Tag: USA

When Holding Cash Beats Paying Debt

From The US On The Economy Blog.

For families who are struggling financially, there are times when it is better to keep some cash on hand, even if they hold high-interest debt.

A recent In the Balance article highlights the importance of emergency savings to the financial stability of struggling households. It was authored by Emily Gallagher, a visiting scholar at the St. Louis Fed’s Center for Household Financial Stability, and Jorge Sabat, a research fellow at the Center for Social Development at Washington University in St. Louis.

The Struggle to Make Ends Meet

Many families continue to struggle to make ends meet, the authors said, noting a recent Federal Reserve survey that estimated that almost half of U.S. households could not easily handle an emergency expense of just $400.

Given this, they asked: “Should more families be encouraged to hold a liquidity buffer even if it means incurring more debt in the short-term?”

In explaining why it might make sense, for example, to keep $1,000 in a low-earning bank account while owing $2,000 on a high-interest-rate credit card, Gallagher and Sabat’s research suggests this type of cash buffer greatly reduces the risk that a family will:

  • Miss a rent, mortgage or recurring bill payment
  • Be unable to afford enough food to eat
  • Be forced to skip needed medical care within the next six months

Linking Balance Sheets and Financial Hardship

Gallagher and Sabat investigated which types of assets and liabilities predicted whether a household would experience financial hardship over a six-month period.

Their survey encompassed detailed financial and demographic results that covered two time-period observations for the same household: one at tax time, and the other six months after tax time.

“This feature of our data set is ideal for capturing the probability that a household that is currently financially stable falls into financial hardship in the near term,” the authors explained. “Furthermore, the survey samples only from low-to-middle income households, our population of interest for understanding the antecedents of financial hardship.”

They tracked families in the first survey who said they hadn’t recently experienced any of these four main types of financial hardship:

  • Delinquency on rent or mortgage payments
  • Delinquency on regular bills, such as utility bills
  • Skipped medical care
  • Food hardship (going without needed food)

Gallagher and Sabat also asked if the family had any balances in:

  • Liquid assets, such as checking and saving accounts, money market funds and prepaid cards
  • Other assets, including businesses, real estate, retirement or education savings accounts
  • High-interest debt, such as that from credit cards or payday loans
  • Other unsecured debt, such as student loans, unpaid bills and overdrafts
  • Secured debt, including mortgages or debts secured by businesses, farms or vehicles

Controlling for factors such as income and demographics, they then tracked whether the 5,000 families in the survey had suffered a financial shock that would affect the results.

Cash on Hand Matters Most

The authors found that having liquid assets or other assets always predicted lower risk of encountering hardship of any kind, while having debts generally increased the risk of hardship.

Liquid assets had the most predictive power, Gallagher and Sabat said. They noted that a $100 increase (from a mean of $6) was associated with a 4.6 percentage point reduction in a household’s probability of rent or mortgage delinquency.

Liquid assets also significantly reduced the likelihood of entering into more common forms of hardship. A $100 increase in liquidity was associated with declines in the rates of:

  • Regular bill delinquency (by 8.3 percentage points)
  • Skipped medical care (by 6.3 percentage points)
  • Food hardship (by 5.2 percent percentage points)

“These estimated effects are substantial relative to the probability of encountering each hardship,” they said.

Conclusion

“Our findings suggest that households should be encouraged to maintain at least a small buffer of liquid savings, even if the cash in that buffer is not being used to pay down high-interest debt,” Gallagher and Sabat concluded.

FED Lifts Rate As Expected

The FED has lifted the federal funds rate to 1.5% after their two day meeting – the third hike this year. The move was expected and had been well signalled.  This despite inflation still running below target, though they expect it will move to 2% later.  More rate rises are expected  in 2018.  This will tend to propagate through to other markets later.

Information received since the Federal Open Market Committee met in November indicates that the labor market has continued to strengthen and that economic activity has been rising at a solid rate. Averaging through hurricane-related fluctuations, job gains have been solid, and the unemployment rate declined further. Household spending has been expanding at a moderate rate, and growth in business fixed investment has picked up in recent quarters. On a 12-month basis, both overall inflation and inflation for items other than food and energy have declined this year and are running below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Hurricane-related disruptions and rebuilding have affected economic activity, employment, and inflation in recent months but have not materially altered the outlook for the national economy. Consequently, the Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will remain strong. Inflation on a 12‑month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1-1/4 to 1‑1/2 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

Voting for the FOMC monetary policy action were Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Patrick Harker; Robert S. Kaplan; Jerome H. Powell; and Randal K. Quarles. Voting against the action were Charles L. Evans and Neel Kashkari, who preferred at this meeting to maintain the existing target range for the federal funds rate.

