Showing posts with label Economy. Show all posts
Showing posts with label Economy. Show all posts

Wednesday, July 19, 2017

Living on Borrowed Time

Last week a five-minute blast of very high straight winds hit our property in Michigan’s Upper Peninsula. In the hundred feet between our house and cabin and the lake, we lost all or parts of eight large trees: three hemlocks, two spruces, one cedar, and two maples. I haven’t explored the south end of my near-shore property, so there could be more. I have traveled most of the paths that wander through the remainder of my eighty acres looking for damage and found nothing major.

Why the disparity in damage levels, and does this have any larger significance beyond me having serious chainsaw work ahead of me?
  
View of lake 2013. Note density of trees and short understory

When I bought the land in 1997, the trees at the lake’s edge were generally towering white pines and sprawling white cedars. The next tier of forest consisted of black spruce (60%), white pines and white spruce (10%), and deciduous trees (mostly red maple, white birch, quaking aspen – 30%). Beyond that 100-foot line, the deciduous trees became dominant with evergreens accounting for at most a quarter of the trees.

The black spruce were already starting to die from blight. A diseased tree would first exhibit the problem in the fall when many of the needles at the treetop turned yellow. By the next fall, the tree would be dead, and within three years the top would blow off, leaving a twenty-five-foot stub, which generally fell in the following decade. After twenty years of this infestation, perhaps five percent of black spruce near the lake remain.


The understory 2017

The spruce deaths have opened the understory for new growth, and a mass of balsam, pine, and hemlock have reached up to fifteen feet tall. During this period, a few of the white pines, which were already past their prime and on their decline, have also died, losing their needles and dropping branches as the years pass. A third source of destruction occurred when beaver “harvested” up to a third of the large deciduous trees in that first hundred feet, including almost all of those at or very close to the water.

One advantage of all this woods-thinning is that we have a much better view of the lake from our house than when we first built it. The bad news is that when we consider the density of trees taller than twenty-five feet in that first one-hundred feet, there is no forest. Those trees have become a collection of individuals.

More open view of lake 2017 (of course it was foggy the day I took this)

Those of you without significant forest experience may not realize that trees in a forest grow differently compared to the same tree in a suburban yard. Because of the lack of competition in the yard, trees grow out, expanding their canopy using long limbs that require thick trunks. The quest for canopy space in a forest requires rapid vertical growth. Light reaching the floor of a forest signals affected trees to grow tall as quickly as they can so they can grab that small spot in the canopy. Lower limbs are quickly abandoned. Strengthening the trunk takes a back seat to reaching height quickly. This results in tall, thin trees whose trunks are often brittle.

Twenty years ago, high winds that whipped across the lake were met by a dense collection of trees. Pines formed the core of the defensive front. Tall and supple and strong, and backed up by the large numbers of spruce behind them, they forced much of the wind to deflect up and over the forest. Now the big trees are isolated, with large gaps between. High winds are no longer deflected up; they retain their strength, sweeping past the pines, and pounding individual trees with their full force.

The unbroken wind uses the densely packed needles to apply extra leverage to individual trees, causing those cedar and spruce trees with shallow or weakened root systems to tip over. Trees with stronger root systems, like maples, birches, and hemlocks, remain standing, but the unchecked winds apply immense force to their leafed out or needled upper portions. If the trunk has a weaker spot, the winds can rip the tops of those trees off their bases. This is what happened to the hemlocks and maples.

Collectively, the forest—before it was weakened by disease, old age, and beaver—could withstand almost any straight winds with only minor damage to the tall trees. Individually, trees are hard-pressed to sustain the periodic battering we receive in the U.P.

The birch and maple trees initially benefited when the black spruce died and dropped to the forest floor. There was more light for them. Their roots had less competition. When the beaver wreaked its devastation, it didn’t chew down the evergreens, leaving the towering hemlocks to stand alone. When a huge pine died, all the other trees grew faster using the extra light.

The tall trees that remain now claim a disproportionate share of the natural resources. Their leaves or needles gather most of the light. Their extensive root systems, hidden under the ground, absorb most of the water and nutrients.

