Debt Service or Food?
Merrill Lynch reported yesterday that American households spend more on debt service than food.
That startling statistic underlines the extent to which the credit problem is influencing household cash flows. Sacrifices will be needed to bring the ratio of interest payments-to-income down from 14% to the level it usually reaches at recession lows, about 10%.
That means the American consumer is going to have to find $400 billion in cuts to their household budget in the next nine months. Despite the bad news on unemployment yesterday which generally confirmed my contention that we have been in a recession since January, the stock market went up. This is because market makers figure all the bad news is already discounted into stock prices. But Merrill's David Rosenberg, who called this correctly many months ago notes there is a problem with this theory which is based on the assumption that the recession will be a garden variety six month long affair.
But if this consumer led recession turns out to look more like the 1973-75 down cycle (which we think it will), the stock market is priced only 34% of the way and the Consumer Discretionary sector only 39% of the way.
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For the purposes of understanding fully the import of the debt-service v food expenditure comparison would be some kind of graph plotting, over a period of the last several decades, periodic measurements -- in one line, (a) the amount of spending of US households on debt service as a % of total income, and in another line, (b) the amount of spending of US households on food. By comparing the comparison between the two itself over time, the fact that (a) now exceeds (b) can be seen in its importance relative to other economic times, including other recessions.
One of the problems of 'business' world type news, as when the WSJ reports on some multinational's quarterly earnings, is that the meaning of the information often is not contextualized by reporting, say, what quarterly earning for that corporation have been for the last 12 quarters and are projected for the next several quarters. This is extremely frustrating to the social critic who is a generalist and isn't just focusing macro. (This method problem also has ideological implications -- keeping info understanding in the hands of a relatively smaller number of micro-focused professionals, by sheer coincidence of course).
April 5, 2008 2:59 PM | Reply | Permalink
For the purposes of understanding fully the import of the debt-service v food expenditure comparison would be some kind of graph plotting, over a period of the last several decades, periodic measurements -- in one line, (a) the amount of spending of US households on debt service as a % of total income, and in another line, (b) the amount of spending of US households on food. By comparing the comparison between the two itself over time, the fact that (a) now exceeds (b) can be seen in its importance relative to other economic times, including other recessions.
One of the problems of 'business' world type news, as when the WSJ reports on some multinational's quarterly earnings, is that the meaning of the information often is not contextualized by reporting, say, what quarterly earning for that corporation have been for the last 12 quarters and are projected for the next several quarters. This is extremely frustrating to the social critic who is a generalist and isn't just focusing macro. (This method problem also has ideological implications -- keeping info understanding in the hands of a relatively smaller number of micro-focused professionals, by sheer coincidence of course).
April 5, 2008 3:12 PM | Reply | Permalink
April 5, 2008 4:06 PM | Reply | Permalink
Yep.
This is a consumption-driven recession, triggered when the mortgage mess was set off by Greenspan's 17 straight quarter-point increases in the fed fund rate ending in Summer 2006. The credit mess was a direct result, but the only thing that will pull the economy out of the recession is going to be an increase in consumption.
Where do the consumers get the money to return to consumption?
Real wages have not increased since 1970. Household consumption increased for two decades because second wage earners entered the work force, but that ran out in the 90's to be replaced at the margin by pulling equity from the home to pay credit card bills. To keep that working through the first bush term and get him reelected, Greenspan had to encourage the housing bubble. That's over, leaving a great deal of wealth literally evaporated?
Now jobs are being removed from the economy.
No more workers for families to send out, no more wealth (real or imaginary) to tap into and create a wealth effect, and now fewer jobs along with inflation (oil and food in particular.)
Oh, and Bush is doing a great Herbert Hoover impression. The "stimulus" plan is a joke - a snowflake thrown to a forest fire. Wall Street thinks back a decade or two and thinks this will be over a six months. It won't. There is no place for the consumers to get more money to spend. Unemployment benefits? A week's take-home pay every month? That's a few snowflakes.
The bush administration is in paralysis, partly through ideology and partly because Bush is a lame duck who never gave a shit about working as President in the first place (as opposed to giving speeches and traveling to foreign countries and getting to hear "Hail to the Chief" being played for a life-long utter failure.)
So that's another year lost. Then a year or so trying to figure out what to do, another year or so beating down conservative obstructionism, and then a lag time of a year-and-a-half to four years before anything that IS done starts taking effect.
Four years minimum, and eight years is very likely.
