Leverage giveth and leverage taketh away

A new study out of the Federal Reserve today confirms what some of us already knew. The leverage bubble excessively inflated consumer net worth from 1992 to 2007 and now that the bubble has burst, consumer net worth has fallen all the way back to where it began 18 long years before. This is causing some to conclude that the housing crash evaporated net worth, but really that is only half of the story.  Centuries of history assure us there is a full cycle of human behavior that completes this tale.

Adding leverage inflates growth and demand on the way up and everything looks better year over year. This encourages naive consumers to take on more and more payments and obligations–buy bigger houses, trips and cars.  It encourages service providers and manufactures to ramp up targets, expectations and capacity. Overhead, egos and entitlements soar–rising revenues and credit lines appear to afford everything. Lenders take pride and bonuses for “genius growth” finding innovative ways to extend more and more loans. Governments happily ramp up spending with expectations of ever rising tax revenue-mostly collected from capital gains made on rocketing asset prices. Central Bankers are seen as rock stars as they repeatedly cut policy rates lower with each sign of any consumption fatigue.

Until rates hit bottom and interest payments cannot be serviced from income.  Then economic hell breaks loose.  Excess leverage implodes, ridiculous asset prices collapse on their owners, and once favorable conditions go hard in the opposite direction for 15-20 years. We are working our way through this downside now. See: Fed says US wealth fell 38.8% 2007-2010.

“Median net worth declined to $77,300 in 2010, the lowest since 1992, from $126,400 in 2007, the Fed said in its Survey of Consumer Finances. Mean net worth fell 14.7 percent to a nine- year low of $498,800 from $584,600, the central bank said yesterday in Washington. Almost every demographic group experienced losses, which may hurt retirement prospects for middle-income families, Fed economists said in the report.

“The impact has been a massive destruction of wealth all across the board,” said Lance Roberts, who oversees $500 million as chief executive officer of Streettalk Advisors LLC in Houston. “What you see is an economy that’s really very, very stressed for the bottom 60 to 70 percent of the population that’s struggling just to make ends meet.”

The good news is that consumer debt levels are finally moving back down in the US. Everyday people are beginning to understand how wacky things were. They have lived to see the downside of leverage. Now they are admitting loses, reining in spending and clearing debt through repayment and bankruptcy. These are all steps toward healing and financial health and a more self-sustaining economy in the future.

Now it is up to the banks and governments to do the same. Debts that cannot be repaid must be written off and down. Balance sheets that were over-inflated must now be marked to market. Entitlements that were promised will need to be reduced.  CEO’s, bankers and politicians who took kudos and excessive pay on the way up must admit they were fools and step aside. Some will need to go to jail. Some will need to give back proceeds of crime and negligence.

The world will get back to the discipline of daily work, patience, and spending less than we make, and the cycle will complete once more.

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2 Responses to Leverage giveth and leverage taketh away

  1. Andrew says:

    There will be growing political pressure in Europe and here to use inflation to deal with the high levels of sovereign and personal debt. Inflation is the most politically expedient and acceptable solution. This means a transfer of wealth from savers to debtors as debtors outnumber savers. Whether we like it or not printing will be the way out.
    I believe the ZIRP policy of the FED to the end of 2014 is a step toward central bank targeting of nominal GDP over other measures. If GDP is growing at 1%, inflation will be acceptable at 4%.
    If true this implies care in how ones bond portfolio is constructed.

  2. Martin says:

    Ceo’s will give back nothing…
    Some high living individuals will learn.
    Most will feel they were victims and will whine and repeat the same pattern asap.

    Human behavior will prevail as always.

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