compared to a high school diploma, and a master’s degree at $400,000 beyond a bachelor’s degree, most students are making a wise decision to borrow money now for college, since the costs of the debt are greatly outweighed by the financial benefits of a college degree.
However, given the limits on public student loan amounts put into place by the federal government, it is becoming more difficult to pay for college with public loans and personal savings. The maximum amount that can be borrowed from the government is $31,000 for dependent undergraduate students, $57,000 for independent undergraduate students, and $138,500 for graduate students (and any undergraduate loans count against this total). Given that tuition at many private schools has exceeded $50,000 per year and many professional graduate programs can cost over $100,000, federal student loans are inadequate. This means that the student is responsible to fill in the gap, and the best option for students that don’t have thousands of dollars in cash available is private student loans.
Shopping for private student loans can be a difficult process because there are many more options available, but those options also provide the opportunity to obtain a good deal on student loan debt. We suggest using one of the many private student loan comparison sites that are available online to find the lender that suits you best, and our research found that Discover private student loans offered attractive rates, the option to defer payments while in school part time, a graduation bonus, and numerous other perks. Even if you do qualify for public student loans, current rates and terms for private loans make them an attractive option, so keep them in mind when looking at your options for next semester.
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By B.P.T., on July 22nd, 2011
The Credit Card Accountability, Responsibility and Disclosure Act, (CARD Act) is now one year old, and the Consumer Financial Protection Bureau released data showing its impact on the credit card industry as it prepares to begin its role as regulator of consumer financial products later this year.
This data showed that credit card late fees dropped from $901 million in January 2010 to to $427 million in November 2010, due to a cap of $25 on the first late fee on an account and $35 for a second late fee within six months of the first offense, and the number of accounts that were charged late fees dropped by 30%.
Also, the number of accounts that were impacted by an interest rate increase dropped from 15% a year to 2% in the year after the new regulations took effect.
The final change mentioned by the agency was a regulation that prevents credit card issuers from penalizing cardholders for going over the card’s limit, unless the cardholder requests that these charges be accepted. As a result of this change, many credit card issuers have eliminated over the limit fees that were charged if a transaction pushed an account over its limit. These fees were as high as $39 before the new rules were put in place.
However, not all of the changes that have taken place since the enactment of the CARD Act have been positive. Banks have cut perks and added many fees in an attempt to make up the lost revenue, such as application fees, annual fees, inactivity fees, increased balance transfer fees, and even fees for receiving a statement by mail.
Another negative for consumers is that credit card interest rates have risen from 13.26% to 14.27%, making it more difficult to find a low rate credit card, and the amount of available credit has dropped from over $4,400 to $3,900 on the average account, which can hurt those with a high utilization or those who need to apply for a new card.
Overall, the act seems to have accomplished its goals of providing consumers with more information about the cost of credit and the consequences of carrying a balance and protecting cardholders from predatory practices by issuers, but that protection has come at a cost, especially to those with poor credit or lower incomes who have been effectively shut out of the credit market, leaving the results of this regulation mixed at best.
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By Simon Grey, on July 11th, 2011
In a June 21 response, attorneys for the church indicated the church had strategically defaulted on the mortgage after learning its real estate – a 23,635-square-foot office building housing the church – is worth only $2.375 million vs. the $7.653 million owed to the bank.
This strategic default involved an analysis of whether it made sense to use church members’ donations to pay the underwater mortgage while also trying to save money for expansion needs.
I remember arguing with a preacher once over the morality of strategically defaulting on one’s mortgage. He was of the opinion that, per Romans 13:8, we each have an obligation to pay off our debt. His argument struck as somewhat asinine (but less asinine than the argument that Romans 13:8 forbids the Christian from going into debt).
Anyway, the flaw in this preacher’s thinking was that defaulting did not lead to repayment of the debt. Most mortgage agreements work like this: the borrower agrees to borrow a certain amount of money and repay it, plus a usury charge called interest. The borrower is generally expected to offer some property as collateral. If the borrower fails to pay per the terms of the agreement, then he is in default, and the lender usually reserves the right to confiscate the collateral in order to cover the remainder of the principal. For most mortgages, confiscation of property is generally considered sufficient compensation in the event of a default (which is predicated on the theory that housing prices always go up and never come down).
Thus, the lender is essentially saying that the property offered as collateral is equivalent to the value of the foregone cash. Whether this assumption proves to be true in the long run is not the concern of the church, in this case, but of the bank that makes the loan. And if the bank’s estimation of the future value of property is wrong, it does not follow to claim that the church must repay the bank for a mistake the bank made. Furthermore, the bank has already said that ownership of the property in the event of a default essentially marks the debt as paid, so there is nothing wrong with the church defaulting on its payments in order to save money (in fact, the church would do well to default and then repurchase the property once the bank sells it).
