Koo: The Balance Sheet Recession is NOT Over….

There’s been a lot of talk in recent months about the end of the de-leveraging cycle in the USA.  Richard Koo, who coined the term “balance sheet recession” to describe the de-leveraging cycle, isn’t buying it.  In his latest note he describes why the USA has years left to go.  He says:

“If people who had been paying down debt to repair their balance sheets had actually resumed borrowing, it would mean that balance sheet problems were behind us. However, the fact that the latest colored bar in Figure 1 is above zero indicates that US households are still paying down debt.

Inasmuch as this act of reducing financial liabilities in spite of zero interest rates runs counter to the principle of maximizing profits, it suggests that US households continue to undertake balance sheet adjustments.”

See the accompanying chart via FT Alphaville for details here.

I think Koo’s view is confirmed by the NY Fed’s latest data on quarterly household debt trends.  They showed another quarter of de-leveraging.   But the balance sheet recession isn’t an event.  It’s a process.  And the process is very clearly moving in the right direction.  For instance, see the improvement in consumer borrowing year over year:

We’re obviously digging out of a deep hole there, but we’re digging.  Household debt is on the verge of turning positive.  There’s still a lot of work to be done here and the recovery remains fragile, but we’re moving in the right direction.  I’d previously estimated that the balance sheet recession could be over by 2013/2014.  That could be a bit optimistic if you consider “the end” a return to historical trend debt accumulation of about 7%, but we’re moving in the right direction.  Just one more reason why it’s so important for the government to remain supportive of very weak private sector trends here….


Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. Cullen, I’d be curious to hear(actually read) your views on household debt. Say that we go positive this year, which is very likely. Household debt relative to disposable income is still at 120% or so, which is far higher than the 80~ish percent or so that was historically the norm before the giant debt binge that began in the 1980s in earnest.

    Also, debt service as a percentage of GDP is artificially low due to central bank intervention. The historically low mortgage rates can’t last and won’t last more than a few years at most.

    If we will see the next decade with a positive debt accumulation, is that really good? Private debt will increase. Federal debt will likely not decrease – the best we can hope for is a stabilization. And that stabilization/stagnation of federal debt will hinge on a very unlikely event – that there is no event; namely, no recession for the next 7-9 years. Which is incredibly unlikely considering that the last one began over 6(!) years ago and ended four years ago. Normally, there’s a recession every 5-7 years. If we stretch it to, say, 7 years, then we still three years if you’re generous and count from the moment the last one ended(June, 2009).

    Second, despite a lot of criticism, there have been quite a few papers confirming the basic thesis of Rogoff & Reinhart about debt to GDP. It’s also important to remember they looked at gross debt, not net debt, and this means that the U.S. crossed that threshold over a year ago.

    My point? That the extremely rosy predictions of the CBO will not materialize. We wont see 3.5 to 4% growth in the 2014-2020 period. I think it was you who showed a chart about Fed predictions on the economy one year ahead of the predicted year as well as at the start of the year in January compared with the final results.

    What was true was a general pattern of overestimating the economic growth between 1 to 1.5% for each year. This is just the general pattern. Add to this the, at best, stagnating federal debt(which might as well increase if we get a recession in the next 3-4 years) plus a slowly increasing private debt load.

    While the doomsters were wrong, I’d just like to caution that we just may end up like Japan, only that it will likely take 25 years or so and the U.S. will have a higher unemployment than Japan has/had.

    I don’t think the “bond vigilantes” will ever strike. It will not be a sudden event. I think it will be a slowly grinding process. Thoughts?

    • To some extent I agree, but on the other hand, a lot of that is speculative. And, secondly, in such a high-debt situation we’re in, everyone (or almost everyone) look bad. Therefore, the U.S. will be cut more slack as the alternatives look even worse.

  2. “We’re obviously digging out of a deep hole there, but we’re digging. Household debt is on the verge of turning positive. There’s still a lot of work to be done here and the recovery remains fragile, but we’re moving in the right direction”

    Ok, this is weird. First of all, we should say debt ‘growth’ is on the verge of turning positive. This chart should go with the absolute level of debt in the household sector. Putting the two together, one would be happier to see the ‘growth’ be -ve for a long time. As a rough estimate, how about -ve for half the time it has been excessively positive? Surely, recovery is not when growth turns positive, but when absolute levels are sustainable?

    • In other words, debt growth turning +ve would be a bad thing, given the absolute levels of debt (contrary to what you say). Would you disagree?

      • DJ, if you think of debt as “money”, like MR does, it is easier to swallow.

        • Swallow what? The point being made is that credit growth will be good for the economy. Yeah, ofcourse, but only in the short term, given the absolute levels of debt. Ofcourse, absolute levels of debt don’t matter if they are sustainable. So, are we saying that too here? That absolute levels are fine. Where’s the argument for that?

          • Consumer debt is CURRENTLY at an all time high.

