An Accident-Prone Economy

One of the economic realists I enjoy reading is Northern Trust’s Paul Kasriel. NT makes their Economic research available on a 24 hour delay; (I’ve always felt that was a smart business move).

In a NYTimes article a week or so ago, Kasriel coined a very astute phrase to describe the many increasing risk factors the United States economy faces in the upcoming year:  We have, according to Paul, a "very accident-prone economy." That sums the situation up nicely.

Here’s the context of that quote:

"DOES a financial train wreck lie dead ahead for American consumers and investors? Paul Kasriel, chief economist at the Northern Trust Company in Chicago, fears as much. He reckons that even a mild recession next year could spiral into something ugly, given the combination of rising interest rates, off-the-charts consumer debt and a cooling housing market.

"We have a very accident-prone economy," Mr. Kasriel said. "We have the most highly leveraged economy in the postwar period, and the Fed is increasing rates. In the past 30 years or so, whenever the Fed has raised interest rates, we’ve quite frequently had financial accidents."

The specific data is none too pretty:

"Here’s a stunning figure: In the third quarter of 2005, Mr. Kasriel calculates, households spent a record $531 billion more than their after-tax earnings, on an annualized basis.

These nonstop shoppers have propelled consumer spending to a record high as a share of gross domestic product – 76 percent in the third quarter, Mr. Kasriel said, up from 73 percent in 2000."

This is precisely what I was referring to earlier this week when I noted that GDP has been propped up by borrowing and spending, rather than production

And, we have been discussing how Real Estate has been driving the economy for about a year now. This is yet another risk factor:

"Bidding wars for homes have driven the value of residential real estate to a record 204 percent of disposable personal income, according to Mr. Kasriel; in 2000, the figure was around 150 percent.

CONSUMERS are not alone in their love affair with real estate. Portfolios at United States banks are also mightily laden with such assets. In the second quarter this year, Mr. Kasriel said, 61.7 percent of banks’ total earning assets consisted of mortgage-related holdings. Ten years ago, that share was 48 percent; in 1987, it was just one-third.

But now, because many consumers have come to use their homes as cash machines, the properties have much less equity in them. In the second quarter, for example, homeowners extracted $280.3 billion in equity from their properties, down only slightly from the record of $306.1 billion at the end of last year.

Other gauges point to danger. Mortgage debt as a share of the market value of residential real estate now stands at 43.2 percent, Mr. Kasriel calculates, up from 33 percent in 1987."

The graphs also raise some red flags about sustainable consumer spending into 2006:

click for larger graphic


courtesy of the NYT

These days, the standard response to the debt question is that net household assets (after debt) are 49 trillion dollars. Problem is, we head that argument in 2000, only to learn that those assets are capable of going down in value.  While house won’t go to zero (like or even drop 80% (like the Nasdaq did), their prices are subject to market forces. That’s why "if Christmas sales disappoint this year, it
could be because American consumers, who have never been more
leveraged, are awakening to this economic truth: the assets may shrink,
but the debt doesn’t."

After the Debt Feast Comes the Heartburn
NYT, November 27, 2005

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What's been said:

Discussions found on the web:
  1. D. commented on Dec 9

    This is what worries me…

    1. Banks “print” the money
    2. Every loan has a multiplier effect on the economy
    3. They’ve been making real estate loans like never before
    4. Real estate loans are very easy to securitize thanks to FNM and FRE… and VERY low credit spreads
    5. That’s what banks have been doing
    6. They can just take a deposit, leverage it 20x with a real estate loan, sell it, upfront the profit and quickly make another loan. Can you imagine the multiplier effect this has had on the economy? These real estate loans have probably had more impact on the conomy than any other type of loan BECAUSE they are so easy to off-load vs. other types of loans
    7. Productivity has been spectacular? Never mind that the calculation doesn’t include something like half the industries, but productivity growth is totally dependant on liquidity!!! They go hand in hand.
    8. Short rates are rising. If banks don’t pay more on deposits, they will lose them. Leverage will shoot up and they’ll have to sell some loans or call some back…
    9. Many banks are currently facing inverting yield curve conditions
    10. The multiplier effect goes both ways.

  2. Lord commented on Dec 9

    Have faith in the American consumer to break the BoC.

  3. touche commented on Dec 9

    Today the Fed released 3rd quarter household debt figures, and the ratio of this to disposable personal income soared to a new high, 121.6% up from 116.8% in 2005:1, 112.7% in 2004:1, 107.9% in 2003:1 and 101.2% in 2002:1.

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