Sunday, August 9, 2009

The Problem with American Cars

I recently test drove a Chevrolet Corvette on a fluke. I found the car impressive and recommend it to anyone who is in the market for a sports car.

By way of comparison, I test drove an Audi S5 and a Porsche 911 4S. The Corvette I drove (3LT) had a nicer interior finish than the S5. Its performance was in the same ballpark as the 911 4S, although not as good. Its price is comparable to the Audi and nearly half of the Porsche. On top of it, Corvette had the most muscular feeling and sound - while delivering the best gas mileage!

But there is a problem: Its image. I have been told by multiple people that a Porsche is more "befitting" of my image than a Corvette. Basically, the wisdom is that if you are an overweight, middle-aged, white guy that sports a mullet, was twice married to a stripper (but the same girl), then the Corvette is for you. So, regardless of the collective impressive feats by GM to create a very good car, the "upper crust" wisdom is that the Corvette is designed for the armpit of the society.

This is a problem for GM; but, as a class, American cars have a bigger problem. To illustrate the point, I will name a few key product categories in the automotive space:
  • Most stylish
  • Highest performance
  • Most economical
  • Most reliable
  • Most luxurious
  • Most innovative
Like it or not, "American car" does not fit any of these attribute unless you die for breathing on NASCAR fumes or are red-white-and-blue-from-the-heartland-American. Revisiting those categories, here are the first product families that come to mind:
  • Most stylish = Italian
  • Highest performance = Italian; maybe German
  • Most economical = Japanese
  • Most reliable = Japanese
  • Most luxurious = German for most people; English and Lexus
  • Most innovative = German; Japanese
For American cars to have a chance of surviving, they need to own at least one of the categories above (hint to auto executives - given the times, it needs to start with most economical and most reliable, but good luck unseating the Japanese).

Consumers should be drawn to American cars because they fall in love with them, or because they think that American cars are emblematic of a key product category. GM and Ford will only get so much mileage out of the die-hard American who buys American out of his patriotic duty.

Addendum: GM's recent announcement of the Volt's 230 MPG rating has generated quite a bit of press, some of which has a skeptical tone. Per the emails that I am monitoring, I clearly get the picture that, no matter what GM's moves or announcements are, the American public (like those in Silicon Valley) will regard it with skepticism. If my GM's observations are also true for Ford, Americas car maker challenges are formidable when trying to acquire the public's confidence in efficiency (and perhaps reliability). On the flip side, Toyota's Prius and Honda's Insight are quite well accepted.

Saturday, July 4, 2009

Broken National Priorities

The tax code is quite revealing about the politics of a country.

Take these case studies:

Case 1: I want the best education for my child. I am willing to make sacrifices and pay for it. However, there are no tax incentives to encourage this behavior. It is left to my own initiative to spend the extra dollars so that my child, and by extension, the next generation, is better prepared.

Case 2: I create a lifestyle business. I decide that that lifestyle business needs a Porsche as a company car. I lease the car and I can write off the associated expenses against my income. Here, there is a clear tax benefit that encourages consumption for today and does nothing to encourage investment for building a stronger tomorrow.

In other words, the government says that ostentatious consumption is good, but education is not. This is a clear example of misplaced national priorities, priorities that encourage individuals to party it up today with no regard for building a stronger nation for the future.

America - we are in trouble.

Tuesday, June 23, 2009

Uh-Oh: History Is Repeating Itself

On 29 March 2009, I posted my first blog here with now an infamous chart:

From my initial blog: The horizontal axis in my homemade chart represents a monthly timeline, with 0 corresponding to market peaks in 1929 (blue line) and 2008 (red line). The vertical axis is a log scale with 1 being the market high.

Paul Krugman's recent posting uses another, more reliable metric for compating 1929 to 2008. It is scary that history is repeating itself:

Saturday, June 20, 2009

Confused Iranian Protests

Current events in Iran have invigorated Iranians internationally. Pro-Iranians-in-Iran-protesters protests in Palo Alto, California, are an example of this international invigoration.

To the untrained eye, these protests come across as pro-Western-values (thus pro-modernization of Iran) demonstrations. Be weary of what you see.

At one level, the English chants and placards were in support of democracy and free speech in Iran; this much is great. It plays well for the American media, most of whom do not speak Farsi and are not familiar with the more subtle signals.