            Don’t make me do the work for you, Cullen, and cite the actual data.

            Your “the deleveraging trend is headed in the right direction is hogwash.”

              • I’ll show you this (just one news article link; I’ve misplaced my St. Louis Fed chart):

                Published Thursday, January 10 2013, 07:50 PM EST

                Consumer debt rises to all-time high

                (NEWSCHANNEL 3) – Consumer debt rose to an all-time high in November, as Americans borrowed more money.

                Total borrowing rose to a record $2.77 trillion.

                I realize this is stated in nominal terms, but where’s that “relative to income” data?

                • Well,

                  you have to compare it to SOMETHING. It’s like saying that govt debt is too high because it’s at an all-time high or that earnings are good because they’re at an all-time high. That depends. Govt debt is usually compared relative to GDP. Earnings are relative to shares outstanding. You can’t just say “this is at an all-time high” and expect that to be the full picture.

                  In the last 5 years household debt relative to income has fallen an unprecedented level. Personally, I find debt:income the most relevant measure here, but I guess you can use other things. But using debt in nominal terms relative to itself doesn’t provide you with much of the picture.

                  Make sense?

                  • Oh, I agree with you.

                    I was merely stating that I have not seen any data demonstrating that consumer debt has fallen 20% relative to real income from prior periods (or highs).

                    If you have any such data, I’d find it genuinely useful.

                  • This record consumer debt article is very interesting in light of this new article putting student loans at the same unsustainable 15% delinquency rate that subprime mortgages reached back in 2007. You can walk away from a house, but not a student loan, while tenured faculty and high attendance rates are ensuring tuition growth far above inflation. Does anyone else not see this as an enormous elephant in the room as these loans are chopped up, packaged, and sold to investors just like mortgages? So despite debt levels coming more into line with incomes, people are still unable to pay off their loans. Differing from the subprime crisis, I’m thinking this is mostly an unemployment/low wage problem particularly for young people. However, as the unemployment rate has dropped, this problem has continued to grow, so any jobs created are going to people with more experience first and young people get discouraged, drop out of the workforce and live with their parents. Also, is it a bubble? It might not be able to pop because any wages are garnished in bankruptcy to continue feeding the loan payments. Therefore, I would put the instability levels higher than subprime loans, but the question is how much money can be slowly paid back incompletely before the institutions who own these bonds simply can’t sustain themselves on the meager returns and go belly up themselves? 30%? 40%? One thing is certain to me – this will continue to be an enormous drag on asset prices as the older generations will use the extra income from slightly better employment to pay mortgages/credit cards/save up for retirement and the younger generations will be mired in debt, buying nothing. Thoughts?


  3. My guess is that households that spend years addressing debt will not suddenly turn around and begin accumulating debt again. That takes confidence, and confidence in this economy (and this government) is gone for many people. With the sharks circling at the state, local and federal levels looking to take in more government “revenue” through taxation, I certainly won’t be accumulating more debt anytime soon. The objective will be to shed for some time, before another crisis sinks me back into the same hole.

  4. The fact that we are still digging has to give pause to the Balance Sheet Recession hypothesis.

  5. The public is trying to dig out of its hole while the government digs a deeper hole.

    • JE,

      Your comment reminds me of the (false) equivalency made between a currency-user’s debt and a a currency-issuer’s debt. For the user, the hole can indeed swallow and financially bankrupt the user. But for the the issuer, maybe a “hole” is not an appropriate analogy, since in the case of the United States, one way or another it can always ‘finance’ further spending or meet any financial liability.

      Inflation, not affordability, is the constraint.

      Cullen, my comment here is obviously consistent with MMT. Is it also consistent with MR?

      • Yes, MR and MMT recognize the same constraint – inflation. I just wouldn’t describe the govt as the currency issuer in the same broad sense that MMTers tend to do. The devil in understanding our monetary system is in the details and not generalized metaphors. The govt is more like a very powerful user in that they essentially bribe the banks to bid at auctions using their power to tax as a support mechanism to get the banks to do their bidding. Technically, the govt doesn’t actually issue money. It outsources money creation to banks and harnesses its banking system to support govt. But the point remains – unless you can tax people and essentially bribe others to bid at your auctions then you shouldn’t compare a household to the govt.

        • MR says that banks issue our money, i.e. endogenous money, in conjunction with the public’s demand for credit. But I don’t think you’d say that banks, as currency issuers, cannot go bankrupt, right?

          This is a point I feel MR has not adequately addressed. In the United States, according to MR, is there a currency issuer that cannot go bankrupt?

          According to MR, the U.S. government is not the curreny issuer, but nevertheless can’t go bankrupt. On the other hand, the private banking system is the currency issuer, but banks can go bankrupt.

          It would seem then that there is no currency issuer that also cannot go bankrupt. What do you think?