Therefore, it is not wrong for the church to default on its loan, for it is simply making a prudent financial decision and will, even by defaulting, pay its debt. The bank, not the church, is responsible for determining market risk, and the bank, not the church, should bear the consequences of making the wrong decision.
By Simon Grey, on May 18th, 2011
Enrollment will decline once this becomes common knowledge: The brutal job market brought on by the recession has been hard on everyone, but especially devastating on the youngest members of the labor force.
About 60% of recent graduates have not been able to find a full-time job in their chosen profession, according to job placement firm Adecco.
And for those just entering the workplace, a bout of long-term unemployment can affect their career plans for years to come.
I have two friends from college who graduated recently. One of them has an Associate’s in graphics design; the other has a dual-major Bachelor’s in graphics design and business administration with a minor in marketing. They both work at Target. They both have tens of thousands of dollars in student debt.
I have another friend who graduated a year ago with an Associate’s in network security. He makes minimum wage working at Walmart and pays $400+ per month on his student loans.
These guys are relatively intelligent and quite hard-working and reliable. They are educated. And they work crap jobs because they have to pay off a ton of debt that they accrued pursuing a piece of paper that hasn’t actually improved their job prospects.
And so, my advice to any all high school seniors is this: when you graduate, get jobs anywhere you can and forget about going to college. Look into an apprenticeship, if possible. Alternatively, learn a trade and start developing work contacts. College is not worth the cost anymore, unless you’re going into a hard science or engineering. Medicine is socialized, so avoid it all costs.
Computer science is mostly overrated because you can learn everything you need to know online. Everything else is B.S.
If you go to college, you will have debt that you cannot ever default out of; you have to pay it back. You will lose at least four years of your life. And on top of all this, you are not more employable with your degree than you were as a high school graduate. There are better things to do with your life than earn a college degree.
By Claus Vistesen, on April 18th, 2011
In a seminal paper [1] from 1958 Franco Modigliani and Merton H Miller showed why investors should not care about whether firms were financed with debt or equity. This led to the idea of the the debt irrelevance proposition and although the DIP is a theoretical benchmark rather than a real world rule the 1958 paper by Modigliani and Miller remains a key contribution to the finance literature. We should not however extend the same role to the recent attempt by researchers [2] to re-invent the DIP in a new guise replacing “debt” by “demographics”. Allow me to explain why.
Demographics, Just Forget About It …
My point of departure is Edward Chancellor’s recent GMO letter in which he tackles what he considers to be the non-issue of Japan’s dire demographics. He emphasizes two things; firstly, that economists are notoriously poor at predicting demographic variables and secondly he notes that whatever relevance demographics might have for macroeconomic analysis at large (of which Mr Chancellor appears skeptical) it is irrelevant for the investor;
Besides, long-term demographic forecasts aren’t particularly relevant for equity investors. It’s true that changes in the population have a sizable impact on GDP growth. But stock market returns are not positively correlated with economic growth. Returns from equities are a function of valuation and future returns on capital – a subject to which I will return later – rather than changes in GDP. Nor is there a positive correlation between population growth and stock market returns. In short, investors should not get too hung up on inherently unreliable long-term demographic projections for Japan.
It is important to underline, in fairness to Chancellor, that the points are made with specific focus on Japan but the the argument seems to have a more general hue. This is even more obvious in relation to one of Chancellor’s main references in the form of Morgan Stanley analyst Alexander Kinmont’s note entitled The Irrelevance of “Demographics”? Kinmont puts up the following four points which I will use as my points of reference;
1. It is not clear that demographic estimates are accurate over long time frames. In fact, while spurious specificity is one of the attractions of demographics as a talking point, the fact that neither death rates nor birth rates have proven predictable should caution one against accepting any assertion about demographics.
2. It is not clear that demographics are the critical variable in determining the level of economic growth. That role falls to the growth rate of TFP.
3. It is not clear that equity returns are related to absolute levels of growth. Equity returns are an issue of valuation. Nominal returns are greatly affected by inflation too.
4. It is not clear that demographic change, even if it is allowed as a negative for economic growth, is necessarily negative for stocks, as certain forms of demographic change may be associated with a rising equity market multiple. Demographic change could in fact represent a benign environment for stocks.
