Non-Housing Debt

"If he makes anybody rich, let him make himself rich...so he can pay off his school loans."
--Carl Fox (Wall Street)

Consumers have been taking on more non-housing debt over the past decade. It now comprises about 30% of household debt (mortgage-related debt comprises the remaining majority).

While car loan debt burden has been on the rise, student loans are the primary contributor to the increase. Their share of consumer debt has more than tripled since 2003.

Credit card debt, on the other hand, as declined slightly as a fraction of total consumer debt.

Repo Madness

All our times have come
Here but now they're gone
--Blue Oyster Cult

As we've noted, the Fed has embarked on another monetization program. A primary focus of this intervention is the repo market, where short term financing rates have skyrocketed over the past few weeks, surpassing highs during last decade's credit market freeze.

We've written about repos before, and speculated that they could potentially lie at the epicenter of the next financial system meltdown (here, here, here).

The question, however, is why now? What is causing the repo market to crack at this moment?

The regulatory backdrop has been ripe for some time. Post-crises revisions to banking regulations have forced banks to set aside more than $1 trillion in reserves. Repo rates are rising in part not because of a scarcity of cash in the banking system, but because that cash cannot be used to fund repo loans. Regulations are also constraining the return creditors can realize on large lending positions in short term money markets.

The Fed's sell down of QE program assets has exacerbated the stress. Until the Fed (predictably) suspended its QE unwind a couple months back, it was draining tens of billion$ monthly from the system as it sold back the bonds that it had previously purchased during QE (with money created out of thin air, of course). Those sell backs took cash off the repo market, perhaps to a tipping point. Now, the Fed's recent monetization program is once again sending cash (created out of thin air) in exchange for bonds (as shown above).

Peter Schiff adds that ever more federal debt coupled with shorter maturities on that debt means that record levels of debt need to be financed daily. Banks have dutifully bought those bonds--as they in part are required to do by recapitalization laws put in place since 2008. Once again, this leaves less cash available to fund repos.

Perhaps it has just been the confluence of these factors that have cracked the repo market, although I can't help but think that something more acute is pushing this situation overboard. We'll likely know soon enough.

Also not hard to think back to the early days of the credit collapse. Early tremors (e.g., New Century Financial) before the dominos starting hitting each other in the mortgage markets. Is the repo market an early tremor this time around?

Emergency Fund

"I'm tapped out, Marv. American Express has got a hit man looking for me."
--Bud Fox (Wall Street)

An early step toward financial independence involves establishing an emergency fund. An emergency fund is cash savings that can be used to pay expenses in the event that either a) you have no income (e.g., temporarily unemployed) and must pay routine expenses such as mortgage, rent, utilities, insurance, entertainment, etc, or b) you are subject to a large, unusual expense that your regular income can not easily fund (e.g., big car repair, medical expense).

It is commonly proposed rule that an emergency fund should be large enough to cover six months of living expenses. Personally, I would recommend more than that--a year's worth of expenses is a better target.

To determine how large your emergency fund needs to be, you first need to estimate your expenses. I recommend estimating expenses on a monthly basis for an entire year. An easy way to do this is to make a spreadsheet. Put months JAN thru DEC in the rows. In the columns, put various categories of expenses (school payments, clothes, entertainment, transportation, insurance, etc). When you are young, you won't have many expense categories but it is a good habit to begin tracking them.

Once your spreadsheet is set up, forecast your expenditures for each month throughout the year. If you think you'll spend $100 for clothes this month, then put that estimate in the appropriate cell. Sum up your expenses each month, and then sum the months to get an annual estimate of expenses. That number serves as the initial target for your emergency fund.

As the year unfolds and you pay actual bills, replace the estimates on your spreadsheet with the actual amount you spent. If you actually spent $121 on clothes this month, then revise accordlingly. On my spreadsheet, I boldface actual expenses to distinguish them from my forecasts. Over the course of the year, you'll get a better idea of what you actually spend, and that bottom line number for annual expenses will become a more accurate target for your emergency fund.

