2014

If you want to look for a date by which our economy is going to really start feeling the pain, look to 2014, when mandatory entitlement spending for Baby Boomers really starts kicking in. Steven Wieting writes for Citigroup:

The demands of fiscal promises made to the baby boom won’t simply go away.  Instead, away from cyclical forces likely to improve near-term budget deficits,  mandatory spending in entitlement programs in excess of revenue growth merely  begins in calendar 2014 (see Figure 6).

No mainstream U.S. presidential candidate has offered specific proposals to  eliminate the funding gap in U.S. entitlement programs that build continuously in the  calendar years of 2014 and beyond. If for some significant portion of that period,  both low interest rates and high deficits persist, then what can the U.S. expect?

It is much more difficult to measure the effects of “business left undone,” rather than  obvious impact, like the brief surge in U.S. solvency concern. But in a “cold,” crisis,  rather than a conflagration, one should expect trend weakening in U.S. investment,  productivity and wages if unusually large savings flows are directed at federal  deficits, leaving less savings for productive private investment, all else constant.

Yes, with both a strong government credit profile, and private investment  opportunities, the U.S. could be able to import foreign savings, in our view, running
a current account deficit of greater magnitude perhaps than current readings, near  3% of U.S. GDP. However, the degree to which foreign savings failed to be invested  productively during the 2000s housing boom provides a warning. More importantly,  the long duration of worsening in the case of healthcare and retirement entitlements  suggest a build up of liabilities to the external sector of unprecedented magnitude.

Deficit spending — away from short-term stabilizing effects — has the negative  long-term impact of compounding. By the Congressional Budget Offices estimates,  the federal interest share of U.S. GDP would rise from 1.4% in 2011 to 7.2% by  2030 and 15.8% in 2050 in a scenario in which current policy is followed, and  government healthcare costs rise at a somewhat slower pace. This leaves even the  effectiveness of government weakened. But the impact on private investment,  productivity growth and wages would be more pronounced.

Under assumptions in which there are no offsets for reduced flows of savings into  private capital formation, we estimate each 1 percentage point of the primary (noninterest) U.S. budget deficit per GDP would reduce productivity growth by about 0.2  percentage points. This provides an equivalent drag on potential GDP growth and  an estimate of the trend real interest rate.

Home Prices

As the chart shows, even with the collapse we have experienced since 2005, we are still at levels that look outrageously high given a normal progression. If we were to return to something like 2001-2002 prices, we would still have a LONG way down to go. The early 2000’s bubble corresponds almost exactly with the low rates from the Fed that were in place to combat the dot com collapse and the Enron scandal.

Add to our still-inflated prices a falling birth rate, retiring baby boomers and people with one kid or less who don’t exactly need 4,000 square feet and massive kitchens because they never eat at home and I think that we will see malaise in housing for at least another decade.

Our Short Sale

Last week we closed on a short sale here in Virginia. Our house sold for about 158,000 dollars less than we paid for it. It lost that much in 4.5 years. Some lessons learned:

* The sale took about six months to complete. The process restarted at least once and the closing date was extended a few times.

* The banks are government-sized bureaucracies. The left hand doesn’t know what the right is doing. You aren’t dealing with a person, but a system. One side was pushing along a foreclosure while the other was working with us on the short sale.

* We had to stop making our payment in order to play this game. Although our payment really was killing us, you can’t do anything until you fall behind. The bank only works with those who quit paying. For us, this was no huge loss as we wanted out of the house and had a good situation to get into on the other side. It made eminent sense for us to do this, but it’s not for everybody.

* We maintained our homeowners policy on the property and continued to pay utilities throughout the six months. The house was well-maintained and I think that helped us, although I’m not sure.

It is good to be free as Mr. Gallagher said!

Housing in Virginia 2010

It is now May of 2010 and there is no sign that housing is recovering here in Virginia. I live out in the exurbs, so in close to the city core things are probably a bit different. Out here, most of the homes that sat empty last summer still sit empty today. Most of them don’t have any signs on them at all and grass is now waist deep. I am no expert, but I imagine that a home sitting empty for a summer or two warps, cracks and falls into disrepair. Mold sets in. Bugs get in. Who wouldn’t want that? The few homes that do sell are at fire sale prices, 150K or more under where they were in 05-06.

Will these homes eventually need to be demolished? Will this neighborhood and those like it turn into exurban ghettos? After all, we are only another oil shock or inflation shock away from it being totally unthinkable to do the 1-3 hour commutes (each way) that we do here.

All things considered, housing isn’t picking up steam here. There are years of pain ahead.

Subsidies for the World’s Most Expensive Healthcare

Writing a market analysis for Citigroup’s weekly Portfolio Strategist newsletter, Steven Wieting outlines a dire future for America’s government debt. Note that this is far from a partisan magazine, it is a real-world analysis of possible scenarios for investors. An extensive excerpt follows:

§ Markets may still be overestimating the short-term vulnerability of the U.S. economy amid a strengthening and self-sustaining cyclical recovery. At the same time, the risks to U.S. economic performance in the long term have actually never seemed more dire.

