U.S. Imperial Military Presence Overseas Requires More and More Debt to Cover the Bills; the Two Major Risks to Our Economy in 2011 are Debt and Pension Obligations and the Continuing Crash of the Housing Market

The two major risks to our economy in 2011 are (1) the first—naturally!—is the debt and pension obligation problem in the 50 states, their cities and other municipalities. (2) the other major threat is the continuing crash of the housing market. Cognitive failure to comprehend our massive societal breakdown is especially rampant among those who are in some sense "successful" within the current mess, i.e. they have a job of some importance, they make good money, their personal lives are in order, etc. These people are deeply inclined to believe the Empire is still salvageable, even when they admit its deep flaws.

Two Major Economic Risks in 2011

December 21, 2010

Decline of the Empire - There are many threats to the alleged economic recovery in the United States. As the Empire declines, it is hard to choose one particular area of concern while ignoring all the others. America's decline is all-encompassing, not piecemeal. It is ubiquitous, not isolated. This makes it almost impossible for most people to see it, even if they were psychologically inclined to accept it, which they almost never are.

Cognitive failure to comprehend our massive societal breakdown is especially rampant among those who are in some sense "successful" within the current mess, i.e. they have a job of some importance, they make good money, their personal lives are in order, etc. These people are deeply inclined to believe the Empire is still salvageable, even when they admit its deep flaws. They're inclined to take America's corrupt politics seriously while engaging (for example) in earnest discussions of whether Obama has "compromised his principles" in recent deals with the Republicans. His principles?

Another perception problem stems from gradualism. The Empire has been falling apart for three decades now. A fish swimming in polluted water gets used to swimming in polluted water—if that water hasn't already killed it. For example, look at this graph.

Source. Public debt, including government "borrowing" from social security (i.e. intragovernmental holdings)

After the early 1980's, economic (GDP) growth and our Imperial military presence overseas required more and more debt to cover the bills. In the private sector, household debt grew and grew to cover the income deficit required to support increased consumption. See my post Keynesian Delusions. Those born in 1970 were only 10 years old when the debt equation started to change. If you were born after 1980, you never lived in a world which wasn't like this. Those under 40 years old might be forgiven for asking Decline? What decline?

For the successful types I talked about above, regardless of how old they are, it seems that no amount of damage will persuade them that we're up the creek without a paddle. In the few decades leading up to 2008, things fell apart at a sufficiently slow pace to allow them to constantly adapt to the new conditions. Even now, after the meltdown, they are still able to put a happy face on unemployment well above 10% and the still-crashing housing market. In other words, they are hopeless.

Thus when we talk about new threats to the economy, we must remember that many people simply deny that the country is in deep, deep trouble. Moreover, any specific threat must be understood in the context of the Empire's decline. In its proper historical context, a collapse in some new sector (e.g. Muni bonds) should be seen as just another brick in the wall.

With this brief preamble out of the way, we can point to two major risks to our economy in 2011. The first—naturally!—is the debt and pension obligation problem in the 50 states, their cities and other municipalities. This 60 Minutes video highlights those problems.

The other major threat is the continuing crash of the Housing Market, which I reported on yesterday. Tech Ticker's Aaron Task interviewed Richard Suttmeier of ValuEngine.com. If you think I'm a pessimist, listen to Richard, who thinks that there is downside risk of a 15-30% drop in average national home prices. And just like me, he's a level-headed guy.

In upcoming days and weeks, I will talk about other threats to our economy in 2011. There's no dearth of things to choose from.

Housing Disaster Update

December 20, 2010

Decline of the Empire - Is the Housing Market the forgotten crisis, as columnist Rex Nutting recently asserted? It depends. If you check in with Calculated Risk everyday, then you receive the same updates on the disaster I do. But if you look for mainstream media reports, there are few new stories making the rounds because glowing reports are hard to come by. There are no new initiatives to "save" the market because all the previous ones, such as HAMP, were miserable failures. Here's Nutting—

For typical Americans, two things determine their financial well-being: Their job and the equity they have in their home [left]. They get almost all of their income from wages and salaries, while most of their wealth is tied up in their house. When wages and house prices are rising, they are confident. When wages and house prices are falling, they are fearful.

Policy makers may have rescued the banks, but they haven’t figured out a way to bring back the jobs that were lost, nor have they found any answer to the problem that was the nucleus of the crisis: housing...