          • JK, I’ll go out on a limb here, and say that I don’t think you’ve got how the banks are coerced to support the government quite right. You’re thinking in terms of inside money creation (loans create deposits) in the usual interplay between private banks and non-banks. Yes, it’s true that banks have a special charter from the gov to do that, and that does technically come into play with some Treasury bond auctions in which banks can do the same for the Treasury (i.e. create a deposit, called a TT&L account, out of thin air for Treasury, which then must ultimately be transferred to Treasury’s Fed reserve account, in the usual way of transferring a bank deposit, before it can spent by the gov. The bond, then held by the bank, essentially taking the place of the loan on the asset side of the bank’s balance sheet). However, I think the USUAL method that banks are “used to support the gov” is that they are “bribed” to act as intermediaries for non-banks who ultimately hold the bonds that Treasury issues. The reserves transferred from banks to Treasury in the process (matched in a 1:1 ratio with private non-bank deposits spent on the bonds) are in turn spent by the government back into private hands in the form of bank Fed reserve deposits (bank assets) backing private non-bank deposit accounts (bank liabilities, and private non-bank assets). This is the story Cullen usually gives that the government actually just redistributes money (from Peter to pay Paul) when it issues debt and spends the resulting proceeds back into private hands. In the process a net new financial asset is created and held by the private sector (the bond). In the usual case I’ve described above (banks as intermediaries) this private bond holder is a non-bank. Thus banks can still go out of business, but there will always be other banks to be coerced or bribed into acting as this intermediary.

            Even in the case where the bank is ultimately the bond holder, once the gov acquires the proceeds of the bond sale into its Fed reserve account and spends it, the end result is similar. No new inside money ultimately is created: instead the banks hold the NFA (rather than non-banks). The banks’ equity is unchanged (except for any premium they can earn in the process).

            So when you write:

            “It would seem then that there is no currency issuer that also cannot go bankrupt.”

            I don’t think that’s quite the way to look at it. Ultimately in the consolidated gov-issues-debt/gov-spends-proceeds operation, no new currency is issued by anyone! Instead a new financial asset (the Treasury bond) is issued by Treasury and held by the private sector.

            The whole process is illustrated here in a simplified way:


            If you try the operation called “Government Spends (Consolidated)”

            To see the case where banks ultimately hold the bonds try these three operations in this order:

            1. Gov Issues Debt (Banks Buy via TT&L)

            2. Treas Moves Funds From TT&L to Central Bank

            3. Government Spends

          • When I state “No new inside money ultimately is created:…” in the 2nd paragraph, you might be able to argue the opposite, since in this process (steps 1, 2, 3) you can see that private non-banks end up with more equity, as they are the recipients of gov spending in this case. Since the process started off as a typical ex-nihilo bank “loan” (except in this case to Treas.) it’s unclear to me how to classify this new equity in the hands of the private sector.

            Just try the tool and see exactly what happens to everyone’s balance sheets in both cases. I think it makes it pretty clear.

            • …”more equity” for households in both cases, but in the TT&L three step approach, the household assets have more deposits, whereas in the one step non-TTL approach they have more treasuries. So it seems that really is more inside money in the TT&L case, since overall reserve levels have not changed… only household deposits have increased.

            • So in summary, in the usual non-TTL approach to gov debt issuance and spending there is no net currency issuer, since there is no net new currency, only new bonds (held by non-banks).

              In the less-common TTL case, new net inside money (currency) is issued by banks and ultimately held in the non-bank private sector as deposit-assets. This is in addition to new bonds (held by the banks). So I guess with respect to this less common means of the bond purchasing / gov-spending process, it is possible for the “currency issuer” (banks) to go out of business… subject to the qualifications that Cullen mentions below, of course.

              Overall private equity, however, has increased by the same amount in both cases above (TT&L and non-TT&L). I think that’s correct!

              • The Fed can and does buy back bonds, so in that case the bank or non-bank cannot go bankrupt lending to the government.
                PS: I believe there is a net currency increase, precisely because of the previous point, that Treasury bonds are always reedemable for ‘money.’

                • Hi Johnny,

                  I agree the Fed can buy Treasury bonds from banks or non-banks, during OMO or QE (of course the Fed can also sell bonds during OMO too). However, neither of those cases can be thought of as “lending to the government.” All the operations I describe my earlier comments ultimately leave the Fed’s balance sheet unchanged (with resp. to the private sector). Those operations do increase reserves on bank BSs, so that is an instance of “outside money” being issued I think, but equity levels in the private sector remain unchanged. In the case of QE with non-bank sellers, the bank deposit of the non-bank grows. And in all cases where the Fed buys bonds, reserve levels at the banks increases. Reserve levels increase in either case (bank or non-bank), unlike the gov-issues-debt/gov-spends operations I describe in my earlier comments. Because reserve levels increase, I believe you can say that’s a case of “outside money” being issued.

