Tuesday, March 15th, 2011

Our Debt: Why Rich People Should Be Worried Too

Back in the days before the great bull market began to charge in August of 1982, there was a soothsayer called Joe Granville. He was the Mad Money Jim Cramer of his day, a showman and exhibitionist whose performances included walking on water (across a swimming pool in Tucson, dressed in a tuxedo) and a piano-playing chimp. Despite that his demeanor wasn't what you would expect of a great financial brain, he attracted a large following of investors for his $250-a-year financial letter (about $615 in today's money), partly because, as People magazine explained, he had called four major stock-market turns in two years. His reputation grew to the point that when he issued a "sell everything" fax to his premium subscribers in January 1981 the market dropped 2½% on its busiest trading day to that point in history.

For every big financial turn, there's at least one hero who saw it coming. It's not surprising, when you think about it. Given the number of promoters airing their opinions, it would be surprising if someone, somewhere, hadn't called it, maybe even three or four times in a row. It's like the monkeys with the typewriters. The surprising thing isn't the occasional masterpiece. It's when the same lucky monkey who wrote Taming Of The Shrew then proceeds to peck out Two Gentlemen of Verona and Love's Labour's Lost. And, sure enough, Joe Granville's reputation didn't survive the Great Bull. Apparently, he's still in business, but I read somewhere that over the past 25 years his recommendations have lost an average of 20% a year. No word on his piano-playing chimp.

There are various heroes for the financial crunch of 2008-10; such as Robert Shiller of Yale, who called both the dotcom and the housing crashes, and Meredith Whitney, the banking analyst formerly at Oppenheimer who first exclaimed, in October 2007, that Citigroup was wearing no clothes (and who, by the way, is now predicting a meltdown in the municipal bond market). Perennial doomsayer Nouriel Roubini of NYU is also often cited, although he was already something of a stopped clock by 2008, more focused on the trade deficit with China than on the exponential rise of house prices.

Lately, the economic duo of Kenneth Rogoff and Carmen Reinhart have become talk-worthy because of a series of studies of past financial crises focusing on the dire consequences of having too much debt. Their most recent paper on "The Aftermath of Financial Crises" caused a stir because it's telling us that running up bigger deficits will only prolong the problem, a prescription that goes against the current policy of deficit-financing backed by both political parties—whatever they may say to the contrary—in the recent tax-cut-extension act. Probably nobody disagrees with Rogoff and Reinhart that our debt is a problem, but how big a problem is it and why is it a problem?

Well, if you add up $14.5 trillion in mortgage debt, $14 trillion of national debt (Treasury bills and bonds), $2.5 trillion in consumer debt (credit cards, student loans, car loans, etc.) and $3 trillion in state and municipal debt, you get to around $34 trillion. Given that we have about 140 million people working right now, that works out to about $240,000 for every working stiff in the country.

The median household (about 2.5 people) in the US has an income of around $52,000 a year, and that's including things like unemployment and Social Security benefits.

To pay back $240,000 at five percent over thirty years would cost this hapless worker about $1,300 a month or $15,500 a year. Obviously, that doesn't leave much for spending on stuff. Which in turn means companies don't make as much stuff and don't need to hire as many people, which means fewer paychecks, which means… the debt makes it much more difficult to pull out of the slump.

According to Rogoff and Reinhart, unemployment rises by seven percentage points after your average financial crisis—we're at about five so far—and the employment down-cycle lasts more than four years. House prices go down 35% over six years and stock markets go down 55% over three and a half years. Per capita real GDP goes down 9% over almost two years (ours went down about 4% and has just recovered to the level it reached in the fourth quarter of 2007). These are all average numbers for post-WWII crises. During the Depression, the United State's GDP per capita went down a lot more—almost 30%—and bottomed out after four years. And because tax revenues go down when nobody has a job, government debt goes up—by an average of 86%. Which, of course, makes it that much harder for the economy to climb out of the swamp. Since March 2008, the government's debt has so far increased about 49%—and it's still climbing quite rapidly.

But one of the most interesting questions—and one that doesn't seem to get much emphasis in the media— is, to whom exactly do we owe all this debt? We talk about "the debt" almost as if it were a kind of mythic Black Hole into which indentured humanity will have to pitch income forevermore, yet the debt must be owed to somebody. So who? Who are the blighters seated at the other end? Aliens?

