Trumped! A Nation on the Brink of Ruin... And How to Bring It Back

by David Stockman

  Worse still, it’s based on the myth propagated by Bernanke and other modern Keynesians that nominal incomes among economic agents all march higher in lockstep as the central bank pursues its spurious 2.00% annual inflation targets.

  In fact, there is no lockstep march or equitable inflation at all. The incomes and wealth of the bicoastal elites gain far more from financialization and asset inflation than they lose to the CPI, while stagnant nominal wages in the flyover zones are relentlessly squeezed by too much inflation in the cost of daily living.

  In a word, today’s central banking policy inflates Wall Street and punishes Main Street. One point of evidence for the latter is that new firms and jobs are not being created at a pace to keep up with growth in the working age population. Accordingly, the labor force participation rate has been falling for two decades, even as the value of financial assets has soared.

  So Wall Street is winning and Flyover America is losing. There is a reason Donald Trump is resonating with the latter—and it’s not just red neck racism and xenophobia, either.

  It’s the handiwork of the Washington and Wall Street corridor. Capitalist growth, dynamism and prosperity is being extinguished in America because it is being betrayed by a rogue central bank and the Washington politicians, Wall Street gamblers and tech-sector bubble riders who prosper from it.

  HOW FLYOVER AMERICA GOT BURIED IN DEBT

  Worse still, the Fed’s monetary central planners have no clue that high taxes, transfer payments and public debt undermine the economy’s supply side incentives, productivity and capital efficiency. They assume, in effect, that consumption is the magic elixir of economic health and that any spending for that purpose will do.

  In fact, the whole objective of interest rate repression is to induce households and businesses to leverage-up and spend at rates higher than warranted by current incomes and cash flows—even if it does encumber their future with ever increasing debt service obligations.

  Accordingly, a big share of the household income/spending gap that resulted from Washington’s off-shoring policies was backfilled with debt—especially prior to the financial crisis. During the two decades after 1987, household debt erupted by nearly 7X. Even after the year 2000, household debt grew by nearly $7.5 trillion—more than double the $3.4 trillion gain in nominal personal consumption expenditure (PCE).

  In all, what had been just $2.7 trillion of household debt—credit cards, auto loans, mortgages and other loans—at the time of Greenspan’s 1987 arrival in the Eccles Building soared to $14.3trillion on the eve of the financial crisis. Bubble finance literally buried Main Street America in mortgages and other consumer debt.

  Nor was this $11.6 trillion gain in household debt simply a reflection of an expanding economy and rising nominal incomes. To the contrary, as we demonstrated in Chapter 2, the household leverage ratio went virtually parabolic, climbing from about 100% of wages and salaries in 1987 to nearly 220% by the early 2008 peak.

  And that didn’t happen because Main Street households suddenly became financial profligates and debt addicts. The explosion of household debt, in fact, was induced by the Wall Street/Washington housing bubble.

  Part of the latter was attributable to the feckless campaign for homeownership promoted by both ends of Pennsylvania Avenue via the massive mortgage subsidies conferred by Fannie Mae and Freddie Mac; the rest was owing to the Fed’s unrelenting efforts to push interest rates far below their honest, market-clearing levels.

  Needless to say, this massive, prolonged tampering with the price and risks of home mortgage debt deformed the entire residential housing market, causing prices to rise far above levels that would have occurred in an honest, unsubsidized market. In fact, between Greenspan’s arrival at the Fed in August 1987 and the housing bubble peak in 2007, the nominal value of residential housing stock rose from $5.5 trillion to $22.5 trillion or by 4X.

  Again, that eruption of the market value of residential housing wasn’t at all a reflection of a booming economy and bigger GDP. The value of the housing stock had been 110% of GDP in 1987, but by the time that Greenspan and his merry band of money printers were finished it had reached 155%—a figure well beyond anything previously recorded or even imagined.

