Breakingviews

It’s the budget, not the economy, stupid

By Rob Cox 

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

It’s the budget, not the economy, stupid. That variation of the 1992 slogan that propelled Bill Clinton into the Oval Office may now apply to Mitt Romney’s candidacy. The Republican presidential wannabe’s choice of conservative House budget chief Paul Ryan as his running mate has the power to transform a heretofore mealy campaign into something substantive: a referendum on fixing the American balance sheet.

It’s pathetic that it has taken the nomination of a 42-year-old Wisconsinite from Congress to give Romney’s candidacy much appeal, even to his base, beyond the simple fact that he is not Barack Obama. But at a time when debt crises threaten the sovereignty of developed nations and the U.S. fiscal picture is about as bleak as it has been has outside of wartime, righting the country’s finances is the stuff of long-term legacy creation.

Despite his relative youth, Ryan has spent 13 years in the House, neutralizing arguments that he’s unprepared for the post. Though that includes the Bush era, when Congress was at its most profligate, Ryan has since distinguished himself as a proponent of fiscal probity. His recent counter-proposal to the White House’s budget was a serious attempt to propose constructive fixes to vexing long-term economic problems.

Elements of Ryan’s plan, particularly deep cuts to entitlement and Medicare spending, offer the Democrats a distinct target. But that’s a necessary debate for the country to engage in. For Romney, too, it’s a better issue to campaign on than a half-hearted defense of the GOP’s more recent obstructive record in Congress.

Moreover, whatever either candidate says on the stump, tangling with America’s finances will be the chief legislative task of the new president. Congress will not find a solution to the so-called “fiscal cliff” of some $450 billion of tax increases and $1.2 trillion of spending cuts that take effect from 2013. In all likelihood, a lame-duck legislature will extend the implementation of these into the first half.

Uncle Sam still living well beyond his means

By Martin Hutchinson The author is a Reuters Breakingviews columnist. The opinions expressed are his own. Uncle Sam just can’t seem to stop living beyond his means. While U.S. consumer credit failed to match its June 2008 peak, outstanding debt of domestic U.S. non-financial sectors still stands at nearly 250 percent of GDP, against 232 percent just before the financial crisis hit. While the consumer has deleveraged a bit, business debt is flat and government borrowing has soared. At some point, this just has to end. 

Economists Carmen Reinhart and Kenneth Rogoff demonstrated that recessions preceded by a financial crash can be exceptionally deep and long, because of the reduction of debt that needs to occur before normal growth returns. Since 2008, with unprecedented levels of fiscal and monetary stimulus, no net U.S. deleveraging has occurred; rather the liabilities of non-financial sectors have grown faster than GDP. While households have cut back (partly through defaulting on mortgages and credit cards) from 97 percent of GDP to 83 percent, business debt kept pace with GDP and the government’s balance sheet has soared from 57 percent of GDP to 89 percent. 

In the longer term, taking a 20-year comparison from 1992, all three sectors have increased their debt-to-GDP ratios by more than 20 percentage points, though the increase in government borrowing has been entirely concentrated in the last four years. As a result, economic activity since 2008 has been given an artificial boost. That suggests that the true deleveraging process, in which debt is reduced closer to 1992’s level of around 182 percent of GDP, will be very painful indeed, requiring major reductions in consumption at all levels. 

The first stop will be the federal deficit, which inevitably must come down. The corporate sector will likely need more equity, which would dent stock prices generally. Though anathema to policymakers, higher real interest rates would allow consumers to rebuild savings and discourage further indebtedness. Whatever the solution, it’s hard to see a trifecta of negative real interest rates, rising stock prices and trillion-dollar deficits lasting too much longer.

Risk appetite set for brutally hot Spain vacation

By Ian Campbell The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Global markets are being shaken out of their laid-back summer. Risk appetite faces an unpleasantly hot and long vacation in Spain’s provinces. Stocks, commodities and the euro are likely to suffer. Yet again the dollar, yen and safe-haven bonds will win.

For the last two months, euro worries and stocks had decoupled. The sense was that the euro zone could be propped up and global growth stimulated. A rout of risky assets on July 23 leaves both assumptions evaporating.

The immediate catalyst for volatility is the suggestion that several of Spain’s provinces will follow Valencia and seek support from Madrid. A short-selling ban on Spanish stocks reeks of panic. Elsewhere in the euro periphery, reports that the International Monetary Fund is washing Greece off its hands are unsettling. But so long as Greece has a government that isn’t giving up on meeting austerity targets, Europe is unlikely to abandon it.

Spain and Italy are the more acute worries. The yield on Spain’s 10-year debt is at 7.4 percent, Italy’s at 6.34 percent, having overtaken Ireland’s last week. Regionally and nationally Spain’s economy remains in fiscal distress. Spanish debt is rising far too fast, by 68 billion euros – more than 7 percentage points of Spain’s falling GDP – in just one year, to 72 percent of GDP. After the recently agreed European support for banks, additional external assistance for Spain seems certain to be necessary, even if the next crunch refinancing is a couple of hot months off.

Until there’s clarity about how Spain is to be supported, markets will play out well rehearsed defensive moves. The euro is likely to continue its not unwelcome slide, breaking below $1.20. Stocks and commodities, which have risen to two-month highs despite global growth fears, look set to be stewed. A retreat below the sub-1300 early June S&P 500 low would seem a minimum.

