On top of this, there is now a sobering article for The Atlantic’s July/August 2020 issue — which warns another banking calamity is a strong possibility and which ought to be required reading for all sentient Americans. It also, to me, clearly shows why Trump - the most ineffectual, incompetent leader in over 100 years- cannot be allowed a repeat performance. (Aside from this, I am still puzzled by recent polls showing a plurality of Americans - 48% to 35 %- favor Trump over Joe Biden to deal with the economy. Ahem...this is the same Bozo who crashed the economy leading to 42 million unemployed, folks!)
Anyway, with respect to the Atlantic piece, UC Berkeley law professor Frank Partnoy writes:
"After months of living with the coronavirus pandemic, American citizens are well aware of the toll it has taken on the economy: broken supply chains, record unemployment, failing small businesses. All of these factors are serious and could mire the United States in a deep, prolonged recession. But there’s another threat to the economy too. It lurks on the balance sheets of the big banks, and it could be cataclysmic. Imagine if, in addition to all the uncertainty surrounding the pandemic, you woke up one morning to find that the financial sector had collapsed"
The prime culprit? The 'CLO' or collateralized loan obligation. According to Prof. Partnoy:
"After the housing crisis subprime CDOs naturally fell out of favor. Demand shifted to a similar — and similarly risky — instrument, one that even has a similar name: the CLO or collateralized loan obligation. A CLO walks and talks like a CDO, but in place of loans made to home buyers are loans made to businesses — specifically, troubled businesses. CLOs bundle together so-called leveraged loans, the subprime mortgages of the corporate world. These are loans made to companies that have maxed out their borrowing and can no longer sell bonds directly to investors or qualify for a traditional bank loan.”
Adding:
"CLOs have been praised by Federal Reserve Chair Jerome Powell and Treasury Secretary Steven Mnuchin for moving the risk of leveraged loans outside the banking system.”
Understated in all the huff and puff about expanding debt is that just because CLOs are "praised" by Powell doesn't mean they aren't risky. (Recall before the 2008 credit crisis and housing collapse, the then Fed Chair Alan Greenspan praised adjustable rate mortgages - ARMS - at the heart of the housing meltdown). Also, we know most of the outstanding debt - probably 75 % - is not from stimulus packages such as the CARES Act- but a combination of extended tax cuts and overleveraging in the financial markets. Two years ago the warning was sounded by the IMF as reported (April 17, 'IMF Sounds Alarm On Excessive Global Borrowing' ) in The Financial Times, though the leveraging debt was not mentioned specifically, i.e.:
"The world's $164 trillion debt pile is bigger than at the height of the financial crisis a decade ago, the IMF has warned, sounding the alarm on excessive global borrowing. The fund said the private and public sectors urgently need to cut debt levels to improve the resilience of the global economy, and provide greater firefighting ability it things go wrong... World borrowing is more than twice the size of the value of goods and services produced and 225% of global gross domestic product. This is 12 percentage points higher than the peak of the previous financial crisis in 2009.
Vitor Gaspar, the director of fiscal affairs at the IMF, singled out the U.S. for criticism, saying that it was the only advanced country that was not planning to reduce its debt pile - with the recent tax cuts keeping public borrowing high."
Meanwhile, in the WSJ Business & Investing section one is alerted to the understated role of leverage (i.e. 'In Selloff, A Trading Strategy Is Faulted' (Feb. 9th, 2018, p. B11). So we learned:
"Risk parity funds aim to reduce the danger from a collapse in any one market by limiting bets on more volatile assets like stocks and commodities, and use leverage to load up on safer assets such as government bonds."
In a separate WSJ piece, Paul Hannon warns us:
"In the U.S. and elsewhere, government debt is set to soar this year, reflecting lower tax revenue and the cost of financial aid to households during lockdown. The International Monetary Fund forecasts that U.S. government debt will reach 131% of annual economic output this year, up from 109% in 2019."
