Saturday, March 31, 2007

House of (Debt) Cards

by Tula Connell, Mar 26, 2007

The crumbling house of cards spilling across the subprime mortgage loan industry is big news right now. There were signs these risky loans could cause problems as early as two years ago, but it takes awhile for the mainstream media to pick up on bad economic trends. As economist Tom Palley puts it, “the U.S. economy is showing signs of a potentially rapid deceleration.”

Source: Economic Policy Institute
Source: Economic Policy Institute

In particular, there is accumulating evidence that the housing sector slowdown may be becoming a meltdown. In many areas house prices are falling, house sales are down nationally, and mortgage delinquencies and foreclosures are rising—especially in the sub-prime market. This has caused tremors in broader financial markets. The only good news is employment and wages continue growing, but labor markets conditions are also widely viewed as a lagging indicator.

Of course, just as quickly as the media is finally getting the story, corporate apologists are trying to make the nation’s deep debt look like no big deal.

David Leonhardt’s Economix column in The New York Times this week is a case in point. Leonhardt makes the usual stabs at showing both sides, but, ultimately, comes down on the side of “don’t worry, be happy.” The trope he uses is a familiar one: Point out that our concern over Issue X has been going on for a long time. Then conclude that since Issue X wasn’t as bad as we thought the first time, it won’t be now. In this case, Leonhardt uses the re-release of a 1912 film, “The Usurer’s Grip,” to show how the nation long has worried over debt. He describes the film as

a cautionary tale about borrowed money that revolves around the Jenkses, a fictional middle-class family who need a $25 loan so their young daughter can be treated for consumption. After a loan shark tricks Mr. Jenks into borrowing at an interest rate of 180 percent, the family is brought to the brink of ruin.

And he ultimately concludes that a few new guidelines, “voluntary or government-imposed, will force lenders to be clearer about the terms they’re offering borrowers” and the mess will be solved.

But economist Stephen Roach at Morgan Stanley sees it this way:

To me, the real debate is about “spillovers”—whether the housing downturn will spread to the rest of the economy. In my view, the lessons of the dot-com shakeout are key in this instance. Seven years ago, the spillover effects played out with a vengeance in the corporate sector, where the dot-com mania had prompted an unsustainable binge in capital spending and hiring. The unwinding of that binge triggered the recession of 2000–01. Today, the spillover effects are likely to be concentrated in the much large consumer sector. And the loss of that pillar of support is perfectly capable of triggering yet another post-bubble recession.

And although household debt was big news a few years ago, the media seems to have become bored with the issue—even though total consumer credit debt, excluding mortgages, hit a record $2.4 trillion in September. Factoring in mortgages, outstanding household debt soars to about $12.3 trillion. Based on figures from the Federal Reserve, the Center for American Progress found that Americans for the first time owe more money than they make: The average family now is spending 14.4 percent of its disposable income on debt repayments—the largest share since the Fed began collecting such data in 1980.

Leonhardt briefly references how the enormous amount of foreign capital flowing into the nation has enabled the mortgage business to “become bigger, more competitive and more innovative.” A look at this foreign capital highlights the context missing from Leonhardt’s piece. In 1912, the United States was not a debtor nation. But in 2007, the world’s richest nation (that’s us) is borrowing from the world’s poorest nations to the tune of more than 6 percent of its gross domestic product (GDP). Kenneth Rogoff, a Harvard economic professor and former chief economist at the International Monetary Fund, puts it this way:

This is not a normal state of affairs. And it’s certainly not something we expect to see from the world’s richest country. Back when Britain was on top they were lending money to the world, but we’re borrowing from the rest of the world. Our current account trade deficit is now more than our defense spending and incredibly we’ve been borrowing from the rest of the world like this for several years now. I think we’re going to reach a point where the rest of the world decides that they don’t want to lend to us. And that can be kind of traumatic.

Which brings us to another movie Leonhardt should take a look at. Rogoff discusses the nation’s debt crisis in the recently released documentary film, “TIME-BOMB: America’s Debt Crises, Causes, Consequences and Solutions.”

John Ince, a former reporter at Fortune magazine and the film’s producer/director, writes:

Recently the Chinese, holders of about $1 trillion in U.S. Treasuries, recently set up a new agency of their central bank to take a hard look at their investments overseas, and their continued financing of U.S. deficits may come under close scrutiny. If global investors were to begin to balk at picking up the tab for American excesses, it would be a monumental embarrassment to the United States.

In FY [fiscal year] 2006, the current account trade deficit is on track to set yet another record, on the order of $700 billion. To put this in perspective, billionaire investor Warren Buffet points out that, “Fifteen years ago, the U.S. had no trade deficit with China. Now, it’s 200 billion dollars.” He says if the country does not change course, the rest of the world could end up owning $15 trillion worth of the United States. That’s equal to the value of all American stock.

Roach notes China’s export growth surged to 41.5 percent so far this year—“a dramatic acceleration from the still rapid 27 percent pace of 2006.” On this side of the Pacific, the United States accumulated a record $764 billion trade deficit, with the Bush administration’s flawed trade policy in large part behind this staggering debt. Current trade policy has cost the United States millions of good jobs by encouraging multinational corporations to move overseas with tax breaks, lopsided trade rules and an overvalued currency. (Check out the AFL-CIO recommendations on the nation’s trade policies here.)

So, the subprime mortgage loan collapse is not the only debt crisis of concern. It’s the bigger picture of the nation’s debt crisis—personal, national and trade—that’s tumbling across the nation like a fragile house of cards.

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