Fed Keeps Countercyclical Capital Buffer at 0 percent

The Federal Reserve Board announced on Friday it has voted to affirm the Countercyclical Capital Buffer (CCyB) at the current level of 0 percent. In making this determination, the Board followed the framework detailed in the Board’s policy statement for setting the CCyB for private-sector credit exposures located in the United States.

The buffer is a macroprudential tool that can be used to increase the resilience of the financial system by raising capital requirements on internationally active banking organizations when there is an elevated risk of above-normal future losses and when the banking organizations for which capital requirements would be raised by the buffer are exposed to or are contributing to this elevated risk–either directly or indirectly. The CCyB would then be available to help banking organizations absorb higher losses associated with declining credit conditions. Implementation of the buffer could also help moderate fluctuations in the supply of credit.

The Board consulted with the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency in making this determination. Should the Board decide to modify the CCyB amount in the future, banking organizations would have 12 months before the increase became effective, unless the Board establishes an earlier effective date.

Digital Lending; On The Up

S&P Global just published their 2017 U.S. Digital Lending Landscape report.

They estimate that 15 of the most prominent U.S. digital lenders grew originations at a compound annual growth rate of 129.4% during the five-year period ended Dec. 31, 2016. Going forward, they project slower growth for the industry as lenders focus on building sustainable businesses
with higher quality borrowers.

They predicts that these lenders will originate $62.84 billion in new loans during 2021, up from $29.31 billion in 2016. This represents a CAGR of 16.5% for the five-year period ending Dec. 31, 2021.

Personal-focused lending is projected to grow at a CAGR of 12.4% to $24.31 billion by 2021. The small and medium enterprise and student-focused lending segments are projected to grow faster, with respective CAGRs of 21.5% and 18.4%.

Regulation remains unclear for the industry, but signs of progress have emerged during the past year. Regulators have started to take a closer look at digital lending in an attempt to create a fair and clear regulatory framework.

Venture activity picked back up during the first three quarters of
2017, with $832.5 million raised by the lenders in our analysis.
Student-focused lender Earnest was acquired by student loan
servicer Navient for $155 million in November.

Interest rates and loan sizes have remained relatively unchanged over the past year as lenders focus more on adjusting the rates and loan sizes associated with specific credit grades.

As regulators take a harder look at digital lending, corporate
governance and management teams must ensure that their
companies are beyond reproach. 2017 was the second consecutive year in which a high-profile CEO has been forced to
leave their company.

Fed Lifts Smaller Mortgage Loan Threshold

The Consumer Financial Protection Bureau (CFPB), Board of Governors of the Federal Reserve System, and Office of the Comptroller of the Currency (OCC) today announced that the threshold for exempting loans from special appraisal requirements for higher-priced mortgage loans during 2018 will increase from $25,500 to $26,000.

The threshold amount will be effective January 1, 2018, and is based on the annual percentage increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) as of June 1, 2017.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 amended the Truth in Lending Act to add special appraisal requirements for higher-priced mortgage loans, including a requirement that creditors obtain a written appraisal based on a physical visit to the home’s interior before making a higher-priced mortgage loan.

The rules implementing these requirements contain an exemption for loans of $25,000 or less and also provide that the exemption threshold will be adjusted annually to reflect increases in the CPI-W. If there is no annual percentage increase in the CPI-W, the agencies will not adjust this exemption threshold from the prior year. However, in years following a year in which the exemption threshold was not adjusted, the threshold is calculated by applying the annual percentage change in CPI-W to the dollar amount that would have resulted, after rounding, if the decreases and any subsequent increases in the CPI-W had been taken into account.

Is Peer To Peer Lending Mirroring Sub-Prime?

An interesting paper from the Federal Reserve Bank of Cleveland “Three Myths about Peer-to-Peer Loans” suggests these platforms, which have experienced phenomenal growth in the past decade, resemble predatory loans in terms of the segment of the consumer market they serve and their impact on consumers’ finances and have a negative effect on individual borrowers’ financial stability.

This is of course what triggered the 2007 financial crisis. There is no specific regulation in the US on the borrower side.  Given that P2P lenders are not regulated or supervised for antipredatory laws, lawmakers and regulators may need to revisit their position on online lending marketplaces.

While P2P lending hasn’t changed much from the borrowers’ perspective since 2006, the composition and operational characteristics of investors have changed considerably. Initially, the P2P market was conceived of as individual investors lending to individual borrowers (hence the name, “peer-to-peer”). Yet even from the industry’s earliest days, P2P borrowers attracted institutional investors, including hedge funds, banks, insurance companies, and asset managers. Institutions are now the single largest type of P2P investor, and the institutional demand is almost solely responsible for the dramatic, at times triple-digit, growth of P2P loan originations (figure 2).