The other thing you have to do, of course, is save money to build your emergency fund. Put your savings in accounts where you can easily access cash to pay bills if you have to. Although it would be nice to earn as much interest on these savings as possible, the priorities here are safety and ease of access. If you have to sacrifice some returns in order to ensure liquidity, then do so.

Be patient. Emergency funds are not completed overnight, especially when you're just starting out. Over time, though, tracking your expenses and building savings to fund life's expenses will put you in better control of your financial future.

Net Worth

Don't you try to pretend
It's my feeling we'll win in the end
--Simple Minds

"Where do I stand financially?" One way to answer that question is to periodically estimate your net worth. Simply defined, net worth is the difference between what you own and what you owe. The more you own and the less you owe, the greater your net worth.

In financial accounting, the instrument for measuring net worth is called a balance sheet. When companies report their financial results, they include a balance sheet so that shareholders can understand the capital structure of the business and their underlying net worth (a.k.a. shareholder equity). Individuals can similarly employ the balance sheet approach to get an idea of their net worth.

Assets

First comes what you own, a.k.a. 'assets.' Record them, then add them up. Here's a list of typical assets, beginning with the most liquid:

Cash and cash equivalents. Value of checking accounts, savings accounts, CDs held in banks. Don't worry about physical cash on hand unless it's substantial.

Investments. Value of brokerage accounts, mutual funds, IRAs, 401(k)'s.

Alternative assets held in physical form. Precious metals, collectibles, other real estate besides personal dwelling. Value of alternative assets can be harder to estimate because they are less liquid. Be conservative with your estimates.

Home. If you own a house, include the property's estimated value. A conservative reference is often the county assessment done every few years for property tax purposes.

Car. Estimated selling price of a car if you have one. Remember that car values depreciate quickly, so be conservative.

Other personal property. For the most part, ignore possessions like clothes, electronics, etc. They usually have little 'salvage value' if you have to sell them.

Liabilities

Next comes what you owe, a.k.a. 'liabilities.' For the most part liabilities are various forms of debt. Record them, then add them up. Here's a list of typical liabilities.

Credit card debt if balance not paid off monthly.

Student loan debt--remaining balance that you owe.

Car loan debt--remaining balance.

Home mortgage debt--remaining balance.

Other debt. Rare but could include personal loans (money you've borrowed from another person) and other unusual obligations.

Don't include monthly bills like phone, cable, gas and electric as long as they are paid when due.

Net Worth

Once you've summed up your assets and liabilities, find the difference:

Net Worth = Assets - Liabilities

You want the number to be positive and growing over time. When you are just starting out, you net worth will be small. It may even be negative. The way to stay out of negative territory is to avoid debt. Stated differently, owning tons of assets matters little from a net worth standpoint if those assets have been funded by a mountain of debt.

The smaller your debt load, the quicker that you can build your financial net worth.

Personally, I estimate my net worth quarterly using a spreadsheet. Nothing to obsess over. Just a way to track progress along the way.

Ten Year Yields

The years run too short and the days too fast
The things you lean on are the things that don't last
Well it's just now and then my line gets cast
Into these time passages
--Al Stewart

Last time we suggested that interest rates are among the most important prices in markets. Of the myriad interest rates shaping markets on an everyday basis, there is one in particular that you'll want to pay attention to: the interest rate (or yield) on ten year US Treasury bonds. People often refer to this interest rate as '10 year yields.'

Ten year yields are important because they influence a goodly share of other interest rates on the planet. Interest rates on mortgages, car loans, student loans, and credit card balances are all linked to 10 year yields. Why this is so is largely beyond the scope of this post. Let's just say that America's status as the world's premier borrower carries lots of weight when it comes to setting interest rates.

Smart investors tend to know where 10 year yields currently are and how they've been trending. So where are they currently? The most popular data series of 10 year yields is known as the TNX, which for some strange reason requires you to divide TNX values by 10 to get the actual interest rate. First, let's look how 10 year yields have been behaving on a daily basis for the past few months:

Note that the most recent value of TNX reported on the graph sits at 24.67. When we divide by ten, this translates into a 10 year yield of about 2.5%. Note also that 10 year yields have been in a downtrend since late last year. In fact, they have fallen 20% or so since November.

