Mar072017
Americans increasingly accumulate the wrong kinds of debt
Americans borrow more money for consumption rather than the acquisition of assets.
Not all debt is created equal. I borrowed large sums to buy cashflow properties in Las Vegas, debt backed by a cashflow-producing asset. The income stream repays the debt with interest, and if for some reason I am unwilling to pay back the loan, the lender can auction the property and either receive their money back or obtain cashflow equal to or greater than the payment on the debt. That is asset-backed debt.
Lenders provide asset-backed debt for the purchase of property, plant, and equipment. When lenders evaluate these loans, they consider the useful life, the recovery and resale value, and the cashflow the asset may generate (if any).
Asset-backed lenders assume the debtor’s word means nothing and any recovery of capital will come solely from the collateral pledged to cover the loan. In this world, there is no signatory assurance of repayment, only collateral repossession, cashflow, and resale.
Asset-backed debt is essential to the functioning of our economic system. Many businesses could not raise the equity to obtain the property or equipment necessary to its operations. Lenders can loan against working capital at very low rates with little risk. If businesses free up their money, they grow the business, and our economy grows and prospers. In short, asset-backed debt is useful and freeing.
On the other hand, signatory debt is slavery. Signatory debt is money given to a borrower simply based on the borrower’s promise to repay. It has nothing to do with an asset, and if the borrower chooses not to repay, recovering signatory debt can be very difficult because it’s not backed by tangible collateral.
Signatory debt provides no useful purpose. Signatory debt provides a short-term economic boost as demand is pulled forward, but once it is consumed, money that would ordinarily have been spent by the borrower on consumer goods is instead diverted to the lender for debt service. It’s only when signatory debt is expanding that the economy is stimulated, and the expansion of signatory debt is often a Ponzi scheme.
Signatory debt creates Ponzis
The problem with signatory debt is simple: people don’t want to keep their promise to repay when it is inconvenient. Ponzis live to consume. They will take money under any terms offered, and when it comes time to pay the bills, they will seek more borrowed money to keep the system going. Borrowing money to repay debt is the essence of Ponzi living.
Ponzis inevitably spring from signatory debt. Not everyone who borrows with no collateral is a Ponzi, but Ponzis could not exist without signatory debt. A lender’s only deterrent to providing unlimited debt growth, and thereby unlimited economic growth, is the losses created by Ponzis.
Our current home mortgage lending system backed by the government, and without strict controls, Ponzi borrowing with home loans is inevitable, which is why I diligently report on burgeoning mortgage equity lending.
Conflating asset-backed debt and signatory debt
Lenders conflate the distinction between asset-backed debt and signatory debt by over-loaning on assets. The housing bubble is a classic example, but lenders do this with car loans, commercial loans, and personal property loans.
A home loan has a component of asset-backed debt. The portion of the cost of ownership (payment, interest, taxes, insurance, HOA) equal to rental is asset-backed. If the loan balance is limited the size supportable at rental parity, the property could be rented for an income stream capable of sustaining the debt service.
However, once the cost of ownership exceeds the cost of a comparable rental, the only assurance the lender has of getting repaid is based on the signatory promise of the borrower. Therefore, the loan is part asset-backed and part signatory. When lenders cross the line from asset-backed to signatory debt, they turn good debt into evil debt and inflate asset bubbles. Lenders did this in both the residential and the commercial real estate markets during the 00s.
Once lenders cross the line from asset-backed debt to signatory debt, they are inflating an unsustainable Ponzi scheme. Inevitably, prices will crash back to asset-backed levels determined by rental parity. it’s not a matter of if, only when, as we witnessed when the housing bubble burst.
Our economy is finally pulling out of its decade-long malaise. Unfortunately, a growing portion of this expansion is built on the unstable foundation of increasing signatory debt.
Americans now Hold Over $4.1 Trillion in Consumer Debt: Last Debt Bubble Peak was at $2.5 Trillion.
Americans now hold an incredible $4.1 trillion in consumer debt. This latest data shows that Americans are now back to having an insatiable appetite for spending beyond their means. Unlike mortgage debt, consumer debt is not building up any future equity here. The largest category of consumer debt is student loan debt. Even at the peak of the last debt bubble, consumer debt totaled roughly $2.5 trillion. While student debt makes up about $1.4 trillion of the consumer debt here, auto debt is above $1 trillion.