Yet, the symbols and slogans - those only understood by Iranians - are anything but supportive of these English messages. In the Palo Alto event, one of the Farsi chants translates to "death upon those who cause the death of my brother." Umm, OK; radical and sort of Marxist sounding, but we can chalk this up to emotion letting. Then there were the Iranian flags, not the current-day ones with the "God" center and square and "God is Great" Arabic script in the decorations, but the one with the lion brandishing a sword over a rising sun.

This flag is that it represents Iran under the Pahlavi "dynasty," when Reza Shah (Shah's father) and Shah where in power. Given who this flag represents, it is a strange way of demonstrating support for democracy and free speech.

The real trouble is the combination of the symbol and the slogan. To me, it sounds like bloody revolutionary inclinations to take Iran back some 30 years at a time when things were not so great for the average Iranian. Of course, if you were pro-Shah and toted the party line, things were great for you. If you had a different opinion or political views, imprisonment without a trail (not even a sham trial) and torture were not out of the mainstream practice. The nostalgia for pre-revolution times is misplaced. The mullahs are the new Shahs; different beasts are in wolf clothing, but the wolves are still out.

If internationalized Iranians really want to change Iran, the best method is to migrate back, take their skills and values with them, and create change from within. Displays of emotion may feel good but creating good feelings does not create the type of change that Iran so desperately needs.

Saturday, June 13, 2009

Citizen: What is Your Worth?

Economists have a way of placing an economic value on everything. Free capitalist markets have a way of placing a monetary value on nearly everything. Notable exceptions are love, life, and citizenship. But are these really exceptions?

Love is the most complicated of these examples and deserves a deeper look within itself. For the time being, if we confine "love" to a definition that two people chose to maintain a (hopefully long-term) for some mutual gain and strip the emotional dimension, you can see where the argument goes.

Human life clearly has a value and its creation is becoming more and more a sell-able product. On the creation side, witness the availability of fertility clinics and surrogate mothers. On destruction side, witness life insurance, and hit men who charge a fee to end someone's life.

And, in a world where nothing is sacred, citizenship is also for sale. Per USCIS, EB-5 visas grant the right of immigration to alien entrepreneurs who invest either $500,000 or $1,000,000 (depending on conditions - see here for details). US is not alone is offering this type of immigration. Nearly all countries offer some sort of immigration rights by virtue of cash. In some cases, like the US, the cash has to be invested into a business activity. In other cases, cash could be offered as a bribe to a government official in exchange for citizenship rights.

So, after all, citizenship is for sale and its value is determined through some non-transparent national policy or government agent individual action. Given that this is the case, why not call a spade a spade and make citizenship a sell-able good on open markets?

Corporations sell ownership shares on stock exchanges. Market activity and (hopefully sound) financial analysis determines the value of those shares. A company that is succeeding in increasing its market share, profit margins, and future prospects is valued richly. A company that is seen on the decline is punished through a lower valuation of its shares.

The same analogy could apply to countries. Just as companies sell shares in the open market, countries could sell citizenship. The value of each citizenship share could be determined through market activity and the prospects of individuals in those countries. For example, if universal health care and very high social safety nets (through government handouts) are seen as highly desirable traits, those factors will drive up the value of citizenship in the open market. Or, if a favorable business environment and the possibility for individuals to "strike it rich" are seen as important traits of a country, then citizenship in that country will be valued more richly.

For a market to exist, there needs to be buyers as well as sellers. Identifying buyers is easy. Today, they are the immigrants that leave their home country for another in search of better prospects. But who are the sellers?

The sellers will be those who willingly sell their citizenship to immigrants on the open market for cash. They could then use the proceeds to buy citizenship in a "cheaper" country and use the residual cash to pursue whatever they please in that country in accordance to the new home country's laws.

In effect, the case is for making the value of citizenship more transparent, and its transfer through monetary means more facile. This will attract like-minded individuals into a common country where the perceived virtues can be accentuated through the injection of new participants into the political and policy making scene. And for those who do not like it, well, they could cash out and pursue their individual interest elsewhere.

The word citizenship, at some level, connotes patriotism and nationalism. Because of this baggage, citizenship has become a sort of an ephemeral and in some cases sacred concept that has made it difficult to acquire and impossible to transfer through financial means. Yet, citizenship is for sale.