Now, let's elongate the time horizon and examine the past few years on a weekly basis:

Note that prior to the recent downtrend, 10 year yields had been in a multi-year uptrend during which time yields more than doubled. The low point in mid 2016 of about 1.4% was an important one because it constituted an all time low in 10 year yields.

One more time frame--the big picture. Going back as far as my charting app permits, here's a graph of monthly 10 year yields since 1980:

The general direction is obvious. Ten year yields have been grinding lower from highs above 15% (!) in the early 1980s to present levels over the course of nearly 40 years. That maths out to an 80-90% decline. Now that's a downtrend!

In true, unhampered markets, such a pattern is unlikely. Interest rates should fluctuate with such factors as supply and demand for savings and people's preference for living larger in the here and now.

This prompts several important questions. If interests rates haven't been free to fluctuate naturally, then who/what has been forcing them lower over time? What are the possible motivations for wanting to force them lower? And, what are the potential adverse consequences of manipulating interest rates lower for such an extended period of time?

We'll surely discuss these questions going forward. Meanwhile, try to maintain a regular sense of the levels and trends of 10 year yields. This will help you as an investor.

(Un)Affordable Housing

Our house
It has a crowd
There's always something happening
And it's usually quite loud
--Madness

As Ryan McMaken and Tom Woods observe, the most straightforward way to make housing more affordable is to build more of it (ECON 101). Instead, policymakers want to subsidize housing.

One way to get more affordable housing is by building more housing. But most policymakers seem more interested in schemes for subsidizing housing instead. https://t.co/2tYoTW0l4u

— Ryan McMaken (@ryanmcmaken) February 5, 2019

Housing subsidies discourage supply and increase demand. Consequently, prices will ____. (Put on your ECON 101 hats)

Everything Bubble

"It's clear as a bell to those who pay attention. The mother of all evil is speculation--leveraged debt. Bottom line: it's borrowing to the hilt. And I hate to tell you this, but it's a bankrupt business model. It won't work. It's systemic, malignant...and it's global."
--Gordon Gekko (Wall Street: Money Never Sleeps)

Ten years after the credit market meltdown, Ron Paul observes that we are not better off economically. In fact, we are worse off.

Huh? With all the positive economic headlines popping up daily, and stock markets just a couple of percent off all time highs, how can we be worse off?

The problem is leverage and debt--leverage and debt that are multiples higher than the leverage and debt of 10 years ago that nearly took down the financial system.

Today's leverage and debt were spawned by the most aggressive central bank monetary policies in the history of the world--as well as by government policies of bailing out all nearly all institutions that, thru their reckless borrowing and lending practices, nearly tanked the system last time.

Whereas during the last cycle easy money and credit poured into the real estate market, this time around easy money and credit has poured into everything. Credit cards, student loans, cars, housing (again), stocks, and, of course, government. As RP notes, "Federal debt is over 21 trillion dollars and expanding at tens of thousands of dollars per second."

What we have is an Everything Bubble. The crisis potential of this Everything Bubble, when it pops, promises to dwarf the meltdown of 10 years ago. The more accurate comp will likely be the Great Depression.

Home Price Trends

Rory Devaney: These houses are fantastic.
Tom O'Meara: They're pretty old, around 1900.
Rory Devaney: Our new ones are older than that.
--The Devil's Own

Interesting analysis on home price appreciation. From 1891 thru 1996, US home prices only exceeded inflation by 15% on a cumulative, not annual, basis.

In fact, for the 50 year period stretching from 1890 thru 1940, home prices had trouble keeping up with inflation.

That thinking changed, of course, during early 2000s run-up in home prices when it seemed that home values only went higher. Housing became an 'investment' and then a 'speculation.'

Then the bubble popped.

While some home markets once again have that frothy feel, long term data suggest that, from an investment standpoint, home purchases are, at best, an inflation hedge. And likely worse once borrowing and maintenance costs are factored in.

Zero Debt Again

Maybe someday
Saved by zero
I'll be more together
--The Fixx

After paying off my home mortgage several years ago, I promised myself to remain debt free. Simply put, debt reduces freedom.