Housing is the forgotten crisis. It wasn’t always so neglected. Early on in the downturn, the government dug deep into its policy tool kit to find answers for the collapse of housing.

They lowered interest rates in an effort to boost affordability. They took over Fannie Mae and Freddie Mac, and they told the Federal Housing Administration to lend freely. The Federal Reserve purchased more than $1 trillion in mortgage-backed securities and bonds to support housing. They approved tax credits for buyers, and extended those credits several times. They tried to get lenders to modify loans.

Nothing has worked.

Not only has nothing worked, but the Housing Market continues to deteriorate. According to Core Logic's House Price Index, house prices have fallen for 3 months in a row, the most recent decline being 1.9% in October from the September level, which itself showed a decline of 1.8% from August.

From Calculated Risk. I took the liberty of marking the Bubble Era (1995-2007). The bubbly times also include the first first bubble in Tech (the Web, Telecommunications) as reflected in the NASDAQ. This first bubble burst in 2000. From CR: "In Q3 2010, household percent equity (of household real estate) declined to 38.8% as the value of real estate assets fell by almost $650 billion. Note: Something less than one-third of households have no mortgage debt. So the approximately 50+ million households with mortgages have far less than 38.8% equity."

As house prices decline, more mortgages go underwater (i.e. into negative equity), there are more foreclosures and unsold inventory increases. This cause house prices to decline further, which means more mortgages go underwater ... and so on. I don't exactly when this pernicious positive feedback loop will stabilize, and neither does anybody else. When it does, we can say the Housing Market has hit bottom.

Nutting is concerned about the impact that equity loss has on "consumer" spending. I have decided that I will never again use the word "consumer" without quotation marks. From Nutting—

Since early 2006, American families have lost $7 trillion in home equity — more than half of their equity has simply vanished. Many millions, of course, have lost everything they put into their house, and more.

Years of blood, tears and sweat equity gone. Remember, for most families, home equity accounts for most of their wealth. In the past, wealth in the form of home equity has often been the ticket to upward mobility; many a small business or college education has been funded from real estate wealth...

Rising housing wealth helped drive consumer spending in the middle of the last decade. The best guess by economists is that consumers will spend about a nickel more if their housing wealth rises by $1, or spend a nickel less if wealth falls by a dollar. The bubble boosted consumption by about 6 trillion nickels.

Needless to say, spending driven by phony equity created by the bubble is not coming back anytime soon. Nutting does not mention, and may not know, that Americans flocked into houses during the bubbly times to compensate for the wealth they were not accruing in wages and incomes. The median income in the United States has been falling since 1997, and it's not an accident that this fall comes just after the beginning of the Bubble Era (see chart above).

Anyway, that's all over and done with. The bubbles being blown now by the Federal Reserve will not have a new "positive" effect on household balance sheets. Rising gasoline prices or rising stock prices or rising asset prices in China do not increase the household wealth of ordinary Americans.

Nutting goes on to say that the rich are spending more money, as I've written about lately. Of course this does nothing to help the Middle Class, whose ranks are dwindling, nor does it help the poor, whose ranks are swelling. Here's Nutting's conclusion—

The upper middle class and the rich, of course, haven’t slowed down. Spending isn’t as volatile for them as it is for the rest of us. Their holdings of stocks, mutual funds and other financial assets are worth more than their home equity, so they feel richer than they did a year ago.

Not so for those in the middle or bottom of the income scale, who have fewer financial resources to buffer themselves from economic shocks. For them, the recession never ended. And it might be getting worse.

The huge loss of phony housing equity that ordinary Americans have sustained over the last 3 years accentuates the failure of real median wages and incomes to rise for 13 years now. Americans were not buffered from economic shocks before the Housing Bubble, they weren't protected from economic shocks during the Housing Bubble—obviously!—and now they are more vulnerable than ever before after the Housing Bubble. Homeowners will continue to lose equity until the Housing Market bottoms out. Nobody knows when that will occur. Will it happen next year? — unlikely. 2012? — perhaps. 2013? — possibly.

From this point of view, the American economy has been fraudulent for a long, long time now. The collapse of the Housing Bubble exposed this fraud. But if you read DOTE every day, you already know that. Nothing has changed, at least for the better. In fact, some circumstances have gotten worse. Counterintuitively, mortgage interest rates are rising post-QE2. Will wonders never cease?

There's your housing disaster update.