So, why not call a spade a spade and make citizenship a trade-able good on open markets?

Sunday, June 7, 2009

Individual Liberties

The question is, to what extent should an individual have rights and at which point can the state restrict the rights of the individual.   The discussion has been centered on the topic of gay marriage and how allowing it is, in effect allowing other forms of non-traditional marriage.  The tension in the argument is whether individual rights allow alternative unions to be labeled as marriage or whether the state can be in charge of imposing a definition for marriage.  

In our case, let's define the state as the United States, in that there are democratically elected executive and legislative branches.  Coming back to the question, we ask to what degree can the legislative branch impose restrictions on individuals and enable the executive branch to enforce those restrictions.

Americans have an ingrained sense of individual liberty.  The rights of the individual are paramount.  To what extent, then, should and individual have rights?  Should the state act as a paternalistic figure and subjugate its citizens to the rules of some majority, or do individuals have rights that are unalienable despite the will of the majority?

Robert Nozik famously said that individuals have rights insofar as their rights do not violate upon the rights of others.  In the clearest case, we can agree that individuals have a right to not be murdered.  This right does not restrict the rights of others not to be murdered; conversely, if it were the case that individuals had the right to murder, the society would soon go down the path of disintegration. 

Examining the case of marriage, it is not clear why same sex or polygamous marriages between individuals who willingly partake in these unions violate the right of others.  One cannot reasonable argue that he has the right to live in a society where marriage is the union of a man and a woman as this "right is clearly restrictive of others rights.  

Looking beyond marriage, and if we accept the notion that individuals have rights insofar as their rights do not violate the rights of others, there are many other major implications.  These implications are as base as the right to education, therefore taxation to support education, to the right to have secure borders, therefore the existence of a military.  In each case, individual liberties of those who assert these rights should be assessed against the violation of rights of others who may have dissimilar interests.  The answers are not clear cut, and require intense and deep debate.

So, how does one motivate ongoing social discourse to examine these issues and is our existing political infrastructure sufficiently geared to allow this discourse between citizens in an open way?  One may argue that a free press and media are there to enable this discourse; however, with the recent proliferation of commentators and diminishing of strong journalistic standards, the nation is at the mercy of those who speak the loudest and have the best access to communication channels. 

The voice of the citizen engaged in a civil discourse is lost; the question is, how we can get it back.

Monday, May 25, 2009

State of the "Union:" Genders, Numbers, and the Taboo

The question of allowing same-sex marriage raises troubling points.  The trouble is the question of what freedoms Americans should be granted, and what the definition of marriage is.  As mentioned in my earlier posting, the Bill of Rights explicitly allows for the freedom of religion.  This is to say that the state will not sponsor or advantage any religion or faith above any other.

Those who argue that marriage is the union between a man and a women predicate their argument on religious grounds.  The trouble with this argument is twofold:  Over time, the religious definition of marriage has evolved and there is that bit in the Bill of Rights that grants freedom of religion. 

The Bible neither endorse nor condemns polygamy.  And, while it includes passages that describe a relationship between only a single man and woman, it does not specifically prescribe monogamy.  Likewise, it includes passages regarding Abraham, Jacob, David, and Solomon, all of whom had multiple wives. Moses has a sort of an odd warning to Solomon in Deuteronomy 17:17 regarding polygamy:  "He must not take many wives."  What is not clear is whether the meaning of "many" is "more than one" or "more than what Solomon could afford."  But these minutia are besides the point, the point being the lack of definitive rejection of polygamy in the Bible.  It should be noted that polygamy has been in common practice throughout the ages, and still is in many faiths around the world.  Therefore, one cannot claim monogamy as "God's way" by claiming residence or Biblical prescription.

That aside, the Bill of Rights does grant Americans freedom of religion.  This right prohibits the enforcement of an ideal justified through religious teachings of any sort.  In other words, it should not matter what the Bible - or any particular religious text - says when it comes to the creation of laws and granting of rights in the US.  The paramount issue is individual rights; namely, can individuals willingly join and leave unions without any coercion or credible threats?  If I, as an adult, am free to marry whomever I want and can leave that person by my free will, then that marriage should be allowed as I am ultimately exercising individual rights.

