The New Economy
America is deep in debt. But how deep?
That question seems simple, yet analysts and pundits give answers that differ by trillions of dollars. Sometimes tens of trillions. That confusion arises because there are various ways to tote up America's debts.
Many observers often focus on the publicly held debt – the bonds that the Treasury has sold into financial markets. By that measure, the federal government owed a bit more than $10 trillion at the end of last fiscal year.
That figure is important because it measures how much the federal government has had to rely on outside investors. For that reason, it does not include the special Treasury bonds in the Social Security Trust Fund and similar accounts owned by the federal government itself. From an accounting perspective, those bonds net to zero – a part of the government owes money to another part. But they are important to Social Security legally and politically. Some analysts use a measure that includes the trust funds, bringing the federal debt to more than $14 trillion.
That's not the only measurement disagreement. Social Security and Medicare reflect a major commitment to seniors in the years ahead, but the government hasn't identified enough dedicated financing to pay for them. Some analysts believe these unfunded amounts should be viewed as debts as well. Their size depends on technical factors like the future growth rate of health spending and how far you look into the future. Depending on their choices, analysts can get huge measures of indebtedness: $50 trillion or more.
This range of figures – $10 trillion, $14 trillion, $50 trillion – sows confusion about how indebted the United States is. Yet none of them captures all of America's debts. The government has a host of other obligations that often get overlooked.
These other liabilities appear in the government's little-known financial statements. Those statements use concepts familiar to anyone who has worked with a corporate balance sheet listing assets and liabilities. The government's liabilities include more than $7 trillion in obligations that don't appear in standard budget measures.
That's real money, even in Washington.
The largest are commitments to federal employees, retirees, and veterans, including pensions and postretirement health benefits. Those commitments, which get surprisingly little attention, now stand at almost $6 trillion.
Another $1 trillion in liabilities includes obligations for environmental cleanup, government insurance payouts, and ongoing commitments to Fannie Mae and Freddie Mac. Add in publicly held debt, and the government owes more than $17 trillion, before accounting for future commitments to Social Security or Medicare.
Of course, the government has assets: buildings, aircraft carriers, and a sizable portfolio of financial assets. Federal accountants tally those as worth a bit less than $3 trillion. The government's net liabilities round out to nearly $15 trillion, 50 percent larger than the public debt alone and comparable to the value of all goods and services produced by the US economy each year.
The US is thus in debt to the tune of roughly 100 percent of gross domestic product. That's daunting, but it need not be fatal. As the economy recovers, our obligations – both past and future – should be manageable if policymakers overcome our greatest liability: a political system that addresses short-term crises rather than long-term challenges.
– Donald Marron, director of the Urban-Brookings Tax Policy Center, previously served on the board that establishes accounting standards for the federal government.
What Europe needs now is a good "heavy," a bad hombre who talks tough enough to scare the politicians and citizens into doing the right things – and who will make them face the consequences if they don't.
An enforcer seems to be the only way to shove Europe's debt-laden nations toward fiscal sustainability and keep the eurozone from blowing up. The problem is: The obvious candidates for the post aren't up to the job.
A European fiscal union could swing the job. For Germany to agree on any union in which it and other strong members would guarantee Eurobonds that bail out weaker nations, it would demand the kind of stringent rules and accountability that are sorely needed. While this fiscal union may be gradually taking shape, it remains patchy at best and lacks a defined process to rescue struggling nations.
So European policymakers need to embrace the only enforcer they currently have: the bond market itself. As Greece, Ireland, and Portugal have already found out, the bond market is a particularly unforgiving taskmaster that cares not one whit for diplomatic niceties or political sensitivities. When it speaks, it tells uncomfortable truths.
The first truth the eurozone needs to understand is particularly uncomfortable: Member nations may default. Government defaults are nothing new. However, the eurozone should take great care that a default does not lead to an implosion of its financial system, as it would cripple the real economy.
That leads to the second uncomfortable truth: If the eurozone is to survive, policymakers will have to stop trying to save European nations and save European banks instead.
Banks have one major advantage over nations. While nations must go into the market to fund themselves, banks can use their central bank. Banks employ a business model that uses substantial leverage. While the leverage makes banks vulnerable, central banks can keep even a technically insolvent banking system afloat.
Importantly, any capital injection can support a high multiple of debt. That's why the US Treasury injected money into the banking system in the fall of 2008 as part of the infamous Troubled Asset Relief Program (TARP) program rather than purchasing toxic assets outright. Europeans had their own bank bailouts at the time. As politicians worldwide weigh the cost of acting versus the cost of inaction, they are aware that further bailouts may amount to political suicide.
