GDP up 2.5% but....

http://online.wsj.com/article/SB10001424052970203554104577001513470146048.html?mod=ITP_pageone_1

I really want to be excited about the third quarter GDP results that were released yesterday, but the details of the report gives me concerns.  The economy grew by 2.5% in the third quarter which is a big jump over the paltry 0.7% rate experienced earlier this year.

Although 2.5% growth is good--it is not good enough to make a substantial dent in our unemployment rate.  To  have sustained employment growth you need the GDP to grow at a  rate of at least 3%.  Consumer spending makes up 70% of our economy.  In order to have sustained economic growth we also need to see an increase in the income of our citizens. More income means that Americans can spend more and grow our economy.

So what did this report show?  Consumer spending was up 1.54% over the quarter.  That is great news--it means that 70% of our economy is growing.  However, other data in this report suggests that this growth in consumer spending may not be sustainable.  Inflation adjusted after tax income dropped by 1.7% in the quarter--the first drop in income since the fourth quarter of 2009.  In addition the savings rate (savings as a percentage of disposable income) dropped to 4.1%--it's lowest level since early 2010.  So what does this mean?  Consumers bought more goods in the third quarter even though their income dropped.  With income dropping how were consumers able to spend more?  Simple--they dipped into their savings to pay for this spending increase.

The only way to have a sustained recovery is through increases in after tax income.  If income goes up people can spend more.  Let's all hope that this is just a minor, one-time, data blip and not the foreshadowing a more serious problem in our future.

Why Obama is Changing Student Loans Programs

Summary:


Why did the Obama administration make changes to the federal student loan program?  They are responding to the following concerns:

1. The cost of going to college appears to be increasing by more than inflation for the last three decades;
2. Despite the cost increase--going to college is still a good deal for most--but not as good as it used to be;
3. Many students are taking out more in loans each year to attend college;
4. Student loan default rates are up;
5. The unemployment rate for recent college graduates is more than double the rate for all college graduates;
6. Starting salaries for recent college graduates, adjusted for inflation, are down over the last decade;
7. College students and their parents vote in elections;
8. This is why college students and recent college graduates are Occupying Wall Street.

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President Obama announced some significant changes to the federal student loan program today.  The major changes include:

• allowing an estimated 6 million people who hold both direct government student loans and government backed private loans the ability to consolidate these debts into one government loan--it is anticipated that this could result in the reduction of the annual interest paid on these loans by an average of 0.50%; and
• moving up the start date of a program already approved by Congress that caps monthly student-loan payments for borrowers with low incomes from 2014 to 2012.  Existing rules allow borrowers to limit their loan payments to 15% of income, with all debt forgiven after 25 years of payment.  The new rules would cap loan payments to 10% of income, with all debt forgiven after 20 years of payment.  This new Pay As You Earn program could help 1.6 million existing students and recent graduates.

Also today the Department of Education and the Consumer Financial Protection Bureau announced that they were teaming up to launch a new "Know Before You Owe" project aimed at creating a financial aid shopping sheet which colleges and universities could use to better help students understand the type and amount of aid they qualify for and easily compare aid packages offered by different institutions.  For an example of what this financial aid shopping sheet could look like go to: http://www.consumerfinance.gov/static/students/disclosure.pdf

Why does the Obama administration believe these new programs and policies needed?  Student loan debt and college tuition rates increase at rates much greater than inflation. Unemployment rates are up dramatically for recent college graduates.   Many college graduates have taken whatever job is available to pay the bills --the business student as waitress and the law student as bartender.  Not surprisingly, given the job situation for many recent graduates, student loan default rates are up quite a bit since 2007.  Lastly, incomes are down on an inflation adjusted basis (unlike tuition) for recent college graduates.  It is really quite simple--higher college costs and fewer, lower paying jobs makes paying back student loans difficult.  This is why many young people are Occupying Wall Street.