This is the crux of the argument for same-sex marriage:  It is the wish of two adults to marry in accordance to their free will.  Same-sex marriage is a question of individual rights; it is ultimately the American way.

But, when it comes to individual rights, namely the wish and ability of an adult to make a decision for his betterment without coercion or a credible use of force*, why should the American way only extend to monogamy (single man-woman, man-man, or woman-woman relationships)?  If it is the wish of multiple, freely willing adults to engage in polygamy, why should the American way stop that choice? One can imagine marriages where are the traditional polygamous type, the non-traditional polyandrous (one wife, many husbands) type, or the tribal kind where multiple men and women are in a marriage, with "multiple" defined as "as few as zero and with no upward bound," making it possible for exclusive groups of many men or many women to be in a tribal marriage together.  

Call this modern love or taboo.  Despite its moniker, polygamy, polyandry, and tribal marriage clearly extends beyond most Americans' sensibilities and comfort zones.  Which, of course, begets the question of whether the existence of something uncomfortable or unusual make it un-American.  Coming back to the central point, if we wish to respect individual rights and adults are free to make choices* without coercion or a credible threat, then adults should have that right.  

We, Americans, have a long way to go before we fully digest our constitution and understand its ramifications.  And we, Americans, have a long way to go before we grant individual rights as they should be granted.

* Examining the notion of individual rights will be the topic of the next blog.

Saturday, May 23, 2009

Choose One: Outlaw Divorce or Allow Gay Marriage

Over a cup of coffee, an Italian friend was explaining Italian relationships; more precisely, how the termination of Italian marital relationships plays out.  The state has to grant the right for divorce given probable cause.  And, as it turns out, marital infidelity is not probable cause.  Piecing the information that my friend relayed to me, were it the case that cheating hearts constituted grounds for divorce, about half of Italian marriages would dissolve.

We, in the US, are self-critical because of our high divorce rate.  The infamous statistic that is bantered about is that nearly one out of every two marriages fail.  This is "about half;" so, Americans and Italians are far more alike than divorce statistics would have you believe.

Yet, just focusing on the statements above, there is something profoundly different between the US and Italy.  In the US, it is easy to get married; a couple can simply go through a Las Vegas drive-through church to declare themselves husband and wife.  It is nearly as easy to get divorced (assuming willing parties and no legal or financial vengeance in the mix).  In Italy, the state grants the right for divorce upon sufficient grounds; accordingly, the state requires that a couple be schooled in marriage prior to tying the knot precisely because it is difficult to legally separate.

This brings the question of relationships onto a broader stage; namely, what should the relationship between the state and the individual be?  Shall the state prescribe details of people's lives, or shall people be let free, make their own decisions, assume their own responsibilities, and keep the state as intrusive as possible?  

We Americans like to think of ourselves as members of a free society where the state is small and relatively unobtrusive.  Witness our Bill of Rights, abridged for readability:
  • Freedom of religion
  • Freedom of speech
  • Freedom for peaceful assembly
  • Freedom to petition the government for grievances
  • The right to bear arms
  • Freedom from arbitrary government seizure of property
  • Freedom against unreasonable searches without probable cause
  • The right to be tried in a court of law
Basically, we do not like our government dictating what we can do within certain limitations.  Unfortunately, those boundaries are rather murky.  

Going back to the marriage question, it is not clear why same gender marriages are unlawful in 45 out of the 50 states given that we prize our freedom (the quibbles centering on the religious definition of "marriage" being the "union of a man and a woman," which makes for a poor argument given than the religion definition of marriage has changed significantly over time and that there is freedom of religion).  So, we Americans are a bit tortured on how much we prize our freedom and whether we want to accept the inconvenient consequences of being free.

Sunday, May 3, 2009

Hypocrisy and the Hippocratic Oath

The current health care reform debate prompted me to query the doctors in family about their profession.  The doctors in my family provided refreshingly frank feedback, and  devoid of the facade that they would naturally put up if speaking with less familiar individuals.  

I walked away from the conversations with a new regard for medical doctors.  Namely, whereas I had perceived doctors as selfless individuals who worked endless hours for the benefit of others (and who happened to earn a nice living in the meanwhile), my new perception puts medical doctors in the same class as consultants.