          • MR says the govt has chosen to outsource money creation to banks. This doesn’t render the banks immune to solvency issues. Nor does it make the govt immune to solvency issues. A govt goes bankrupt when it can’t procure funds via taxes. The fact that it has access to its own printing press is 100% irrelevant in such an environment. The currency will die in an environment in which it can’t procure tax funding. It really does lose access to funds even if it doesn’t “run out of money”. The point MR makes is that the govt is a currency user in some capacity because it must be able to USE pvt money via the procurement of tax receipts. This is a point that MMT totally misrepresents and even abuses.

            The idea of a currency issuer is a lot less useful than most MMTers presume. Why not just describe the current monetary arrangement as it really is and not how MMT wishes it was? The govt outsources money creation to the banks and uses its extraordinary powers of taxation to sustain its own funding source. The govt is most certainly a currency user in some capacity. Of course, it’s inflation that would render procurement of taxes impossible, but that doesn’t mean we should go and overemphasize the concept of “currency issuer” as if no one in the world understands that the US govt has a printing press (though there are plenty of people who misrepresent this reality).

            And yes, the govt could theoretically take full control of the money supply and issue every dollar, but MR doesn’t describe an alternate reality. It describes the system as it is. And that system involves banks making money and the govt using its extraordinary powers to harness the banks and its private sector to obtain funds. Understanding why the govt’s constraint is different than a bank’s constraint has ZERO to do with the concept of a “currency issuer” and EVERYTHING to do with understanding how inflation and access to resources renders a govt incapable of functioning. MMT literature is littered with comments about how the govt can “always afford to” do this and that. That’a categorically false. A sovereign currency issuer (though that concept doesn’t even apply to the USA) can run into very real times when it literally cannot procure funds via taxes and therefore cannot afford to just print money. But the abuse of the term “always” is just as abused as the concept of “currency issuer”. It’s an extremist generalization that makes an oversimplified point on the way to totally mistaking how the system is actually arranged.

            • In fact, one could also add that as long as we have a functioning monetary system where inflation isn’t ravaging the system, then the banking system is always solvent and also doesn’t have a solvency constraint in the aggregate. It cannot, by definition, because the govt has chosen to facilitate and support the existence of this private market based money issuance design. So the govt MUST use its powers to tax to support that system. So, like states, the banking system in aggregate has an implicit govt guarantee that virtually eliminates its solvency constraint. But again, this is all about understanding the real constraint – inflation because the power to support the banking system ultimately comes from the power to tax which is a byproduct of pvt output.

              Again, this is all about understanding a chosen design and a balance of relationships. MMT builds a model that is overly govt centric and misleading with regards to the balance of relationships and their actual roles in our actual design.

              • Cullen, it seems that the US gov is now in a position in which it is deficit spending, but not really on fiscal stimulus (depending on how you view defense spending I guess). You mentioned in your
                “The Continual Failure to Understand the Balance Sheet Recession” article that “In Europe,…, many of the economies are in depression because the government sector pulled back spending at a time when the foreign and private sectors couldn’t sustain growth.” You imply that the US large budget deficit is preferable to Europe’s approach in this case. And again, that deficit is not currently for fiscal stimulus, but to support the “basics” (i.e. SS, Medicare/Medicaid, Defense).

                Can you envision a scenario wherein the “austerity” approach used in Europe is the best course of action? Say, starting from where we are now, … no additional fiscal stimulus spending, just the “basics”… can we get ourselves into a place where we need to either raise taxes or cut spending or both (i.e. austerity)? And I’m really talking austerity here, not the decrease in spending and increase in revenue that would naturally result from rising employment (fewer unemployment benefits for the gov to pay and a bigger tax base for more revenue). What would that austerity situation look like? What are the events that could lead us there? What is the chance that we could get there, and if there’s a reasonable chance of getting there, what steps can we take now to try and avoid that dire situation?

              • Thanks,

                I guess what I was trying to ask was: is concept of a “currency issuer” useful, according to MR. I see your point that it’s a broad generalization that isn’t particularly useful.

                • I think it’s a useful concept, but I just think MMT way overstates its importance and portrays the actual design of our system incorrectly in describing the govt as a pure currency issuer and not also deacribing the capacity in which it is a self ascribed user. MMT tends to go full bore state centered in describing the govt as a pure issuer of all money.

                  You just have to be careful using the term because many people wont realize that currency usually refers to outside money. But to call the govt a money issuer leads people to believe the govt issues all the money, which is not right. It supplies the money that supports use of inside money.

          • Seen another way, bankrupt banks shouldn’t be a big deal: they get their power from a gov charter to create inside money. Ultimately, what is a bank other than that charter? Answer: a guy w/ a spreadsheet. That’s pretty much all you need right? A guy with a spreadsheet, and the charter! Those are a dime a dozen! So a few go bankrupt, … charter a few more! ;^)

      • I understand the inflation constraint. What I’m saying is that just because we don’t have inflation at our current level of debt doesn’t mean you can be confident that we won’t have inflation when we make the debt load twice as heavy.

