T Piketty and Capital Beyond the 21st Century

Popular Economics Weekly

Thomas Piketty’s Capital in the 21^st Century is about more than proving that excessive income and wealth inequality has been the norm over centuries by so-called free market capitalism, or its social democratic versions in Europe. It’s also about how future generations might share in that wealth, and hence what capitalism must look like in future centuries, if it is to survive.
For it has to be no surprise that capital growth must exceed economic growth, and so earnings, for a country to be able to feed all its citizens. Because the whole system is built upon creating enough excess to invest in order to expand future growth. That is why the capitalist system was created. That excess is called profits; or the amount of capital above and beyond operating expenses, including wages and salaries. And companies need to invest most of their profits in expanding their output, if they hope to survive.
Piketty’s contention is that capital has to be taxed in some way to guarantee a more equal distribution of its benefits for future generations, so as to avoid some of the risks inherent in more unequal wealth distribution—such as Great Recessions, Depressions, or rising levels of crime and social dysfunction as enumerated in Richard Wilkinson and Katie Pickett’s The Spirit Level.
There are several forms this can take. Nobel economist Robert Shiller has proposed inequality insurance as an answer to the propensity of capitalist systems to accumulate its wealth in fewer hands. This is insurance that governments could set up to redistribute the excess wealth being created under capitalism.

“Inequality insurance would require governments to establish very long-term plans to make income-tax rates automatically higher for high-income people in the future if inequality worsens significantly, with no change in taxes otherwise,” says Dr. Shiller, as an example. “I called it inequality insurance because, like any insurance policy, it addresses risks beforehand. Just as one must buy fire insurance before, not after, one’s house burns down, we have to deal with the risk of inequality before it becomes much worse and creates a powerful new class of entitled rich people who use their power to consolidate their gains.”

The “entitled rich people” have already begun to counterattack Piketty’s research data that he has posted online. They mainly contest his assertion that income and wealth inequality is built into the current capitalist systems. Chris Giles, Economics Editor of the Financial Times, even asserts that in Europe there hasn’t been any inequality, historically. Even though he doesn’t challenge Piketty’s main thesis, that historical returns on capital have outpaced the growth in wage and salary, and even overall economic and population growth.
Conservatives have to be looking out of another window, if they are trying to refute his data, though Giles doesn’t challenge Piketty’s conclusion for the US economy. It has the highest level of inequality of all developed countries per the CIA’s World Factbook, higher even than many developing countries.
For instance, we know that US corporate CEOs’ average CEO-to-worker pay ratio in 2012 was about 350 to 1. In 1960, the average chief executive earned 40 times as much as the average worker. By 1990, the average CEO earned 107 times as much. In the following decade, this ratio rose to 525:1 before settling back to 301:1 in 2003, after the 1991 recession.
That’s in part because average household incomes have been stagnant since 1980 after inflation, whereas the top 1 percent’s earnings have skyrocketed—garnering some 96 percent of total US national income generated since the end of the Great Recession.
British economist Andrew Smithers observes in his new book, "The Road to Recovery," one of the reasons. Stock-related bonuses for executives encourage them to make decisions that boost their share prices in the short term, rather than in the long term. The result is that they spend corporate capital less on long-term investments, which will set their companies up for future profit, and more on shoveling dividends to investors, which props up their shares quarter by quarter.
And that is the very antithesis of what the capitalist system was created to do. Otherwise it is just benefiting the few vs. the many, as we said. For instance, Smithers observed American companies devoted 15 times as much capital to investments as they disbursed to shareholders, until the 1990s. Today the ratio is less than 2 to 1. And we know the top 25 hedge fund managers earned some $24.3 billion in 2013, according to Forbes Magazine.
So will the capitalist systems we know today survive? And if so, in what form, or is there a better, more equitable, economic system we cannot yet see?

Harlan Green © 2014

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Where Is Housing Affordable Anymore?

Financial FAQs

How much salary do you need in order to afford the principal and interest payments on a median-priced home in your metro area? To find out, HSH.com, a mortgage data service, took the National Association of Realtors’ first-quarter data for median home prices and HSH.com’s first-quarter average interest rate for 30-year, fixed-rate mortgages to determine how much of your salary it would take to afford the base cost of owning a home--the principal, interest, taxes and insurance--in 27 metro areas.