Still, in Europe, the focus must be on making eurozone banks strong enough to stomach sovereign defaults. Bank runs need to be avoided, thus making the sovereign default more digestible for the economy as a whole. You can't avoid losses, but you can avoid a financial meltdown.
The good news is that high borrowing costs provide indebted governments the "encouragement" to reduce spending; indeed, the language of the bond market may be the only language that forces policymakers into action.
This is a global financial crisis. Simply put, there is no such thing anymore as a safe asset. Investors may want to take a diversified approach to something as mundane as cash. Just as China diversifies its reserves into a basket of currencies, individuals may want to consider doing the same.
It's structured like a Big Mac. It could almost pass for a Big Mac, except that the bun is ... well ... black. Not blackened, totally black. Like two well-formed pieces of charcoal.
It's also French, which means that the only way to get a black-bunned Darth Vader burger is to travel to the world center of haute cuisine, visit one of Quick's more than 400 restaurants, and plunk down €4.90. (That's $6.29 – but given the state of the euro, check back tomorrow. It could be cheaper.)
And because it's French, the Darth Vader burger comes with a few quirks.
For starters, don't call it a Darth Vader burger. In French, Luke's father (père de Luc) is known as Dark Vador ("Dark Vah-Door").
Also, you can't walk up to the counter and order un Dark ("Unh Dark"), because Quick is also offering the "Dark Burger" (an homage to Darth Maul).
You can, however, use the term "burger," which these days is instantly recognizable on either side of the Seine. (Un Dark Vador burger, s'il vous plaît.)
If burger noir isn't your thing, there's the aforementioned Dark Burger, which comes on a red bun with sauce aux trois poivres (three-pepper sauce).
If a bun with paprika and beet dye seems too adventurous, you can get the Jedi Burger, which comes with a regular looking bun (sans the sesame seeds of le Big Mac). Just be ready for the dés de mozzarella (diced mozzarella) that sit on the uppermost steak haché goût grillé (grilled patty).
The sandwich promotion starts a little over a week before the release of "Star Wars: Le Menace Fantôme 3D" and runs through March 5.
They are 30 million consumers, representing a quarter of US households, who earn a collective $1.3 trillion a year. But banks don’t want to serve them, because they lose money. And the nonfinancial institutions who do serve them may not be offering them much value in the long term.
Welcome to the world of the unbanked and underbanked, who in a weird twist may have fewer banking options after Congress passed legislation aimed at protecting them from high bank fees. So who will serve these consumers, who either use no mainstream financial services or have a checking or savings account but also utilize nonbank financial services such as check cashers, payday lenders, and pawnbrokers? A huge opportunity awaits someone.
In the good old days, banks would have stepped in. They received substantial revenue from interchange and overdraft fees, which essentially subsidized checking and savings accounts. But financial reform passed by Congress in 2010 brought the so-called Durbin amendment, which slashed banks’ profits on debit card transactions, and Regulation E, which severely limited the overdraft fees that banks could charge.
In response, many banks have instigated high fees that effectively discourage low-income customers from opening (or keeping) accounts. It’s not by accident. To get a sense of why banks aren’t terribly interested in serving low-income customers, take a look at the following example. Imagine it’s 2007, pre-crisis and pre-regulation.
Let’s assume each deposit account costs the bank $250 a year to maintain regardless of the balance of the account. Adam deposits $10,000 into his bank account, while Brenda deposits $100. The bank loans out that money at 7 percent interest, making $700 off Adam and $7 off Brenda. They pay each customer an interest rate of 1 percent, meaning that Adam earns $100 in interest, and Brenda earns $1. But since each account costs the bank $250 to maintain, the bank makes $350 off Adam and loses $244 on Brenda.
Although Brenda’s deposit earns less in interest than it costs to maintain, the bank also makes money every time she swipes her debit card and every time she incurs an overdraft fee. The latter was particularly lucrative for banks, particularly because low-income customers, who tend to have lower balances, are disproportionately more likely to incur overdraft fees. Ten such charges a year would cover the cost of her checking account, even without revenue from debit card transactions.
Today, that equation looks much different: The bank now lends at 5 percent interest, and pays out 0.1 percent on deposits. Adam’s account earns the bank $500, while he only receives $10 in interest; Brenda’s garners only $5, and she earns 10 cents in interest. On balance, Adam’s account is still profitable for the bank: it nets $245. The bank now loses $245.10 on Brenda’s account, and can no longer count on swipe or overdraft fees to make up the difference. There’s no incentive to hold onto a large number of low-income accountholders. Quite the opposite.
