Edward Conard

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  • “…challenges misconceptions that distort our economic debates.” - Arthur Brooks, President of the American Enterprise Institute
  • “…a fresh argument for the productive value of inequality.” - David Autor, Professor of Economics, Massachusetts Institute of Technology
  • “A full-throated defense of economic dynamism.” - The Wall Street Journal
  • “…serious thinking for serious thinkers. …a thought-provoking blueprint for growing middle- and working-class incomes.” - Mitt Romney, former Governor of Massachusetts
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Upside of Inequality Oxford Unintended Consequences

Macro Roundup


Saturday, September 20, 2014

AI Summary. Research indicates that much of the reduction in household debt came from lenders charging off and writing down loans rather than from households actively repaying, with one estimate attributing two-thirds of the decline to write-offs. High-leverage homeowners did not significantly increase repayment of non-housing debt.

Karen Dydan FCIC
Date Posted:
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Analysis shows 2/3 of household debt reduction is due to write-offs, not active repayment. Banks’ actions drove debt reduction, not consumer behavior. @KarenDynan @NYFed

Did household debt fall because of loan write-offs rather than repayment?

Core argument: Karen Dynan estimates two-thirds of household debt reduction came from write-offs rather than active repayment, with the New York Fed paper putting gross charge-offs on foreclosed homes at $1.3tn and net write-downs likely smaller.

The analysis of mortgage pay down versus charge off reveals that a significant portion of household debt reduction stems from charge-offs rather than active repayment. Daniel Cooper's study indicates that high-leverage homeowners did not significantly increase non-housing debt repayment, contradicting claims that such repayments contributed to the sluggish economic recovery. Karen Dynan estimates that two-thirds of household debt reduction is due to write-offs. The NY Fed paper highlights the complexity of measuring mortgage debt pay down, noting that gross charge-offs for foreclosed homes reached $1.3tn, with net write-downs likely smaller. This suggests that banks' contributions to debt reduction through foreclosures and write-offs were substantial, aligning with the Financial Crisis Inquiry Commission's $350bn estimate of expected mortgage losses. Overall, the data indicates that the reduction in household debt was largely driven by financial institutions' actions rather than consumer behavior.

Takeaways by Macro Roundup® AI

  1. Karen Dynan estimates two-thirds of household debt reduction came from write-offs rather than active repayment, with the New York Fed paper putting gross charge-offs on foreclosed homes at $1.3tn and net write-downs likely smaller.
  2. Daniel Cooper's study finds high-leverage homeowners did not significantly increase non-housing debt repayment, contradicting claims that such repayments contributed to the sluggish economic recovery.
  3. The New York Fed analysis suggests household debt reduction was largely driven by financial institutions' foreclosures and write-offs, aligning with the Financial Crisis Inquiry Commission's $350bn estimate of expected mortgage losses.

Here are my notes on the analysis whether increased household savings or lender financing and write offs account for the pay down of household debt. I’m surprised there hasn’t been much more analysis of this, since the extent to which households dialed back consumption is central to the Keynesian view of the recession. If someone there has a more thoughtful prospective, I’d love to learn from them.

In my review/criticism of Mian & Sufi’s book, I argued: “Even if Mian and Sufi are right, they never convincingly show that highly levered homeowners saved sharply more when home prices fell. The authors present evidence that low-income households borrowed against the rising value of their homes and spent the proceeds. They assume these same homeowners saved at a similar rate when home prices declined. This assumption need not be true, nor does it seem likely. Low-income households tend to consume all of their income and save little for retirement. When home prices rose prior to the recession, low-income homeowners borrowed against their unrealized real estate gains and consumed much of that additional wealth. When home prices fell, these homeowners had no need to lower their consumption beyond the level required to pay back the loan.”

Daniel Cooper at the Boston Fed (see attached paper) uses the PSID survey to conclude: “The percent of high leverage homeowners who were repaying their non-housing debt did not jump relative to other household types—a finding that is inconsistent with the claim that debt repayment by highly levered households has contributed to the sluggish economic recovery. … The vast majority of debt repayment by households was due to foreclosures, but debt charge-offs through foreclosure are not a form of active household debt repayment.

Cooper references a study by Karen Dynan, formerly at Brookings, now at Treasury, who claims 2/3s of the HH debt reduction stems from write offs, but I could only find quotes from her, no study/data.

Apaper by economists at the NY Fedexplains the difficulty of measuring the sources of mortgage debt pay down.