Graph: HSH

The good news is that conforming 30-yr fixed rates are now down to 3.875 percent for a ½ origination point in California. The Hi-Balance conforming 30-yr fixed rate is now 4 percent with a ½ pt. origination fee.

Residents of the five cities that need the lowest annual salary to afford a median-priced home were: Cleveland ($29,788), Pittsburgh ($30,177), St. Louis ($31,275), Cincinnati ($31,850) and Detroit ($32,250). The five least-affordable cities were: Boston ($79,820) Los Angeles ($85,964) New York City ($89,788), San Diego ($98,534) and San Francisco ($137,129).

Unfortunately, HSH used very conservative debt-to-income (DTI) ratios to arrive at these numbers, making them seem more sensational that they really were. HSH used standard 28 percent "front-end" debt ratios, and a 20 percent down payment taken from the NAR’s median-home-price data to arrive at their figures, said the blog. But Fannie Mae allows up to 45 percent for all debt, and even 50 percent DTI, in some cases, so that homes even in the most expensive cities don’t require such high salaries.

A buyer can in fact own a home that is 160 percent higher than the median prices with the same income, or conversely, instead of the $137,150 annual salary, it can be as low as $103,000 per year with San Francisco’s $679,800 median price, if no other debt obligations.

This is while April total existing-home sales, which are completed transactions that include single-family homes, townhomes, condominiums and co-ops, rose 1.3 percent to a seasonally adjusted annual rate of 4.65 million in April from 4.59 million in March, but are 6.8 percent below the 4.99 million-unit level in April 2013.

Graph: Calculated Risk

Total housing inventory at the end of April jumped 16.8 percent to 2.29 million existing homes available for sale, which represents a 5.9-month supply at the current sales pace, up from 5.1 months in March. Unsold inventory is 6.5 percent higher than a year ago, when there was a 5.2-month supply, which is slowing those price increases.

Homes are still affordable, even in the highest-priced cities, in other words. But it’s no surprise those are the coastal cities that also have the most robust economies.

Harlan Green © 2014

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New-Home Construction, Permits Soar

The Mortgage Corner

Housing starts jumped in April and building permits hit their highest level in nearly six years, offering hope the weak housing market could be stabilizing, according to the US Census Bureau’s April report on housing starts.  This means more homes will be available to make up for the current inventory shortage, the lowest inventory of homes for sale since early 2000.

Groundbreaking for homes surged 13.2 percent to a seasonally adjusted annual pace of 1.07 million units, the highest since November 2013, the Commerce Department said. Ground-breaking for single family homes rose 0.8 percent, while starts for the volatile multi-family homes segment surged 39.6 percent.

The housing starts report suggested building activity would likely continue to rise for some time, according to Inside Debt, as permits to build homes jumped 8.0 percent to a 1.08 million unit pace in April. Permits for single family homes, however, rose just 0.3 percent. Permits for multifamily housing soared 19.5 percent.

Graph: ICAP

A separate report showed consumer sentiment falling in May on worries over income growth, tempering the housing data's upbeat signal on the economy. The news has been good but not consumer sentiment which has softened noticeably so far this month, to 81.8 vs 84.1 in final April and 82.6 vs mid-month April. The latest reading is below the low estimate in the Econoday forecast.

Weakness is split evenly between the composite's two components with expectations down 1.5 points from final April to 73.2 and with current conditions down to 95.1 which is 3.6 points below final April and which signals specific monthly weakness for the run of consumer data for May.

Graph: Econoday

Gas prices are steady and are not affecting inflation expectations which remain stable to lower, at 3.2 percent for 1-year expectations which is unchanged from final April and at 2.8 percent for 5-year expectations which is down 1 tenth.

It's hard to explain the fall off in this report, says Econoday. Job indications are strong led by the big bounce higher in the April employment report and followed by two straight weeks of significant declines in jobless claims. The stock market is making new records and housing prices are strong so far in 2014, two factors that add to consumer wealth. So we see consumer confidence continuing to improve this year as consumers feel more wealthy with a steadily improving housing market.