It can be argued that student loan debt is actually asset-backed debt because the borrower is investing in their own mind. However, what happens when the knowledge this borrower accumulated turns out to be worthless? What happens when they fail to get a degree, or they obtain a degree that doesn’t lead to a high-paying job?
The entire principle behind asset-backed debt is that the debt acquires an asset of greater or equal value. Student loans often fail to meet this standard. Without a cost-benefit analysis applied to student loan debt, and without a backup plan if the borrower fails to obtain a degree, student loan debt becomes signatory debt — except that the borrower can’t extinguish this debt in bankruptcy. It truly becomes debt slavery.
We’ve also seen a large rise in subprime auto debt suggesting that people are borrowing beyond their means to consume. Delinquencies are also rising suggesting any tiny slip up in the overall economy and this credit bubble can burst too.
Subprime auto loans are clearly a bubble. Lenders piled in because the new chip that disables cars provided a stronger incentive to repay and greatly reduced the cost of repossession. As with any debt expansion, lenders provided too many loans to risky borrower pools, and now, despite the chips, the deadbeats decided not to pay.
Consumer debt surging to record levels
Americans are now borrowing and spending at record levels. This would be fantastic if incomes were keeping up but many are trying to keep up with the Joneses by spending future income via consumer debt. This chart sums up the desire to spend:
Source: Federal Reserve
Showing signs of weakness we have over 10 percent of all student loan accounts being delinquent by 90 days or more. And this is the largest consumer debt segment. Auto debt delinquencies are also rising suggesting people are having a tough time paying their car loans. …
Banks are more comfortable lending money now that we are 10 years passed the excess of 2007. The Great Recession officially ended in 2009 and while banks have had generous bailouts, it appears that American consumers are being bailed out via access to debt. If we take a tiny trip down memory lane, we will remember that solvency was the issue during the last credit bubble. People took on too much debt relative to their ability to pay. The amount of consumer debt being issued is troubling to say the least.
It also underscores why we need the economy to run hot for a while. We need wage inflation to provide borrowers the capacity to repay these debts, and we need monetary inflation to reduce the value of the currency they will use to repay it.
While auto debt and credit card debt can be discharged via bankruptcy, student debt cannot. That is very significant. Many younger Americans are being put into a new form of debt serfdom through going to college and taking out mini mortgages that they simply cannot pay back.
Here is one of many horror stories when it comes to student debt:
“My original debt from 1998 was $25,000. 8 years later I have a debt of $75,000. I am no banker or accountant, but I am assuming this will continue to triple every 8 years if I remain in poverty and thus in default. So am I correct that in 8 more years I may owe $225,000? That in 16 years I will owe $750,000; in 24 years, $2,250,000, and then at retirement time in 32 years I will owe $6,750,000? 6 Million plus? Haha. Now, of course, if this were any other form of debt that became this cancerous I could file for bankruptcy. Not for student loans though. At age 72 I may owe $20,250,000. Heaven forbid that I live to see my eighties. At age 88 I may owe $182,250,000.
I think we are just beginning to see how crazy this is going to get. If my math is correct, in ten years there are going to be a lot of impoverished people, people making less than $20,000 a year, who have these ludicrous million dollar debts.
My heart about exploded when I got the letter saying I owed $75,000. After I recovered, all I could do was laugh. It is so absurdly much that they might as well have told me that I owe a million bucks, and now, upon further reflection, it appears they will be telling me I owe them a million bucks in the not so distant future.
I wonder if people with unpayable student loan debt will due to accumulated stress, loss of work, and an inability to pay for medical needs in old age, have on average shorter lifespans than those who do not? This will make an intersting study in fifty years.”
So an original debt of $25,000 has ballooned to $75,000 in eight years. Why? Because the debt compounds with interest and charges are put upon charges. Of course if someone cannot pay, you see how comical the situation can get in a macabre sort of way. You can read other stories here. Does this even sound like a good situation to put young and older Americans into?
Consumer debt being over $4.1 trillion is troubling when student debt, auto loans, and credit cards are leading the way forward. Apparently we like repeating history and people may like to forget that at the root of the Great Recession was a giant credit bubble.