When Bush took a lot of flack for being out of touch when he said he was unaware of reports to expect $4 per gallon gas next summer, his media staff had to respond.
Yeah, maybe Bush is in touch with the economy, particularly since he is directly and personally responsible for most of the current set of economic problems.If I were in charge and as responsible for the current mess as he is, I'd be out of the country a lot, too.
April 5, 2008 4:42 PM | Reply | Permalink
If I purchase everything with a VISA card, then my entire income will be either savings or debt service. This is true even if I pay off the card every month as every penny paid to Visa is dept service.
If I pay $100 by check and then deposit $100 in my checking account I have no dept service. If I charge $100 on Visa and then pay Visa $100, I have just made a $100 debt service payment. I am no richer or poorer with either method, but one is debt service and the other is not. The transition in payment methodology from checks to cards is nothing to get overly excited about.
As people use credit cards more and checks less, debt service will rise. Big deal.
Food in this country is inexpensive. I don't find it suprising at all that credit card payments plus mortgage payments are more.
April 5, 2008 4:36 PM | Reply | Permalink
Debt service is money paid to service debt, not a credit card balance investopedia
...and the rise in household debt service can be seen in data at the federal reserve
April 5, 2008 5:24 PM | Reply | Permalink
Abdul, Noble is correct.
The $100 paid to cover what was spent is not debt service. The Interest and fees are the debt service, something you don't pay when you use a check. The interest and fees occur because you buy now with borrowed money and pay later, with interest and fees added.
Since some 60% of credit card users pay only the minimum payment each month, there is a lot of debt service out there. Add in the over-limit and late payment fees, that is also debt service. Then there are membership fees and others. The money over and above what is paid for goods and services just for use of someone else's money is the debt service.
Debt service payments do nothing positive for the productive economy. They are just money paid to use money at different times. It is economically non-productive money spent by consumers. And since it is all charged and handled by computers, it creates almost no employment.
Debt service is a drain on the real economy by the financial economy. And at 14% of household revenue, it is a damned big drain. That is money that, if spent in the real economy, would create jobs and real income for other consumers. As it is, it only goes to make bankers and a few computer programmers, probably in India, richer.
America could clearly have a better functioning economy by outlawing the use of credit cards. Debit cards, since there is no time difference between expenditure and payment, are not at all the same. The interest payments are not there.
Now if you want to say there is no difference between debit cards and checks, your might be correct.
April 5, 2008 7:11 PM | Reply | Permalink
Since when does debt service not include principal? A mortgage payment is 100% debt service and includes principal, interest, and fees.
Debt service definition
April 5, 2008 9:55 PM | Reply | Permalink
Abdul-The Merrill Lynch report I cited used interest payments=debt service
April 6, 2008 11:06 AM | Reply | Permalink
Seems to me the "Son of the Prophet" is correct and M-L's David A. Rosenberg is being sloppy in failing to keep the "interest payments to income" ratio distinct from the "debt service as a percentage of disposable income" ratio.
But that carelessness is understandable, because what his investor-audience really wants to know is how much consumer discretionary spending will be affected in a recession.
Although the time frame isn't mentioned (because not relevant?) Rosenberg says (implies?) that to reduce the interest-income ratio from 14% to 10%, consumers will have to increase debt service by $400 billion. That's $400 billion less to spend on discretionary consumables -- whether the sum comprises principal, interest, or fees doesn't matter to Rosenberg's intended audience.
And he might even be right.
April 6, 2008 12:23 AM | Reply | Permalink
Thank you. Now the question is where was he being sloppy. Is the 14% debt service as understood by the rest of the planet, or is it only interest?
April 6, 2008 9:33 PM | Reply | Permalink
The point is the money is spent, and the individual must pay it back with interest.
Owing money to the bank is not like having money in the bank.
April 6, 2008 1:13 AM | Reply | Permalink
If homeowners are paying 14% of family income on mortgage including both principal and interest then we have no housing problem. And that would mean they have no credit card debt or auto debt. Or student loans.
Something doesn't add up.
Tell me. On your credit card, when you buy something for $100 do you not pay interest and fees? Even if you pay it off immediately, which most cc holders don't do? Whatever you call them, those interest and fees are a drag on the economy. They are also almost the total profit of the commercial banks.
April 6, 2008 2:01 AM | Reply | Permalink
However, I also accept that I am unusual. :-) (In fact, I tend to be way off the edge of most bell curves.)