The tall trees are now this forest’s billionaires. The black spruce were the forest’s middle class: hollowed by a disease that benefited those at the top of the food chain that claimed much of the canopy and feasted on the nutrients released to the soil. The understory trees are the forest’s working poor, struggling to get by on the scraps left by the big trees, but flourishing where they do receive enough light.

Those billionaire trees are living on borrowed time. When the winds come, the eviscerated middle class can no longer support them, and one by one they will be toppled.

~ Jim

This blog first published 17 July 2017 on Writers Who Kill.

Friday, April 22, 2016

Time to Lighten Up on U.S. Stocks?

As those of you who follow my financial blogs know, I am a believer that the largest component of long-term investing results is one’s asset allocation. To maintain a proper allocation, one must periodically rebalance portfolios.

Since the beginning of the year, the S&P 500 has risen about 3.9%, which does not seem like a huge change. However, the year started off with a sizeable correction, so from its low this year, the S&P 500 is up over 14%.

And since it’s low in 2009, the S&P 500 is up over 200%, demonstrating why bailing on stocks when all seems gloomiest is exactly the wrong approach. And, I would argue, so is going all in on stocks as the markets continue to appear rosy. (That would be now.) Rebalancing forces one to sell off relative winners to buy relative losers.

If you haven’t rebalanced in a few months, it might be a good time to determine if your portfolio needs attention.

Only rarely do I change the allocation percentages of my various investment categories. Now, however, is one of those times. My sense is that U.S. stock markets are overpriced. As noted, The S&P 500 has already risen over 200% in the last seven years. That’s past. What matters is the future, and current price has everything to do with collective future expectations.

My expectations are a bit gloomy:

The bull market is already seven years old, but still propped up by expansive fiscal and monetary policy. The Fed still keeps interest rates artificially low. The U.S. Federal government stills pumps money into the economy. Its projected deficit for the year is $500 billion. Continually applied, these types of polices lead to bubbles.

Interest rates are much more likely to rise than decline (a negative to both stocks and bonds), unless a recession occurs.

Commodity prices have fallen substantially, temporarily boosting profits (consider airlines, for example). The five-year decline is likely to reverse.

The dollar has risen substantially over the last five years compared to major currencies (Euro and Yen by 30+%). This means U.S. based exports are more expensive and foreign earnings for U.S. companies have less value.

Much of the U.S. unemployment slack has been erased. This means corporations will have to pay more for talent they need. At the same time, much of the increased profit margin they have wrung out of labor costs by converting full-time positions into part-time and on call employees, outsourcing, and eliminating defined benefit pension plans and the like has already been fully reflected in earnings.

When (not if) the next recession occurs, the Fed will have fewer resources to counteract the liquidity crises that will surely occur because it has kept interest rates artificially low. Similarly, with the U.S. debt at record levels, Congress will be unlikely to approve appropriate economic relief measures.

Thus, the next recession will likely last longer and be deeper than would be the case if the U.S. economy were not starting from a position where expansionary measures are constantly in effect.
All of which says to me that U.S. stocks are riskier than usual in my portfolio. Recall that I am older and retired, which means I have fewer years to recover from any bear market and (worse) I do not have the ability to purchase more investments through savings from future earnings.

So my situation is different from yours, as may be my analysis of what to expect. But I figured I’d share my thinking and maybe learn something from everyone’s reactions.


~ Jim

Thursday, September 12, 2013

Who Deserves a Quality Life?

The fifteen dollar minimum wage: over the last month pundits on every side of the economic icosahedron have put forth their arguments, couched in terms of effects on job creation, inflationary pressures, global competition and the like. It’s either great, terrible, probably okay or not.

I’m a number geek so the numbers side of things is interesting to me, BUT all the economic back-and-forths miss the real question: Who deserves a quality life? Keep that in mind as we look at the general pros and cons of a minimum wage.

Most economists agree that establishing a minimum wage decreases the number of jobs that economy produces. Well, no kidding. If we had no minimum wage and paid less than any other country in the world, we could have all the jobs we wanted—assuming people would take them.

So let’s get real. We have a minimum wage now and we’re not going to abolish it. The only real argument is about the level of the minimum wage. Minor changes to the minimum wage have not had the deleterious effect to jobs that opponents have suggested. That means a bit of an increase can be had with little economic dislocation. As evidenced by the current lack of jobs, decreasing the minimum wage by letting inflation wear away its real economic value hasn’t produced a plethora of new jobs either.