  The greatest extent of that $17 trillion inflation of the housing stock, of course, occurred in the bicoastal precincts. But it did lift handsomely the value of 60 million owner-occupied homes in the flyover zone, as well. That is, until the whole Washington/Wall Street-inflated housing edifice came crashing down after 2007.

  In the end, the entire housing/mortgage bubble amounted to a onetime parlor trick of monetary policy. So long as the household leverage ratio kept rising, it permitted families to supplement spending from their current wages and salaries with the proceeds of incremental borrowings.

  This ratcheting-up of household debt and spending, in turn, caused currently reported consumption and GDP to be enlarged as well.

  HOW FLYOVER AMERICA WAS DUPED BY MEW

  For a time this artificial goosing of living standards by the central bank money printers did help insulate Flyover America from feeling the full brunt of its shrinking job opportunities and the deflating purchasing power of its pay checks. What it couldn’t afford, it borrowed.

  No more. As is evident in the chart below, the household LBO is over and done. After peaking at 220% of wage and salary income in 2007, the household leverage ratio has retracted to about 180%.

  Yet that modest decline does not mean American households are out of the woods; the household leverage ratio is still more than double the 75%-85% level that pre-dated the Greenspan era and remains far above pre-1980 levels that had been consistent with healthy and sustainable household finances.

  At the same time, the modest deleveraging so far is a leading indicator of the distress that has been felt in Flyover America since the Great Recession. Self-evidently, the preponderant majority of households have been forced to cut their consumption expenditures back to the levels of current earnings, which, in turn, are not rising nearly as fast as the 3.1% inflation rate afflicting Flyover America.

  Accordingly, living standards are now shrinking. The sharp rise in the leverage ratio between 1987 and 2007 had induced households to live beyond their means. But the end of that faux prosperity has now brought them back to reality. Indeed, traversing the “payback” side of the leverage curve, they have become disillusioned, sullen and desperate.

  There is also no secret or mystery as to how America’s working households were led into this appalling debt trap. The fact is, the befuddled Greenspan actually bragged about it when he celebrated the higher consumption levels that were being funded by MEW (mortgage equity withdrawal).

  That was just Fedspeak for the fact that under its interest rate repression policies, American families were being massively incentivized and encouraged day and night by cash-out mortgage financing ads (“Lost another one to Ditech!”) to hock their homes to the mortgage man and splurge on the proceeds. This reached nearly a $1 trillion annual rate and 9% of disposable personal income at the peak just before 2008.

  Yes, that did buy a lot of extra new cars, flat-screen TVs, vacations, trips to the mall, landscaping projects, kitchen remodels and man caves, among others. But even as Greenspan’s vocabulary conceded at the time, this was spending financed by balance sheet “extractions”, not current “earnings”.

  So what was happening behind the screen during Greenspan’s spurious MEW campaign was deplorable. The faithless Washington and Wall Street elites were actually spurring American households to strip-mine the equity from their homes and bury themselves in mortgage debt.

  Total mortgage debt outstanding thus soared from $1.8 trillion to $10.7 trillion—or by nearly 6X—during the 21-year period ending in 2008. And even though housing prices more than doubled, the ratio of equity to owner-occupied housing asset value plunged from 67% to 37% over the period.

  The depletion of homeowner equity during the Greenspan housing bubble era
was a profoundly destructive turn of events. It not only resulted in the trauma of foreclosure for upwards of 15 million households in the years since 2007, but also left tens of millions of additional households—many of them rapidly aging baby boomers—far less financially secure than they had been prior to the Washington engineered housing boom.

  Indeed, it is not hard to put a price tag on the enormity of the incremental debt burden now being lugged around by American households. To wit, had the historic debt-to-wage-and-salary ratio not been catapulted to its current debilitating level and, instead, remained at the historic 80%, household debt today would amount to about $6.5 trillion.

  That means the $14.3 trillion of currently outstanding household debt represents an extra $8 trillion. And that is the financial albatross, which is spreading financial insecurity and deficiency across Flyover America.