        Interesting question you posed below regarding the currency issuers and bankruptcy.

        • Who is making the debt loan twice as big? Just because we have a certain size deficit today and the last few years doesn’t mean it will continue. When jobs come back (and they are) you get new tax payers, and fewer getting checks for unemployment, food stamps, etc.

          I’ve never seen Cullen or anyone else address this either, but personally I think if there ever came a time where interest on the debt was too large, it would be a simple matter of raising money via taxing savings and/or massive taxes on the super rich. And/or taxing the bond holders themselves. Tax China the total amount of their bond holdings – since the don’t have the cash they hand over their bonds and we extinguish them. Viola, problem solved. Now of course you’d be wise to say “that will never happen” but what sounds ridiculous today won’t sound so crazy if we ever were in a spiraling debt situation. JMHO

          • ‘Just because we have a certain size deficit today and the last few years doesn’t mean it will continue’

            That’s our difference in a nutshell. I believe that when you look at the demographics and the expanding entitlements that the deficit will grow even if jobs come back on line.
            And your solution of raising taxes speaks to the fear people have that future generations will pay for this spending. You can easily talk about raising taxes on the super-rich, but if you want to raise tax revenue, you have to hit the middle class.

            • Johnny, I see your concern w/ demographics… but we can look at Japan for at least one potential glimpse into our future, … maybe? It’s not a pretty sight, but they have a similar demographic problem (probably a lot worse, because they also have cultural problems with allowing immigration… we do too, but not as severe and we have a LONG history of opening the gates in the past).

              Also they have a debt/GDP ratio that more than twice ours, right? They haven’t had inflation problems… they’ve struggled to avoid deflation as I understand it… for decades now. Isn’t that correct?

              • But Japan is not a pretty future. If we’re Japan in five years, we could have some serious political problems.
                By the way, I am not saying that present policy will necessarily lead to inflation. It might, but as you suggest, it might lead to deflation.

                • You keep saying that Japan is not a pretty future. For the past 20 years they’ve consistently had one of the most productive economies in the world, with an incredibly high standard of living. I don’t think we’ll become Japan, but even if we did, can you explain WHY that’s a bad thing? Economic growth cannot continue forever, that’s simple mathematics. So maybe they’ve figured out a sustainable equilibrium?

                  • “Economic growth cannot continue forever, that’s simple mathematics.” That is a bold statement (and it kind of reminds me of a line from Anchorman). Insofar as the Earth does not have an infinite life, I suppose it is true, but you seem to be making a Malthusian argument with near-term implications. And the Malthusian pessimists will probably continue being wrong for a long time. Humans innovate. It’s what we do.

                    • I’m speaking really really long term. Running out of resources, etc. Which, of course, presumes we don’t start building off-world colonies.

                  • Disagree about the standard of living. Japanese society has many problems resulting from lack of opportunity for young people; you can see it most notably in the low birth rates. It’s a very unhappy society.
                    Still, Japan is being held together by its very high social cohesion and social equality, which we don’t have in the U.S. If we have another decade of low growth, it will hit the lower classes the hardest and there will be political turmoil, imo.

                    • Johnny, Low birth rates in Japan is the exact opposite of lack of opportunity. Remember back in the 80′s (I think) The Japanese Govt was willing to pay 10,000 to women to get pregnant. The women were working and having careers so they were not interested in spending time raising children.
                      Heck generally it’s the poor that are having kid like rabbits. What else is there to do where your poor but….

                    • Cowpoke, Japan is such a strange society that maybe it’s hard to draw conclusions — but, imo, when couples stop having babies, it’s a sign they’ve lost faith in the future. Marriage rates declining, birth rates below replacement. Will create opportunities, yes, in about 20 years.

              • Tom, I never got time to read through your discussion with Joe in Accounting about excess reserves. Do you mind directing me to where that is located on the site?

                • Pierce, no problem. It’s in the latest page(s) of “Ask Cullen.” I’ll try to get you some links to some of Joe’s most interesting statements. Unfortunately that whole area has been damaged by some unknown problems… perhaps related to using bold characters (I blame Cowpoke ;) ). I believe that in an attempt to cut out the cancer, Cullen went through and chopped out some of Cowpoke’s comments… and maybe some of mine, etc. … but that resulted in a jumbled mess over there… lost indentations, non-sequential comments etc. It’s still a mess!… but Cullen doesn’t have time to sort it out right now he said. All the discussion took place in “Ask Cullen” though.

                    • Pierce, BTW, if you have any insights and make comments in that thread… and you see me on here sometime, give me a heads up. I still had a few questions to Joe/Cullen that were left unanswered.

          • hangemhi, I’ve addressed this situation and related ones several times, and Johnny Evers has given me feedback about my musings… however, I’ve never seen Cullen address this. Perhaps he has, but I haven’t seen it. I too would love to see his take. What I wrote is almost verbatim your 1st paragraph (regarding increased tax base and less unemployment, should recovery process continue).