A little change is not what is needed. Measured against inflation, the minimum wage is considerably less than it was when I graduated from high school in 1968. 

Chart taken from CNN.com


To get back to the same real value as the 1968 minimum wage would require us to increase today’s $7.25 by almost 50%.

But that’s not enough. Why should I, and why should you, be willing to pay someone so little they cannot live decently?

Assuming you have a job that pays decent wages, imagine with me what it must be like to try to live on $15,000 a year. With rounding, that’s the result of working forty hours a week, fifty-two weeks a year at the minimum wage. Also imagine you have one child to support. You have no benefits, other that perhaps a 401(k) plan you can’t possibly afford to contribute to in order to earn the company match and the opportunity to purchase a family medical plan, for maybe a third of your income—not likely.

In the U.S. this level of income for a family of two is just below the published poverty line. It is well below the impoverished line. Some unions are calling for a $15 minimum living wage. At that level, a full-time job will earn $31,200. That’s not exactly rolling in money, but it is closer to the amount needed to take care of basic necessities including healthcare.

Others have gone to great lengths to try to figure what a living wage means. I’ll rely on the results posted on http://livingwage.mit.edu/ . Half the year I live in Chatham County, Georgia (Savannah area). According to this calculator, the living wage for an adult and child, the adult working a 40-hour week, is $18.30. That is 22% above the level demanded by the $15 minimum wage proponents. Imagine how far away from a living wage $15 would be for this hypothetical family of two in New York City or San Francisco.

Okay, I know some of you are mentally griping about my single parent family. Let’s look at a family of two parents, both of whom work at minimum wage, and two children. As reported by the folks at MIT the poverty level wage is $10.60, and the living wage is $18.82—higher than for a single parent with one child.

Okay, I convinced you and everyone else and, we’ve increased our minimum wage to a living wage. What are the consequences of that action?

Overnight millions of families will be more economically secure. The money we pay these workers will be recycled back into the economy because although these workers are now being paid up to twice as much as they used to earn, they will not be saving much of this money. It will be used to purchase living necessities. The psychological health of affected families will certainly improve. Government programs to support the working poor will be less needed.

Bad news will arrive as well. All economists agree that with such a dramatic increase in wage rates, we will surely lose jobs—and many proclaim that is the reason for not making such a change.

Heck, we lost a lot of jobs when we abolished slavery too. We abolished slavery because it was the right thing to do. Counting jobs lost is a mathematical argument. Economists disagree on how many fewer. There will be increased costs for things that currently utilize “cheap” labor. Food crops will cost more to harvest. Fast food will be more expensive. The list is long.

By not paying people fair, living wages we hide the true cost of the items and services their labor produces. The extra costs show up elsewhere: in the Earned Income Credit, in emergency room costs when people without insurance get routine care, in higher medical expenses because people cannot afford relatively inexpensive preventative care, and as a society we collectively pay for expensive restorative care.

We cannot use the fear of higher unemployment to argue against treating people fairly. A significant portion of our long-term unemployment problem (as opposed to that caused by the most recent recession) is caused by the very poverty a living wage would diminish.

Despite the fact that paying living wages will not solve all our economic problems, it is morally the right thing to do.


~ Jim

Thursday, January 3, 2013

Republicans Blink


The deal hammered out in the U.S. Senate and reluctantly approved by the House this week was massively flawed; however it did call the Republicans’ bluff on no tax increases. Technically they might be able to hang their hats on the proposition that since they did not vote until January 1, they were actually voting for a decrease in taxes because the so-called Bush tax cuts had expired. The only people who might buy that are the politicians themselves.

Lots of people will focus on the many flaws of this legislation, but let’s look at the real positives.

(1) A bill passed Congress with bipartisan support. Huzzah! Everyone was grumbling (which is often the case with legislation that has bipartisan support) but a supermajority in the Senate and majority in the house voted yes. This proves they can do it!

(2) Republicans and Democrats voted for a tax increase. As I have written before, our annual deficits cannot be solved with spending cuts alone. Although House Republicans voted almost 2-1 against the bill, this vote shows recognition by a majority of legislators that we must also have increased revenue.