Take a look at this chart created by Mark Perry a Professor of economics at the University of Michigan (for the whole article go to:  http://mjperry.blogspot.com/2011/07/higher-education-bubble-college-tuition.html):

Wow--College Tuition is going up at a faster rate than health care!

This chart shows college tuition rising by by 7.45% a year from 1978 to 2011 compared to a 5.8% annual rise in medical care costs.  As you can see from the new home data in the chart--the housing bubble's home price increases pale in comparison to the price increases in college and health care.  However, it is important to remember that the housing industry, with housing being the single largest asset owned by most individuals, is a much more significant part of our economy than health care or universities and colleges. 

Many point out that college tuition and fee rates that are published by colleges dramatically overstate the amount of tuition actually paid by students and graduates.  Many who go to college receive Pell Grants and other scholarships that materially decrease the tuition sticker price.  The sticker price is what a minority of students actually pay for college.  These are valid points, however it doesn't negate the fact that the college tuition sticker price has nearly tripled, after adjusting for inflation, over the past 30 years.  The fact that discounting off the sticker price exists doesn't prove that the net cost of going to college isn't increasing at a rate greater than overall inflation.  Although I cannot prove that net college costs are increasing much quicker than other costs, I would venture that such an impression is held by most of our citizens.  The Pew Research Center recently conducted a poll and asked if college is affordable today--only 22% agreed that is was (see:  http://www.pewsocialtrends.org/2011/05/15/is-college-worth-it/2/).


I believe that going to college is definitely worth the investment.  I realize there is a debate that some want to have about the economic value of a college degree.  It should not come as a surprise that this exact topic was also debated during the Great Depression in the 1930s.  It is easy to question the economic value of a degree if you can't find a job when you graduate or if you are forced to take a job that does not require a college degree.  I very much agree that college is still a very good investment despite the increase in costs.  The following charts below do a great job of proving the huge economic benefits to an individual of a college degree:

http://www.bls.gov/emp/ep_chart_001.htm

http://economix.blogs.nytimes.com/2011/06/25/why-college-brings-a-huge-return/

http://economix.blogs.nytimes.com/2011/06/25/why-college-brings-a-huge-return/

What do these chart tell us?  Basically having a college degree will give you an opportunity to make much more income and greatly reduces the likelihood that you will become unemployed.  The charts support the argument that an investment in higher education will pay back great returns over your working life time.  In fact, the typical full-time worker with a four-year degree is earning 65% more a year than a high school graduate.  Recent unemployment figures show that the unemployment rate for a college graduate is 4.2% versus and 9.7% for someone that has a high school degree.   However, one of the problem with these statistics is that they include all adult college graduates over many decades.  They really don't answer the question of what is likely to happen to a young person that is graduating from a four year college in 2012 or what has happened to someone who graduated during the Great Recession that began in 2007.  What is likely to happen to them?

Many young people continue to take on new debt every year to pay for college.  In fact the amount of student loans taken out each year has doubled over the past decade and exceeded $100 billion for the first time in 2010 (see the chart below).  In 2011 the total amount of student loans outstanding is expected to exceed $1 trillion.  In 2010 the amount of student loans outstanding exceeded credit card debt outstanding--historically student loan debt was a fraction of credit card debt.    

The expectations of many undergraduates have changed dramatically since they started college.  Let me tell you the story of one young man (let's call him Jack) that I know who is a senior today but started as a freshman a few weeks prior to the collapse of Lehman Brothers.  Jack's economic deal was that his parents would cover 60% of his net tuition cost and he would pay 40%.  But the Great Recession changed the deal.  His father was in the construction industry.  His parents for the first three years of college could only cover 40% of the tuition and in his senior year could not help at all. Instead of graduating with less than $40,000 in student loans he will likely have more than $80,000 in debt.  Each year Jack's parents thought things would get better and that they would be able to contribute more--but that did not happen.  I think there are many students in the Class of 2012 who had their "deal" changed.  Parent, grandparents, uncles and aunts as a result of the Great Recession we not able to help out as much as they expected.  And the summer jobs they hoped to get did not appear. 