Big retailers fill the void
By contrast, some big retailers are offering financial services that actively court low-income people. Stores like Walmart and Best Buy can take advantage of economies of scale, as well as boost in-store sales if they offer financial services to shoppers. Beyond this, Walmart doesn’t offer deposit accounts, so it doesn’t have to worry about the cost of maintaining them, or about paying interest to accountholders. Instead, Walmart makes a profit by charging fees to cash checks or buy prepaid debit cards.
While these onetime fees are more appealing to some people than the ongoing and often hidden fees associated with many big banks, it’s questionable whether financial services offered at retailers are actually a bargain. Wal-Mart, for example, charges $3 to cash a check between $300 and $1,000, and levies a host of fees on the prepaid Walmart MoneyCard. Compared with the average 2 percent to 4 percent charged at most street-corner check cashers, Walmart is generally cheaper. But if you cashed two $500 checks, used an automated teller machine (ATM) twice, and reloaded your prepaid card once, you’d incur $16 in fees – far more than mainstream checking accounts.
Even more worrying, however, is the indirect harm of remaining unbanked: Those without access to mainstream financial services are far less likely to save for retirement, college, or emergencies. Bank accounts are more secure than relying on cash. Directly depositing part of your paycheck into a savings account helps you adhere to your budget. The unbanked, however, do not receive these incentives or safeguards.
What about credit unions?
Unlike either banks or retailers, credit unions are not-for-profit. They’re member-owned, and pay their “shareholders” in the form of lower interest rates and higher yields. In addition, most credit unions have less than $10 billion in assets, and so are exempt from the Durbin amendment. Oddly enough, checking account costs can be 50 percent lower for small institutions. Larger banks face high overhead costs from bank branches, ATMs, and so on, while credit unions and community banks can outsource call centers, payment processing, and ATM networks.
But while credit unions aren’t put off by low-income members, they may not be as highly motivated to recruit this population as chain retailers that stand to make a profit. This may in part explain the low profile that credit unions tend to have as compared with their for-profit counterparts.
Given the low fees of credit unions, why do so many people seem to prefer less conventional options to fulfill their financial needs, and why are they content to live without checking or savings accounts? There are several possible explanations. For one thing, the term credit union is still only vaguely familiar to many people. People may not be clear about what services credit unions offer, and they’re often unaware that credit unions are not-for-profit institutions, where profits are funneled back to members in the form of lower fees and better interest rates.
In addition, so many people have had bad experiences with unexpected fees at banks that some feel they are better off avoiding financial institutions altogether. Paying a fee at Walmart to cash a check is a one-time deal: You know exactly how much you’ll have to pay, and there won’t be any surprise fees down the road.
Serving the underserved
This “‘underserved’ market is considered one of the fastest growing segments in the United States and represents significant potential for banks willing to develop new products and services,” a 2011 study by the consulting firm KPMG concluded. Altogether, the unbanked and underbanked have around $1.3 trillion in income, and spend $5 billion each year paying off predatory loans. A 2009 survey by the Federal Deposit Insurance Corp. found that some 9 million households were unbanked and another 21 million were underbanked. Nearly a third of African-American households and a quarter of Hispanic households were underbanked.
The KPMG study highlights a number of services that may be important for banks to offer as the number of unbanked and underbanked people rises. For instance, check cashing and bill-pay for noncustomers, as well as international money transfers, are services in demand among these groups. The study found that the number of unbanked and underbanked people is growing as a result of falling credit scores caused by “negative events” in their personal lives that are often linked to the downturn in the economy. Sudden unemployment, for example, can cause a previously banked individual to be forced to leave his or her financial institution.
As the ranks of unbanked and underbanked Americans continue to swell and big banks avoid serving them, big retailers stand to make a profit by finding cost-effective ways to offer financial services to the underserved. In an ironic twist, stores like Walmart have an advantage in many consumers’ eyes because they aren’t affiliated with a mainstream financial institution. In the end, the task will continue to fall to credit unions, big banks, and big retailers to make their case to the unbanked and underbanked and provide services that truly meet the needs and financial limitations of these groups.
– Tim Chen s the CEO of NerdWallet, a credit-card search website.
Fixed mortgages rates for 15- and 30-year loans dropped to record lows this week, but it's not clear that lower interest rates are having much impact.
Not for would-be borrowers. Applications for new mortgages and refinancings are down, according to the latest survey of the Mortgage Bankers Association.
Not for the housing market. "Activity in the housing market continued to be depressed by the substantial inventory of foreclosed and distressed properties," according to minutes of the Federal Reserve's monetary policy committee meeting in December.
Nevertheless, rates continue to edge down.
Fixed mortgage rates for a 30-year loan dropped 0.03 of a percentage point to 4.18 percent, according to the Jan. 4 survey of large lenders by Bankrate.com, an online aggregator of financial rate information. Four weeks ago, it stood at 4.24 percent.
A fixed 15-year mortgage also fell to 3.4 percent. These are the lowest rates for 15- and 30-year mortgages in the 26 years of Bankrate.com's weekly survey.
One of the main factors keeping rates low are continuing concerns over Europe's debt crisis. Nervous about a sudden downturn there, investors are pouring money into the relative safety of US Treasury bonds. That influx of money lowers interest rates.
The Federal Reserve has also been actively trying to reduce mortgage rates by buying up mortgage-backed securities. Fed officials hope to perk up the depressed housing market by making homes cheaper to own for would-be buyers and also to put more money in the pocket of homeowners by making their mortgages less expensive. So far, the effort doesn't appear to be paying many dividends.
"Low mortgage rates appeared to have only modest effects on the rate of mortgage refinancing," according to the minutes of the December meeting, "likely because of tight underwriting standards and low levels of home equity."
Mortgage applications fell 3.7 percent for the week ending Dec. 30, 2011, the Mortgage Bankers Association reported Wednesday. Not only were applications for a home purchase down 9.7 percent from the level two weeks earlier, even after adjusting for the holidays, applications for refinancing also fell 1.9 percent.
Despite recent stronger economic data, the United States is likely to fall into a recession that will spread globally. The reason? The US has too much debt – and reducing it hurts growth.
After three decades of US consumers and financial institutions globally taking on more debt, they're now reducing debt – but it's a multiyear process and far from finished. US and European governments are also under pressure to cut debt after incurring huge deficits in the 2007-09 Great Recession. As a result, I expect slow economic growth and high unemployment to persist in the US and Europe.
In Europe, real growth as measured by gross domestic product is probably already headed down. Growth was a mere 0.6 percent in the third quarter in the 17-country eurozone. Unemployment in the eurozone was 16.3 million in October – the highest since record-keeping began in 1995 – and the unemployment rate rose to a high of 10.3 percent in October.
After the Great Recession, it's clear that a common euro currency without a centralized fiscal policy is unstable. No long-term solution is in sight, but strong eurozone countries like Germany believe continuing bailouts of weak economies like Greece, Spain, Italy, and Portugal are preferable to an outright collapse of the eurozone – in effect, they're kicking the proverbial can down the road. The effects on the US of a European recession next year are small, but the financial risks due to intertwined banks are great.
Meanwhile, efforts by China to cool her property bubble and high inflation are working, but a hard economic landing is likely to result, with growth rates of 5 to 6 percent versus the 8 percent-plus growth rate needed to create jobs for China's burgeoning population. The ongoing collapse in commodity prices suggests slowing demand from China. Stock markets are also great predictors of economic activity. The Shanghai Composite Index fell 13.4 percent in 2010 and was off 27 percent between mid-April and mid-December.
In the US, the key to the economic outlook is consumers, whose spending accounts for 71 percent of GDP, but they're now embarking on a saving spree to replace their 25-year borrowing and spending binge. And there's no other sector – government, the Federal Reserve, or the private sector – that can provide meaningful economic growth in the next year or so.
In the postwar era, recessions have been inaugurated by the Fed boosting interest rates to reduce inflation. That prospect isn't in sight. But with slow economic growth likely in 2012, it wouldn't take much of a shock to push growth into negative territory. That could come from a sizable drop in housing prices and the discouraging effects on consumer spending. The spreading effects of the European financial crisis and recession could also be the trigger or maybe some of each combined with a post-Christmas consumer spending retrenchment.
This won't be another Great Recession. I'm forecasting a 2.2 percent peak-to-trough decline in real GDP that lasts for a year (versus the 18-month 5.1 percent plunge in the Great Recession). Europe's recession may be deeper with the financial crisis there and the region's real economic decline reinforcing each other. Combining economic downturns in Europe and the US with a hard landing in China means that a global recession next year is also likely, before the stage is set for a weak US and global recovery in 2013.