(3) Congress made most of the changes permanent. It’s important to recognize that permanent does not mean they may not be changed in the future. It means they stay in place forever until they are changed by law.

This differs from Congress’s typical approach of short-term fixes that they need to address year after year after year. This practice of temporary changes became standard because of the way Congress “scores” the cost of legislation. It minimized the costs and maximized benefits to make legislation look good. This process allowed politicians to make claims supported by incomplete economic analysis and also caused myriad opportunities for junk measures (aka pork) to ride along with a bill that must be passed. Making these changes “permanent” takes away “must pass” bills that are tar babies for pork.

(4) It returns the marginal tax rates on those with $400,000 (single) $450,000 (joint) back to 39.6% and also limits deductions and the personal exemption for those earning over $250,000 (single) $300,000 (joint). Capital gains rates will also be greater for higher income earners. These changes show a recognition that those well off must bear more responsibility for our tax revenues than they did.

(5) The AMT (alternative minimum tax) is finally indexed to inflation so it will apply to targeted groups and not add unintended taxes on middle class taxpayers.

(6) Eliminates the payroll tax holiday. While effective as a stimulus in getting more spending money to those working, it was ineffective in its appreciation by those receiving it. Further, it eroded the security of Social Security, which is particularly important at a time when so-called entitlements are all under attack.

(7) Congress blocked an increase in their pay. They actually thought they deserved one for their performance? I’ve said before Congress should get no pay until they pass a complete budget for the fiscal year.

Of course I wish this legislation had done more, but what it did accomplish was mostly pointed in the right direction. The next battle will be waged by the next Congress as it tackles the artificial debt limits imposed in the same short-sighted manner as the “fiscal cliff” by previous Congresses.

Happy New Year.

~ Jim

Thursday, July 19, 2012

Libor Rate Fixing – What’s the Big Deal?


When the Barclay’s scandal about reporting lower-than-actual costs of borrowing to those who compile the Libor rate (London Interbank Offered Rate) I thought, “Isn’t this old news?” Sure enough, Calculated Risk, a blog I follow, posted a bunch of links that reminded me why I had indeed come to believe Libor was something of a fiction.

For the record, let’s back up a bit and describe what Libor is—and it’s not one thing; it’s actually 150 things: Libor rates are set for fifteen maturities and ten currencies. Every day around 11:00 a.m. major London banks report the rates they “expect” to pay to borrow for various lengths of time. The compiler ignores the top and bottom 25% of reported rates and averages the middle 50% to determine the Libor rates, which are released to the public at 11:30. Banks, insurance companies, credit card companies (and maybe even loan sharks for all I know) use these rates to determine the interest rates they charge on loan balances. If you check your loan agreement you may find that it calls for something like the 3-month Libor rate plus 2.75%.

The first thing to note is that if only one bank was misstating their rates by substantially over- or under-reporting their borrowing costs, it would make little or no difference to the Libor rate since the high and low outliers are excluded from the calculation. To make a difference to the reported rate requires malfeasance on the part of a significant portion of the reporting banks.

From documents reported so far, it appears that especially in the midst of the 2008 financial crisis many banks understated their reported Libor rates. People began to use the Libor rate as a proxy for understanding each bank’s health, which explains why a bank might report a lower rate than their real borrowing cost. No CEO wants others to view their bank as vulnerable. If no one will lend to a given financial institution, it will soon have to shut down. (See Lehman Brothers for example.)

As a consumer, this chicanery might actually be good news. If your loan agreement ties your interest rate to an understated Libor rate, you aren’t charged as much as you should be. You win; your lender loses. That is a zero-sum game. Holy financial boondoggle, Batman, the banks screwed themselves? Well, for sure they screwed those brethren not able to offset the losses from preternaturally lowered Libor rates. However, some banks have trading arms that take financial positions on (among other things) the movement of Libor rates. If you knew the rates weren’t going to move as much as the economics of the time suggested, perhaps you’d be a wee bit tempted to place a bet given your inside knowledge.

Perish the thought anyone in the financial industry might use inside information. The fools who took the other side of the Libor bets thought they knew better—but what does that say about them when someone like me, a simple retiree with a bit of time on his hands, was convinced the banks were not reporting accurate figures.