The Wall Street Journal recently reported that more than "14% of Americans between 25 and 34 (5.9 million) are living with their parents, up significantly from before the recession.  Nearly a quarter of them have bachelor's degrees." This was not what many of these parents were hoping for when they dropped their children off at college freshman year. http://online.wsj.com/article/SB10001424052970204505304576654842642615166.html?mod=ITP_pageone_1  

http://www.usatoday.com/news/education/story/2011-10-19/student-loan-debt/50818676/1

Every type of consumer debt outstanding is down since the Lehman Brother collapse except for student loans which are up over 25% since the fourth quarter of 2008.  In 2009 the average college debt for a graduating senior with debt was $24,000 and the average graduating senior debt number had increase by approximately 6% a year since 2005 (according to the Project for Student Debt http://projectonstudentdebt.org/files/pub/classof2009.pdf ). 

http://blogs.wsj.com/economics/2011/08/15/student-loan-debt-climbs/

In 2010 that the total amount of student loans outstanding exceeded the amount of credit card debt outstanding for the first time ever.

http://www.nytimes.com/2011/04/12/education/12college.html

Student loan default rates have increased materially as a result of the Great Depression.

http://www.nytimes.com/2011/09/13/education/13loans.html?_r=3&ref=todayspaper

Students graduating with a college degrees since the Great Recession are finding it more difficult to find a job than they did prior to the Lehman Brothers failure.  Don Peck, a features editor at The Atlantic, in his recent book "Pinched, How the Great Recession Has Narrowed Our Futures & What We Can Do About It" explains some of the problems faced by recent college graduates.  He notes that "Young adults with college and graduate degrees are doing much better than those without; for 2010 as a whole, the unemployment rate among sixteen- to twenty-four-year-olds was 9.4 percent for four-year college graduates, 22.5 percent for those with only a high-school diploma, and 31.5 percent for high-school dropouts."  The Wall Street Journal reports that the "unemployment rate for recent college graduates is grads is 10.7%."  That article also notes that the current unemployment rate for all four year college graduates is 4.2%.  That means that recent college graduates are 2.5 times more likely to be unemployed than all college graduates.  http://online.wsj.com/article/SB10001424052970204505304576654842642615166.html?mod=ITP_pageone_1    

The recently graduated are having greater difficulty getting a job compared to other older college graduates in the work force.  Don Peck also notes in his book that "According to the National Association of Colleges and Employers, job offers to graduating seniors declined by 21 percent in 2009.  They rebounded by 5% in 2010 and are expected to rise again in 2011, but not by nearly as much as they've fallen." 

Lastly, we know that when adjusted for inflation median incomes of recent graduates with a bachelor's degree has fallen by nearly 10% in the past decade, and so has the median income of all families headed by a person with a bachelors degree:

http://online.wsj.com/article/SB10001424052970203476804576614802646278840.html

http://online.wsj.com/article/SB10001424052970204505304576654842642615166.html?mod=ITP_pageone_1

The Real Effects of Debt

Looks like the U.S. needs to go on a Debt Diet!

The PowerPoint slide above is from a Morgan Stanley presentation last year.  It shows how the debt burden of our government, individuals, corporations and financial institutions has ballooned to unsustainable levels.  You have to go back to the Great Depression to see data that is comparable to the debt burden we are collectively bearing today.  To much debt is not just a problem in America--it is a global problem that impacts many developed countries today.    


This weekend I read a very interesting study entitled “The Real Effects of Debt” that was published by the Bank for International Settlements (BIS) in September, 2011:  http://www.bis.org/publ/othp16.pdf.  The study indicates that many developed countries have too much debt and the result of this excessive debt will be less economic growth than we would have with lower debt levels.  The BIS is often thought of as the central banker to central banks.  It does not have much formal power, however its research is quite good and it is a very influential organization.  In fact, it was one of the few international organizations that consistently warned the world about the dangers of excessive public and private debt prior to the collapse of Lehman Brothers.