In January 2016 I broke that vow when I bought a vehicle on ridiculous 0.1% annual financing terms for a 24 month loan. The interest expense on a multiple five figure loan amounted to a couple hundred dollars.

Fast forward two years. Just made my final payment on the car loan. Although the cost was trivial, am grateful to carrying zero debt again.

Where's the Leverage?

"And I hate to tell you this, but it's a bankrupt business model. It's systemic, it's malignant, and it's global...like cancer."
--Gordon Gekko (Wall Street: Money Never Sleeps)

In past bubbles, leverage was concentrated and easy to spot. In the late 1990s leverage clustered in dot.com. In the 2000s it accumulated in housing and mortgages.

This time around leverage is harder to recognize. Yet, derivative usage, corporate debt, duration, and sovereign debt are all at record levels.

It is tougher to see leverage when it is all around us.

Rather than being dormant and local, leverage and its associated risks have become malignant and systemic.

Gross vs Net Standard of Living

I'm sick and tired of you setting me up yeah
Setting me up just to knock-a, knock-a, knock-a me down
--Bruce Springsteen

Assessing standard of living in a debt-laden society can be misleading. A portion of what is viewed as 'prosperity' has been borrowed from the future and must be paid back. This payback taxes, quite literally, future standard of living.

Where would US standard of living be today, for example, if the resources borrowed by current $20+ trillion in federal government debt could be factored out of the picture?

Suppose that you borrowed to the hilt. Jumbo mortgage, car loans, maxed out credit cards, student loans, et al. Of course, for many, this state is not merely supposition. On the surface, living standards would seem quite posh. But when debt is netted out, equity may be below zero.

When evaluating degree of prosperity among highly leveraged entities, gross standard of living provides one image while net standard of living paints an entirely different portrait.

Home Prices and Affordability

"Someone reminded me the other evening that I once said, 'Greed is good.' Now it seems it's legal. But, folks, it's greed that makes my bartender buy three houses he can't afford with no money down. And it's greed that makes your parents refinance their two hundred thousand dollar house for two fifty. And then they take that extra fifty and they go down to the mall. And they buy a plasma TV, cell phones, computers, an SUV, and, hey, why not a second home while we're at it because, gee whiz, we all know that prices of houses in America always go up, right?"
--Gordon Gekko (Wall Street: Money Never Sleeps)

Nearly a year ago, US home price passed thru their previous highs set before the mortgage-backed credit collapse. In fact, over the past few years, home prices have been increasing at a breathtaking pace. The below graph indicates that since summer of 2012, the median price of a new home has increased about 38%.

This is a good example of the Cantillon Effect. First users of cheap mortgage credit have bid up the housing category in a classic compartmentalized inflation.

So what's a little housing inflation matter? Well, for one, home prices are rising faster than incomes, making housing less affordable.

For another, people are more leveraged as they borrow more against less equity. Another economic downturn will once again stress cash flows and mortgage payments, leading to the familiar sound of jingle mail.

Stated differently, rising housing prices are a mirage. Like a decade ago, they are an artifact of cheap credit money bidding up assets ahead of an inevitable tumble.

Pending Home Sales

And I remember how we'd play
Simply waste the day away
--Madness

Found the timing of this piece curious as I've noticed anecdotal evidence of pending home sales declines in my neighborhood. In fact, several properties that were listed as pending almost as soon as they were posted are now back on the market.

Article suggests limited supply and associated higher prices as key factor in pending sales decline. Perhaps, but I'm now seeing properties listed at prices that would have been lifted by buyers a few months ago now sitting there.

Small sample of higher end market to be sure, but has caught my attention nonetheless.

Raising the Debt Ceiling (Again)

In violent times
You shouldn't have to sell your soul
In black and white
They really, really ought to know
--Tears for Fears

Despite Jacob Hornberger's fine argument as to why the debt ceiling should not be raised, the House jammed thru a budget bill that would raise the debt ceiling for the 79th time. The new debt ceiling would be $19.6 trillion.

Rand Paul says that he will filibuster the bill when it hits the Senate floor. Paul does have some experience with this practice.