April 6, 2008 6:08 AM | Reply | Permalink
Re: On your credit card, when you buy something for $100 do you not pay interest and fees? Even if you pay it off immediately
There is no interest charged on balances that are paid off in the first billing cycle. There should be no fees either unless the payment is late. By the way I do think we need to remenber that not everbody is staggering under a load of debt. 40% of the adult population has no credit debt at all, and the median amount owed by those who do is under $3,000. Our comsummer debt problem is mainly due to a significant minority being hugely in debt, as evidenced by the fact that the average credit card debt is nearly three times the median.
April 6, 2008 9:46 AM | Reply | Permalink
Re: Four years minimum, and eight years is very likely.
Nonsense. Things can change very quickly. Remember when Bill Clinton took office? The economy sucked then too (12 years of GOP administration; huge deficits, housing slump, S&L meltdown) but it turned around rapidly.
I am beginning to get sick of all the stupid pessimism being purveyed on liberal blog sites. Granted, eight years of George Bush is enough to send Mary Poppins running for the proszac bottle, but the message needs to be one of optmism. FDR, JFK and (on the other side) Ronald Reagan were all successful because they they preached a message of hope and good news: "Yes we have some problem, but here's the solution and we WILL do it." If you guys are going to sit around like a bunch of hungover Cassandras crying in your dregs, then who in their right mind wants you in charge? (Fortunately, Barak Obama seems to understand this and may well give us the campaign we need this year.)
April 6, 2008 9:45 AM | Reply | Permalink
This is a consumption-driven recession. Just5 show me where the money for new consumption will come from? That's what I don't see, and is the basis from my pessimism.
As consumption has declined, the recession has grown, and it is now causing job loss, which reduces the money available for consumption.
The reason for the recent growth of the economy over especially the last six years has been money provided to consumers by extracting it from artificially inflated home equity. The wealth effect of rising equities motivated more spending an the various methods of refinancing as well as the loose (if not fraudulent) underwriting standards has been the source of additional consumption since at least 2002. The easy money creating unrealistically high home prices is over. That source of consumption funding is not only shut, it is now a negative drag on consumption.
Show me where the consumer demand required to stimulate the economy is going to come from? Without new demand there will be neither new jobs nor will there be additional consumption.
Besides that, the lowered interest rates the fed has introduced is now stimulating inflation rather then economic growth.
Show me the source of new funds for consumers and I'll agree that this might be a short recession.
On the larger scale, the free market crap from conservatives like Phil Gramm is still creating a weaker American economy and will continue to do so for years, as the American real economy declines and becomes an internationalized financial economy with no base in any American real economy. We Americans are trying to earn a living by taking in each others laundry and buying everything else from outside the U.S. where the bankers and wall street has sent the real jobs.
Feel free to be sick of the economic pessimism. You are entitled to close your eyes and ignore what is going on if you wish. If you can show any comprehension of what is really happening and why and can show a way out of this mess, perhaps someone will pay attention to your complaints about what everyone else is saying. Otherwise you are banking on hope, and the cliche is true - hope is not a plan.
April 6, 2008 12:14 PM | Reply | Permalink
Show me the source of new funds for consumers and I'll agree that this might be a short recession.
No problem.
1) Extend unemployment benefits;
2) Reduce employee FICA payments by two-thirds;
3) Increase the size of the F.1040's dependent and standard deductions;
4) Federally finance infrastructure building and repair, say, by $200 billion per year; and
5) Enact such other solutions as may be appropriate.
The real concern is that Americans might grow pessimistic and return to their earlier savings rates. Then, disaster!
April 6, 2008 2:31 PM | Reply | Permalink
Ellen-Your notion of federally financed infrastructure repair is the first variation from your standard Milton Friedman rhetoric in three weeks. What happened? I support that idea and maybe more Republicans will as the recession deepens.
As to the "horror" of Americans returning to a postive savings rate (after three years of negative numbers), I really think the economy can survive with a few less Gaps or Starbucks on every other corner.