  So it is more than fair to say that Greenspan and his money printers are as responsible for the rise of the Trumpist insurrection as is any other single force. That’s because for upward of 75% of all households their “castle” is their principal and only significant financial asset. Yet the nation’s misguided financial rulers induced them to hock it to the rafters.

  The MEW party ended nine years ago, of course, but virtually Greenspan’s entire MEW is still there. Flyover America may not know exactly how it got buried in such massive debts, but it knows that the current Washington and Wall Street Bubble Finance regime has left it high and dry.

  So even as they now suffer a relentless shrinkage of living standards, these contractual debt obligations are chasing the huge cohort of baby-boomers right into their retirement golden years.

  Accordingly, and contrary to the elite media, it is not just racism and xenophobia that is bringing Flyover America to the Trump bandwagon. Actually, they are being herded there by $14.3 trillion of crushing debts.

  WHEN MASSIVE DEBT IS NEVER ENOUGH

  Nor is the once and former housing bubble the extent of the Main Street debt trap. The very essence of the Fed’s lunatic ZIRP policy is to insure that no balance sheet space goes unleveraged. So, even as household mortgage debt has been reduced by about $1.3 trillion since the 2008 peak, the difference has been back-filled by a huge surge in auto loans and student debt.

  And this is where the Keynesian foolishness of our ruling elites becomes downright perverse. If the 2008–9 financial crisis signaled anything to the nation’s central bank, it was that the household sector urgently needed to dramatically reduce debt levels and roll-back the huge upward ratchet in leverage ratios that had materialized over the previous two decades.

  But the Keynesian model is essentially a doomsday machine because it presumes that no amount of leverage is too much if it results in enhanced spending flows during the current period. So instead of encouraging debt reduction and a sharp rebound in the savings rate, the Fed did exactly the opposite of what the doctor ordered.

  That is, it took the interest rate to the zero bound and kept it pinned there for 90 straight months in a desperate effort to coax any borrower who could fog a rearview mirror or sign a student enrollment form to take out a loan and spend it forthwith.

  LAST RODEO FOR THE SUBPRIMES

  In effect, this was the last rodeo of the sub-primes. There is no other way to describe 120% loan-to-value ratios for autos that rapidly depreciate, or $40,000 worth of “loans” to undergraduate students who have no income and no way to demonstrate that they can or will repay.

  This means, of course, that there will be another round of defaults just around the corner—and even before. For example, the default rate for student loans in actual repayment mode—rather than in permanent kick-the-can “student” status—is already in excess of 20%.

  But that’s not the half of it. The real crime is that our vaunted central bankers and other policy makers have been reduced to drafting the most marginal credits left in the U.S. economy to carry-out their delusionary belief that America can “borrow and spend” its way to prosperity.

  In the auto sector, in fact, we have the ultimate example of that kind of debt-fueled perpetual-motion machine. To wit, literally 100% of the gain in auto sales since the 2010 cyclical bottom has been funded with new borrowings.

  As a result, the booming auto sales sector is not nearly what it has been cracked up to be. Sales have already peaked for this cycle, but given the growth in households and driving age population since 2007, an annualized sales rate of 18 million units or higher should be the permanent norm, not a fleeting peak.

  This unsustainable debt-fueled auto-sales recovery is dramatically evident in the chart below. Since the auto cycle bottom in mid 2010, retail motor vehicle sales have rebounded at a $360 billion annual rate, whereas auto loans outstanding have risen by $355 billion.

  But here is a data point that completely belies the illusory debt-fueled prosperity of the auto sector, and, instead, underscores how Flyover America is being led even deeper into the Fed’s colossal debt trap.

  To wit, nearly one-third of vehicle trade-ins are now carrying negative equity.

  That means that prospective new-car buyers are having to stump-up increasing amounts of cash to pay off old loans, which, in turn, is pressuring volume-hungry lenders and dealers to extend loan-to-value ratios to even more absurd heights than the 120% level now prevalent.