The shift toward institutional investors was welcomed by those concerned with the stability of the financial sector. In their view, the P2P marketplace could increase consumers’ access to credit, a prerequisite to economic recovery, by filling a market niche that traditional banks were unable or unwilling to serve. The P2P marketplace’s contribution to financial stability and economic growth came from the fact that P2P lenders use pools of private capital rather than federally insured bank deposits.

Regulations in the P2P industry are concentrated on investors. The Securities and Exchange Commission (SEC) is charged with ensuring that investors, specifically unaccredited retail investors, are able to understand and absorb the risks associated with P2P loans.

On the borrower side, there is no specific regulatory body dedicated to overseeing P2P marketplace lending practices. Arguably, many of the major consumer protection laws, such as the Truth-in-Lending Act or the Equal Credit Opportunity Act, still apply to both P2P lenders and investors. Enforcement is delegated to local attorney general offices and is triggered by repeat violations, leaving P2P borrowers potentially vulnerable to predatory lending practices.

Signs of problems in the P2P market are appearing. Defaults on P2P loans have been increasing at an alarming rate, resembling pre-2007-crisis increases in subprime mortgage defaults, where loans of each vintage perform worse than those of prior origination years (figure 1). Such a signal calls for a close examination of P2P lending practices. We exploit a comprehensive set of credit bureau data to examine P2P borrowers, their credit behavior, and their credit scores. We find that, on average, borrowers do not use P2P loans to refinance pre-existing loans, credit scores actually go down for years after P2P borrowing, and P2P loans do not go to the markets underserved by the traditional banking system.1 Overall, P2P loans resemble predatory loans in terms of the segment of the consumer market they serve and their impact on consumers’ finances. Given that P2P lenders are not regulated or supervised for antipredatory laws, lawmakers and regulators may need to revisit their position on online lending marketplaces.

 

US Tax Plan Will Be Revenue Negative, Result in Higher Deficits

United States: Outlook for Public Finances Worsens says Fitch Ratings who expects a version of the tax cuts presented in the Tax Cuts and Jobs Act to pass the US Congress.

Such reform would deliver a modest and temporary spur to growth, already reflected in growth forecasts of 2.5% for 2018. However, it will lead to wider fiscal deficits and add significantly to US government debt. As such, Fitch has revised up its medium-term debt forecast.

US federal debt was 77% of GDP for this fiscal year. Fitch believes the tax package will be revenue negative, even under generous assumptions about its growth impact. Under a realistic scenario of tax cuts and macro conditions, the federal deficit will reach 4% of GDP by next year, and the US debt/GDP ratio would rise to 120% of GDP by 2027.

The Republican tax plan delivers a tax cut on corporations, seeking to lower the corporate tax rate to 20% from 35%, and removing many exemptions, while eliminating some tax breaks affecting corporate and personal filers. It would leave the overall personal tax burden somewhat lower, although the effects would differ depending on circumstances.

Tax cuts may lead to a short-lived boost to output, but Fitch believes that they will not pay for themselves or lead to a permanently higher growth rate. The cost of capital is already low and corporate profits are elevated. In addition, the effective tax rate paid by large corporations is well below the existing statutory rate. From a macroeconomic perspective, adding to demand at this point in the economic cycle could add to inflationary pressures and lead to additional monetary policy tightening.

Fitch expects US economic growth to peak at 2.5% in 2018 before falling back to 2.2% in 2019. The US will enter the next downturn with a general government “structural deficit” (subtracting the impact of the economic cycle) larger than any other ‘AAA’ sovereign, leaving the US more exposed to a downturn than other similarly rated sovereigns.

The US is the most indebted ‘AAA’ country and it is running the loosest fiscal stance. Long-term debt dynamics are also more negative than those of peers, with health and social security spending commitments set to rise over the next decade. In Fitch’s view, these weaknesses are outweighed by financing flexibility and the US dollar’s reserve currency status, underpinning its ‘AAA’/Stable rating. The main short-term risk to the rating would be a failure to raise the debt ceiling by 1Q18, when the Treasury’s scope for extraordinary measures is expected to be exhausted. The debt ceiling is currently suspended until early December.

US Corporate Tax Reform: Implications for the Rest of the World

The Treasure has released a paper “US Corporate Tax Reform: Implications for the rest of the world” which examines the likely impacts of the US reforms on the US and on the rest of the world, placing the US changes in the context of the global trend toward lower corporate taxes.

