Is 'Financial Repression' The Solution to the Trillions In Unpaid Debt Arising From The Pandemic?

As most who read this blog know, financial posts are often a feature when I am not writing about astrophysics, math, deep politics, climate change or atheist ethics.  Right now, for those who may not read the financial pages, a huge concern is the mounting debt loads which have leaders around the world biting their nails.   It is useful here to consult the graphic showing debt as a percentage of GDP for  5 specific nations and a generic "advanced economies" overall.   This is from the recent Wall Street Journal article 'Debt Battle Awaits Post-Virus World', June 15, p. A2)

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 other words, these funds use debt, i.e. leverage,  to purchase safer bonds.   However, as the piece goes on to point out, when volatility jumps the leverage can force the funds' automated trading strategies to dump those assets, forcing a selloff.  Let me add here both individual investors and whole companies have now taken to the leverage 'drug'  to place their market bets using borrowed money.  The losses they have accrued, along with decades of trillion dollar tax cuts,  have helped to monumentally add to the $164 trillion in global debt.  But WHO is being asked to pay now, even with the party still going on? Well, the average Joe and Jane on Main Street.

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."

See Also:

Economic Policy

Instead of Bailing Out For-Profit Colleges, Congress Should Cancel Student Debt

Are Savers Headed for the Poor House?

Even as Fed Chairman Ben Bernanke gets ready to deliver his annual speech at Jackson Hole, WY - a favored playground of the rich and famous- many seniors on fixed incomes are pondering how they'll survive the next two years. No COLAs for their Social Security to speak of (and they may even be adjusted lower), even as Medicare premiums are set to increase, and (thanks to Faithful Ben) no higher interest on any interest -bearing cash accounts to supplement Social Security income.

The Fed Chairman's recent announcement that interest rates will remain near zero for the next two years, while great news for borrowers, was horrific news for savers - especially seniors who don't wish to risk their assets in volatile markets. (Never mind the Fed's efforts to get them to do just that!)

These prolonged low interest rates have also wreaked havoc on millions of seniors' balance sheets.

For example, just five years ago, a $20,000 CD would've netted a diligent-saving senior roughly $1,000. Now he's lucky if he can reap 'bupkiss', otherwise known as chump change, The nominal rates for many CDs now (say even 5 -year) hang at about 0.5% or ten times less than five years ago. That means the senior will collect about $100 now for a year on his holdings that previous delivered $1,000.

The situation isn't any better in money market funds which currently have $2.4 trillion stashed in them, with a whopping yield for the past year of about 0.01% It's no wonder that 401k companies (i.e. who manage them for corporations) get mad when people bail out of stocks and plant money in money funds. With such a low yield they're unable to charge normal fees without sending the 401k holder's savings into negative territory!

Well, what's a safety-inclined 401 k saver to do? The answer is to hold strain, and max out your 401k especially if you can get a company match! My wife's last twenty 401k statements have shown average quarterly gains on her holdings at 0.0000%. However, if her company matches are figured in as gains, she's averaging about 15% with NO losses. My point? Look at your company match gains as real gains, indeed, as riskless gains!

Also, don't just go to bond funds which lots of financial advisors have recommended for clients as "safety places". To me, bond funds are little better than stocks. Indeed, in 2008, the average bond fund in Morningstar's ultra-short bond category lost nearly 8%. The Pimco fund lost 1.3% that year. Unlike money market funds which assure investors that they will not "break the buck" (i.e. let the magic invested amount dip below parity with $1) the bond funds make no such promises. Ten years ago, I recommended my wife get out of her company's 'Life Cycle' fund - which had two bond funds in it - because she was losing $800 a quarter and got no matches. Now, strictly in money market funds- she's doing much better thanks to her company's matches.

The environment we are in right now, with these absurdly low interest rates (conferring loads of cheap "bubble" money on Wall Street), has been called one of "financial repression" by many economists, which is just as good a name as any. One investment manager at PIMCO, has even predicted seniors will "be punished for many years to come".

