Wednesday, October 01, 2008

Who are the debtors?

PRE-POSTSCRIPT: Drowning in the firehose of commentary about the crisis and "bailout," I can only recommend my favorites, Instapundit (Glenn Reynolds) and Megan McArdle's joint. Reynolds' entries are terse but frequent; McArdle's less frequent and sometimes a bit long-winded (like I'm one to talk). Both have good links to other places. Megan has a funny screed against bad metaphors for the crisis here. Glenn correctly nudges people to use "rescue" instead of "bailout."*

An idea definitely worth supporting is replacing Pelosi and Reid as House Speaker and Senate leader, respectively. Both have been embarrassments to their party and country. Bush's popularity oscillates between 30 and 40%. This Congress' ratings have never been higher than low 20s and have sunk, at times, into single digits. With good reason, it's the most unpopular Congress since World War Two. Assuming the Democrats maintain control of the House (which they probably will, with a smaller majority), the best choice is Clintonista Rahm Emanuel. Politics makes strange bedfellows: weird as I feel typing these words, everyone's disgusted with Reid-elosi, and the Dems desperately need a counter to the cultish children's crusade that is their presidential campaign.

The credit market and housing debt crisis continues to gyrate. Strangely, it seems to have boosted the prospects of the party that bears much of the blame for it. Remember: government is now involved in backing about 40% of home mortgages.

While I would have voted for the bailout bill if no alternative were available, I completely understand the motives of the House members who voted against. They got an earful from their constituents and only weak pressure from the House leadership. It's essential to decouple the credit-liquidity crunch from the longer-term asset-decline problem. It's too early to seriously discuss responding to the latter. The former needs a response now.

Finance/economics blogger Fabius Maximus (F.M. from this point) recently published a fascinating and frightening look at American debt trends since World War Two. While his views are always loaded with doom and gloom, this argument is worth a look; he's backed it up with hard numbers ultimately based on what the Federal Reserve tracks. F.M.'s debt ratio charts show various categories of debt from 1952 until now, as a fraction of GDP. (The GDP is gross domestic product, the annual output of the American economy, the world's largest, at a little more than a quarter of the global total). I'll admit: my jaw dropped too.

Such high debt ratios are the deep fact now spooking credit markets and foreign investors, deeper than the immediate credit crisis or falling housing prices. No society can get into as much debt as we're in and not create a huge crisis of confidence among lenders. With no sign that the debt accumulation will stop, they've cut back their lending, even to the creditworthy. We've been lucky that this debt is denominated in our own currency, allowing the Fed to massage the money supply and keep credit crises at bay in the past. But, still, there is a limit. Evidently, we've reached it.

From these charts, both the numbers and their trends, we can draw some conclusions at some variance with received wisdom.

Government itself, far from being the main debt culprit, is the least. Its ratio reached an absolute peak in 1945 and has not approached it since.

A large federal debt does seem to be a permanent feature of modern America. The period of the 1960s and 1970s, when the federal debt ratio dropped, is misleading in one respect. In that era, government policy was to print money rather than borrow it. The tendency to borrow, established in the 1930s and 40s, returned in the 80s. OTOH, the effect of peace dividends is real: the drop of the federal debt ratio after World War Two and in the late 80s and early 90s reflects the end of one very large and another, less intensive, conflict. Both the 1950s and the 90s were periods of falling federal debt ratios, because the pressure to increase government spending had eased off. The period after 2000 was marked by a smaller, but still significant, surge in federal debt, mostly a result of the Republicans' new eagerness for big government.**

Business enterprises, both financial (banking and insurance, essentially) and non-financial, have developed a large leveraging habit, borrowing in good times -- during economic expansions -- and paying down in bad -- during and just after recessions. They learned to start doing this in the Great Inflation of the 1970s, because inflation makes debt attractive.

But the habit persisted long after high inflation ended in the 80s. The rationale for business debt is simple: borrow now, found or expand a business, and future profits will more than take care of it. While this "leveraging" generally works, it doesn't work consistently enough to prevent major debt crises from hitting poorly performing corporations at every recessionary downturn. It's a risky strategy with extravagant real payoffs, but frequent casualties as well.

Finally, Americans as consumers, individuals and households, have by far the biggest taste for debt -- an extraordinary taste for it, in fact -- much more than corporations and government.

The largest component of this debt consists of mortgages. But it also consists of credit cards, student and home equity loans, and all the rest. Almost 40% of this debt ratio's increase occurred just in the last 15 years or so.

Powerful institutional and social habits reinforce the preference for personal and household debt. Many of our institutions, both public and private, make debt look and feel very attractive. While bankruptcy was made more punitive a few years ago, lending standards have continued to drop (at least, until a few weeks ago). Inevitably, there will soon be a lot of people in a lot of financial pain and legal trouble. It was fine to make bankruptcy more punitive -- but only if borrowing itself had been made more difficult as well.

F.M.'s charts make me wonder something else. Rather than take on too much debt themselves, government (in relation to housing and higher education) and banks (in relation to credit cards, mortgages, and home equity loans) have instead encouraged ordinary people to take on debt, a lot of it. Preaching prudence and probity, but also enticing us with borrowing and spending, often ready to "juice" the economy with cheap credit, these are institutions at war with themselves, sending very mixed messages.
* More accurately, Part I (credit crunch) is a "rescue"; Part II (falling house prices) is a "distressed asset collection and fire sale."

But, ah!, a cynical Ann Althouse smirks in the background :)

** An important feature F.M.'s charts is that his current federal debt totals about $6 trillion, not the $9 trillion you usually hear.

The reason is that he doesn't count $3 trillion in past Social Security and Medicare debt, which (as he rightly points out) merely consists of IOUs written by government to itself. It is not part of the federal debt held by bondholders. In any case, present entitlement costs are at this time paid for by present tax revenue. That will start to change in the next decade, however.

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