Having been a consultant, I have an understanding for the inherit conflict of interest that consultants must deal with.  On one hand, the consultant has to solve a problem for the client.  On the other, the consultant has the goal to maximize his revenue.  The conflict of interest comes when a problem could be solved in a very efficient way (perhaps due to the absence of an actual problem); under this condition, revenue takes a hit.  Being goaled with maximizing revenues often means that the consultant will take a less efficient path or "discover" new problems in an effort to extend the engagement, and thereby aggrandize the bill.  With that, let's take a look at how incentives are created for medical doctors  and why the Hippocratic oath takes a back seat to the almighty dollar.

First, it is important to understand medical billing practices.  This is not a comprehensive study, rather a sketch based on various data points:
  • Billing rate is associated with the doctor's expertise.  Pediatricians make less and intensive care (IC) doctors.  IC doctors with multiple certifications, such as pulmonary disease, make even more.  A pediatrician makes around $150,000 per year.  A high-end specialist can make into the seven figures.
  • Per-minute billing rates are very high.  The figure that was quoted to me was $35/minute.  This makes the hourly rate $2,100 for the average doctor.  Just for comparison sakes, a named partner in California's largest law firm collects less than half this rate.
  • While billing is quoted at a per-minute basis, there is a minimal period for which the patient (or the patient's insurance company) is billed.  The minimum time blocks is 10 minutes.  However, most doctors visit 2 or three patients during the same 1o minute period, effectively tripling the billing rate.
So far, it should be clear that with these billing practices, patients should expect little love from their doctor.  The doctor will be motivated by visiting as many patients as he can during the shortest period of time.  Hopefully, the diagnosis will be accurate.

Another contorting factor is the division of labor among doctors.  As I mentioned above, an IC doctor collects at a specific rate, but an IC doctor with pulmonary disease certification increases his rate by about $100,000 per year.  The distinction between a regular IC doctor and an IC doctor with pulmonary disease certification is the ability to diagnose and treat lung infections.  

Here is the rub:  It is an accepted fact that any patient that spends any appreciable time inside the IC unit will develop a lung infection.  So, the rational IC doctor will want to get a pulmonary disease certification because, if he does not, he will allow the next person to collect the fees for diagnosis and treatment.  Judging by the extra $100,000 per annum increase to the doctor's take home, one can expect a $400,000 total billing that this doctor generates in totality, which is then split between insurance companies, pharmaceuticals, the medical facility, and other administrative costs.

But, if it is an accepted "fact" that any patient that spends any appreciable time inside the IC unit will develop a lung infection, the question is why isn't the medical community working to prevent these infections in the first place?  The way the game is devised, it is far more lucrative to diagnose (or misdiagnose) and prescribe a (hopefully) cure instead of preventing the disease in the first place.  

Which brings me to the Hippocratic Oath.  According to PBS, the modern version of the Hippocratic Oath (written by Luis Lasagna in 1964), has the following directives:

  • I will apply, for the benefit of the sick, all measures [that] are required, avoiding those twin traps of over treatment and therapeutic nihilism.
  • I will remember that there is art to medicine as well as science, and that warmth, sympathy, and understanding may outweigh the surgeon's knife or the chemist's drug.
  • I will remember that I do not treat a fever chart, a cancerous growth, but a sick human being, whose illness may affect the person's family and economic stability. My responsibility includes these related problems, if I am to care adequately for the sick.
  • I will prevent disease whenever I can, for prevention is preferable to cure.
Without diving into the details, I believe I have demonstrated how the four directives are easily violated - not because medical doctors are callous  - because the way medical establishment practices its business today.  You may be interested to know that there are eight directives altogether, which makes the final clause of the modern oath laughable:

  • If I do not violate this oath, may I enjoy life and art, respected while I live and remembered with affection thereafter. May I always act so as to preserve the finest traditions of my calling and may I long experience the joy of healing those who seek my help.

The medical establishment has said that at most 50% compliance with the oath is good enough.  We, the patients, just hope that disease diagnosis and treatment has a far better success rate.  

Cough, cough.

Saturday, April 18, 2009

Impact of Government Economic Stimulus on Consumers

Q:  Given that the consumer is already under debt duress, does the government's massive stimulus program to stave off the recession create new consumer burdens?  In other words, does government's current expenditure policies make it harder for the consumer to repay his debt?

