Tweet
Consumer Weakness Is in the Cards
January 11, 2007 (RANDALL W. FORSYTH - Barron's)
PAPER OR PLASTIC? Americans evidently are opting for the latter -- not because they want to, but because they have to.
Borrowing on credit cards has shot up while the use of homes as automatic teller machines has dropped off precipitously, the data show. For some reason, U.S. consumers are leaning more on the most expensive sort of debt, and, for some reason, cutting back on the cheapest, and more tax-favored, form of borrowing.
That would mark a reversal of Americans' borrowing habits in recent years. They had enjoyed money for nothing -- borrowing against their houses, whose prices were ever inflating.
They could use their homes as a cash machine, either by refinancing their first mortgages and taking out cash -- to pay for the kids' college tuition, renovations, new cars, vacations, pay off credit-card balances, or even a down payment on a second home. Or they could get a home-equity loan for all the same reasons. With mortgage rates at generational lows, and tax deductibility on the interest in most cases, you were paid to go into hock and enjoy the good life.
That seems to be changing. This so-called mortgage equity withdrawal -- or MEW -- peaked a year ago, in the fourth quarter of 2005, at an annual rate of $534 billion, according Goldman Sachs economist Ed McKelvey. By the third quarter of 2006, the most recent period for which data are available, MEW was off by nearly a third, to a $369 billion annual rate.
AntiSpin: With our focus this week on the Monthly Payment Consumer, we note that the demise of the Consumer has been predicted many times over the years. Note that iTulip, while issuing many warnings since 1998, has never discounted the ability of government bureaucrats to engage in a new round of financial and behavioral engineering to keep the Consumer spending, including the creation of the Monthly Payment Consumer. But, after all of these years, after hundreds of interviews, I have come to the conclusion that whatever the next phase of the economy, the Consumer will not figure so large into it. Who or what will pick up the slack is anyone's guess.
The last trick, inflating home prices, has run its course. The Bureau of Economic Analysis says:
This is how a housing bubble runs in reverse. Where might it end if there's no "next trick" to follow the housing bubble?
I play back once again some long lost wisdom, from Joseph A. Schumpeter's Business Cycles, 1939 on the contribution of consumer debt to The Great Depression:
It didn't work.
See also: Q4 2006 Foreclosure Data Alert: Number of Foreclosed Homes Returned to Lenders at Auction up more than a factor of 10 since July 2006
January 11, 2007 (RANDALL W. FORSYTH - Barron's)
PAPER OR PLASTIC? Americans evidently are opting for the latter -- not because they want to, but because they have to.
Borrowing on credit cards has shot up while the use of homes as automatic teller machines has dropped off precipitously, the data show. For some reason, U.S. consumers are leaning more on the most expensive sort of debt, and, for some reason, cutting back on the cheapest, and more tax-favored, form of borrowing.
That would mark a reversal of Americans' borrowing habits in recent years. They had enjoyed money for nothing -- borrowing against their houses, whose prices were ever inflating.
They could use their homes as a cash machine, either by refinancing their first mortgages and taking out cash -- to pay for the kids' college tuition, renovations, new cars, vacations, pay off credit-card balances, or even a down payment on a second home. Or they could get a home-equity loan for all the same reasons. With mortgage rates at generational lows, and tax deductibility on the interest in most cases, you were paid to go into hock and enjoy the good life.
That seems to be changing. This so-called mortgage equity withdrawal -- or MEW -- peaked a year ago, in the fourth quarter of 2005, at an annual rate of $534 billion, according Goldman Sachs economist Ed McKelvey. By the third quarter of 2006, the most recent period for which data are available, MEW was off by nearly a third, to a $369 billion annual rate.
AntiSpin: With our focus this week on the Monthly Payment Consumer, we note that the demise of the Consumer has been predicted many times over the years. Note that iTulip, while issuing many warnings since 1998, has never discounted the ability of government bureaucrats to engage in a new round of financial and behavioral engineering to keep the Consumer spending, including the creation of the Monthly Payment Consumer. But, after all of these years, after hundreds of interviews, I have come to the conclusion that whatever the next phase of the economy, the Consumer will not figure so large into it. Who or what will pick up the slack is anyone's guess.
The last trick, inflating home prices, has run its course. The Bureau of Economic Analysis says:
The definition of income used in the National Income and Product Accounts (NIPA) excludes one important financial resource that could be used for consumption expenditures. Capital gains are not included in income in the NIPAs.
Although only realized capitals gains provide cash that can be spent, unrealized gains can be used as collateral to support additional borrowing of cash, or they may be treated as substitutes for saving out of current income. When a household owns an asset that has increased in value, the household could potentially spend the capital gain yet still have as high a net worth as it did before the gain occurred.