As individuals we need to keep in mind that we should never invest in something we don’t understand. That includes not investing money with someone who buys and sells financial instruments you don’t understand—it’s just as likely they don’t understand those financial instruments either. As further proof, just look at the hedging operation that has already cost JP Morgan Chase billions and they haven’t completely unwound their position.

As usual, the lawyers will make out the best since they represent both sides of all suits (and they have already started over the Libor mess) and always figure a way to be paid.

Oh, and if you want a way to fix the problem of the phantom reporting, here’s my solution. Forget about publishing an expected rate. Have the banker boys tell us the highest rate they actually paid during the last 12-hours. There might be a bit of a lag in the data, but we can audit the results and put behind bars those who lie. Which would you prefer, fresh lies no more than 30-minutes old or half-day-old truths? I’ll take the truth, thank you.

~ Jim

Sunday, June 5, 2011

Solving The US Income Imbalance

In this post I am going to simplify the US economy and ignore both imports and exports. I know that’s a gross simplification, but with that assumption it is much easier to illustrate my central point. Once we’re through with the analysis you can decide whether including exports and imports (and the fact that we are importing more than exporting) materially changes my basic proposition.

Let’s further simplify and start with an economy of 100 people, no inflation or deflation, no imports or exports. At the beginning of our analysis the economy is “balanced.” It produces exactly 100 units of output. Each person is paid 1 unit of output, is allowed 1% of the produce and owns 1% of the production facilities. We’re starting with a utopian commune.

But we live in a capitalist society and after a short time (say 1 year) the economy has changed. Efficiencies have been discovered and the same 100 people can produce 105 units of output. However, not all people in the economy participated in creating the extra five units. The laborers retain their one unit of purchasing power; the 5% of management employees retain the extra five units. The math is simple: 95 of us are paid (and spend) 1 unit each. The five folks in management receive (and spend) two units each—one unit they spend on “necessities” and one on “luxuries.”

The economy hums along. Growth continues so in year two the economy can produce 111 units of output. The 95% aren’t quite as willing to see all of the productivity accrue to the managers and insist on a raise. Management counters with a dividend of .01 units per share. The masses now receive 1.01 units of output. The top 5% get 2.01 units and pay themselves each a 1 unit bonus for a total of 3.01 units. [Math check: (95 x 1.01 = 95.95) and (5 x 3.01 = 15.05) total 111 – yep good to go.]

The masses spend their 95.95 units (95 on necessities and .95 on luxuries). Management spends say 2.5 each (1 on necessities and 1.5 on luxuries) for a total of 12.5 units for the five of them. They still have a total of 2.55 units left over but have nothing else they really want to buy, so they look for a place to store their accumulated wealth. Let’s say the five get together and decide to buy up some farmland (they aren’t making more, you know). They convince a few of the masses to sell their portion of the country’s farmland and because of the effect of supply and demand, the value of all farmland increases.

Everyone in the economy feels better about that and those of the masses who sold their share of the nation’s farmland take the 2.55 units they received and acquire additional luxuries. The economy is balanced: somebody buys everything that the economy produces. Everyone feels better because they were able to increase their purchasing power and (for those who still retained their portion of the farmland) their net worth increased because of the increase in farmland prices.

This process continues: the economy becomes more productive. Most of the productivity is returned to management in the form of bonuses. They use a portion of those bonuses to acquire assets (farmland and factories). The masses continue to receive their wages and sell off assets to afford some of the luxuries the rich can afford. Some even go into debt to get some luxuries now rather than deferring consumption.

By 2007 in the US the share of income going to the top 1% was about 23%, approximately the same peak level attained in 1928, the year before the Great Depression started. As a comparison, from the start of World War II through the mid-1990s the share of income going to the top 1% varied from around 9% to 15%. (Source: Piketty & Saez: “The Evolution of Top Incomes: A Historical and International Perspective)

As reported by the Wall Street Journal, (4/30/2010), a study by New York University economist Edward Wolff estimated the top 1% of wealth holders in the US owned about 35% of all national wealth. Since there is a mismatch between what the top 1% of wealth holders own and what the top 1% of income receivers get, it means wealth is not getting its “fair share” of the income pie. Management (who supposedly work for the owners) have skewed the game to capture an outsized percentage of corporate profits. As one example of this phenomenon, in 2007 the CEO of Bank of America, Kenneth Lewis, took home about $100 million in total compensation (including the value of stock options).

Consider for a moment how you could possibly spend $100 million in a year. Every day you must spend over $270,000—and you can’t skip any holidays or take a vacation from your shopping. Because of the inability for the superrich to spend all their income, there will be a mismatch between what the economy produces and what the people can purchase unless the excess the rich don’t spend on goods and services is taxed away and given to the less well off. This is a far cry from the utopian beginning where production and spending corresponded.

Republicans maintain that if we drop the marginal tax rate on the well-off (they never call them rich) this will magically cause employers to create more jobs and thereby stimulate the economy. Here are some inconvenient facts: The top marginal Federal income tax rate in 1950s was 91-92%. In 1964 it declined to 77% (70% in 1965). In 1982 it dropped again to 50%. In 1987 it decreased to 38.7%. I suspect we would all trade the 1950s economic growth, when Federal tax rates were indeed a confiscatory 91-92%, for that we have experienced in the first decade of the 21st century, when the highest Federal income tax rate was a comparatively modest 39.1%.

Because of advances in technology the US economy produces more goods and services than we can buy, leading to excess capacity. If income were more evenly distributed, consumption would increase. Kenneth Lewis and his ilk have (cue the violins) tremendous difficulty spending all their income; but if we took his $100 million in 2007 and spread it around to 300 million Americans we each wouldn’t have much problem spending an extra thirty-three cents, would we?

We could, of course, attack our US deficit by increasing tax rates and thereby allocate income to more “productive” purposes than bidding up asset prices (farmland, housing prices, gold, etc, etc.). Far better is to allocate a larger percentage of the accumulated productivity gains of the last twenty or thirty years to the middle class—the people who actually created the gains (as opposed to those who managed the creation) through the form of increased wages. Such a redistribution would immediately stimulate the economy. Even if the masses did the “right” thing and saved a significant percentage of their wage increases to prepare for retirement, in the aggregate they would save less than the rich, who cannot spend their money fast enough. The increased consumption would stimulate the economy, provide additional jobs (further stimulating the economy) and, even at current income tax rates, the extra taxes the Federal and state governments collect would go a long way to balancing the various budgets.

To close, I don’t mean to imply that nationally we should be consuming more meals out or plastic dojobbies that will break after a year. In fact, we should be investing in our education, our crumbling infrastructure, our basic research to fuel future productivity gains. Consuming those goods and services will continue to fuel the productivity gains we need to develop a better tomorrow—but that’s a blog for another day.

In the short-term, government spending can (and did the last two years) ameliorate the negative impacts of the recession portion of business cycles. Such spending cannot correct structural imbalances within the economy. To regain a humming economy and full employment we must address the current gross income inequality in the US.

~ Jim

Friday, June 3, 2011

Anchoring, the Current Housing Crisis and Why US Economic Growth will be Anemic

In the previous post I discussed anchoring and how it affects our personal finance decisions. In this post I’ll look at how anchoring’s is exacerbating the current housing crisis.

Most commentators agree the housing bubble was caused by a combination of factors including speculative fever (prices will only go up), overleveraging (requiring 0% down and no asset verification in the worst cases) and fraud (both by mortgagees who lied about their income and assets and lenders who fraudulently enticed owners to take our first, second and third mortgages with misrepresented terms). Add to the mix that many homeowners drew down their equity in attempting to maintain a standard of living that their incomes could no longer support.

When supply (builders were creating new homes at accelerating rates) finally surpassed demand, housing prices stopped rising and started to decline. Like a tiny pinprick in a fully-inflated balloon, it doesn’t take much to let all the air out of an asset bubble. Once prices stabilized (or declined), banks realized the gig was up and tried desperately to strengthen their balance sheets. A financial game of musical chairs ensued and as always seems to be the case, the taxpayers were the ones without a seat and ponied up billions to save the investment banks, AIG, and eventually GM and Chrysler. [To be more accurate, future taxpayers were the victims as there was no increase in taxes to pay for the bailouts.]