Yes, the government's spending program does, indeed, create new consumer burdens; however, it is possible that the stimulus program will better enable consumers to lower their debt.  Of course, for the stimulus program to work, the expenditures have to be responsible and effective.  For the purpose of discussion, let us assume that the Obama administration will spend the money as effectively as possible.  With that set aside, let us look at the ramifications of this massive expenditure program.

Indeed, the consumer will see additional burdens in the years to come.  These burdens will come in one or many of the following forms:
  • Inflation
  • Lower dollar value
  • Higher taxes
  • Slower economic growth
Inflation, lower dollar value (as measured against other currencies), and higher taxes all have the same impact to the consumer:  Given a fixed paycheck, they take away from that paycheck's actual value.  Slower economic growth means, among other things, that it will be harder to argue for a pay raise to offset the hit on the paycheck's value erosion.

First, let's put things in perspective.

The Bush administration came into the office under unusual economic circumstances:  It inherited the largest budget surplus ever.  Driven ideologically, the Bush administration proceeded with one tax cut after another while creating new expenditure obligations and entitlement programs.  This was the only administration in history to push for tax cuts while waging wars.  Not surprisingly, the end result after eight years was the biggest budget deficit in history.  

Deregulation is a longer historic arc which began in the 1980s.  As regulatory bodies were weakened, financial crises became more common:  The Savings and Loans failings of the 1980s, Long Term Capital Management in the 1990s, Enron in early 2000s, and the collapse of the financial industry in 2008.   Recent profit reporting by various financial houses are also suspect.  In essence, it is difficult to tell who has clean books and real profits any more.

These set the backdrops in which the Obama Administration must operate, thereby framing the problems that they have to deal with and the limited solution set.  One point is worth making:  I am not indicating that deregulation or tax cuts are necessarily good or bad; I am only indicating that as they were implemented, they had certain, unpleasant and unfortunate ramifications. 

The Bush Administration handed a  self-amplifying double whammy to the Obama Administration:  A financial crisis and a failing economy.  As the financial crisis deepened, credit became harder to get.  As credit became harder to get, the economy suffered more.  And the ever increasing suffering economy further exacerbated the financial crisis.  The Obama administration had to stop the financial crisis and boost the economy simultaneously, and do so at a time when America already had a record budget deficit.  The solution that the administration chose was to pump liquidity into the financial sector (keeping zombie banks alive) and massively increase government spending (with the goal of creating jobs, albeit this is questionable) while having limited latitude to raise taxes.

As any consumer knows, when you spend more than you earn, you burn up your savings.  If you do not have any savings, you get deeper into debt.  In the US, we are getting deeper into debt, and we are financing this debt through foreign borrowing.  To keep the foreign money coming in, the US will have to increase interest rates to keep US bonds an interesting buy.  The interest rate hike will hit every consumer by making borrowing more expensive and forcing a higher portion of the consumers' incomes to be allocated towards servicing debt.

Of course, the US will have to pay back the debt.  It can do so in an honest way, by keeping inflation in check, or the expedient way, by inflating its way out of debt.  Printing money is the perfect inflation creation mechanism:  By increasing the money supply at a faster rate than economic growth, the US will simply lower its debt obligation by effectively transferring wealth from the debtors to itself.  

However, inflation will have other unkind effects, one of which is the devaluation of the dollar against foreign currencies.  Because US is a net importer, the devaluation of the dollar means that foreign goods - the kind that we consume voraciously - will become more expensive.  This erodes from the dollars purchasing power and will make the average consumer poorer.  

At some point, inflation will have to be brought in check and some realistic portion of the debt will have to be paid back.   This will mean a further elevation of interest rates - and taxes, both of which again put pressure on the consumer.

So, the outlook for the consumer is grim.  However, this outlook is far less grim than the alternative where the financial crisis and economic downturn viscous circle would completely collapse the world economy and create a long-term, worldwide depression.  

There is no easy way out and the consumer will have long-term pain.  The path that we are currently on seems to be the least painful path, but keep in mind that we made a key assumption:   The Obama administration will spend the money as effectively as possible.  The wrong policies, or poor implementation of the right policies, will drag us down even further.