          • hangemhi, Although like I write above, I’ve brought up the same points you do, Johnny too has a point about democraphics. Re: the unemployment benefits, for example, how much of the budget do they represent now? I have the distinct impressino that SS, Medicare/Medicaid, and Defense are the big three by far in our budget.

            I heard Bill Maher give a stat the other night that was revealing: He said the ratio of people on disability to those working right now is 1:13, whereas in the late 1960s it was < 50:1. That's a little worrisome… that's "disability" not unemployment benefits!

            But still, I think to address demographics, we can combat that buy allowing more immigration. We certainly have a long history of doing that!

            Also, I've asked Cullen (so far w/ no response) a similar question which essentially boils down to "Under what circumstances are true austerity measures justified (i.e. raising taxes and/or cutting spending) in a recessionary economy?" I've also asked him what he thinks Japan should do.

            • Unemployment is costing about a $100 billion per year over the past five years. Not sure what it costs in a good economy, probably half that.
              Food stamps have doubled under Obama to about $72b per year.
              THese automatic ‘stimulus’ programs have very little to do with the deficit.
              Disability is an interesting concept. An aging workforce is going to have more disability. A man who works outside or works construction is very likely to be broken down in some way (back, knees) at age 60. There is also a lot of blood pressure and diabetes issues out there. Obviously we have to provide for people who can’t work, while we are finding work for those who can.

              • So just for a rough order of magnitude, we might assume that tax revenue also increases by something like $50 Billion (or $25 Billon) should half those that are unemployed find work.

  6. These guys would beg to differ:

    Bloomberg – “Consumers have reduced their debt burdens enough to be able to withstand higher taxes and help sustain the U.S. economy’s expansion, according to Pavilion Global Markets Ltd. strategists…Mortgage and consumer-loan payments amount to the smallest percentage of after-tax income since 1983, according to quarterly statistics compiled by the Federal Reserve.
    The debt-service ratio was 10.6 percent of disposable income in last year’s third quarter. Five years earlier, the figure peaked at 14.1 percent. Pavilion highlighted the drop yesterday in a report with a similar chart.
    Household spending is poised to “strongly contribute to growth” this quarter and next, Pierre Lapointe, head of global strategy and research at the Montreal-based firm, and two of his colleagues wrote. Consumers account for about 70 percent of the
    economy, according to Commerce Department data.
    Other indicators besides debt-service expense bode well for consumers, they wrote. The report cited a rebound in the housing market, the end of a decline in inflation-adjusted wages, and a slowdown in debt reduction.
    Taken together, they will outweigh the economic effect of ending a temporary two-percentage-point cut in the payroll tax and possible automatic reductions in federal spending this year, the report said.”

  7. What bothers me about the ‘balance-sheet recession’ is that inference that this was caused by consumers taking on too much debt.
    That lets a lot of people off the hook — the financial institutions that leveraged that debt and lost trillions, the government agencies that bailed out banks but not consumers, the traders who believe the market is the economy, the politico-banking class that moved jobs offshore and then demanded the consumer borrow to replace his decling wages.
    The whole key to this recovery is going to be wages. If the consumer can deleverage, he won’t be able to spend or borrow if his wages don’t go up. Not to mention with labor participation still declining, the worker is going to be supporting extra people.

    • A BSR isn’t confined to the consumer, but I agree, the insolvency of the banking system is a far greater issue in the current environment.

      In attempting to place blame more equitably, I also agree with you. In the lender/borrower circumstance, I have to place more responsibility with a poor lending decision than with a poor borrowing decision.

      • The banks did not make poor lending decisions. They made risk-free loans, with a US taxpayer backstop in case they went bad. If I lent somebody 100K, charged them 6.25% interest, and was guaranteed that if the loan went bad I would be given new, fresh money to replace with the toxic money, with zero downside, I would say that is a genius lending decision on my part. At the same time, as the bank, I will dictate to the world that the guy I lent the money to is now a deadbeat, unworthy of credit unless he is charged a reasonable rate of 29.99%.

        The US is now one giant moral hazard. Unless you remove the backstops (FHA, Fannie, Freddie, TBTF, Student Loans etc.), we will continue to play this idiotic shell game of when SHTF, it’s the supposed breakdown of the “free-market system”, when as irony would have it, a true free-market system, devoid of backstops and bailouts, would have prevented the crisis from ever happening in the first place.

        • Exactly… That’s why financial sector recovered so quickly. If you have the gov side with you, you’ll never loss, but the country will pay a terrible price.

          • The Fed not only backstopped the 100k mortgage, it backed the $1 million mortgage backed security that went sour.

        • Tell that to AIG, Bear Sterns, Lehman, Wachovia, and Countrywide. You are overestimating the “risk-free” aspect and exagerrating how banks made loans knowing they had support.While I am sure some banks expected the govt to get their back when shit hits the fan, as they did in the late 80s, early 90s, and 98, (and really throughout the hisotry of banking in the US, even pre-Fed), but obviously no one knew who’d be helped and who wouldnt and how.

