Individuals May Be Deleveraging, but the Nation Isn't

This post from OptionARMageddon has some rather sobering charts. While individuals are deleveraging, the first chart shows that we as a nation are still increasing overall debt. Now before you start talking about how we can handle it because it is all relative, check out the second chart on debt as a percentage of GDP. Yes it is all relative, and right now it is looking relatively terrible compared to where we were in the not too distant past. As a percent of GDP, U.S. debt is well over twice as much as it was when I graduated high school. I won't tell you when that was but you can make a good guess from the chart. Let's just say I had never seen a computer in person before my high school graduation. More disturbing, it is up - as a percentage of GDP - more than a third this millennium alone. This is not a good sign for those that think we are on the road to recovery. We are, my friends, on the road to a stark new reality.

OptionARMageddon is not the only site to notice the debt load. Sudden Debt had a nice piece on it yesterday. As this site also observes, a true economic recovery will need us to reduce this debt load but so far the government has not figured out (or accepted) this painful fact. The government probably realizes this but hopes it is not true as the reality is it will take many years, perhaps over a decade, for deleveraging to get us to where we need to be and no politician (facing reelection in the not to distant future) wants to tell his or her constituents this reality.

Yet hey, what do I know. The stock market seems to have a perpetual upward movement and daily I scratch my head (and other parts) trying to figure out why.

Defining Irony

I love to go and listen to presentations by financial planners. They pretty much all say the same thing on asset allocation and the like and they all try to pretend the last two years did not happen. Yes they will pay lip-service to it, but they will not address how their out-of-the-book recommendations are tied to models that ignore fat tails like we have just been through. Indeed, I read a couple of months ago a nice piece on how according to many of these models certain financial market changes were so extreme that the models would not have predicted them happening in the entire history of the planet Earth, yet they happened three times in a single month last year. Yet we still depend on these same old approaches because historically they "usually" work. I guess at the moment you could say the past two years are behind us so the models should work better now going forward.

I headed this topic in terms of irony as I was sitting yesterday listening to a representative from Merrill Lynch tell me how to invest for my retirement. All I could think of while I sat there was how Merrill Lynch almost bit the big one (and would have if BofA (BAC) had not bought it) and how Lewis has this week been testifying how he got strong-armed a bit into buying Merrill Lynch. Yet here I was having them explain to me how to diversify and allocate among different retirement investments. Basically they said they would look at my age, my savings, my savings rate, my income, my target retirement age and a few other factors to properly allocate my retirement dollars between equities, bonds, fixed income, etc.

What they were not saying was that this was based on a computer model that invests on historical norms and that does not adjust at all based upon current economic conditions or fundamentals. It only adjusts for the most part based on my age. Maybe this works for most people but I still prefer to control my fate and base it at least in part on what I see to be economic conditions and fundamentals. My retirement account presently is larger than it was two years ago so I do not think I am totally off base with this philosophy because I am pretty sure the woman presenting has significantly less in her retirement than two years ago. My approach is obviously not for everyone, but if you spend 2-5 hours a day or more reading up on financial matters, you may be better off to, at least in part, call your own shots.

Mortgage Madness

Mish provides in the linked post some additional details on how mortgage rates have skyrocket in the past few weeks, and, as a consequence, new mortgages and refinancings are frozen. I noted yesterday that my own experience with rates up 1% in a month. My lock at 5% was good for 30 days and the appraisal, which came in close to 15% lower than I thought it would, did not come in until a few days before the lock expired. The mortgage company probably would not have done the deal had I not had cash available to pay down my existing mortgage so that I could reduce the principal needed for the refi loan and keep my LTV at an acceptable level. The lender also add a quarter point to my closing costs, but given that I was shaving over a full percentage point off my rate, it was still a deal. Not everyone can do this and a lot of refinancings in the works are tanking, after folks have already incurred the cost of an appraisal.

I wrote a few weeks ago on how I suspect a lot of banks are going to take it on the chin with the low rates that existed here for the past few months. Looking at Treasury auction action, more than a few players are betting on inflationary times ahead - despite current deflationary pressures. If inflation goes to seven or eight percent, my new mortgage company will be paying me to borrow money. And if this apparent recovery does take hold (I don't think it will for a couple of years, but who knows) then the record breaking stimulus dollars globally could lead to high inflation rates. Either way, those institutions giving 4.5-5.0% loans that are fixed for 25-30 years are truly taking a big risk. My first mortgage in 1991 was at 10.5% and that was an ARM. I considered it a good rate as rates had been over 15% not too many years before then. I am not saying rates will go there again any time soon, but they do not have to go up too much from where they are today for some institutions to be kicking themselves on the low rates of the past few months, which is undoubtedly why many institutions are looking for any excuse to get out of locked in rates.

Disclosures: None.

Comments

[Moon Kil Woong]

I have a hard time not laughing at brokers seling their pitches. As the author mentions, they are a lot better at sizing up your wallet and determining what products give them the most commissions than determining the best performing investments for you.

That's because they are pure sales. Back in the old days brokers were paid to help people craft portfolios of stock with little transaction commissions. Nowadays they couldn't help you do that if they tried and I propbably wouldn't want them to because they don't know anything about the market. Back in thwe old days they actually worked for their money. Now they just sell mutual fund reputation and expect an annual fee as well as letting Uncle Sam tax your theoretical gains (did they ever figure out for you how bad that is for your financial health?)

Sadly, most people would be better off with a discount broker and no advice. Perhaps that's why people's financial status is so bad in the first place. Wasn't it brokers who told them buying a house with no money down was good since they could still keep their retirement piggy bank growing? A lot of good that did them. Now they have no house and their assets have dropped 50%. If they are lucky they aren't out of a job. If they were the broker would be saying, "See isn't it good I told you to keep your money in reserve for a rainy day?"

2009 Jun 12 05:48 AM

[Partly Sunny]

Thanks. Well said and entertaining.
One suggestion: Next time you attend an investment dinner/seminar, stop by the bar for a quick one. It'll make everything more entertaining. And you can blissfully enjoy the great meal they serve.

2009 Jun 12 09:25 AM