§ Far from hoarding labor (unlike others), the U.S. has just endured the deepest two year decline in employment of the post war period. Signs abound that production, employment and investment declines have been unnecessarily severe, an overshoot. Friday’s data surprised with three consecutive months of private employment gains, with some confirmation in the separate survey of households.

§ But few had ever contemplated entering a well-advertised period of demographic weakening and higher dependency levels with a U.S. budget deficit so large as a starting condition.

§ The structural budget deficit looks potentially unmanageable even five years from now, when employment is assumed to be “full” and the financial supports of the recent crisis are paid back as fully as they ever will be.

§ Higher taxes have always seemed necessary to cover elder-care entitlements in the period ahead. But as a start, taxes are being raised instead to cover expanding entitlements further and can’t be used again for initial deficit reduction or offsets to future large increases in spending programs in place.

§ With the presumed passage of expanded subsidized healthcare coverage for nearly all in need, U.S. consumers, taxpayers and employers will have to buy more of the same healthcare goods and services sourced at the highest observable cost per unit in the world.

Unusual Digression in Short and Long View

On visits to clients across different parts of the world in recent weeks, we have continued to sense at least a worrying complacency with the long-term outlook for the U.S., against residual fears that the economy is incapable of cyclical recovery. In essence, many investors seem to overestimate cyclical vulnerability, while underestimating structural economic risks for the U.S. over the long run, in our view.

Far from hoarding labor (unlike others), the U.S. has just endured the deepest two year decline in employment of the post war period. Signs abound that production, employment and investment declines have been unnecessarily severe, an overshoot.

[…]

At the same time, the risks to U.S. economic performance in the long-term have actually never seemed more dire.

A demographic bulge in the dependency ratio has always loomed beginning in the early- to mid 2010s. That “bulge” worsens gradually for the following 25 years.

Few had ever contemplated entering this period with a U.S. budget deficit so large as a starting condition. This structural budget deficit looks potentially unmanageable even five years from now, when employment is assumed to be “full” and the financial supports of the recent crisis are paid back as fully as they ever will be.

Higher taxes have always seemed necessary to cover elder-care entitlements in the period ahead. But as a start, taxes are now being raised instead to cover expanding entitlements further and can’t be used again for initial deficit reduction or offsets to future large increases in spending programs already in place.

Following the recent political debate, many Americans might have come away with the notion that health insurance companies “charge too much” for healthcare. Perhaps the insurers need to hire their own cheaper doctors and build their own cheaper hospitals to compete with the existing supply of them. Assuming otherwise, they will still need to pay the same amounts for hospital stays, procedures and medicines as before, at the highest observable cost per unit in the world. But now, with the presumed passage of expanded subsidized coverage for nearly all in need, U.S. consumers, taxpayers and employers will have to buy more of those same goods and services, sourced from the same supply base.

Aside from small experimental steps to develop competitive exchanges for individual insurance coverage, never before have we seen a U.S. policy solution seem so detached from the underlying problem it purports to address. Americans want more healthcare, and will need more as the population ages. But the existing system fails in almost every way to match economic benefits with costs, obscuring them instead.

And while the latest reform effort purports deficit reduction over ten years, it does so on roughly six years of expenditures and 10 years of tax increases. More importantly, medical entitlements have never been “overpriced” into budget outlooks allowing for positive cost surprises (see Figure 11). The healthcare overhaul achieves the bulk of its purported spending cuts through limiting Medicare payments to doctors, hospitals and nursing homes, cuts that Congress has failed to pass through repeatedly since 2003, instead opting for more spending. Private insurers, meanwhile, would see some ostensible limits to their pricing, but generally would need to expand coverage, and purchases of healthcare services and goods.

In two places in the developing and developed world, laypeople mentioned to us that healthcare in the U.S. would now properly come for “free” for those unable to pay for it. If only that was true. Instead, future tax payers will have to come to grips with the costs of a system that for now is neither disciplined by competitive market forces nor rationed like other public welfare programs.

But if not in healthcare, rationing will take place in other places. Public education outlays for the future taxpayers have reportedly been a target of near-term budget constraints. While never free from waste, these are human resource investments that contribute to the future economic output. There are investments in the individuals who will carry the larger future tax burdens of the dependency bulge of coming decades.

We have been concerned for some time that a greater, unsustainable share of future entitlement outlays will end up deficit financed, with costs simply put off further into the future. At least that may be attempted. But among other concerns, lenders to the U.S. may feel less than certain about that stream of future income and output if incentives are so skewed against those who will need to provide it.

The Housing Crisis – not Over by a Longshot

There is a hope out there that the housing crisis is passing and that prices have bottomed out. I doubt it. According to Zillow our house is worth $73,000 less than when we purchased it three years ago. I brought this up at work last week and another guy said that his house is worth $200K less.

This means that there will be years more of people walking away from their homes, defaulting, or stuck in places they need to leave. And if values were to somehow rebound to where they were, it would mean that the bubble had been re-inflated and we would be back in inflationary la-la land.

It’s a mess and I don’t see a good solution. I think there will be more bankruptcy, more pain, and a general reset of the playing field. We need a year of Jubilee.