Harlan Green © 2014

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

New Fannie, Freddie Regulator Won’t Cut Loan Limits

The Mortgage Corner

WASHINGTON (MarketWatch) — This headline just out.  Mortgage-finance giants Fannie Mae and Freddie Mac won’t be directed to lower the limits for mortgages that they back, the new head of their federal regulator said Tuesday. In a departure from his predecessor, Mel Watt, director of the Federal Housing Finance Agency, is generally seen as favoring efforts to maintain borrowers’ access to credit, rather than focusing on winding down the government sponsored enterprises.

This is terrific news for the housing market, needless to say. One of the first actions by President Obama’s appointee to run the Federal Housing Finance Authority (FHFA) is to make it easier for home borrowers and buyers to obtain conforming mortgages—mortgages that are guaranteed by Fannie Mae and Freddie Mac, and which comprise more than 60 percent of mortgages issued these days.

The conforming limits will therefore still be $417,000 for the best conforming rates—3.875 percent with 1 origination point for 30-year fixed rates in California today—and $625,500 for so-called Hi-Balance conforming loans—now at 4.125 percent for 0 points origination in California.

“This decision is motivated by concerns about how such a reduction could adversely impact the health of the current housing finance market,” Watt said Tuesday at a Brookings Institution event.

This is while Congress and the White House work on housing-finance reform, with the Obama administration still trying to shut down Fannie and Freddie, even though they are the only agencies willing to guarantee 30-year fixed rate mortgages for middle class homeowners and buyers, and thus are the reason housing is recovering at all.

It is the misguided belief that allowing Fannie Mae to disappear—the Federal National Mortgage Association formed during the New Deal—and Freddie Mac, or the Federal Home Loan Mortgage Corporation, formed in the 1970s to further affordable housing—will no longer make the government responsible for keeping a viable housing market for most Americans.

Graph: Calculated Risk

But that is flatly wrong. Without some kind of federal ‘backstop’ that guarantees both mortgage quality and assurance that banks will continue to lend mortgages, we would not have the housing market and a homeownership rate of today. The early 1980s were the best example of banks and lenders refusing or unable to issue new mortgages when then Fed Chairman Volcker raised interest rates above 16 percent to combat inflation.

The foreclosure rate for conforming loans has always been the lowest of any conventional loans. Fannie Mae reported recently that the Single-Family Serious Delinquency rate declined in March to 2.19 percent from 2.27 percent in February. The serious delinquency rate is down from 3.02 percent in March 2013, and this is the lowest level since November 2008.
And Freddie Mac also reported that the Single-Family serious delinquency rate declined in March to 2.20 percent from 2.29 percent in February. Freddie's rate is down from 3.03 percent in March 2013, and is at the lowest level since February 2009. Freddie's serious delinquency rate peaked in February 2010 at 4.20 percent.

So their foreclosure rates are close to the historical average of 1 percent, whereas other ‘private label’ mortgages (those mostly portfolio loan issued and held by banks) have remained above 4 percent.

The FHFA is looking at making sure that the companies operate safely in the current environment, Watt said. Watt, who has been noticeably absent until now from the debate over how to reform the U.S. housing market, said Tuesday that the FHFA has three goals: maintain, reduce and build.

“Since any stumbles along the way could have ripple effects in the $10 trillion housing finance market, there’s a lot at stake in getting this right,” Watt said. But getting it right doesn’t mean the federal government shouldn’t have the responsibility to maintain the viability of homeownership, a responsibility it has kept since the 1930s.

Harlan Green © 2014

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Why Low Interest Rates Are Here to Stay

Financial FAQs

Some have called it a Putin bond rally. Or it might be new Fed Chairperson Yellen’s determination to keep interest rates as low as possible, until economic prosperity returns to Main Street. It might as well be because our employment rate is still above 6 percent, with many millions of the long term unemployed out of work.

In fact, for all of these reasons, interest rates are returning to their Great Recession lows. This will certainly boost housing sales and prices, as it has for motor vehicle sales, as well as shorter-term borrowing that small businesses need, in particular.