To listen to the pols you'd think, indeed, we owe it all to the Chinese, who will therefore shortly become our lords and masters. Actually, that's not really true; it's just a convenient diversion. John Boehner, for example, recently attacked the debt-mongering (while ignoring that it's mostly due to Bush tax cuts and Bush wars) by declaring that it was "immoral to rob our children’s future and make them beholden to China." Truth is, this makes about as much sense as him pronouncing his name "Baner." In Treasuries, for instance, our total debt to China is about $1.1 trillion. It's not nothing, and there's likely other debt than Treasuries, but in the whole $34 trillion scheme of things it's clearly not the main problem.

The fact is, we owe most of this $34 trillion to our real lords and masters, viz., rich people. That is, John Boehner's campaign-funders; hence the China diversion. It stands to reason, really. The debt built up because for decades our working stiff has been spending more than he makes. He was only able to do that because rich people were willing to lend him the money, which they did because (a) they have, literally, more money than they can spend; and (b) they needed to keep the economy humming along and so preserve the value of their investments. There's a little bit more to it than that, which has partly to do with the magical ability of banks (N.B., owned by rich guys) to create money, but the essence is there: only people who don't spend all their income, by definition, can lend money, so who the hell else would we be owing all that money to?

Now you can see why our economic system is prone to periodic crises. If rich guys take too much of the national income, year after year, the economy can't sustain itself and eventually collapses. That's maybe one reason why the countries with the highest income inequalities are often the poorest. In terms of the "Gini coefficient," a measure of income inequality, the US ranks in the worst 30% in the world, right between Jamaica and Cameroon, and with greater inequality than such countries as Tunisia, Egypt and Libya.

In other words, income inequality is, in the long run, a recipe for economic disaster. And economic disaster isn't good for anyone—not even rich guys. It might, for example, do the wealthy well to remember that, between 1928 and 1933, the number of millionaires in the US went from around 30,000 to around 5,000 (see Kevin Phillips, Wealth & Democracy). You can only suck so much blood before the victim dies, and then what are you going to do for food?

Clearly, what we need for our long-term economic health is a system that allocates income more equally. Theoretically, it would be possible to do this without taxation, by giving wage slaves a bigger share of the pie. But that would mean lowering executive pay and/or corporate profits, measures that probably won't be accepted voluntarily. So we're left with taxation. The fact is, it's in the best interest of all Americans, including the high rollers, to raise the tax rate on the upper-income tiers. Taxing the rich isn't just morally fair, it's good for the economy. The more grounded and rational rich guys, like Warren Buffett and, recently, Bill Gross of Pimco, recognize this; but the current in Washington is clearly with the delusional fringe that thinks lowering taxes on the rich promotes growth. After all, worked pretty well so far; right, George?

The fact is, the economy will come back into balance at some point, either through defaults (which will result in rich guy creditors being no longer so rich), inflation (likewise) or a long and grinding repayment of the debt (rich guy stockholders no longer so rich). One way or the other, the rich-guy creditor-stockholder is going to take his drubbing. With little prospect of getting the rich-guy tax rate up near term, it looks like we're going to have to do it the hard way. Forsooth!

Carl Hegelman (a pen name) is a corporate bond analyst and a connoisseur of leisure.

Image courtesy of the Gallery of Space Time Travel, via Wikimedia Commons.

20 Comments / Post A Comment

NinetyNine (#98)

Though this is generally spot on, the debt figure is a little high because presumably some of that debt is the other side of pension funds (particularly the bonds) and other investments of those are who aren't in the top decile. And without a figure for assets, it's not really a proper balance sheet (again, most of the assets are concentrated at the top, but it's a little dodgy to offset debt with income only). That's not to say every working stiff owes substantially less than $240K, but since mortgages & consumers debt account for half, it's not like this is some Bleak House scenario where people are paying off their parents' debts. So a good $130-145K is shit you bought.

SidAndFinancy (#4,328)

To which I would add, it's not just working stiffs paying it off: retirees pay income taxes, property taxes and capital gains taxes, virtually everyone pays sales taxes, and, of course, corporations pay taxes.