The BIS report looks at government, corporate and household debt of 18 developed nations (the OECD nations) including the U.S. over that last 30 years.  The article notes that debt can be good for a country, an individual and for corporations and that debt if used correctly can increase economic growth.  But at some point debt becomes a problem.  Just like drinking wine and eating chocolate cake—at some point what is pleasant in moderation becomes a problem in excess.  A threshold is crossed and the amount of debt suddenly becomes a drag on an economy and reduces a country's economic growth rate.

The BIS report focuses on the amount of debt a country has (household, corporate and government) as a percent of that country’s GDP in a particular year.  As you may recall, Gross Domestic Product or GDP refers to the market value of all final goods and services produced by a county in a given period, like a calendar quarter or year.


What are the problematic debt levels that they identify in this study?  The study estimates that a country's economic growth is reduced when debt levels cross the following thresholds:   

• for government debt  85% of GDP 
• for corporate debt 90% of GDP; and
• for household debt 85% of GDP.

So what are some of the results of this sobering study?  Well, the authors of the study add up all forms of the 18 countries non-financial debt (household, corporate and government).   They discover that over the past 30 years the ratio of debt to GDP in these advanced economies has increased on a relentless basis from 167% of GDP in 1980 to 314% in 2010.  This means that over a 30 year period debt increased by an average of 5% of GDP per year.  That is an amazing growth rate.   

Luckily (but scarily) the U.S. has the fifth lowest total debt to GDP ratio in the study.  But don’t pat yourself on the back yet—Greece had the fourth lowest total debt to GDP ratio—yes that is right, Greece is doing better than the U.S. by this aggregate measurement.  In the U.S. the aggregate of household, corporate and government debt to GDP ratio went from 151% in 1980 to 268% in 2010 or a 4% of GDP increase per year over the last 30 years.  Greece’s total debt to GDP ratio in 2010 was 262% (up from 92% in 1980)  and Japan’s was 456% (up from 290% in 1980).

According to the study half of the countries had a government debt to GDP ratio in 2010 that is equal to or less than the 85% of GDP threshold and half of the countries are over that threshold.  The countries over the government debt threshold include:   Japan (213%), Greece (132%), Italy (129%), Belgium (115%), Canada (113%), Portugal (107%), France (97%), U.S. (97%) and U.K. (89%).    As you can see many countries look like they need to go on a government debt diet.  The three countries with the lowest government debt to GDP ratio in the study are Australia (41%), Finland (57%) and Sweden (58%).

The corporate debt threshold identified in the study is 90% of GDP.  Only three countries have corporate debt to GDP ratios lower than 90%:  Greece (65%), U.S. (76%) and Australia (80%).  The median corporate debt to GDP ratio in the study for all 18 countries is 126%.  The three countries with the largest corporate debt to GDP ratios are Sweden (196%), Spain (193%) and Belgium (185%).  According to this study many companies need to go on a debt diet.

The last threshold noted in the study is a household debt to GDP ratio of 85%.  Eight countries have a household debt to GDP ratio of less than 85%.  The countries with household debt to GDP ratios in excess of 85% in 2010 are:  Denmark (152%), Netherlands (130%), Australia (113%), Portugal (106%), U.K. (106%), U.S. (95%), Canada (94%), Norway (94%), Spain (91%) and Sweden (87%).  Again—it looks like a lot of households throughout the developed world need to go on a debt diet.

So what can you conclude from this study?  Many developed nations have too much debt and until they complete a debt diet they will have suboptimal economic growth.  The best we can hope for in the developed world is a muddling through economy until this debt hangover runs its course. 

The bright side for the United States is that on a relative basis our household debt and government debt burdens could be worse, and sadly are in many other nations.  But the negative of this report is that many countries, including the U.S., have very difficult debt problems that they must solve and the likely solutions could negatively impact global economic growth rates for many years to come.