If the majority of toxic mortgages wind up on the government’s balance sheet, when the foreclosed house is eventually repurchased at a much lower price, if this if financed by a bank, the bank will show this as loan growth. But how does the toxic debt that must be written off get taken into account? Is there a time lag at all between these two events? Is it possible that these loans could be double-counted?

This may sound confusing, but I hope you get the idea I’m trying to wrap my head around.

How have you taken the following into account:

1)Demographics – at what point do the baby boomers actually start to worry about their retirement and start saving, (ie.. when do they turn Japanese?) regardless of their ability to take on more debt. The majority of baby boomers’ children are under water on their mortgages, so they can’t borrow any more.

2)The economy is being sustained almost solely by government debt. How long can this continue, not only before foreign lenders revolt, but Americans themselves demand that their government tighten the reigns (this may be a the issue that the Republicans choose as their battle cry in 2010)? By asking that the government not leave their children with a legacy of debt, will America not bring a double-dip recession upon itself?

It seems to me, though, that the non-financial business number bears watching as well — non-banks can and will approach their balance sheets very aggressively and conservatively, and at $10T that is not an insignificant number … a decline just to 1 standard deviation of trend would offset quite a lot of growth in financial debt.

In addition, there will be more pressure on mortgates, also huge in aggregate so small changes are still big numbers. A change down would not necessarily be a function of good behavior on the private individual, but more likely writedowns. An unknown variable, but possibly big impact, at a minimum a drag.

It just seems to be with downward pressure on these two, the fin sector would have a hard time offsetting without an additional very aggressive boost from the fed gov’t.

I do feel a little ill about “ample room for deficit spending” — when you think of the tax rates following the 1950s … just really ugly … dreading those, and still assume they will be correlated with gov’t debt …

Great article, however I’m confused by your conclusion, where you seem to contradict yourself. You say that you consider a collapse to be the most likely outcome during this cycle. But you also think there will be a multi-year recovery.

Dodge

BINGO! That probably happens when the labor market and the goods/services market get oversupplied. IMO, the fed does NOT care about the labor market being oversupplied. IMO, they like it that way because of that supposed wage-price inflation spiral garbage and that it leads to excess corporate profits for their business buddies.

However, the fed along with the spoiled and the rich can’t seem to believe that the goods/services market can get so oversupplied that fewer hours need to be worked. IMO, that was one of the points of getting the lower and middle class so far in debt, to “trick” them into working more hours in the present and in the future (as in NO retirement).

I don’t believe that is the whole story.

IMO, the fed lowered interest rates to sucker excess debtors further into debt and to get excess savers into more risky assets.

I believe that calculatedrisk has a post about retail sales and housing leading to recoveries. Would that actually be the lower and middle class going further into debt to increase retail sales and increase housing?

I would say interest rates have fallen because total labor costs have fallen, price inflation has come down, and the spoiled and rich want to “steal” from the lower and middle class in the high wage countries using negative real earnings growth, interest payments, and/or seizing the collateral/assets of the lower and middle class in the high wage countries.

http://www.creditwritedowns.com/2009/06/means-of-deficit-reduction-medicare-and-social-security.html

So, I see your point that interest rates could rise if we don’t see a credible path to longer-term fiscal discipline. However, I think the best strategy politically is to stay the course (on stimulus) until you are forced to deviate. Reining in stimulus now could be costly in the 2010 elections. I’m looking at this in terms of political calculus, which is how Washington operates (I’ll have more to say about my reasoned view of stimulus in a future post).

As for what’s healthiest, ballooning debt to unsustainable levels is reckless in the extreme. Yes, individuals should be deleveraging much more than they currently are. Over the long-term that is what is best for America.

But, apparently, no one gives a damn about the long-term.

1. You say:

GOVERNMENT DEBT:

“This chart is fairly benign when you look at aggregate levels as a percentage of GDP.”

IMO looking at the end of this fiscal year, it’s not benign. Counting future retiree obligations even with a haircut, it’s ridiculously high. But any corporation would have to count those obligations.

2. Under Financial Services Debt, you say:

(3.)”The financial services sector contracted in Q2 relative to GDP for the first time since 1982. If this is a rear-view mirror view, that means recovery could continue. However, if this is a canary in the coalmine, that is negative for the U.S. economy. This number bears watching.”

What do you think of the view that the healthiest thing for the economy as a whole and especially for individuals (as opposed to AmEx) would be for the household sector to continue to deleverage and get to back to where it once belonged, which is not to spend money at high interest charges and spend what it has saved or is currently earning?

This seems a self-evident truth , yet policymakers have ignored it for a couple decades , at least , and continue to do so.

The graph you , or someone , needs to construct is one which posits what gdp growth would have looked like over the past 70 years or so if debt/gdp levels had remained at some arbitrary sustainable level — i.e. a level lower than today’s , maybe more like what existed in the ’60s.

In other words , show the world in a simple , visual manner what most of us sense intuitively , that much of the “growth” of recent decades was illusory , because it was based on compounding — thus , unsustainable — debt relative to gdp.

Such a graph would also help to disabuse people of the notion that the stock market accurately reflects underlying economic strength. Some people , at least. Kudlow & Co. , for example , are paid to resist such disabuse.

what about the unemployment effects on this theory and the fact that consumers cant add-on more debt (their credit worthiness suffered severely, particulary the home ATM). Savings slowly ticked up, but i agree not as much as expected @ end-of-08.

what r your S&P short-term-bullish targets? 1100s or 1200s? thanks!

As I said in the post, consumer credit is much less important than mortgage credit. Unless, we see deleveraging there, I am now anticipating retrenchment less than I was before.

“As for the household sector, aggregate debt levels are not decreasing substantially – not in mortgages or consumer credit.”

Actually households ARE deleveraging significantly with respect to the size of their outstanding debt… the effect just looks smaller with respect to GDP than it does for financials because financial debt is much larger. But they are connected and household deleveraging can accelerate financial deleveraging… Oh and one other reason the effect looks smaller is of course that GDP has contracted… so the debt reduction in nominal terms does of course get partially offset by falling incomes (a mild version of the classic debt deflation nightmare scenario).

Look at the Fed’s graph of Total Consumer Credit Outstanding. Then the same data in percentage terms. Falling at almost a 5% annual rate and still accelerating! And this data is monthly so more recent than FoF data (though consumer deleveraging has been occurring since late 2007).

I’ve been playing with the FoF data too… you might be interested in these graphs the first of which shows that government borrowing has canceled out deleveraging (for now) and halted GDP contraction. That may not last depending on how stimulus plays out…

I also pulled together some graphs on Japan’s battle between private deleveraging and government borrowing (guess which wins?) that may foreshadow what is to come in the US, depending on political outcomes.