US indebtedness - The scope of the debt trap

Technorati Tags: US Slowdown

The long-term implications of high US personal (or family) debt may be worse than we anticipate. Various forecasts, discounting economic outputs from "back-to-normal" scenario 2-4 years in the future, may not have accounted for the problem correctly.

Debt stick on - even increases in bad times
Debt, much unlike losses, has an uncanny ability to stick - tying up future cash-flows for years, thereby constraining future consumption. Debt sticks on through job-losses, bankruptcies. In fact it increases - either in form of accumulated interest or future interest rates or loan availability. At least in India, where we do not have personal bankruptcies, this created systemic household poverty for generations. Drawing parallels from that, I believe, the time it will take to get the balance-sheets of US families to saner level of gearing might be much longer. Further more, for US, this exercise needs to be undertaken in/around recession years. Though it may not be generations, like in developing India, but it cannot be simply 2-4 years we anticipate.

Debt cause social pain
Corporate turnaround experts understand the kind of discipline and dispassionate execution it requires just to make small improvements. And it is still easier with a "company" than with household expenditures. Household cannot cut jobs and costs the way corporates can. Governments in progressive countries, like in US, tend to intervene with additional spending on social support - particularly education and healthcare. That spells problem for US.

In sum
We need to understand for median household debt what would be a good time frame get back in shape. We also need to understand the costs required to get them back in shape. The real future outcomes will lie hidden in these details.
As soon as we correctly value and discount these costs, the bearish-ness will vanish. Bulls don't like bullshit about recovery. Show us a real recovery and it's cost and we will "bear" it all the way into a bull run!

 

International Finance - A systemic weakness?

In my last post, I mentioned that wealth concentration exposed the financial systems to risks. The risk is compounded by inherent weakness of the financial system that  were not designed to accommodate. These systems are weak and plagued by complicated issues.

• Firstly, these were created as a subset of national governance systems. Consequently the flexibility of these systems are limited by the overall governance infrastructure in each nation.
• Also, unlike the capital movements, these standalone national regulatory systems are not inter-connected in any meaningful manner. Meaning any response to international financial crises will be subject to foreign-policy-like ambiguities and negotiations and, therefore, delays.
• The regulations are patchy - unable to control global momentum.

Popular, informed expert opinion is also weighing in on this shortcoming.
You can read Michael J. Panzner

in the modern global financial system, where many participants are either unregulated or are monitored by a patchwork of country or sector-specific regulatory overseers, chances are that a derivatives-related catastrophe will see a similar lack of coordination that will produce a far more devastating outcome than if it was a purely domestic affair.

It is one thing for a central banker to summon the heads of various financial firms into a room to sort out the mess at hedge fund LTCM, as the New York Federal Reserve chief reportedly did in 1998. Despite the fact that the Fed had limited statutory authority in the matter, it is not hard to see why none of those who were asked to attend turned down the "invitation."

However, if a derivatives time-bomb is set off by the failure of a large London-based hedge fund, will a banker in the Cayman Islands, an investor in Japan, an insurer in Germany, and a regulator in France feel similarly inclined to respond, or even to take the lead? That is assuming, of course, that those affected even understand what is going on or why it may be relevant to their own interests. Overall, there appears to be little, if any strategy in place for dealing with cross-border financial upheaval.

And Marshall Jevons linking to Davos

At the World Economic Forum in Davos, Mr Knight said the “major challenge” for regulators was the “the Balkanisation of regulation – fragmented across market segments, across national jurisdictions and yet we want to have a global financial system”.

And Dani Rodrick

How do you deal with capital flows when they are so prone to boom-and-bust cycles and generate (roughly once a decade) financial crashes with painful economic consequences?  The mainstream answer is that you do not regulate capital flows directly--through capital controls such as financial transactions taxes or deposit requirements--but you rely instead on prudential regulation of financial intermediaries. The best way to avoid crashes, this argument goes, is not to "throw sand in the wheels of international finance" (as Tobin famously put it), but to make sure that intermediaries do not take excessive risks.

In Sum...
A system so designed will be prone to momentum effects. The momentum is aggravated by wealth concentration. International finance needs to evolve beyond the free capital movement to counter this risk. A system of seamless regulatory response needs to be developed. Hopefully the thinkers at Davos will lay the first stone of a potent globalized interlinked system.