“Mortgages are more complicated because after a charge-off and foreclosure, there is typically a house that can be resold, albeit often at a discounted price. For example, a borrower defaults on her $100,000 mortgage and the lender repossesses her house. The lender then resells the house to a new buyer, who pays $80,000 for the property, making a 20 percent down payment and financing the remaining $64,000 with a thirty-year mortgage. The amount charged off on the original borrower’s credit report in this case is $100,000, but the net change of mortgage indebtedness from this series of events is only -$36,000 (=$64,000 minus $100,000). We do not have property-level data on housing debt, and therefore cannot infer the amount of a charged-off mortgage balance recovered by the bank through resale of the asset or the resulting contribution to aggregate mortgage debt by the new owner. This data shortcoming prevents us from allocating percentages of the mortgage debt decline to: 1) a net charge-off and 2) changes in active borrowing and repayment.”

Nevertheless, the paper concludes: “So did consumers reduce their use of debt? Yes.” Obviously, HHs “reduced their use of debt” since they could no longer borrow, so that’s not very conclusive/insightful and I suppose if HH paid down a dollar of debt they could be said to have paid down debt, but frankly the paper seems to leave a lot unresolved.

Of the $400 billion of non-mortgage/non-student debt the paper examines, it appears only $85B was paid down. (more straightforward than mortgages)

It also says, “While all kinds of borrowing contributed an annual average of about $350 billion to consumers’ cash flows between 2000 and 2007, by 2010 consumers reduced their cash flows by $138 billion to reduce this debt. This represents a nearly $500 billion change in annual cash flow from debt in just three years.” But that seems to indicate that $350B/yr of $500B/yr decline in spending (70%) stems from HHs not borrowing enough to continue spending $350 billion/yr more than they earned and, at most, only $138B per year for three years ($420B) being used to pay down debt.

The paper also says the gross charge offs for foreclosed homes was $1.3 trillion so surely net write downs (after reselling the houses) are substantially smaller (perhaps in the range of the Financial Crisis Inquiry Commission’s $350 Billion estimate of expected mortgage losses) but timing complicates the issue. If the bank forecloses but can't sell the foreclosed house for several years, then the bank may have temporarily contributed to a larger share of the net pay down of household debt at the trough than just write offs.

Looking at the inventory of unsold foreclosed homes shows theinventoryof foreclosed but unsold houses rose from 250,000 units to about 1.5 million units at the peak. (There was an additional 1mm unit increase in “seriously delinquent mortgages,” but I don’t know how the Fed/Equifax (which is used by the NY Fed) accounts for those mortgages on the balance sheet of households). But between an approximate $250 Billion increase in foreclosure inventory (at a guesstimated $150,000 per foreclosed house; less than the average house), $350B mortgage write offs (per the FCIC) and $300B non-mortgage write-off, that’s $900B of the $1.2T of debt pay down contributed by banks at the trough—slightly more than Karen Dydan’s 2/3s write off estimate (since the inventory is not fully written off; just temporarily financed with bank equity).

http://www.newyorkfed.org/householdcredit/2013-Q3/

Would love your perspectives or anyone else’s there.

Total $12.7T $11.5T

Student0.60.8

Other 0.4 0.3

Credit Cards 0.9 0.7

Auto 0.8 0.7

Mortgage $10.0T $9.0T

‘08 Q4 ‘11Q1

Monday, October 6, 2014

AI Summary. Europe's weak domestic demand since the Eurozone crisis has produced a current account surplus of roughly $400bn a year, making it the world's largest capital exporter. With the European Central Bank holding real yields down, the resulting excess savings are expected to drive large capital outflows that shape global asset prices.

Izabella Kaminska FT Alphaville
Date Posted:
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The Euroglut, a significant global imbalance, stems from Europe’s lack of domestic demand post-Eurozone crisis, evidenced by high unemployment & a record current account surplus of around 400bn USD annually.

Does Europe's weak domestic demand make it the world's largest capital exporter?

Core argument: Europe runs a record current account surplus of roughly $400bn a year, larger than China's in the 2000s, positioning it as the 21st century's largest capital exporter, according to the "Euroglut" thesis.

The Euroglut, a significant global imbalance, stems from Europe's lack of domestic demand post-Eurozone crisis, evidenced by high unemployment and a record current account surplus of around 400bn USD annually. This surplus, larger than China's in the 2000s, positions Europe as the 21st century's largest capital exporter, driving international capital flow trends. The European Central Bank (ECB) exacerbates this by lowering real yields, creating a domestic asset shortage and incentivizing foreign asset purchases. Consequently, Europe’s excess savings and ECB policies are expected to lead to substantial capital outflows, influencing global asset prices and yield curves. As European countries adopt negative rates or FX managed regimes to counteract these imbalances, Europe emerges as a dominant force in global financial markets, akin to China in the previous decade.