Monday, April 6, 2009

Why Did Lenders Lend, and Why Do They Keep Lending

A series of thoughtful questions were posed to me on private email.  I have captured the essence of those questions and my answers here:

Q:  Why did the lenders overextend borrowers in the past Decade?
This has been a hot discussion topic in mainstream media.  It is hard to understand the rationale of lenders, be they mortgage companies or credit card issues.  The answer to this puzzle seems to be that the financial wizardly wisdom of the past decade was that high-risk loans could be collateralized and packaged (into collateralized debt obligations) so that the overall risk would be lower than the risk of any individual loan.  Add in rating agencies that were - for lack of better terms - sleep at the wheel, bonuses affiliated with selling debt and debt-backed securities, and the false sense of security that credit default swaps (insurance policies for CDOs), to create a perfect storm of reckless behavior by lenders that encouraged reckless behavior by borrowers.  Once the house of cards fell apart, the tipping point being Lehman Brother's bankruptcy, the wheels of the wheeling and dealing debt market came off.
Q:  Why do lenders continue to overextend borrowers through credit card debts?

Credit card companies are (comparatively) actively turning away customers, increasing their borrowing rates, or lowering the credit limits of their most risky customers.  American Express is a case in point.  As a result, we may see lower credit card debt levels in the ensuing months; however, credit card limits are preset.  Other than active intervention by financial institutions mentioned previously, there is nothing to stop consumers from borrowing until they reach their credit limits.
Q:  Will higher debt interest rate obligations further reduce consumption?

Absolutely.  Lower consumption will occur either because a higher percentage of disposable income will become allocated to servicing debt or because the consumer becomes insolvent.  In either case, this bodes poorly for US' short-term economic growth.

Sunday, March 29, 2009

US Consumer, 1929, and 2008: Are we in trouble?

The horizontal axis in my homemade chart represents a monthly timeline, with 0 corresponding to market peaks in 1929 (blue line) and 2008 (red line). The vertical axis is a log scale with 1 being the market high.

A few notes about the blue line:
  • The market did not reach its 1929 peak value during the next 10 years depicted in the chart. Markets regained the 1929 high in 1954, or 25 years after the fact.
  • The market reached bottom in 1932, 3 years after the crash began.
  • There are many temporary periods where the market went up for some reason. These temporary upticks do not establish a long-term trend. As implied above, the long-term trend was a very slow, prolonged recovery.
The chart below tracks total consumer debt from 1952 through the end of 2008 as a percentage of GDP (source of this and other similar graphs is WSJ).

Let's separate out consumer debt into real estate and credit card tranches (there are other types of debt, but their value is negligible compared to these two debt categories).

There are two curious elements that jump out from the above chart:
  • Real estate debt dwarfs credit card debt and appears to have peaked (this is good).
  • Credit card debt is steadily increasing (this is bad).
So, what is going on? Let's look at another, related chart first:

Owner's equity in real estate has dropped precipitously from a 1952 peak of 80% to approximately 45% today. This drop in owners equity matches the increase in home mortgage loans that you see above.

Let's go back to the question: What is going on with consumer debt?

In normal times, real estate equity values would have an inverse relationship to real estate debt; however, home mortgage debts are dropping at the same time as home equity in the past few quarters (look at the tail-end of both graphs). This means that real estate debt is dropping mainly due to an increase in foreclosures, not because the consumer is in a better financial shape or paying back his debt.Regarding the consumer paying back his debt: He is actually taking on more debt because credit card liabilities are increasing.

So, what is going on? The US consumer is in trouble.

Let's go back t the red line in the first chart. Consumers are the underlying reason why the economy functions. There is a person at the end of every dollar. Today, just like 1929, the consumer debt to GDP ratio is nearly 100%, and all signs point to continued financial weakness with the US consumer. In the meanwhile, expect unemployment numbers to increase. Now you can connect the dots, or if you will, extrapolate the red line into the future (hint: the blue line is a good indicator).

The good news: The 2008 downturn is likely to be more muted than the 1929 downturn due to systemic economic improvements. The downward trend will not be as steep as it was in 1929.

The bad news: We have a structural problem with consumer spending and savings patters in this country. Fixing our current situation will take a long time because we are dealing with real estate debt, personal spending patterns, may years of accumulated debt, and so forth. This problem took a long time to make and will take a long time to resolve. Again, look to the blue line as an indication of the future.