The paper says that the economic impact of the Republicans’ tax plan will depend on how time and compromise shape the package that is ultimately legislated. Key in this regard is the size of the cut, how it is funded and whether investors believe it is a permanent reduction.

On 27 September 2017, the United States (US) Administration and Republican Congressional leadership released a framework for US tax reform, including a reduction in the federal corporate tax rate from 35 to 20 per cent.

The key elements of tax framework with respect to corporate tax are:

  • a reduction in the federal corporate income tax rate from 35 to 20 per cent;
  • immediate expensing of depreciable assets (except structures) for at least 5 years;
  • limitations on interest deductions;
  • the removal of the domestic production deduction;
  • an exemption for dividends paid by foreign subsidies to US companies (where the US company owns 10 per cent or more of the foreign company); and
  • a one-time tax on overseas profits.

These proposals were reflected in the draft of the Tax Cuts and Jobs Act released by the House Ways and Means Committee on 2 November 2017.

This paper examines the likely impact of this reform on the US and rest of the world, placing the US changes in the context of the global trend toward lower corporate taxes.

In theory, a corporate tax rate cut stimulates investment by making more investment opportunities sufficiently profitable to attract financing. The extent to which this is the case in practice will depend on how the tax cut is funded and whether investors consider the tax cut to be permanent. If the corporate tax rate cut results in an overall reduction in tax on US investments and investors believe that the tax cut is permanent, we are likely to see an increase in the level of US investment. If investors believe that the tax cut is temporary, the effect on US investment may be minimal. Ultimately, the economic impact of the plan on the US will depend on how time and compromise shape the final package.

If a US corporate tax cut does result in an investment boom, goods, labour and funds will be required. In a scenario in which the investment boom is largely funded domestically from US savings, negative impacts on the rest of the world are likely to be short-lived and modest.

Realistically, however, a US investment boom is likely to be only partially funded domestically and would draw funds and goods from the rest of the world. In this scenario, the rest of the world would experience a decline in capital stock resulting from the flow of capital into the US. The magnitude of the resulting welfare loss in those countries will depend on the size of the US corporate tax cut; how it is funded; the elasticity of the US labour supply response and the US saving response. For Australia, the size of the negative impact will also depend on how other countries respond.

While the size of the US economy means changes to the US tax system have particular significance, it is important to consider these reforms as part of an ongoing trend. As capital markets have become increasingly global and business location increasingly mobile, governments have sought to drive economic growth in their jurisdictions by lowering corporate tax rates. The US reforms have the potential to accelerate tax competition between jurisdictions, making Australia’s current corporate tax rate increasingly uncompetitive internationally.

While the Administration and Republican Congressional leadership have indicated that they will ‘set aside’ the idea contained in the House Republicans’ 2016 plan to move to a destination-based cash flow tax (DBCFT), this paper also provides a discussion of the theoretical underpinnings of the proposal.

How Has the Economy Performed around Fed Chair Transitions?

From The On The Economy Blog.

Jerome Powell has been nominated to be the next chair of the Federal Reserve Board. Historically, what has happened to economic growth following a transition?

Average Growth Sometimes Slows in the Short Term

Whether a transition to a new Fed chair affects economic growth in the short term is not apparent at first glance, as can be seen in the figure below.

GDP per Fed Chair

Notable growth slowdowns occurred immediately after Chairs William McChesney Martin, Paul Volcker and Ben Bernanke took office. However, growth was stronger in the year after the terms began of Chairs Arthur Burns, G. William Miller, Alan Greenspan and Janet Yellen.

Taking the average of all seven Fed transitions since World War II, the economy grew about 0.6 percentage points more slowly in the year after a new Fed chair took office than during the year preceding the transition, as seen below.

GDP periods new Fed chair

Clearly, this is due to the very large slowdowns that occurred after Martin, Volcker and Bernanke took office. It was more common for growth to increase in the year after a transition than to decrease, but the magnitudes were smaller.

Average Growth More Often Slows over the Medium Term

In the two years following a Fed chair transition, average growth was about 0.7 percentage points less than during the two years prior to the transition, as seen in the figure above. Growth slowdowns in three-year and four-year before-and-after comparisons were somewhat larger, at 1.5 and 1.3 percentage points, respectively.

While only three of the seven transitions resulted in growth slowdowns at the two-year horizon, five of the seven transitions resulted in slower growth in both the three-year and four-year periods. In addition to transitions to Martin, Volcker and Bernanke, who experienced growth slowdowns at every horizon considered here, transitions to Miller and Greenspan also were followed with slower three- and four-year growth than had occurred prior to their terms.

