Wednesday, August 19, 2009

Today's Quick Reads

Overcapacity will be a lasting problem: I am going to keep reiterating my stance that we have too much stuff in the US until I see people taking the idea that we need a significant amount of rationalization more seriously. Accordingly, when I come across people who I think are smart and articulate (such as people who write for The Telegraph) echoing my concerns I will not hesitate to recommend their commentary. This particular article is by Ambrose Evans-Pritchard from The Telegraph whose column I have bookmarked on my computer due to the consistent quality of his analysis:

Too many steel mills have been built, too many plants making cars, computer chips or solar panels, too many ships, too many houses. They have outstripped the spending power of those supposed to buy the products. This is more or less what happened in the 1920s when electrification and Ford’s assembly line methods lifted output faster than wages. It is a key reason why the Slump proved so intractable, though debt then was far lower than today.

Thankfully, leaders in the US and Europe have this time prevented an implosion of the money supply and domino bank failures. But they have not resolved the elemental causes of our (misnamed) Credit Crisis; nor can they.

Excess plant will hang over us like an oppressive fog until cleared by liquidation, or incomes slowly catch up, or both. Until this occurs, we risk lurching from one false dawn to another, endlessly disappointed.

Or in other words, until we can clear excesses out of the system the ever-present surplus capacity will limit job growth, wage increases, and GDP recovery. I don’t think this is a wild-eyed, Cassandra type conclusion. I'm not saying the sky is falling and we are all doomed. But, when this overcapacity is combined with our debt overhang that needs to be reduced, it seems pretty clear to me that growth will be anemic until both items are proactively addressed.

This recession may only serve to increase the gap between rich and poor: I got the link to this article in The Telegraph from The King Report. It presents some troubling stats that indicate that lower income people in the UK are facing inflation when it comes to the price of their necessities while the richest group of people are actually seeing some prices drop:

How does this prospect for more households in financial difficulty fit with the encouraging macro data in recent months, though? The answer lies in the structure of indebtedness. Looking at the structure of household cash flows again, the top quintile of UK households appears to be doing extremely well; not only are they making their ends meet, there is a lot of excess disposable income left over – this may help explain why Mulberry bags have been selling so well, for example.

And according to a recent analysis by the Institute of Fiscal Studies, whilst lower-income households are facing up to 5pc inflation, those in the top quintile are enjoying deflation. Thus it appears that there are strong drivers for a further widening of the gap between the rich and the poor. Hasn't it always been this way? Not to this extent – previously, lower-income households had not been able to build up the levels of debt that were reached in the past few years.

This is UK data so it does not necessarily translate to the US. In fact there is certainly an area in which the upper end in the US is starting to suffer as much as the lower end: housing prices.

The results of this growing divide are reflected in the housing market, where prices of bigger homes (for those ever-so-wealthy top quintile households) have remained healthy, while the rest of the market continues to languish.

Based on the data I follow the stratification that apparently exists in the UK no longer is present in the US. As more prime borrowers start to fall further behind on their mortgages, the high end housing sector has begun to take a substantial beating. Aside from this obvious difference though, I can envision a scenario in which the price of things like food and gas (which poor people spend a much larger percentage of their income on) rise as a result of our current fiscal and monetary path and serves to further widen the income gap.

Maybe the fears among the health insurance companies regarding ObamaCare have been completely off base: This editorial in the NY Times paints a picture of the how the insurance companies are viewing the administration's health care reform proposal in a way I hadn’t thought of. I haven’t been following the sector closely but I know at some points there were large sell offs in the stocks due to concerns about the impact a new government insurance company would have on margins and earnings. But now that the public options seems less of a priority, maybe reform will end up being a boon to these companies:

Insurance companies are delighted with the way “reform” is unfolding. Think of it: The government is planning to require most uninsured Americans to buy health coverage. Millions of young and healthy individuals will be herded into the industry’s welcoming arms. This is the population the insurers drool over.

This additional business — a gold mine — will more than offset the cost of important new regulations that, among other things, will prevent insurers from denying coverage to applicants with pre-existing conditions or imposing lifetime limits on benefits. Poor people will either be funneled into Medicaid, which will have its eligibility ceiling raised, or will receive a government subsidy to help with the purchase of private insurance.

Young, healthy people who are required to have health insurance and more government subsidized enrollees? I can see why the current discussions could sound very favorable to the insurance companies if they don't have to compete with a public option.

If all states were only more like Vermont: You sure don’t hear those words very often, but a piece in the Wall Street Journal discussed by The Baseline Scenario guest writer Mike makes a convincing argument that Vermont’s lending laws were effective in limiting speculation and predatory lending:

In laws passed between 1996 and 1998, Vermont required lenders to tell consumers when their rates were substantially higher than competitors’, with notices printed on “a colored sheet of paper, chartreuse or passion pink.” And in what officials believe is the first state law of its kind, Vermont declared that mortgage brokers’ fiduciary responsibility was to borrowers, not lenders. This left Vermont brokers partly on the hook for loans gone sour…

Vermonters didn’t see the same sharp rise in home ownership that swept much of America in recent decades, which, despite the bust, buoyed economic growth… By 2007, the percentage of owner-occupied households as a whole reached 68.1%, up from 63.9% in 1990, according to U.S. Census data. Vermont started at a higher base but saw ownership rise just 1.1 percentage points in that span, to 73.7%.

So while Vermont did not see the same growth in home ownership, the overall percentage (based on the 2007 data) was more than 5% higher than the national average. Along with that came fewer subprime loans, which we know have been much more likely to go into default. So basically you get the attractive combination of higher home ownership percentage and lower defaults. Who can argue with that?

Mike also suggests that by banning prepayment penalties Vermont limited the number of subprime loans because the ban made them less profitable:

My own thoughts, and the research is finding this as well, is that “lenders designed subprime mortgages as bridge-financing to the borrower over short horizons for mutual benefit from house price appreciation…Subprime mortgages were meant to be rolled over and each time the horizon deliberately kept short to limit the lender is exposure to high-risk borrowers.” The prepayment penalty is what made these bad-faith loans profitable to the lenders, and with house prices increasing, prepayment penalties allowed lenders to bet directly on this housing appreciation.

To put it a different way, banks, instead of underwriting borrowers, were betting that house prices would increase, and paying consumers to sit in the houses…Banks don’t normally bet on house prices – they have exposures, but they are secondary exposures related to recoveries and risks – they bet on consumers. Getting rid of these prepayment penalties keeps them from taking that side bets.

For those of you who do not believe in regulation or consumer protection, Vermont appears to provide an example in which limiting the actions of lenders so far has produced a positive outcome. Now, I’m sure you could find some unintended consequences. There always are with regulation. However, in this case I think this outcome probably is the lesser of two evils.

(Picture of random stuff courtesy on