April 6, 2008 4:28 PM | Reply | Permalink
Re: As consumption has declined, the recession has grown, and it is now causing job loss, which reduces the money available for consumption
This is true in every recession. It's part of the positive feedback loop of a recession: people lose their jobs and drastically curtail their spending. However, only a small minority of people (given the size of the whole nation) have suffered this reversal. Many of these people will find new jobs (some laid off from my office already have). And I predict as well that we will not see calamitous levels of job losses if only because we never saw a hiring boom before this started: businesses did not staff up to unsustainable levels (as they did in the late 90s) so they have far fewer superfluous people they can cut. Additionally many of the job losses will happen in the contingent work force (temp work is indeed declining fast) and in the outsourced workforce overseas. And no, this is not a consumption-led recession. It is a housing bubble collapse recession whose main generator is the immense losses mortgage holders (including those who inverted in securitized mortgages) are seeing in their portfolios. The consumption decline is a secondary and derivative effect. Again, the pessimism I keep seeing is unwarranted. Yes, we are having a recession. Yes, it will probably be followed by another jobless recovery. Yes, we may see a long period of anemic growth afterward (assuming that major policies in both the public and private sector do not change). But the sky is not falling, and in a couple of years we will be looking back at it, glad that it's over, and using it as lesson in What Not To Do.
Re: Show me the source of new funds for consumers and I'll agree that this might be a short recession.
Well, there's people like me who am on track to have my best paid year ever. Again, not everyone is in the same boat. Lots of people do well even in bad times. The unemployed will have a hard time of it due to our meager safety net. But there are many of us out here with well-paying jobs who had the sense not to run up the credit cards. We're your source of economic strength.
Re: Feel free to be sick of the economic pessimism.
I want the Democrats to take the White House and increase their lead in Congress. Pessimism is absolutely the worst strategy for that. If FDR could preach optimism in the 1930s I think we could easily do so today.
April 6, 2008 6:25 PM | Reply | Permalink
Your first paragraph starting "This is true in every recession..." assumes that we have a well-functioning economy that has just hit a bad patch and it will blow over quickly. The problem with that is that the economy has been struggling along for six to eight years with all increases being based on consumption that was financed from the housing bubble - refinance to pay credit card debt scam. That's gone now. It won't be replaced.
This isn't a normal recession based on excess production so that when the warehoused stuff is sold the workers will be hired back. This is a recession based on lack of consumer demand because workers/consumers have not gotten a real wage pay increase since 1970. The two gimmicks that kept the economy growing were put the second adult in the household to work, and when that wasn't enough, create the housing bubble and suck out the false increase in home equity for use by consumers.
There is no source of consumption funds to replace the housing bubble scam, and it was only just barely keeping the economy out of recession.
Even without high levels of job losses, the economy cannot return to the levels it was at last year. There's a bunch of economic activity that has been based on the housing bubble scam that simply will not be replaced, and that stuff will have to work its way out of the economy before the recovery starts. Six to eight years built in? How long to work back out? Two, three years if we are lucky.
For your second point, there are always some people doing well. My dad was never out of a job during the Depression and got several promotions. Anecdotes aren't of much value in macro economics.
As for the not talking pessimistically, that only works when everyone is fully aware of the problem and the solutions have been put into place. Right now, the media is just beginning to get the idea, but has no idea of the severity of the problem. The House apparently has heard from voters, but the Senators are the wealthy elite and don't like to be rushed, especially if it means changing their minds and changing who things their supporters don't want changed. Ellen's uncharacteristic but minimal response above is somewhat promising on the awareness front. But solutions?
Paulson's garbage is left over repackaged material from trying to get government out of the regulation business. The current problem will require more regulation. as Ellen's contribution above shows, all the possible solutions will come from Congress, and they haven't started yet. And I expect severe obstructionism from the Republicans, of the kind that is below the radar, so that they can blame the Democrats for being do-nothing. We all know that the Republicans put party above the nation, and they aren't going to change now.
So I don't think that being honest about the problems we are facing should stop. You are proposing behavior like Nightline who has not reported on Iraq for what - sixteen months?
It's not yet time to strangle the Truth, because the Truth hasn't gotten out yet.
April 6, 2008 9:16 PM | Reply | Permalink
Extended Unemployment will not replace the income from working. It still represents a net decrease in consumption, besides being time-limited, probably an additional 13 weeks.
Reducing standard deductions might help, if the tax withholding tables are adjusted quickly.
Increase federal building and work projects? Good idea. My bet is that the conservatives will obstruct it to make the Dems in charge look bad, just as they have been doing last year and this year. The Republicans aren't going to change their spots just because the nation needs it, especially if they can score political points when they have nothing else going in their favor.
Other solutions as appropriate - let's see, those are what Bush has been decrying as "Pork" aren't they? Think he'll change from his current process of channeling the spirit of Herbert Hoover? If he does, he'll see to it that there is a political poison pill built into the legislation like some anti union measure.