This is what makes it a dangerous environment for so many seniors, because it invites a barrage of terrible advice that may actually cost them a lot of money in the end.

One of the persistent finance tropes that makes the rounds is that people will "lose" money if its kept in cash, CDs, money market funds or accounts. Even this morning, one female guru was warning that people will LOSE on account of inflation. Of course, this is recycled bollocks intended to entice people to take on more risk than they're willing to accept.

Consider - if over the next two years the most inflation prone commodities are fuel (for heating, as well as auto) and food - groceries.

Let's say I average $100 a month on the first right now and $500 a month on the 2nd. Let inflation cause the first to go up by 5%/year and the latter also by 5% each year (a kind of worst case scenario). Then after 2 years, inflation on the first eats up roughly $180 and on the second $900. That is a total of $180 + $900 = $1080 "lost". But how much is really "lost" when total financial holdings (in fixed income) are reckoned in?

First, the interest on my total fixed income holdings over the same time, assuming no changes made by any of the banks, should be about $4,000. Even if one allots 15% of that as a loss - for taxes, that leaves: $3,400.

In absolute terms, I haven't lost because the net interest earned still tops the inflation amounts. (I regard it as a true loss only if the total from inflation -hiked costs eats up all my interest!) What this shows is, contrary to the money guru's blather, the registration of loss will actually depend on the fixed income holdings. If these are small then, yes, that means there will likely be losses - whereby the interest that would have provided income is eaten up by increased food, fuel prices.

The point? A saver religiously sticking to his savings program (while keeping frivolous spending at bay) to do what he does best: SAVE- is the best solution! SAVE, SAVE and SAVE - don't accept risks that ensure losses that must be made up- and so build up your total saved holdings so the interest earned is ample to withstand moderate or even higher inflation over years!

What about medical inflation? Even here, estimating a 14% per annum increase in drug costs for my Medicare prescription drug (aciphex), this amounts to about $225 over the next two years. Again, even factoring this into the higher inflation costs doesn't portend a true loss. Even if my wife's meds' inflation are factored in ($440) that still doesn't convert to a true loss.

Now what if one's fixed income savings are not so much that any leeway is allowed, and the person is operating close to the margins? In this case, assume that $1080 in additional inflation-driven costs in food and fuel not only eliminates one's earned interest, but puts one $1,000 into the hole.

In this case, there are always adjustments (done on the basis of retrospective analysis) to one's consumption that can be made, as suggested by authors Vicki Robbins and Joe Dominguez in Your Money or Your Life. For example, the simple expedient of eliminating all (more expensive) processed foods at the grocery store. Or, dropping one or more cable stations. In energy terms, maybe check on ways to save (such as turning off the furnace gas during the summers) which are provided yearly by utility companies. If 'push comes to shove', then yes. .. cut back on charities, or better, substitute action volunteering in selected charities for monetary donations.

Even a simple change like eating out less per month can help. If you eat out twice a month, then change it to once. If you've been going to Outback, then maybe go to Applebee's instead. Or, don't eat out at all! Besides, the best food is that you can cook yourself!

Shopping patterns and prices are also up for grabs. People being squeezed in Bernanke's "financial repression" vice can thus take their shopping bags to the nearest Dollar Store, as opposed to a Big Box store or large commercial supermarket.

The point is that just because interest rates are nearly zero doesn't mean you should let yourselves be chased into risky stock markets.

It is not seniors' job (nor anyone's on a low or fixed income) to help prop up the smoke and mirrors stock market.

The sooner more finance gurus get that, the better.

As for the best advice: Retaining a rigorous discipline about spending and saving is the only genuine way to make a dent over the long term. If one is a spendthrift now, even a 10% interest rate suddenly bestowed by the Fed won't help. All that extra money will just be wasted. If one is a diligent saver, and prudent in the disposition of purchases, even a near-zero interest rate will not convert him into a pauper!