Hannon makes clear Joe and Jane American are going to have to pay the piper, especially if we are to avoid bank collapses such as forecast by Prof. Partnoy. While the Federal Reserve has ruled out negative interest rates (for now) three other options are on the table, none of them palatable:
1) Apply more austerity using a combination of spending cuts and higher taxes. However, the worry of the financial elites is that this may trigger even more political division and austerity protests along with the ones against the police.
2) Allow inflation to roar back diminishing the value of the dollar and thence, the magnitude of the debt owed.
3)Financial repression is therefore preferred. (According to a 2015 paper by economists Carmen Reinhart and M. Belen Sbrancia, it lowered the average interest bill for 12 governments by between 1% and 5% of GDP from 1945 to 1980). It therefore "played an instrumental role in liquidating the massive debt accumulated during World War II"
Basically, financial repression means sustaining policies that ensure interest rates remain low. These would include: central bank purchases of gov't bonds and regulations prodding investors to hold such securities. (Since March, the Fed has slashed its benchmark interest rate to near zero, bought $2.1 trillion in Treasury and mortgage bonds, and rolled out numerous lending programs).
Of course, apart from savaging savers, the repression strategy would cut ordinary citizens' spending even more. Now, according to the latest data, one will also have to add spending pullbacks by the wealthy.
Economists at the Harvard-based research group Opportunity Insights estimate that the highest-earning quarter of Americans has been responsible for about half of the decline in consumption during this recession. And that has wreaked havoc on the lower-wage service workers on the other end of many of their transactions, the researchers say. According to Michael Stepner, an economist at the University of Toronto:
“One of the things this crisis has made salient is how interdependent our health was. We’re seeing the mirror of that on the economic side.”
As income inequality has grown in the U.S. , so has inequality in consumption. That means that when the rich spend money, they drive more of the economy than they did 50 years ago. And more workers depend on them. When workers lose jobs or the rich stop spending in those job areas it translates into acute financial pain. Add in the pandemic and the situation becomes intolerable - which means more stimulus money has to be infused.
This is why Fed Chair Jay Powell told the Senate Banking Committee two days ago that congress needs to pump more money in, and especially that it should consider extending unemployment benefits beyond the current July 31 cutoff date. He also warned the recovery would be long and arduous and jobs not likely to return until consumers felt confident enough to go out and partake in the economy, i.e. in dining out, cinema attendance, even shopping for durable goods. In Powell's words:
"Some form of support for those (unemployed) people going forward is likely to be appropriate. There are going to be an awful lot of unemployed people for some time until a vaccine appears."
In the heat of a battle like this, no one is obsessing about how much pandemic -related debt is exploding. As the World Bank's chief economist explains it (WSJ, ibid.): "This is a war. In a war, you worry about winning the war, and then you worry about paying for it."
So true.
Update: From WSJ June 19, p. A8 ('Americans Skip Millions Of Loan Payments')
"Americans have skipped payments on more than 100 million student loans, auto loans and other debts since the coronavirus hit the U.S., the latest sign of the toll the pandemic has taken on people and finances. The number of accounts in deferral, forbearance or some other type of relief reached 108 million at the end of May, according to credit reporting firm TransUnion."
"The surge in missed payments suggests that the flood of coronavirus related layoffs has left many Americans without the means to keep up with their debts. Many people have used up their stimulus checks and unemployment benefits."
From same page story ('Debt Relief Has Ripples'):
"Benign though the many debt forbearance decisions may seem, they're rippling through the financial food chain with unpredictable consequences. America is living out a financial experiment unseen in modern times - testing what happens when the economy deals a devastating blow to millions of borrowers, but lending institutions behave as if it hadn't.
Repo agents and debt collectors may be criticized but they clear the detritus of soured loans, recycling the lent capital. Their activity helps keep money moving between lender and borrowers, especially high risk borrowers. .. With the credit recycling machinery largely frozen, banks may be less willing to make loans."
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