Saturday, August 4, 2012

Debt and debt bombs

Which debts are the most toxic? Which are prairie fires, and which are hearth fires?

Apparently, the US is running up a tab that our children will be working in coal mines to repay until the end of time. That is, to hear the Republicans talk about it, now that Democrats are in charge of spending. When Republicans are in charge, the national debt "doesn't matter", and military adventures particularly are ripe for charging on the big credit card, being "special" expenses, of course.

The US is full of debts. Every dollar bill is a liability of the US Treasury, and most financial assets are someone else's debt. What makes one debt toxic and another a pillar of stability and the American way? A rundown of the most significant debt pools in the US, is, as far as I can make out, runs something like this:

Total bonds of all kinds:31.2 trillion
Corporate bonds:3.6 trillion
Mortgage debt:13 trillion
Municipal bonds2.7 trillion
Federally issued bonds:17 trillion
Consumer credit debt:2.5 trillion
Corporate paper1 trillion
Money Market / Repos10 trillion
Currency in circulation 1.0 trillion
(Corporate stocks:15 trillion (NYSE only)
4.5 trillion (Nasdaq) )
(Home equity20 trillion, residential
5 trillion, commercial)
Total wealth:~60+ trillion
(Derivatives:hundreds of trillions, in virtual gambles.)

So about half of what is customarily considered wealth in the US is in the form of debt instruments. What makes a debt instrument problematic to the economy at large? One characteristic is volatility. The current crisis was brought on by the unanticipated (by most) reversal in housing appreciation. Collateral disappeared, refinancing capability dried up, and an enormous edifice of debt (CDOs, MBS's, banks themselves) built on top of this creaking foundation was called into question, then into panic. The Federal reserve / Treasury, using its essentially limitless funds, allowed some to die and some to live.

So some debts are destabilizing if their solvency is pegged to market valuations that can gyrate significantly. Corporate debt is similar, though less prone to market-wide crisis than real-estate debt, which is pegged to a single nation-wide market. Corporations go bankrupt all the time, yet the corporate bond market marches on, adding layers of higher and higher (junk) risk for adventurous speculators. Rarely, however, does a complete market meltdown occur. Even if the stock market crashes, bonds are senior and get first crack at the assets of a company in any crisis.

A second issue is serviceability. Again in this crisis, as people lost jobs and income, their mortgages succumbed to deliquency and ultimately foreclosure- a loss to everyone involved. Corporations can go bust as well, but their books tend to be a bit better understood, with risks priced into their bonds as the market evolves. At any rate, the corporate bond market seems less prone to cataclysmic revaluations than real estate, at its marginal frontiers.

Lastly come government debts. Municipalities do go bankrupt, as we have recently seen. And it may become more common as the enormous public pension commitment overhang screws more cities to the wall. But still, it is very rare, and bankruptcy by entire states is unknown in the US.

Still more is bankruptcy by the federal government unknown. Not only is its power to tax enormous, but its power to issue the currency makes insolvency literally impossible, from any financial perspective. So its stock of debt neither gets called in during a crisis, nor is subject to wild swings of perceived quality and soundness for any financial reason, but instead swings, if at all, at the perceived willingness of the political institutions to stand behind it.

So the cost of federal debt does not lie in financial system instability or serviceability, unlike other forms of debt. It lies elsewhere, in the political pressures of taxation to pay the debt's interest, and / or inflation if the neccessary taxation is spinelessly avoided. Obviously, at this low point in the business cycle, these costs are not issues at all. The cost of our federal debt continues to decrease as interest rates decline and the government rolls over past longer-term debt. This is a good time to exchange private debt for public debt.

But in the long run, nominal and real interest rates will go up, and inflation pressures will re-appear, and the political cost of carrying high federal debt (i.e. transferring money from taxpayers to rich bond-holders) will increase. When and by how much? It is hard to say. Japan is going on 2+ decades of ultra-low interest rates and economic stasis. If we face that future, then essentially never and not much is the right answer. At the same time, this is not a future anyone wants.

Even if we don't care about grinding unemployment and domestic hopelessness, perhaps we might care about our geostrategic position that is melting away as the US and the West stagnate vs the growing powers of China and Asia. Or perhaps we might care about the real demographic problem of the baby boom, which is not (in macro terms) how to pile up enough pieces of gold for their retirement, but how to educate enough workers and drive enough real economic innovation and growth to take care of those boomers in old age without impoverishing everyone else. Dollars don't do nursing and don't replace hips ... doctors and nurses do.

If we were to successfully use federal debt to restore normal domestic economic activity, we might have to reduce federal spending at some future point, or raise taxes to match, or use the Federal Reserve's interest rate arm to dampen growth in the private sector. It may be difficult politics, but it isn't rocket science. There are plenty of tools at our disposal to deal with it. It just takes a functional & rational political system. Which is truly the worrisome point in today's dilemma, making all the more maddening the political right's policy of destroying the government to prove their thesis that government is bad, which justifies destroying it, .. because it doesn't work .. because .. you get the picture.

  • Krugman on why the debt is OK.
  • The left side of the deficit debate is hardly left at all.
  • California is in a serious energy bind.
  • Life after fossil carbon.
  • Steve Jobs- the lost interview. Very interesting thoughts on technology, craftsmanship, and how to run companies.
  • This would be hard to make up.. "British solution to unemployment – make them work for free", by Bill Mitchell.
  • A post-religion story.
  • China faces a real estate crunch.
  • NHS- what real democracy looks like.
  • Defense department: best-in-class at screwing up software projects.
  • Poland has the answer to the euro.. get out of it.
  • Now to take your mind off it all, a Haydn recommendation from Steven Stark.

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