  That’s kicking the metal down the road with a vengeance!

  In fact, outstanding subprime auto debt is nearly 3X higher than it was on the eve of the financial crisis, and average loan terms at nearly 70 months are a ticking time bomb. That’s because cars depreciate faster than loan balances can be paid down over that extended duration, meaning more and more of outstanding auto credit will be under water in the future.

  And that’s the skunk in the woodpile. With today’s technology auto loans are supposed to be inherently low risk. If push-comes-to-shove the repo man can find cars anywhere in America and tow them back to the lender for re-sale.

  But this assumes that used-car prices will remain at current levels, and that’s the catch. The coming tidal wave of vehicles coming off lease is fixing to send the used-car market and the whole trillion dollar auto-financing system into a tailspin during the next four years.

  Needless to say, ground zero for the great auto repo rampage ahead will be Flyover America.

  Indeed, payback time is already peeking just around the corner. The virtuous cycle of declining used-car volumes and rising used-car prices has exhausted itself. Yet that was crucial to the debt financed car-buying spree since early 2010 because it meant rising trade-in prices and therefore enhanced capacity to make down payments and loan terms.

  Stated differently, Main Street households were again being lured into cheap loans that do not provide a stable foundation for the eventual rollover of their vehicles and the loans encumbering them.

  Indeed, that’s exactly what happened last time around. In the run-up to the new-auto sales crash in 2008–9, used-car prices plunged by 20% and new light-vehicle sales fell from an 18 million annual rate to barely 10 million at the bottom of the cycle.

  By contrast, during the first three years of the post-June 2009 recovery, used-car prices soared by 24%, enabling the credit fueled recovery of new-vehicle sales shown in the graph.

  The worm is now fixing to turn because the used-car market is facing an unprecedented tsunami of used-vehicles coming off loans, leases, rental fleets and repossessions. As shown above, used-vehicle prices have been weakening for the last several years, but between 2016 and 2018 upwards of 21 million vehicles will hit the used-car market compared to just 15 million during the last three years.

  This means used-car prices are likely to enter another swoon like 2006–8, causing trade-in values to plummet and thereby draining the pool of qualified new-car borrowers.

  Likewise, new-car loan and lease finance will be shrinking because the estimated “residuals” on leases and collateral value on loans will be lower. That means loan-to-car price ratios will
come down—just as trade-in values on existing vehicles are also dropping. The resulting financing gap means lower sales and production rates in the auto sector.

  In short, there has not been a healthy recovery of the auto industry owing to 90 months of ZIRP and the Fed’s massive money printing escapades. This misbegotten monetary stimulus has only generated a deformed auto financing cycle that is now reversing and that will soon be extracting its pound of payback.

  Indeed, when the cycle turns down, fogging a rearview mirror is never enough.

  To be sure, there is nothing very profound about the certainty that an auto credit boom always creates a morning after hangover, and that the amplitudes of these cycles is getting increasingly violent owing to the underlying deterioration of auto credit. Currently, credit scores are dropping rapidly and upwards of 80% of new retail auto sales are loan or lease financed.

  Moreover, the race to the bottom is happening once again in the lease market. That is, monthly lease rates have gotten so ridiculously cheap that the implied residual values are at all-time highs. This means that when the used-car-pricing down cycle sets in during the flood of vehicles ahead, massive losses will be generated, causing a sharp contraction of the leasing market, as well.

  Stated differently, the auto sales piece of retail sales has virtually nothing to do with a rebounding consumer. It’s a reflection of an artificially bloated and unstable credit cycle that is about ready to take the plunge, and thereby deliver another blow to the faltering economics of Flyover America.

  THE STUDENT LOAN BINGE—A GENERATION OF DEBT SLAVES

  The only thing worse than the MEW legacy plaguing seniors is what’s happening on the other end of the demographic curve. Among student age Americans, the degree of debt enslavement has become even more draconian.