However, absent a miracle from RP or others, the mortgage on our future is getting more burdensome once again.

Debt Profile

"You think you're free. You're not."
--Diamond Dog (Con Air)

Interesting Pew study that profiles increased tendencies for American households to increase debt and leverage over the past few decades. Approximately 80% of households have some type of debt. Younger Americans hold more debt while having lower incomes (higher leverage ratio).

Particularly interesting is the balance sheet snapshot, which indicates how few liquid assets Americans tend to have. Liquid assets and cash to debt ratios at all ages is alarmingly low.

Because debt reduces freedom and cash increases freedom and flexibility, it appears that most Americans have elected to sacrifice freedom in order to live larger in the near term.

All the King's Men

We
Are young but getting old before our time
We'll leave the TV and the radio behind
Don't you wonder what we'll find
Steppin' out tonight
--Joe Jackson

Approximately eight years ago to the day, I was in NYC visiting my good friends at Minyanville. Early tremors were shaking markets as subprime derivatives were beginning to fall apart.

I remember thinking two things. One was that few people in The City seemed aware of the danger ahead. Real estate was flying. $1000 dinner tabs were common. Limos filled the streets.

The other was that the Bush administration and Republicans were going to have their hands full trying to keep the markets together ahead of the 2008 election. They couldn't, of course, as the SPX sank by about 50% over the next year.

Here we are eight years later and the shoe is now on the other foot. Early tremors are once again shaking markets--although with less effect so far as the markets have been heavily medicated. The Obama administration and Democrats are surely thinking about what they can do to prop prices up for the next year.

One problem that they face is that they have already moved heaven and earth to jam markets higher for the past few years. As bad as they were, the Bush people applied nowhere near the preemptive interventionary force currently being administered by the Obama group.

The question is whether this administration has any interventionary capacity remaining. What tricks the Obama administration might still be able to pull to keep those limos cruising the NYC streets in the months ahead?

position in SPX

Subprime Education

Professor Jerry Hathaway: When you first started at Pacific Tech you were well on your way to becoming another Einstein and then you know what happened?
Chris Knight: I got a haircut?
--Real Genius

College students would stand better informed if they heard this 'commencement speech' by George Will. Preferably years before commencement, of course. High school, even junior high, would not be too early.



While the previous real estate bubble created the subprime mortgage, the current higher ed bubble has created the subprime education.

Superb analogy.

Net Standard of Living

Some days won't end ever
Some days pass on by
I'll be working here forever
At least until I die
--Huey Lewis and the News

A family borrows heavily to elevate lifestyle today. Jumbo mortgage. Multiple car loans. Big credit card bills. Student loan debt.

"Look at our standard of living," the family proclaims. Big house. A garage full of cars. Lots of stuff. Vacations. "We are prosperous."

Their prosperity is an illusion, of course. The family's standard of living has not been funded from its own production. Instead, it has been made possible by borrowing resources produced by others. In the future, the family will be working for others rather than for themselves. Unless future productivity is high enough to permit them to maintain their profligate lifestyles while paying off creditors, the family members will have to reduce their future consumption in order to pay their bills.

To correctly assess degree of present prosperity, the extent to which today's consumption comes from borrowed production must be taken into account. If this is done, then many would be surprised to learn how low their net standard of living is.

The family of the United States would be particularly surprised.

Bubbleheads

I'll move myself and my family aside
If we happen to be left half alive
I'll get all my papers and smile at the sky
Though I know that the hypnotized never lie
--The Who

Policymakers + learning disability

= bubble deja vu

Beta Bust

You gotta fast car
Is it fast enough that we can fly away?
We gotta make a decision
Leave tonight or live and die this way
--Tracy Chapman

In the daisy chain of financial markets, the weakest links are the first to go. In 2000 it was the dot coms. In 2007 it was sub prime mortgages.

This time around the harbinger may be small cap stocks. After being the fast cars on the way up for years, they are now being sold the hardest.

The Russell 2000 Index is more than 10% off its highs and has broken numerous technical support levels.

Beta going bust appears to be leading to the downside.

position in SPX