On the first point Kinmont makes points to the irony in that the worry about Japanese demographics seems to be peaking just as Japanese fertility is on the mend. This is a cheap shot though and not one which stands up to scrutiny. First of all on the fertility trend itself I get the same chart as Kinmont’s below using data from the World Bank showing a rebound in Japan from a low point of 1.29 in 2003 and 2004 to 1.37 in 2009. However, Indexmundi which takes its data from the CIA World Factbook has fertility much lower and actually declining in Japan. The latest data point from the CIA World Factbook reports an estimate of TFR in 2011 is 1.21. This is a pretty steep difference and I invite comments as to suggest the right number or at least the right trend.
(click on picture for better viewing)
All this is of course underlines Kinmont’s point that we don’t know the future and that economists have a proven track record for abysmal forecast performance. Still, we should get our concepts right at the offset. Long term projections in age structures are likely to be robust as they are a function of people already being born and while migration may change the course of ageing in any given country the fact that we are all ageing at one at the same time means that there are fewer migrants to go around. I would then claim that ageing does matter and that understanding how an economy such as Japan adapts to the ageing of its population remains one of the most vexing and important issues for social scientists and investors alike.
So when Kinmont implies that low fertility in Japan is a non-issue I have to strongly oppose. Just take a look at the chart above Kinmont himself uses. Fertility has been below replacement levels in Japan since 1970 and on current growth rates (assuming a constant growth rate of fertility which in itself is dubious to the extreme) fertility levels would reach replacement levels some time in 2030-40. So, that would be 60 years with below replacement fertility. Even if fertility in Japan (and again in most of the OECD) took a discrete jump to replacement levels it would do very little to change the outlook for ageing in the immediate future.
In claiming that demographics do not matter Chancellor are Kinmont are taking a very wide brush over the general recognition in the academic literature that our economic systems tend to hit a snag once fertility falls below a certain level (a TFR of 1.5). This is also called a fertility trap and what it means is that it becomes very difficult to escape negative population dynamics once they set in. I emphasize this since it highlights that we are not, as a friend of mine likes to point, simply shooting arrows into the void when we point to the importance of these issues. I recommend the following presentation by Wolfgang Lutz et al and the paper that goes with it or this old post at AFOE by Edward if you are still not convinced.
In terms of the postulated increase in Japanese fertility since the mid 2000 it is a positive development, but as is evident from the data this rebound is extremely uncertain. In addition, we need to know whether this is just an echo of the tempo effect (and thus how large the rebound is likely to be) or whether it reflects a real change in attitudes on quantity. I am open to contributions here but the only thing we can for certain is that ageing, in Japan and the rest of the OECD, will continue its march onwards. Here I also feel that Kinmont puts up a straw man when he invokes the idea of Japan’s population going to zero;
The unrevealed assumption, then, behind the mathematics used to arrive at widely-used population estimates is that the Japanese population will drop to zero. One cannot help but suggest that the logic of demographic pessimism is circular.
I want to re-emphasize that the issue here is not predicting fertility and death rates but recognizing the effect that the current and past trends have on ageing today and tomorrow. Try the recent work by Wolfgang Lutz, Warren C. Sanderson, and Sergei Scherbov if you want to see the cutting edge here and while uncertainty is still a key variable ageing remains a tangible reality. The main question issue I would like to get across is then that the demographic transition manifests itself in a transition of ageing and that this essentially becomes our main unit of analysis.
Growth and Demographics, No Connection?
Kinmont and Chancellor argue that demographics are likely to be less important for growth over time as total factor productivity (TFP) growth tends to be the main driver of growth.
Japan could quite easily grow at a good rate, especially in per capita terms, for a high-income developed country even in the face of a falling population (or more precisely a falling working age population). All that is required is for TFP growth to accelerate back to the level of growth enjoyed by Japan prior to the bursting of the Bubble in 1989. TFP slowdown preceded the population peak. Variation in TFP performance not in labour input growth is likely to be larger than the negative effects of population change.
This is an important point and more importantly, Kinmont offers an argument to explain the declining labour input in Japan’s economy which links in with the fact that Japan has been stuck in deflation and at the zero lower bound for the best part of two decades (my emphasis).
Labour input has in fact fallen at an accelerating pace over the past 20 years. It is clear that the fall is principally a decline in man-hours. This cannot be simply a function of a decline in the working age population because that decline only began in 2000. Instead, its origins must lie in rising unemployment and under-employment. A persuasive new paper, The Paradox of Toil, by a researcher at the NY Fed [3] argues that a decline in labour input is a natural consequence of a deflationary economy with zero (or effectively zero) interest rates.