NinetyNine (#98)

Sure, and you can get exercised about water bills being 'taxes,' but I think maybe you and I are moving towards differing goals with similar arguments. I very much agree with the proposition that we need to sharply increase the tax load on the top decile (which, absurdly, I think I'm in every couple years? I say absurdly because I can barely afford to rent an apartment presently). I would say 'to return to a historic norm' but unfortunately that isn't strictly speaking true, though it is readily observable that periods of strong across the board growth in GDP and individual wealth correlates to a lower GINI coefficient (that vaunted 50s and 60s, e.g.). I just hesitate to roll out extravagant stats (every baby owes a million dollars!) to service the argument because some sharpie comes along with statement like mine. I think it's entirely rational to say reducing income inequity is a healthy policy decision for economic growth without scare tactics. My pony is also arriving any day now.

petejayhawk (#1,249)

Boehner = Böhner = (very, very roughly equivalent to) "Baner."

lbf (#2,343)

Except not really: "BUH-ner".
I have a theory that his tan is a diversion: he paints himself a ridiculous shade of orange so that late-night comedians will make fun of that instead of his name.

btw: I just stopped reading the article at that point just to say that was one of the greatest lines I've read all year.

dado (#102)

During the Clinton administration, rich was defined as those making over $400,000. The Obama adminstration has classified the rich as those making over $250,000, which would have been about $175,000 in 1996. Those are not people who feel rich, generally, and when they get lumped in with Gates and Buffett they go absolutely bonkers. Where do you draw the line?

riotnrrd (#840)

Well, the obvious and simple solution is to create a new top tax bracket (or maybe several) with a higher marginal rate. Unfortunately, in a country where poor people are actively working to repeal the estate tax, this simple and clean solution would never fly.

atlasfugged (#4,481)

@dado: In 1993, Clinton created two new income brackets: the first was for married couples jointly making $115,000-$250,000 and was taxed at a rate of 36% rate; the highest bracket was for couples making $250,000. Adjusted for inflation, the two brackets would have been $175,263.98-$381,008.65 and $381,008.65+, respectively, in today's dollars. The current top tax brackets are $212,300-$379,150 and $379,150+. They are currently taxed at 33% and 35%, respectively. (I'm not considering individual filers).

What Obama has proposed is for the Bush Tax Cuts to expire on married couples jointly making $250,000 a year. Under this plan, the second highest bracket would begin at $250,000, instead of $212,300 as it is currently, and instead of $115,000 (or $175,263 adjusted for inflation) as it would have been under Clinton's policy. Filers in this bracket would be taxed at 36% instead of 33%. The threshold for the highest bracket would remain the nearly the same as it is currently: $379,650, which adjusted for inflation is slightly less than $250,000 in 1993 dollars. So, on balance, Obama's plan is more generous in terms of how the highest two brackets are defined than both Bush's and Clinton's tax policies.

See here (XLS) and here.

I agree with riotnrrd that more brackets would be fairer, but, given the political temperament of our Teabagger-ized Congress, such a proposal is essentially fantasy. Post Bowles-Simpson, the will in Congress is to eliminate tax-brackets, in the name of tax-code simplification (six brackets is somehow too much for accountants to wrap their minds around), not to increase their number.

petejayhawk (#1,249)

It's so sad. A couple years ago, I had a great conversation with my mom about the illusions of wealth. I grew up in the '80s and '90s in an upwardly mobile upperish-middle-class household. At my parents' peak earnings (before divorce, mental health issues, firings, bad business dealings, and other unfortunate events), they had a combined household income of about $200,000 in the mid-90s. They were damn near RICH, in Obama terms.

HAHAHA, that's laughable. Sure, for those of us making less than $200k combined household income, it sounds like a lot, And you know, neither my sister nor I wanted for much. But to say we were rich, or anything near it? That's fucking ridiculous. Absolutely fucking ridiculous. "Rich" means you have money in the bank, that you're not mortgaged out your ass, that you can afford your medical bills, that you don't have to duct-tape your Saturn together to keep it running north of 200k miles. $200k affords a family a pretty decent living, but it doesn't make them rich, and anyone who disagrees can go fuck themselves. Including Barack Obama.

Bettytron (#575)

Well, you were in the top 5-10% of the country for household income. Being able to afford medical bills means you're a sight more comfortable than most other Americans. I'll just be over here fucking myself, thanks.

Well, it sounds like they took on too much debt. I think it's ridiculous to group families making $250k with those who make over a million, but the notion of whether you feel rich or not doesn't really mean anything. In the end, it's not how much money you earn, but how much you spend.

Combined my wife and I make a little over $200k a year, and we will fully admit that we are rich (and before you ask, we live in NYC.)

We are doing better than most of our middle class family members (making around 50-80k who live in other parts of the country) and the majority of our peers, who also grew up just like you did. The reason why is that we have very low debt. We do not have a mortgage, we have a total of around 2k in credit card debt, and around 40k in Sallie Mae student loans. The fact is that the standard of living has gone down for most people in this country from the time when you were a child. Thus, the fact that we live in a safe area, with health insurance, and some money in the bank (i.e. not living check to check) means that we are indeed rich compared to the rest of America.

The mistake a lot of people in our situation make is getting into debt trying living the life that they think people who make over 200k are supposed to live. If you take huge vacations twice a year, go out to bars every night, eat out all the time and spend money on new clothes every week of course you won't think you are rich, because you have no money left. But, you are still rich. You just make poor choices with your income.

One of the things that people in this country fail to understand is that the change in tax rates is marginal, which means that you only get taxed at a higher rate on the dollars you make over a certain threshold. For the majority of those of us who fall right on the border, the real difference in how much you will pay won't be substantial. Don't get me wrong, it is still an amount that is noticeable, but it won't exactly put us in the poor house.

It's better for the long term fiscal health (and therefore my own, personal financial outlook) if the country gets back on the right track by taxing those of us who are more fortunate.

Smitros (#5,315)

Additional background might be provided by Reinhart and Rogoff's book This Time It's Different, which catalogs how eight centuries of financial innovation have failed to escape the gravity of economic fundamentals. CDOs, naked shorts and all that are just the latest steps in the march of folly.

propertius (#361)

I'm always amused by the fact that you can wade through reams of newspaper and other articles on business and economics and never see the name Marx or reference to Marxist analysis. I suppose this is because they see these degringolades as a structural feature of capitalism, not as accidents. It's more comforting to think we can tinker with taxation and save capitalism.

Hamilton (#122)


roboloki (#1,724)

the rich taste like chicken.

Abe Sauer (#148)

Well, I'll start telling everyone it's going to be ok then. Thanks.

Brunhilde (#1,225)

Man. As a former Risk Analyst at (redacted) watching Mad Money the day Jim Cramer put us at the Man. As a former Risk Analyst at watching Mad Money the day Jim Cramer put us at the (redacted) rank on his wall of shame, and everbody on the trading floor watching in silence, and then the one great big "class clown" from (redacted) yells out, "That hurt"…. Jesus. It's not like any of us didn't see it coming. I feel like the people that made the decisions didn't ever look at my market models past the point of "If the market moves this much, this is how much our assets will be worth" rather than "THE MARKETS ARE PROBABLY GOING TO MOVE THIS MUCH ASSHOLES". Sorry. Bitter. 9 months of unemployment–> alcoholism (at the very least) –>job-that-a-mentally-challenged-monkey-could-do-for-half-your-former-salary –> me "working" from the bar today and I really need to shut my computer right fucking now.

rank on his wall of shame, and everbody on the trading floor watching in silence, and then the one great big "class clown" from yells out, "That hurt"…. Jesus. It's not like any of us didn't see it coming. I feel like the people that made the decisions didn't ever look at my market models past the point of "If the market moves this much, this is how much our assets will be worth" rather than "THE MARKETS ARE PROBABLY GOING TO MOVE THIS MUCH ASSHOLES". Sorry. Bitter. 9 months of unemployment–> alcoholism (at the very least) –>job-that-a-mentally-challenged-monkey-could-do-for-half-your-former-salary –> me "working" from the bar today and I really need to shut my computer right fucking now.

AngelinaL (#9,601)

Truly wealthy people cannot see paying interest on debt as a smart thing. Why would you ever pay interest on debt EVEN if your investments out earn the payout. What is the point of having an investment if you are throwing out money… to do nothing. The people you are talking to are not rich – they do a a lot talking, but there is not much substance behind. Plus, debt free is security. If you lose a job, you don't have to worry about people calling you for things that you haven't paid for yet. I got rid of all my consumer debt with the help of clear debt solutions. I have a lawyer bill that I am trying to get rid of (if I ever finish my custody/child support case).

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