Realistically, we need inflation. Most people carry too much debt. Millennials strain under the weight of excessive student loan debt. Generation X struggles under the weight of their bubble-era mortgages. And even the Boomers carry far too much consumer debt into their retirement. This debt will never be repaid in today’s dollars, so inflation benefits far more people than it harms right now.
Chinese investors could exit US in favor of Asia
From the New York website: After two-year stretch during which the yuan depreciated against the dollar, the Chinese currency is on the rise in 2017, which could lead to a shift away from New York City real estate.
“The bulk of yuan depreciation has probably already happened, and if that’s the case there is less incentive for Chinese investors to place money in dollar-denominated assets,” Andrew Haskins, director of Asia research and advisory services at Colliers International, told Bloomberg.
Haskins added that political concerns such as President Donald Trump’s protectionist policies “may also slow the pace” of Chinese investment in the United States, especially if his rhetoric starts to materialize as policy.
Over the past two years the yuan has declined 13 percent against the dollar, but it’s gained almost 1 percent so far in 2017. At the same time, most other Asian currencies have strengthened, most notably the Korean won, which has appreciated 4.3 percent.
Asian investment in U.S. real estate peaked at $33 billion in 2015, but slid by 12 percent last year to $29.1 billion.
Chinese insurance firms, some of the most active buyers in the past few years, have been notably quiet so far in the first few months of 2017. They haven’t made any acquisitions thus far in 2017, amid a sweeping movement to stave off outbound capital and limit speculation.
LoanDepot developing faster, all-digital loan approvals
Lender LoanDepot is streamlining its online loan approval process, allowing borrowers to get faster approvals even when using their smartphones to apply for a mortgage or personal loan.The Foothill Ranch-based lender announced Monday it has launched its latest “digital lending platform,” a new and improved version of its web-based lending program that speeds up loan approvals, the company said.
Eighteen months in development, the new platform lets consumers upload documents, sign forms electronically and communicate with loan officers. Once borrowers give their permission, an automated process verifies their income, bank statments, employment and other financial data, enabling them to quickly get quotes, prices and prequalification letters.
“Later this year, you’ll be able to do a full application within minutes,” said LoanDepot spokeswoman Julie Reynolds.
And they’ll be able to access everything through web browsers on a smartphone, tablet or desktop computer. The system for mobile loan retailing currently is in beta testing, the company said.
The new platform is part of an $80 million investment in technology, the company said.
The investment also includes plans to open a new 65,000-square-foot technology campus in Irvine, where more than 400 employees will continue working on ways to transform the loan application process.
Despite 17 years building online mortgage businesses, LoanDepot Chairman and CEO Anthony Hsieh said his industry has “largely remained devoid of modernization.”
“The digital disruption that changed the consumer experience in online books, home entertainment and consumer goods is just now impacting financial services,” Hsieh said in a statement. “We are building a tech ecosystem that enables us to quickly venture into ancillary services and markets unknown to us today.”
Oh boy! It’s disruptive. I wonder if it delights customers by using Deep Learning AI in the cloud.
Interesting read if you want to learn more about the Republican’s doomed tax overhaul proposal.
Destination-Based Cash Flow Taxation: What is it and Why Does it Matter?
What’s the effect on housing?
Could be minimal or substantial, depending how quickly and fully the dollar adjusts. If the dollar fully adjusts as predicted the real estate industry would likely be agnostic to the shift.
If the dollar doesn’t fully adjust, however, we could see a large decline is purchasing power among consumers, which would undoubtedly trickle into real estate. Many construction materials (i.e. Canadian lumber), appliances and furniture are all heavily imported and could jump in price.
Builders might benefit by being able to deduct labor costs and pay a lower corporate tax rate, which could affect construction rates.
Low-Income Housing Tax Credits (LIHTC) depend on corporate profits and the desire to reduce taxable income. Participation in LIHTC programs dip during times of lower corporate profits, so it’s probably a good assumption that if corporate taxes are lowered, demand for credits to reduce taxes will also fall.
Finally, depending what service exemptions are carved out, if the BAT ends up operating like other VATs around the world, the cost of professional services (including the real estate sector) could rise.
Most economists would agree that income taxes are a bad form of tax. It disincentivizes the very activity (work) which is good for the economy.