In recent years, the personal sector has enjoyed large capitals gains on real estate. The rising net worth resulting from these gains is often cited as contributing to the increases in consumption expenditures that have depressed personal saving. Personal mortgage indebtedness has grown at about the same high rate as the value of real estate owned by persons. Some of the new mortgage debt has been used directly for consumption expenditures by households who have increased their loan balances by refinancing or by drawing on a home equity line of credit. In other cases, increased mortgage debt has been used by buyers to pay higher prices for homes, and the sellers receiving those prices have undoubtedly used some of their gains to fund consumption expenditures. Finally, unrealized capital gains on their real estate may have caused some households to save less of their current income than they otherwise would have.
What happens when housing prices are falling and there are no more unrealized gains to be used as collateral to support additional borrowing of cash, or treated as substitutes for saving out of current income? When a household owns an asset that has decreased in value, there is no capital gain for the household to spend, and net worth declines by the amount of the decline of the value of the home price? And, finally, after years of not saving because their home can be turned into a liquid asset, when they have no source of liquid savings to drawn on, no ready source of cash? Reports like this one suggest an answer: in the short term, these households will draw heavily on credit cards. But the use of cards can only last so long when they can't be re-filled by cash-out re-financing. Although only realized capitals gains provide cash that can be spent, unrealized gains can be used as collateral to support additional borrowing of cash, or they may be treated as substitutes for saving out of current income. When a household owns an asset that has increased in value, the household could potentially spend the capital gain yet still have as high a net worth as it did before the gain occurred.
In recent years, the personal sector has enjoyed large capitals gains on real estate. The rising net worth resulting from these gains is often cited as contributing to the increases in consumption expenditures that have depressed personal saving. Personal mortgage indebtedness has grown at about the same high rate as the value of real estate owned by persons. Some of the new mortgage debt has been used directly for consumption expenditures by households who have increased their loan balances by refinancing or by drawing on a home equity line of credit. In other cases, increased mortgage debt has been used by buyers to pay higher prices for homes, and the sellers receiving those prices have undoubtedly used some of their gains to fund consumption expenditures. Finally, unrealized capital gains on their real estate may have caused some households to save less of their current income than they otherwise would have.
This is how a housing bubble runs in reverse. Where might it end if there's no "next trick" to follow the housing bubble?
I play back once again some long lost wisdom, from Joseph A. Schumpeter's Business Cycles, 1939 on the contribution of consumer debt to The Great Depression:
Consumers' borrowing is one of the most conspicuous danger points in the secondary phenomena of prosperity, and consumers' debts are among the most conspicuous weak spots in recession and depression.
In other words, we shall readily understand why the load of debt thus light heartedly incurred by people who foresaw nothing but booms should become a serious matter whenever incomes fell, and that construction would then contribute, directly and through the effects on the credit structure of impaired values of real estate, as much to a depression as it had contributed to the preceding booms. Nothing is so likely to produce cumulative depressive processes as such commitments of a vast number of households to an overhead financed to a great extent by commercial banks.
No one is predicting much of a bad outcome from housing, private equity, junk bond–the securitized debt bubbles–today. Nor were many worried in 1929. Why? Schumpeter explains: In other words, we shall readily understand why the load of debt thus light heartedly incurred by people who foresaw nothing but booms should become a serious matter whenever incomes fell, and that construction would then contribute, directly and through the effects on the credit structure of impaired values of real estate, as much to a depression as it had contributed to the preceding booms. Nothing is so likely to produce cumulative depressive processes as such commitments of a vast number of households to an overhead financed to a great extent by commercial banks.
It is of the utmost importance to realize this: given the actual facts which it was then possible for either businessman or economists to observe, those diagnoses -- or even the prognosis that, with the existing structure of debt, those facts plus a drastic fall in price level would cause major trouble but that nothing else would -- were not simply wrong. What nobody saw, though some people may have felt it, was that those fundamental data from which diagnoses and prognoses were made, were themselves in a state of flux and that they would be swamped by the torrents of a process of readjustment corresponding in magnitude to the extent of the industrial revolution of the preceding 30 years. People, for the most part, stood their ground firmly. But that ground itself was about to give way.
Today we struggle to understand "what ground we stand on" which is dominated by the convenient but nonsensical belief that ever-increasing credit risk, the product of a hyper-competitive banking and financial services sector–can be made to disappear merely by spreading it around via financial engineering. That's been tried before, in a different era.It didn't work.
See also: Q4 2006 Foreclosure Data Alert: Number of Foreclosed Homes Returned to Lenders at Auction up more than a factor of 10 since July 2006
Comment