Cut FICA by 2/3rds? OK. Not the Medicare 1.45$% (since Medicare is in such financial bad shape already), so that's a cut of 4.67% of the 6.2% FICA. Good idea if they tax the hedge funds and wealthy to make up the loss to Social Security. Otherwise it is another move to destroy Social Security.
Oh, and the FICA cut offers no benefit to retirees. Since they are reduced income individuals and family groups, money sent to them will more reliably increase consumption.
Note that none of this can be done by the Fed. It is also completely against what Bush is on record saying.
Note also that this is pure Keynsian. Some supply-side idiot is going to try to add general tax cuts for the rich to the package.
April 6, 2008 8:41 PM | Reply | Permalink
You forgot the helicopters dropping money from the Fed....
April 6, 2008 11:15 PM | Reply | Permalink
I didn't really forget that. That's money that will not add to consumption. It will just add to inflation.
But they are panicking right now, don't know how to get out of the hole they dug for themselves, and they are trying to look like they are doing something.
They don't really look like they've stopped digging the hole, either. Seen any serious proposals about regulation of investment banks or taxing them to get back the money being thrown at them right now because to the mess they have made of banking? Neither have I.
George (Herbert Hoover) Bush and his bankers are running the show, and don't want to write off all the fake value of those mortgages they wrote in the las five years, either.
Notice that the banker's fellow elites in the Senate killed the proposal that bankruptcy courts be able to write down both the interest rate and total value of the mortgages of people in over their head? So the homeowners will lose the homes in foreclosure and bankruptcy and the banks will still lose the excess (fake, bubble-created) value the mortgage was written for along with the other 25% that foreclosed homes lose in the expenses of foreclosure.
The bankers are being short-sighted. They still think the recession they wouldn't admit exists just last month is going to be a short one and they can keep those pumped-up profits Greenspan gave them with his bubble. Which is another reason why this is NOT going to be a short recession.
And don't forget the inflation. It, too, has already arrived but is being mostly ignored. The money helicopters aren't creating the inflation they are just adding to it.
April 7, 2008 4:43 PM | Reply | Permalink
Re: Your first paragraph starting "This is true in every recession..." assumes that we have a well-functioning economy that has just hit a bad patch and it will blow over quickly.
A well-functioning economy would not have a recesson at all. It would hit a rough patch then right itself and chug on. The economy of the late 90s was not "well functioning" (see: dot.com bubble) and neither was the economy of the late 80s (see: S&L meltdown). Our economy has blown up because of the mortgage bubble meltdown. This is really not much different overall than the economic downturns caused by the dot.com meltdown or the S&L collapse.
Re: This isn't a normal recession based on excess production so that when the warehoused stuff is sold the workers will be hired back.
We haven't had that kind of récession (one caused by excess inventories with temporary layoffs only) since the 70s. The move away from dependence on manufacturing in our economy, combined with just-in-time ordering practices, has (probably) made invetory-fueled recessions a thing of the past.
Re: The problem with that is that the economy has been struggling along for six to eight years with all increases being based on consumption that was financed from the housing bubble - refinance to pay credit card debt scam. That's gone now. It won't be replaced.
Houysing constuction and a boom in the mortgage industry were a big part of the last few years. The stuff you mention above was ephemeral: only very small fraction of people went that route (because only a small fraction of homeowners even qualified, and of those only a fraction had significant credit card debt and only a fraction of those was willing to take the risk). The big problems are A) Loss of construction jobs B) Loss of mortgage industry jobs C) Paralysis in the credit markets
Re: Right now, the media is just beginning to get the idea, but has no idea of the severity of the problem.
The media, which love bad news because it sells, is harping endlessly about the bad economic news.
Re: Paulson's garbage is left over repackaged material from trying to get government out of the regulation business.
Nothing in my comments suggest I regard Mr. Paulson's efforts favorably.
By the way I agree we are not likely to return to torrid growth levels any time soon, though I think high energy prices are the main culprit there. I don't however expect the recession qua recession to be very long-lasting. If you read what I wrote, I am predicting a long period of minimal growth, somewhat like Japan's experience in the 90s (but only somewhat: Japan and the USA are very different countries). A more or less steady state economy where, overall, we end up treading water without getting anywhere. That could change for the better if things are seriously upended after the next election, or could grow worse if the next administration proves even more inept than the current one.
April 7, 2008 7:42 PM | Reply | Permalink