In short, the declining labor input in Japan is a function of deflation and being stuck at the zero lower bound. In addition, this Fed Researcher Kinmont refers to is Gauti Eggertson who studied under Krugman at Princeton and did most of his initial work on the liquidity trap and the zero lower bound. So, I would be careful getting in his way without a strong look at the argument.
I think however that we might be dealing with the problem of a missing link in the sense that demographics may be one of the primary sources of deflation and the liquidity trap in the first place. This is an argument that has been pushed in Japan’s case in the sense that it was a lack of pent up demand that held Japan back in the 1990s as well as deleveraging. Indeed, Japan may hold a cautionary tale on the effects of a balance sheet recession in an economy where fertility has been below the replacement level for an extended period. The Eurozone periphery (ex Ireland) who have even ceded monetary policy to Frankfurt are case studies to this theory I think.
I would also emphasize that as labour input declines so does, obviously, consumption (aggregate demand) input which again feeds into the the paradox of thrift in the closed economy (or perhaps even a realisation crisis?). In an open economy it leads to export dependency as domestic investment actvity responds to foreign demand as well as the excess income you earn from a positive net foreign asset position (if you are so lucky as to have one) becomes a crucial source of growth.
Another more fundamental point is that if the total factor productivity growth (TFP) is a residual what is actually hidden in this residual? Well, I had a wack at the whole argument a while ago from the perspective of the academic armchair.
Technology and productivity are famously assumed exogenous in the Neo-Classical tradition while New Growth theory as it was developed in the 1980s and 1990s emphasised the need to specifically account for the evolution of technology. Today, I would venture the claim that there is a consensus that productivity and technology is a function of what we could call, broadly, institutional quality which encompass almost anything imaginable from basic property rights to the level of entrepreneurship. Indeed, a large part of research is still devoted to pinning down exactly which determinants that are most important here both across countries and through time. Now, I would argue that, in the context of standard growth theory, this is where the scope for the study of the effect of population dynamics is largest. Thus I don’t think it is unreasonable to expect the level and evolution of productivity growth and technological development to be a function of the current population structure but also its velocity which is a function of e.g. migration (new inputs?), future working age size etc. Also, this is also where human capital and the evolution of technology is joined at the hip through the idea of innovative capacity and readiness.
Once we venture into the notion of endogenous growth theory and thus the attempt to directly explain the sources and components of total factor productivity growth there is growing evidence that age structure/demographics alongside a host of other variables are important. Try this one for a recent literature review, and for the general link between growth and demographics the list of contributions is long. You just need to read around a bit.
I would argue then that growth and prosperity of the modern capitalist welfare state is highly conditional on some form of demographic balance and Japan has long since moved beyond into unbalanced territory. Basically, Japan is stuck in a liquidity trap as well as a fertility trap. The latter works along the lines of depressing consumption demand and making it very difficult to maintain key economic structures such as e.g pension systems. In addition, ageing affect the growth path of an economy and leads to export dependency, this last point however which I concede is not yet an established fact in the literature.
What about stocks then?
We seem to have two intertwined arguments here. Firstly, the extent to which demographics may have an influence on growth it is irrelevant for the investor since you can’t buy GDP growth anyway. Secondly, the evidence of a correlation between demographics and equity prices is weak and indeed, if anything, should be bullish for Japan (this last point is made by Kinmont).
Thus the FT summarized the latest findings of the London Business School team of Dimson, Marsh and Staunton, as published in the Credit Suisse Global Investment Returns Yearbook, 2010. The LBS academics examined all the available data (83 markets), and concluded that “99 per cent of the changes in equity returns could be attributed to factors other than changes in GDP”. (…) Growth is not all that it is cracked up to be. This analysis underscores previous academic findings showing that growth
per se to be of only small importance to stocks.
It would be unwise to disagree with the gist of this point. Even if I can make a connection between demographics, growth and investor performance it is very likely that buying into such a story at too high a valuation will lead to poor returns. Buying at the right value is the most important aspect of any investment decision.
This however is not the same thing as saying that just as you make sure to “buy cheap” poor demographics, low growth etc are completely irrelevant. Rather, I think that the extent to which the modern investor needs to understand a decidedly more complex macro picture with lingering deflation, heightened risk of sovereign defaults and zero lower bounds the understanding of demographic dynamics is key. We are then again discussing the question of deflation and low interest rates in Japan;
The origin of Japan’s problems is falling valuation when compared with the rest of the world. When we note in addition that it is excesses of inflation or the arrival of deflation (that is, monetary phenomena reflecting policy errors) which tend to reduce market average valuations, we feel it safe to conclude that demography will have next to nothing to do with the longer-term return profile of the Japanese market either in nominal or real terms.