          But of course moral hazard and TBTF has only become worse. I agree

          • I largely agree with your comment. However, David Stockman has argued that 2008 was a “Blackberry crisis” by which he means the whole bailout plan was the result of a panic attack played out on blackberries between all the inside guys: Goldman, AIG, Bernanke, Paulson, Geithner, BofA, GE, etc. Not that Stockman has any inside info on this, but I found his view interesting. For example thinks GE was NEVER in danger of not meeting payroll since it could always have diluted its stock to do so, which would have lost Imult his job, but that would have been a good thing (according to Stockman). But in Paulson’s inside crony world, ALL these top guys losing their jobs and money was unthinkable, thus the public purse had to used to save them. Stockman’s got a book out now that addresses this I think.

            So you may be right: no guarantees… certainly weren’t for Fuld and Lehman Bros! … however, perhaps there’s something to always appointing the people making these decision from amongst that world… their whole world view is skewed to over emphasize the importance of the financial sector and to disregard the regulatory power of the gov (they have too much regard perhaps for the “genius” of the pvt sector guys).

            • With respect to GE, the idea that they could have “diluted the stock” via issuance of shares has two problems. One, there is no way they could have done such a thing before their commercial paper rolled, as was the case with the money market fiasco. Short-term unsecured lending dried up I threatened every single corp out there, and GE was incredibly irresponsible bottow short, lend long. Two, even if they could raising money through a share offering before the 15 days to roll CP, who would have been buying these shares? The same undercapitalized banks facing margin calls? Highly improbable.

              • Thanks for your comments, Anonymous… here’s the source I had for the Stockman quote on this (transcript of an interview w/ Bill Moyers):


                Here’s the particular sentence (search for “Immelt”… yes I butchered the man’s name in my comment above!) in the text:

                “What they should have been required to do when the commercial paper market dried up – that was the excuse. They should’ve been required to offer equity, sell stock at a highly discounted rate, dilute their shareholders, and raise the cash they need to pay off their commercial paper.” – David Stockman in reference to GE during the financial crisis

                So you’re saying you don’t think that’s accurate or even possible? I personally don’t know enough either way to tell… just thought I’d give you the man’s words so I don’t misrepresent him.

                Stockman also talks about the “Blackberry Panic” in that interview (above) and in this article:


    • I agree, and your comment points to what IMO is a serious flaw with the way our monetary system operates: the Fed seems to see credit growth and asset price inflation as the main goals, and wage growth as a “nice to have” at best.

      Too many households take on more debt than is good for them financially, ISTM, and the political leadership and Fed more or less encourage it.

      • What can the Fed possibly do about wages? They are doing the only things they have the ability to do, and Bernanke says each and every time he testifies or gives a speech that Congress has to do something about Fiscal policy because he can’t. While I agree with all of the above comments about moral hazard and free markets only applying to consumers and not banks, I find that a failing of Congress rather than the Fed.

        • No doubt Ben is just doing the bidding of his masters at the big financial houses, and has developed creative, unprecedented ways of bailing out banks.
          But if he focused on the mandate of maximum employment, he might have come up with some creative, unprecedented ways of bailing out the consumer.
          I realize this blog is devoted to *describing* the system, but my goodness we don’t have to like that system or defend it so much.

          • Johnny, what can Bernanke do for consumers – aside what he’s already done which is drive interest rates down so low so that the biggest overhang of all – mortgage debt, is far easier to get out from under. Now that home prices are going up, fewer and fewer owners are under water. I recall in late ’08 and early ’09 lots of people clamoring for a forced 4% interest rate for everyone with a mortgage. Well here we are 4 years later with 3.5% interest rates. Unfortunately lots of people can’t qualify for re-fis, but again, what can Bernanke do about that?

            • Good question.
              Quickly I would note that the lower rates primarily help those who already had good equity situations.
              My view is that the homeowner who is underwater in a more or less permanant stage ought to default, and get help in doing so. I think these various mortgage relief programs are cynically designed to keep him holding on.
              Also, I think the money (reserves, whatever) spent buying (exchanging) MBS and Treasuries could be better suited to letting people in debt (mortgage, student loan, some credit card debt) walk from those obligations. I know I will be hooted at for stating this, but I suspect that any debt the Fed puts on its balanced sheet will eventually be vaporized anyway, so why not deleverage those at the bottom first.
              I wish I had more specifics. If you put somebody in charge of the Fed who answered to the political process and not the banks perhaps perhaps there would be lots of ideas being suggested.

              • Kind of jumping in the middle here… perhaps you’ve already covered this, but the Fed is (or at least had been in the past) a vital part of the bank regulatory process as well. It seems it doesn’t flex this muscle as much any more.