Takeaways by Macro Roundup® AI

  1. Europe runs a record current account surplus of roughly $400bn a year, larger than China's in the 2000s, positioning it as the 21st century's largest capital exporter, according to the "Euroglut" thesis.
  2. The Euroglut stems from Europe's lack of domestic demand following the Eurozone crisis, evidenced by high unemployment, with the ECB compounding it by lowering real yields and creating a domestic asset shortage that incentivizes foreign asset purchases.
  3. Europe's excess savings and ECB policy are expected to produce substantial capital outflows that influence global asset prices and yield curves, with European countries adopting negative rates or FX managed regimes in response.

"...Euroglut is a global imbalances problem. It refers to the lack of European domestic demand caused by the Eurozone crisis. The clearest evidence of Euroglut is Europe’s high unemployment rate combined with a record current account surplus.Both are a reflection of the same problem: an excess of savings over investment opportunities.Euroglut is special for one and only reason: it is very, very big. At around 400bn USD each year, Europe’s current account surplus is bigger than China’s in the 2000s. If sustained, it would be the largest surplus ever generated in the history of global financial markets. This matters....Euroglut means that as the world’s biggest savers, Europeans will drive international capital flow trends for the rest of this decade. Europe will become the 21st century’s largest capital exporter. This statement is close to an accounting identity - a surplus on the current account implies capital outflows elsewhere.Our premise is that the next few years will mark the beginning of very large European purchases of foreign assets. The ECB plays a fundamental role here: by pushing down real yields and creating a domestic “asset shortage”, it is incentivizing European reach for yield abroad...."Behold the EuroglutLearn moreFollow @izakaminska| Oct 06 14:26 |

As for the global impact (our emphasis):

Euroglut means that as the world’s biggest savers, Europeans will drive international capital flow trends for the rest of this decade. Europe will become the 21st century’s largest capital exporter. This statement is close to an accounting identity - a surplus on the current account implies capital outflows elsewhere.

Our premise is that the next few years will mark the beginning of very large European purchases of foreign assets. The ECB plays a fundamental role here: by pushing down real yields and creating a domestic “asset shortage”, it is incentivizing European reach for yield abroad.

Think about policy over the next few years: at least 500bn-1 trillion of excess cash will be sitting in European bank accounts “earning” a negative rate of 20bps. In the meantime, asset-purchases will drive yields down across the board - there will be nothing with yield left to buy.

Here, meanwhile, is the global imbalance picture in chart form:

So, the basic argument here is that while China’s surplus drove Asian policy in the 2000s, the Euroglut will now become the key determining factor driving European policy from now on.

And extrapolating forwards, Saravelos warns there’s not much that other European countries that also run current account surpluses can do about it other than impose their own negative-yielding/fx floor policies to prevent the hot potato coming to them. In fact, they may just end up compounding the hot potato problem, by effectively being forced to tie their policies in reactive style to that of the Eurozone’s.

On that basis, Saravelos predicts most of the European continent could end up with negative rates or FX managed-regimes in no time at all.

Or as he puts it:

Europe is the new China, and via large demand for foreign assets, it will play a dominant role in driving global asset price trends for the remainder of this decade.

Kaminska, Izabella, "Behold the Euroglut," FT Alphaville, October 6, 2014. Available at:http://ftalphaville.ft.com/2014/10/06/1996952/behold-the-euroglut/

Euroglut is a global imbalances problem. It refers to the lack of European domestic demand caused by the Eurozone crisis. The clearest evidence of Euroglut is Europe’s high unemployment rate combined with a record current account surplus. Both are a reflection of the same problem: an excess of savings over investment opportunities.Euroglut is special for one and only reason: it is very, very big.At around 400bn USD each year, Europe’s current account surplus is bigger than China’s in the 2000s. If sustained, it would be the largest surplus ever generated in the history of global financial markets. This matters.

As he explains on Monday:

In short, Saravelos argues that Europe’s huge excess savings combined with aggressive ECB easing will lead to some of the largest capital outflows in the history of financial markets.

His argument relates to the idea that the global imbalances which were created by Europe’s massive current account surplus are becoming the defining variables which will drive a weaker euro, low long-end yields and exceptionally flat global yield curves, as well as ongoing inflows into “good” EM assets.

So, at least, says George Saravelos at Deutsche Bank.

What ails Europe is not “secular stagnation” or “normalisation”, but rather the much more specific problem of a “Euroglut”.

Izabella Kaminska joined FT Alphaville in October 2008. Before that she worked as a producer at CNBC, a natural gas reporter at Platts and an associate editor of BP's internal magazine.