For instance, the 30-year fixed conforming mortgage rate has dropped to 3.875 percent with a 1 point origination fee for some lenders in California. The US 10-year Treasury bond yield is back down to 2.61 percent as of this writing, and Italy and Spain’s 10-year bond yields have dropped below 3 percent for the first time since their recessions.

Graph: S&P

One can see from the accompanying chart that rates are at historic lows, as low as the wartime 1940s. Why such low rates? The latest rate downturn is probably because of a flight to quality by jittery investors, that see bonds as the safer investment during such uncertain times. It happened with Putin’s invasion of Eastern Ukraine and the US and European threat of serious sanctions that could bring an already weak Russian economy to a period of severe deprivation.

The 18-member Organization for Economic Co-operation and Development (OECD) just reported that 2014 Russian economic growth has probably slowed to 0.5 percent from its earlier forecast of 2.8 percent growth, in spite of Russia’s tremendous oil and gas reserves.

"The moderate recovery that was under way at the end of 2013 has been halted by the turbulence related to the events in Ukraine," said the OECD. "Associated increased uncertainties and capital flight are now weighing on investor confidence. Consumption growth will weaken as real income growth slows and consumer credit becomes more expensive."

And the OECD doesn’t see worldwide economic growth picking up anytime soon. It’s almost a truism that uncertain times mean hoarding of monies. US corporations are hoarding some $2 to $3 trillion in liquid assets, depending on whom you ask, banks more than $1 trillion in excess reserves. That means they see no markets to invest their record profits, and so would rather pay their executives excessive salaries and shareholders higher dividends.

Graph: Econoday

Another reason for such low interest rates is of course the low inflation rate, which affects interest rates even more directly. This is because bond interest rates are usually fixed (except for the Treasury’s inflation-indexed bonds), so any increase in the inflation rate reduces the value of their bonds.

The Personal Consumption Expenditures Index has been below 2 percent since the end of the Great Recession, except for a period in 2011 when expectations of growth were higher. It is now just 1.1 percent, which is what enables the Fed to keep their short term rates so low.

And lastly, Q1 2014 GDP growth came in at just 0.1 percent, with some pundits predicting it could become negative with the next revision. All this is certainly enough to keep both short and long term interest rates low for a long time.

Harlan Green © 2014

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

288,000 Payroll Jobs Created

Financial FAQs

Is the Great Recession finally over? It would seem so with total nonfarm payroll employment up by 288,000, and the unemployment rate down by 0.4 percentage point to 6.3 percent in April, the U.S. Bureau of Labor Statistics reported today.

And the change in total nonfarm payroll employment for February was revised from +197,000 to +222,000, and the change for March was revised from +192,000 to +203,000. Need we say more about the jobs recovery? In fact, private employment is now above the pre-recession peak by 406 thousand, but we are still 113,000 jobs below the overall pre-recession peak because governments lost so many jobs—such as 300,000 teachers.

Graph: Calculated Risk

It’s been the cutbacks in state, local and federal spending that has kept US from a full-blown recovery. This graph that compares government hiring under GW Bush (red line) with Obama (blue line) tells us the damage such a loss of government jobs has done to employment. So there is still much work needed to bring everyone back to work. A real shocker was that the labor force fell by 803,000 in the Household survey, which is why the unemployment rate plunged from 6.7 to 6.3 percent.

Graph: Calculated Risk

In fact, some economists are predicting there might be a labor shortage in 10 years, since so many are either dropping out of the labor force, or just not entering it in sufficient numbers as the baby boomers retire. There is no question that some of the damage was self-inflicted, what with the partisan budget battles and downgrading of US sovereign debt by S&P.

Other factors that kept growth and employment low were soaring corporate profits that weren’t reinvested, while workers’ wages and salaries remained stagnant, so that consumers spent less. The just released first quarter 2014 GDP grew 0.1 percent, in part because of the winter, but also because businesses didn’t order more goods to restock their shelves.

Some of the employment increase was also due to the end of a very severe winter, so we don’t know if such job creation can be sustained. It will be in part up to Janet Yellen’s Fed to keep interest rates down as long as possible, and not be fooled by the artificially low unemployment rate that is due more to workers leaving the workforce than entering it.

Harlan Green © 2014

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen