Savings grace?

Myth of a low-savings rate

Martin Crutsinger of The Associated Press scored big with a deceptive story about the nation’s savings rate. After-tax savings rate, that is — the rate that does not include the $3.2 trillion Americans have socked away in 401(k)s and other pretax savings plans. But Crutsinger’s report led to the headlines sought, like this one in the Columbus Dispatch: “Savings rate lowest since Depression.”

Economists split over negative U.S. savings rate By Tricia Bishop

For the second year in a row, Americans spent more than they earned - $116 billion more in December alone. That's causing scores of economists to wring their hands over the lack of financial foresight, which could have disastrous effects on the economy if consumers suddenly, and widely, overcorrected the problem.

But the figures, announced yesterday with the release of new U.S. Department of Commerce data, might not be as bad as many think. In fact, they just might say more about the changing nature of wealth than about the country's careless cash outlay.

Since the Great Depression, the country's "personal savings rate" (the amount left over after disposable income is used up) was positive. That changed in 2005 when it dipped into negative territory for the first time since 1933.

The situation grew worse last year, according to the data, which means Americans are spending more than their current incomes, most disturbingly by borrowing against their homes or on their credit cards.

But the rate, now at a negative 1 percent compared with 2005's negative 0.3 percent, doesn't factor in spending by those who have nest eggs from prior years, whether from pension payouts, home equity, successful stock portfolios or big bank accounts. Capital gains are not included in the savings rate.

Some Americans are simply cashing in a portion of their stored-up wealth.

So, the issue is, if your profit and loss statement has a loss but your balance sheet shows good equity, why worry. Barry Ritholtz isn't worried, but advises caution.

Household Cash versus Debt: The Liquidity Paradox Posted on Feb 4th, 2007

Ignore Statistical Oddities at Your Peril
James Altucher wrote a thought-provoking column ..., The Underlevered American Household.

While I am sympatico with several of the points he raises, I vehemently disagree with his take on the relative unimportance of a negative personal savings rate in the U.S. I also believe his views on the net household assets of Americans are oversimplified. These issues are far more complex than was suggested by his column, and I'd like to address them.

Rare Data Events Are Worth Examining
The significance of a negative savings rate is due, in part, to its rarity: It has only occurred twice in the past 100 years. Combine that with the shifting distribution of assets across consumer households, and you have a pair of issues worth exploring.

Together, these have potentially significant ramifications for investors. In particular, they may greatly affect several stock sectors, and are especially worrisome for quite a few specific companies.

A fresh take on the subject comes courtesy of MacroMaven's Stephanie Pomboy (via Alan Abelson). Stephanie notes not just the negative national savings rate, but two other relevant data points: The ratio of cash to debt, and how that cash and debt is distributed in the country:

"THE PARADOX OF A LIQUIDITY-FUELED STOCK MARKET in a land rife with illiquid inhabitants is pointed up by the little chart on the right. The one that depicts cash as a percentage of household debt. Which, as is evident at a glance, is shrinking like the proverbial snowball in hell.

That highly graphic graphic comes to us from the excellent Stephanie Pomboy and her irreverent and invariably informative (block those alliterations!) MacroMavens commentary. As she observes, "For all the bragging about the $6 trillion in cash households have sitting on their balance sheets, relative to household debt, this cash cushion is at a record low!"

More disturbing still, Stephanie goes on, is that the households with the cash (and assets) "are not the ones with the debt." Rather, alas, the top 1% of householders hold 30% of the assets and 7% of the debt, while the bottom 50% hold a mere 6% of assets but a burdensome 24% of the debt.

What Stephanie envisions is that just as "the story in 2005-2006 was the cash buildup on corporate balance sheets," the story for 2007-2008 might very conceivably be "a similar increase in saving by households, as they endeavor to repair the damage inflicted by the burst of the housing bubble."

What might this mean? The precise timing is difficult to ascertain - but if the "great mass of consumers finally takes a deep breath and cuts back on their profligate spending," it would not be a particularly positive event for the economy or corporate earnings. And corporate earnings in Q4, we learn this morning, look like they have finally broken their streak of double digits gains.

As to the stock market, it has been driven by liquidity and momentum, and that can continue for quite a while, regardless of the fundamentals.

In defense of leverage Felix Salmon | Jan 22, 2007

Once upon a time, if somebody wanted to set up a company, he would have to spend his own money to do so. That limited the size of companies, and the speed at which they could grow; it also meant huge barriers to entry in most industries. Then bankers came along. If you could borrow money before you earned it, you could set up and grow companies much more quickly. Even so, however, if your enterprise failed, you were still on the hook for the whole enterprise value of the company: you lost all of your equity, but you still owed the same amount of money to the bank.

Today, the world is much more sophisticated, and risk gets chopped up into countless types of security. We're far beyond the simple invention of limited-liability companies now, where the owners of the company have zero personal liability for the company's debts. Rather than just having two asset classes, debt and equity, there's a whole spectrum of asset classes, from senior secured debt at one end, through senior unsecured and junior and mezzanine and PIK debt and preferred equity all the way up to pure equity at the other end. Some debt instruments are so risky that they behave more like equity; others are perfectly safe. There's a security for every risk appetite, and markets are gloriously efficient.