I feel this is a very dangerous claim to make because it assumes that the deflation dynamics of Japan and indeed the problems facing the Bank of Japan in reviving credit growth are unrelated to demographics. In addition there is the unintended consequence of BOJ having to monetize an ever greater amount of JGB issuance in the future which in itself becomes more paramount as Japan ages.
On the second point regarding a direct relationship between demographics and stock prices (asset prices in general if you will) I think Kinmont does better especially because he does not fall into the asset meltdown hypothesis trap. In short the asset meltdown hypothesis states, in a US context, that as the baby boomers retire they will dissave and thus need to sell off their financial assets to a market which cannot support the flow, because the generation in the working age years is smaller, and that this will lead to an “asset meltdown”. Generalized, this is then the classic (and naive) nexus between life cycle economics and financial markets which postulate that dissaving into old age is rapid and imminent.
There are two problems here. Firstly, the empirical (and indeed theoretical literature) has found it very difficult to verify that dissaving occur among elderly cohorts to the extent postulated by the standard life cycle theory. Secondly, the relationship between asset prices and broad demographic aggregates appear weak. Results differ from country to country and most studies take place in a US and Anglo-Saxon setting which tend to bias the results further.
Kinmont does however point to a study by Geanakoplos, Magill and Quinzili [4] which show how the ratio of the 45-54 age group to the 25-34 age group is closely related to P/E ratios. As this ratio is set to increase in Japan, Kinmont ventures the idea that, if anything, perhaps you would want to buy Japan on the basis of demographics.
I have read the research by Geanakoplos et al and I find it intriguing, but my problem is that it does not control for the old age dependency ratio which suggests that the key ratio will be correlated with ageing in general. But I should be hesitant disregarding it on the basis of this hunch. I am preparing a large panel data set at the moment on demographics and stock prices with the aim to essentially rejuvenate a literature which seems too focused on the asset meltdown hypothesis noted above.
On a more general level, demographics and investment has been a core theme in the post crisis flow into emerging markets which, by and large, share the characteristics of being in the middle or at the end of their demographic dividend. Again, this does not nullify the importance of valuation and certainly, the recent soft patch notwithstanding, many emerging markets are still looking expensive.
Where goes the DIP then?
If you build your story up around the notion that investors buy value and not GDP growth you can easily come to the conclusion that demographics are irrelevant for the investor at large. This however would be a mistake.
I would be the first to wish for a return to a state of affairs in which investors needed only to look at valuation and firm fundamentals to make their decisions. Today however, you need to understand the macro backdrop and in order to do that you need a firm grip on how demographics affect macroeconomics. Pointing out that we are poor at predicting birth and death rates as well as pointing to weak evidence between growth and demographics do not cut it. We need not predict fertility and mortality but instead we need to understand the effects of ageing already present and there is plenty of evidence that demographics affect the growth rate and growth path of the economy.
I am more sympathetic to the strict relationship between stocks and demographics which is fickle and not well understood. Clearly, there is not presently any convincing model or framework which suggests how and why you might be able to buy sound demographics on a beta level. My main bet is that demographics should, at least, be used to qualify the notion of the global market portfolio and especially that demographics be used to re-balance such a portfolio over time.
In conclusion, Kinmont and Chancellor bring up some valid and good points in their attempt to brush away demographics as an important input variable to investment and macroeconomic analysis but you shouldn’t be fooled. Just as was the case with the original DIP you accept this new version at your peril.
—
[1] – Franco Modigliani and Merton H Miller (1958) – The Cost of Capital, Corporation Finance and the Theory of Investment, American Economic Review 48 (June 1958) pp. 261-297.
[2] – GMO White Paper – After Tohoku: Do Investors Face Another Lost Decade from Japan?, Edward Chancellor and Morgan Stanley Japan Strategy – The Irrelevance of “Demographics”?, Alexander Kinmont. I realise that I have lately been referring to sources and pieces of research which by nature of their origin (banks, research firms etc) are behind subscription walls. I am sorry, but I will make sure to produce relevant quotes so that my readers can follow the issues and arguments. I cannot upload full PDF versions of the reports for obvious reasons and I hope my readers will understand.
[3] – The Paradox of Toil, Gauti Eggertsson, Federal Reserve Bank of New York Staff Reports, no. 433, February 2010
[4] – Demography and the Long-run Predictability of the Stock Market. John Geanakoplos, Michael Magill, and Martine Quinzili; August 2002, Revised: April 2004. Cowles Foundation Discussion Paper No. 1380
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