    • Wages are not going up. New jobs are in the service sector, and are mostly in the $9-10/hour range. The lack of union pressure will see low wages continuing for a long time. Manufacturing jobs are stagnant. Some hope lowering wages will allow American industry to better compete internationally.

  8. But how long could the consumer accumulate debt at a 7% rate? I don’t think that’s realistic, unless he wants to constantly carry a load like he had in 2006. It seems to me the economy needs some stability, the kind you get with a debt load more like the early 90′s. That would take- oh, I don’t know- too long? Maybe our best shot is to improve our exports. But that is a long way off, too. I think the effects of the BSR could be around for many years.

    • As per above, mortgage and consumer-loan payments are apparently the smallest percentage of after-tax income since 1983.

        • Another under-appreciated point is that state and local govts have significantly improved their balance sheets. They were largely responsible for the dismal payroll numbers over the past few years. If they start re-hiring, the labor mkt might start to look much better.

            • I would be willing to bet that there is evidence states with Right to Work laws may also have lower rates of unemployment as compared to states with no right to work laws, but I would be hard pressed to find an absolute cause and effect correlation between the two statements…the same would be true for your statement.

      • You know- I’m wondering if that improvement is skewed toward upper income. Is it possible most people are still heavily in debt or lack disposable income? I’ll have to check on that. Hopefully it’s better than I thought.

        • A guy who refinanced his $1 million mortgage to save money is going to skew the data so it looks like the public is better off even though kids are graduating with higher student loan debts and retired working class seniors are underwater in their homes.

        • Well, it turns out that debt as a % of disposable income still sucks, at about 110%. Compared to 80′s at 70-80%. Payments as a % of disp inc are at early 80′s levels, however. And middle class income inflation adjusted is at ’97 levels. Can’t find anything on distribution of disposable income by income group but considering where income growth has been, well, good enough for my purposes. And then there’s the erosion of middle class net worth. Not trying to make any political statements, just considering the importance of the spending habits of the middle 50% or so. I think Koo is right, years to go.

  9. The Fed is well aware that deleveraging will continue for a long time which is why it’s premature to expect a large rise in interest rates, or a marked increase in inflation any time soon. Once the private sector deleveraging winds down, government deleveraging will start in earnest, adding yet another headwind to economic rebalancing and growth. With unemployment structurally high and global capacity utilization very low, it’s hard to see private enterprises adding much fuel in the way of fixed capital investment to take up the slack.

    The idea that rising confidence and a spillover of optimism into the stock market can have a significant enough psychological impact to induce people and firms to borrow is patently false. People are still scarred and incredibly cautious after the Great Recession. We have created a generation of prudent savers, which does not bode well for a consumer driven economy. Europe is in the process of creating their generation of prudent savers, and of course, Asians lead the pack when it comes to mattress stuffing, so where will that incremental consumption come from in the years to come? Lets get real, we are in a prolonged period of disinflation, deleveraging, and a slow but steady move toward sustainability, which is ultimately good for the environment and thr future of humanity, but the impact on growth and profits is more nuanced.

  10. Cullen, You note the importance of the government remaining supportive of very weak private sector trends as we continue toward more normalized debt accumulation. Which private sector trends do you feel are most fragile? Thanks, great article.

  11. Very illuminating discussion. I would call myself a monetary system rookie, but eager to learn. Koodos to everyone for great civil dialogue. If only congress could learn to listen to each other! Big Fan of this site. Cullen – thanks for contributing your time and ideas to this.

    • Hello John, I totally agree with your statement. The reason that I keep coming here is that Cullen keeps it civil and the commentators require actual data to back up claims. I get sick of the giddy optimism and the doomsday preppers. Now I just hope Cullen gets a TV network; or at least a show. :-)

      • Re: Cullen’s show: totally agree! He could bring a degree of level headed myth busting to SOOOOO many venues… In fact I think that he should really start out by being INVITED on more shows: CNBC, Bloomberg, Marketplace, PlanetMoney … even general political and late night like talk shows. That would really be educational for a LOT of people. So many people, especially in the general public, have an incorrect intuition and information about how our system works. It seems to me there’s an opportunity there… because he could play the agnostic w/ regard to politics… he’d be more like an expert witness. Of course where reality conflicts with politics (often!), he’d have to set people straight too.

        • “We don’t like complexity and we distrust other systems and think it many times leads to false confidence. The harder you work, the more confidence you get. But you may be working hard on something that is false. We’re so afraid of that process so we don’t do it.” –Charlie Munger

      • I agree as well… I shopped around for a “home” quite a bit, … and I still like to look at other sites and other philosophies out there, but this is always the 1st on my list. Level headed unemotional delivery, good questions and conversations, and detailed explanations make this site good. If Cullen is actually a con man, he’s doing a great job of disarming my internal BS detector!

    • John,

      I’d also like to welcome you. Be respectful and you’ll get it in return. I continue to visit this site because of the interesting and insightful information, commentors, and host.