If VAT tax can partially replace income tax, we will all be better off in the long run, as economic growth would be increased.
The domestic wage deduction is an interesting component. I am not sure it would fly with the WTO. But at the same time though, incentivizing domestic labor, although extremely protectionist, is not necessarily a bad thing.
Actually, I think the proposals in this tax reform are good ones. Due to entrenched special interests and a complete lack of Democrat support, I also think it’s doomed to fail. It only takes a few Republican senators to defect before it won’t pass, and that’s assuming it’s watered down enough to get past a Democratic filibuster.
Its weird that democrats would oppose a BAT. It was originally proposed by a progressive economist.
https://www.americanprogress.org/wp-content/uploads/issues/2010/12/pdf/auerbachpaper.pdf
I guess its equally weird that republicans oppose the ACA which was originally a conservative solution.
This is pure partisan politics. Some Democratic senators probably think it’s a good idea, but supporting Trump is so toxic to Democrats right now that even if Trump proposed something all Democrats would support, they would vote against it anyway for fear of their constituents.
Americans could be killing the McMansion for good
Homebuyers today are emphasizing quality over quantity.
If you live in a suburb of one of America’s major cities, you’re most likely familiar with the idea of a McMansion: a sprawling, often architecturally mishmashed home boasting several thousand square feet.
As the American economy suffered the effects of the 2008 subprime-mortgage crisis, however, photos of foreclosed McMansions in subdivisions across the US served as reminders of what could happen when people try to live beyond their means.
Now, as Americans’ attitudes toward conspicuous consumption have evolved in the wake of the recession, the suburban McMansion as we’ve come to understand it could be on its way out.
Measure S: a voter guide for LA’s anti-development ballot measure
Measure S—which appears on the ballot tomorrow in the city of Los Angeles—aims to reform the city’s broken planning system and scale back what supporters say is the proliferation of big, bulky buildings.
Also known as the Neighborhood Integrity Initiative, the ballot measure would place a two-year moratorium on some types of high-density buildings, chiefly those that are bigger or taller than what the city’s out-of-date land-use rules allow.
Spearheading the initiative is the president of the deep-pocketed AIDS Healthcare Foundation, who’s unwilling to accept that Los Angeles is not a suburban city.
He and his supporters claim certain development projects are displacing low-income renters, creating traffic, and destroying neighborhood character. But opponents say the measure does nothing to keep tenants in their home.
The measure is complex and far-reaching, and housing advocates warn it would devastate the local housing market. It would halt construction and, in turn, drive up the cost of renting and buying in Los Angeles—which is already one of the priciest markets in the U.S.
“Our economy is finally pulling out of its decade-long malaise”
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Au contraire…
http://cdn.tradingeconomics.com/charts/united-states-gdp-growth.png?s=gdp+cqoq&v=201703061722t&d1=20070101&d2=20171231
Can you find a link to the image? The system will post any image type with an actual web address, but it won’t post dynamically generated content and charts.
“Realistically, we need inflation. Most people carry too much debt.”
Wrong only debtors need inflation. Those of us who pay as we go prefer deflation. The veneer on this “recovery” is quite thin.
Amen. I personally would like those in debt to experience pain so they will liquidate and sell to those of us that can actually pay for things.
This! The school of natural consequences is the best education.
I agree with you. I would personally benefit more from deflation at this point, but I also see the handwriting on the wall. It’s still a really good time to take on long-term debt, particularly mortgage debt to buy rental property. The necessary inflation on the way will erode the repayment value of those dollars deferred for 30 years into the future.
Per the US census bureau for July 2015
Population of the City of Los Angeles 3,971,883
Housing units (April 2010) 1,413,995
Residents per housing unit 2.8
But we have a shortage of housing? Yup no bubble here.
The demand is for significantly more housing units, both rental and resale. If that weren’t true, prices wouldn’t be so high. Look at places like Detroit where there are more houses than jobs or people. Entire neighborhoods of older houses have been bulldozed, and many more will as they deteriorate.
My point is houses are being used a financial assets not actual consumption items in Los Angeles. There is also something like 200k vacant houses throughout the city. There is actually plenty of structures to house the entire population of the city with less than three people per. The capacity is not being used.