So why the worries about leverage? Yes, it's entirely possible that certain types of equity are so highly levered that a 2% fall in asset prices will wipe them out entirely. You need to have a very aggressive risk appetite to buy that kind of equity, but if that's your risk appetite, then it's out there for you. The junior debt associated with such assets is also, obviously, very risky as well, since there's a good chance that it, too, can be wiped out relatively easily if prices drop. The riskiness of such debt is reflected in the high yields that it commands in the market. In fact, those yields are so high that often the junior debt outperforms the equity. So if the holder of such highly-volatile debt gets wiped out, don't shed too many tears. For one thing, anybody holding such debt has done very well for themselves in recent years. And for another, they know exactly what they're letting themselves in for, and there's a good chance that all or some of their position is hedged in any case.

This is not a "credit house of cards", or a "Ponzi Game", or any other metaphor in which the collapse of one part of the structure leads inexorably to the collapse of the next. If equity gets wiped out, junior debt can still get paid in full; if junior debt gets wiped out, senior debt can still get paid in full. And so on. What's more, if the equity gets wiped out, that simply is not the same as "the entire capital" of the company being wiped out. In fact, it's only 2% of the capital of the company being wiped out: remember, debt is capital too.

Now there may – or there may not – be systemic risks associated with the global rise of leverage. If banks lend a lot of money into unhedged high-risk debt tranches, it's conceivable that those banks could fail in the event of a credit bust. And no one likes it when banks fail. Similarly, there might well be people who love equity-like positive returns from the debt market in the present but who will be shocked and upset if they get equity-like negative returns from the debt market in the future. But leverage in and of itself is not a bad thing: it's merely symptomatic of an increasingly sophisticated tranching of capital structures.

Although it might be a good time to buy stock in bankruptcy attorneys.

100 Bottles of Beer on the Wall by PIMCO's Bill Gross

Two domestic bubbles in the last decade are testimony to the power of levered money and the recirculation of price insensitive reserves back into U.S. financial markets.... Bond, stock, and real estate trends then, have recently been increasingly at the mercy of relatively price insensitive and levered financial flows as opposed to historical models of value or the growth of the real economy itself.

[M]y critical point is that asset prices are no longer entirely a function of the real economy: it can be just the reverse. The real economy is being driven by asset prices, which in turn are influenced by financial flows of non-historic origin, composition, and uncertain longevity. What used to be an Economics 101 “CIG + exports-imports” analysis leading to predictions for interest rates and stock prices has turned into an Economics 2007 analysis of corporate buybacks, international reserve flows and hedge fund/private equity positioning seeking to front run or take advantage of the first two.

Investors have no more significant example of the influence of financial flows on asset prices than tracking the pace of the U.S. trade deficit in the 21st century, as good a point as any to mark the beginning of our new financial era, since it encompasses both equity and housing asset bubble peaks. In effect, despite the chicken and egg aspect of why the trade deficit exists – because foreign investors want to invest in the U.S. or because U.S. consumers want to buy things – there is likely near unanimity that it is now responsible for pumping nearly $800 billion of cash flow into our bond and equity markets annually. Without it, both bond and stock prices would be much lower, the $800 billion for instance representing 3 - 4x our current federal budget deficit. Almost perversely, then, an increasing current account deficit supports and elevates U.S. asset prices as the liquidity from it is used to buy stocks and bonds.

[T]here is an inherent logic to it: more money in the “bank” – asset prices go up; fewer deposits – asset prices go down or perhaps up less. The logic no doubt is complicated, however, by the continued thrust of financial innovation and the willingness on the part of investors to take additional risk with even the same pot of money. Financial derivatives of all (almost unimaginable) varieties have sprouted to the surface in recent years allowing homeowners to lever home prices, institutions to compress risk spreads, and almost all assets to occupy a seemingly permanently higher plateau based on increased liquidity and perceived diversification of risk across the system.

I have my doubts about this permanent plateau, but the market seemingly does not, and there’s no doubt therefore that “flows” are not the entire answer, even if they have increased their level of influence in recent years. If risk takers decide to “play,” there is a casino awaiting them 24-hours a day, trade deficit or no trade deficit.

Combined, the total rise in corporate share buybacks and the financing for bond and stock markets via the increasing trade deficit have injected an average of perhaps $1 trillion annually of purchasing power into our asset markets since the end of the 2001 recession.

Because hedge funds and levered players of all types have been aware of this trade deficit/share buyback “put” and have acted upon it, the incalculable but conservatively estimatable pump from these two sources alone have poured in several trillions of purchasing power per year. Take that money and use it to invest in further high powered and levered financial instruments such as CDOs, CPDOs, and 0% down funny money mortgages of all varieties and you can understand why asset markets have done so well in recent years, and why, as my initial Outlook sentence suggested, it is so hard to analyze “value” in asset markets these days. Prices are increasingly being determined by value insensitive flows and speculative leverage as opposed to fundamentals.

[A]s Alan Greenspan stated in August of 2005: “The determination of global economic activity in recent years has been influenced importantly by capital gains on various types of assets and the liabilities that finance them.” If financial innovation and the resultant leverage derived therefrom are reflective of our 21st century liability creation, and if the U.S. trade deficit and corporate share buybacks are responsible in part for asset capital gains, then asset prices are increasingly being determined by flows and the leveraging of those flows, as is economic growth itself.