Growth Slowdowns Are a Feature of the Recent Period, Too

It’s possible that early post-WWII Fed chairs faced unusual circumstances that aren’t relevant anymore:

  • Martin helped establish Fed independence from the Treasury after WWII and faced the disruption of the Korean War.
  • Burns served during the Vietnam War and, according to some observers, faced unusual political pressures.
  • Miller served the briefest term of all post-WWII chairs.

It turns out that the average growth slowdown around a Fed chair transition has been larger in recent decades (beginning in 1979) than it was before at each of the horizons considered here. The figure below shows the before-and-after growth averages for one-, two-, three- and four-year horizons for only the four most recent Fed chairs.1

GDP latest fed chairs

Remarkably, the average growth slowdown is nearly two full percentage points at both the three- and four-year horizons. As before, the large declines experienced after the Volcker and Bernanke transitions play the largest roles, but average growth also slowed in the three- and four-year periods after Greenspan took office.

Why Would a Transition Lead to Slower Growth?

The historical pattern shown here might be merely a coincidence. Another possibility is that it might reflect heightened uncertainty in financial markets and the economy as Fed leadership changes. It also might be the result of incoming Fed chairs pursuing monetary policy somewhat differently than their immediate predecessors.

Would a New Fed Chair Face a Growth Slowdown?

The number of Fed chair transitions since WWII is small, so it’s difficult to generalize about what might happen next. Nonetheless, the pattern of slower growth on average after a new Fed chair takes office is striking—especially at the three- and four-year horizons.

Notes and References

1 Janet Yellen has not been the Fed chair long enough for four full years of data, so her four-year data covers 3.5 years.

The US economy is outpacing Australia’s

From The Conversation.

Data this week pointed to a continued shakiness in the Australian economy, while the robust US recovery continued.

In Australia, private-sector lending grew at just 0.3%, compared to 0.5% in August. Perhaps more worryingly, business lending dropped 0.1%. It was, again, housing credit growth that propped up the overall figures, growing 0.5% for the month.

Worse still, new home sales fell 6.1% in September, compared to August, according to the Housing Industry Association. So Australians aren’t borrowing much, except to finance the swapping around of each other’s houses at higher and higher prices. Note to picky readers: yes, prices fell a tiny bit in Sydney last month (0.1%), but are still up 10.5% year-on-year.

The US labour market bounced back from the hurricane season, adding 235,000 private sector jobs, according to data from payroll provider ADP. This wasn’t merely a bounce back — it exceeded expectations of a 200,000 gain. This was the biggest gain since March and further evidence of the strong US recovery.

It was not surprising, then, that Conference Board figures showed strong consumer confidence. What was striking, however, was just how strong those figures were. The confidence index rose to 5.3 points to 125.9 – the highest since December 2000. The present conditions measure was also at its highest level since 2001.

The US Federal Reserve kept interest rates on hold at a band of 1.0-1.25% at this week’s meeting, but signalled a fairly high likelihood of a rate rise when they meet in December. As the statement put it:

The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate.

Perhaps the only real wrinkle is that inflation remains stubbornly low, despite unemployment being at 4.2%. Some measures of inflation expectations are rising, so the best bet is for a 25 basis point rise in December.

The Fed’s statement made pretty explicit how they think about balance these factors, stating:

the Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, and labor market conditions will strengthen somewhat further. Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term.

Of course, current Fed Chair Janet Yellen’s term concludes in February next year, and it is being widely reported that President Trump will not reappoint her. Rather he seems set (to the extent that is possible with him) to appoint Jay Powell as Chair.

I will have more to say about that in future columns, but the main thing to note here is that Powell is extremely likely to continue with the path of monetary policy that Yellen has laid out.

So why is it that the US – which suffered a major downturn – seems to have a stronger economy than Australia – which did not even go into recession in 2008-09?

One view is that the US went through a process of Schumpetarian “creative desctruction”. Homeowners who couldn’t afford their properties got foreclosed on, investment banks that weren’t viable went bust, and the rest of the financial system was recapitalised.

Australian banks, by contrast have made some progress in getting their funding structure to be less short-term and dependent on US capital markets – but only so much. And it seems quite possible that they continue to make questionable loans – particularly interest-only loans – as I wrote about here, and spoke about here.

A second view is that the US economy is better able to adapt to the changing nature of the modern economy. It has much more flexible labour markets – although much harsher and less rewarding for average workers.

Perhaps it is neither of these, but presumably both the Reserve Bank and Treasury are trying to understand what looks like a striking different between the US and Australian experiences.

Author: Richard Holden, Professor of Economics and PLuS Alliance Fellow, UNSW