That was then; this is now: Homeowners and banks are both falling victim to anchoring errors. Until these are corrected, the economy will have a difficult time making much forward progress. Homeowners with positive equity (market value less mortgage is positive) are still anchoring on what they paid for their home. When evaluating a job offer in a different area, they decide they cannot afford to sell because they have lost money on their house. They fail to recognize that the money has already been lost whether or not they sell. This makes it harder for geographical imbalances in the labor market to correct.

Similarly, banks holding underwater mortgages (the market value of the house is less than the remaining mortgage) are often unwilling to take a loss on their mortgage if the owner finds a buyer willing to buy their house for fair market value (called in today’s parlance a “short sale”]. They too have already lost on their investment, but prefer to defer full recognition of their loss. One reason is anchoring—in this case they have not fully written off the lost value of the mortgage they hold.

In every market downturn, anchoring on historic housing prices lengthens the duration of the imbalance between asking prices and selling prices. Sooner or later, the strength of market forces brings the prices together and market stability returns.

The strength and length of the housing bubble means that the adjustment process will be longer than usual. The number of foreclosures that have and will occur has generated another perverse reason for lengthening the turmoil: the company that services the mortgage only earns money while the mortgage exists AND they earn even more money when it goes through foreclosure proceedings. The mortgage itself may have several owners as part of the Collateralized Mortgage Obligation market. The mortgage servicing agents have little incentive to reflect the economic interests of the homeowner or mortgage owner over their own.

A short sale in which the mortgage owner writes down the value of the mortgage to the net sales price might be the best thing for both homeowner and mortgage holder, but it stops the cash flow for the mortgage servicer and is therefore rejected. Even when the mortgage servicing agent and owner are the same financial institution, the employees are from separate departments and their compensation structures are not aligned to overall corporate goals, but to departmental goals.

In the meantime these two anchoring forces have bumped heads and eventually underwater homeowners realize they have already lost all of their equity. They reset their anchor and understand anything they pay to the bank is throwing good money after bad. They stop paying on their mortgage, ultimately being evicted from their house through foreclosure. They also stop paying real estate taxes, and maybe insurance too; both costs provide no benefits to them. The mortgage servicer ends up with increased fees and the mortgage owner doesn’t get his money until the house is eventually sold, usually at a much lower price than market value. By the time a house is foreclosed, the owner is usually over a year in arrears.

I’m a big fan of the blog Calculated Risk. It has frequent posts on the housing market and my extrapolation of their charts and graphs implies that we are still at least three years out from foreclosures returning to “normal” levels. The results of these overhangs are that housing prices continue to slip, and because of the excess inventory (supply greater than demand) new construction is at record lows as a percentage of housing stock.

The good news is that current construction is near all-time lows for housing stock. Continued population growth (and eventual household formation) means that demand will grow to meet supply and the dearth of new construction will hasten that day.
However, construction is usually a key driver of new jobs in economic recoveries. Job growth has been anemic is this recovery, largely (but not entirely) because of the paucity of new construction. New construction employs not only builders, but those who supply building products, appliances, etc. The leveraging of one new job within our economy has the effect of creating four or five total jobs.

Economists may determine economic cycles based on increases and decreases in macroeconomic statistics such as GDP (gross domestic product) or perhaps the more indicative GDI (gross domestic income). Nominal GDP is higher now than it has ever been. Even real GDP (nominal GDP adjusted for inflation) is near or at an all-time high. So what’s the problem?

People (voters) based their understanding on microeconomic values. Can they buy as much as they used to? NO. Are they being paid higher wages for the same amount of work? NO. The population continues to grow and per capita GDP is still below all-time record levels. And remember, we humans anchor at the best of times…

But wait a minute: if that’s all true, why is it that I noted in my last post that at the end of April 2011 my net worth had almost returned to its all-time high? (Note: May and the first few days of June have not been as kind and perhaps April will turn into a new temporary anchor for me!)

Loosely speaking, stock markets have done well because corporate profits have soared. Bond markets have done well because the Fed has kept interest rates very, very low. These corporate profits have not been uniformly distributed across the economy—only those with substantial assets have benefited. Real wages continue to decline for most working Americans; corporate executives, for whom real wages are once again increasing, are the exception.

In the next post, I’ll talk about why this imbalance, unless corrected, will put a hobble on the economy.

~ Jim