The dollar, yen and safe-haven bonds again look like the beneficiaries. The U.S. 10-year Treasury now yields just 1.4 percent, its lowest since the 1800s. That makes it less likely the U.S. Federal Reserve will print money again to drive Treasury and mortgage yields down: euro fear is doing the job. And in the absence of that, the correction in risk assets may be steeper.

U.S. student debt on scary trajectory

By Daniel Indiviglio The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

U.S. student debt is on a scary trajectory. New statistics from the New York Federal Reserve show just how steep it is. Education loans are piling up at an unsustainable rate and delinquencies are rising despite the slowly improving American economy. Instead of trying to tackle the problem, Washington’s policies continue to exacerbate it.

Student loans in the United States have surged to $900 billion from $360 billion in just seven years. Even as the U.S. housing bubble inflated between 1999 and the start of 2006, mortgage balances didn’t grow that fast. The bursting of that bubble triggered the worst recession since the Great Depression. Sure, the numbers were considerably larger. But there’s enough student debt to cause trouble – more than auto loans or credit card debt, for example.

And people are struggling to make their payments. The Fed’s numbers show that a startling 12 percent of borrowers aged 40 to 49 are at least 90 days behind. That’s a demographic that should be in the prime of their careers and free of such stress. The unemployment rate for that group is probably under 7 percent, according to Bureau of Labor Statistics data, significantly below the national average of 8.2 percent. Moreover, though joblessness has declined from its late 2009 peak of 10 percent, most age groups are experiencing higher rates of student loan delinquencies.

The implication is that even as the U.S. economy slowly improves, many Americans will continue to struggle under the weight of borrowing that was supposed to bring them qualifications and well-paid jobs. Most of the loans are backed by taxpayers, raising the prospect of huge writeoffs for the government down the road. But instead of working out how to curb the growth of the loans, policymakers continue to subsidize student borrowing. Just this month, President Barack Obama signed legislation to keep the cost of education loans at a below-market 3.4 percent.

Making further borrowing ultra-cheap is the wrong medicine. At the recent growth rate, Americans’ student debt will exceed their credit card and auto loan balances combined within five years. With incomes growing only slowly, something will have to give.

U.S. student loan fix robs the old to pay the young

By Daniel Indiviglio The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Keeping student loan rates low is requiring some devilish financial engineering from U.S. lawmakers. To cover the cost of the education subsidy, they’re blessing some aggressive accounting for government-backed pensions. The plan could put taxpayers on a bigger hook for both retirees and graduates.

The hocus-pocus is tucked away in a transportation bill, passed as most Americans were gearing up for Independence Day festivities. Federal spending on highways and related infrastructure has grown too large to rely on the gasoline tax alone. So to cover the $14 billion hole and another $6 billion to reduce student borrowing rates, Washington essentially raided its pension guarantee fund.

The Pension Benefit Guaranty Corp, which insures private retirement plans, can ill afford it. The fund’s net deficit last year increased to $26 billion.

Congress is leaning on the PBGC in a similar way it did Fannie Mae and Freddie Mac earlier this year to pay for a temporary payroll tax cut. Then, it hiked mortgage insurance premiums for 10 years to pay for a mere two-month extension. This time, it uses a decade’s worth of boosted pension guarantee premiums for roads and a year of cheaper tuition loans.

It gets worse. Congress also conjures up another $9 billion in revenue over 10 years to fill the remainder of the gap by relaxing accounting standards for pension funds. It allows employers to use discount rates based on average corporate bond rates over 25 years instead of two years. That lets them contribute less money for the same expected return. With fewer contributions, corporate tax deductions fall and government revenue magically rises.

It’s a clever solution for everyone but taxpayers. To cover coming payouts, pension contributions needed to rise by at least $50 billion annually for the rest of this decade, according to George Mason University’s Mercatus Center. So, the accounting change effectively makes a taxpayer bailout even more likely.

Bankruptcy loses its taboo for California’s cities

By Agnes T. Crane and Martin Hutchinson

The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Bankruptcy is no longer taboo among California’s struggling cities. San Bernardino has just become the third Golden State municipality in two weeks to fail – ending a four-year hiatus since fellow California town Vallejo began its costly and protracted court battle against creditors. So far, though, investors seem pretty sanguine.

Granted, the three cities, which also include Stockton and Mammoth Lakes, are hardly bustling metropolises – each has a population of less than 300,000. But California, home to the glamorous Silicon Valley and Los Angeles, has the high taxes, big government and heavy regulation that are characteristic of major metropolitan areas.

That makes it especially tough for cities in the state’s heartland that can’t attract the glitterati. They have also been hammered by the housing market bust. Throw in rising pension costs and terrible governance and it’s likely that other towns will turn to the courts to remedy their woeful finances.

Yet municipal bond yields on lower-rated debt actually fell 0.06 percentage point to just 3.71 percent in the days after Stockton and Mammoth Lakes turned to the courts. Compare that to the height of muni madness two years ago, when investors feared a wave of defaults would rip through the $3 trillion market. Yields then topped 5 percent.

So what gives? First, the hysteria in 2010 was overblown. Bankruptcy is, and should be, the last resort for cities and counties who have exhausted all other options. As San Diego and San Jose have shown this year, governments can deploy more creative initiatives to plug budget shortfalls.

Central bank stimulus won’t solve the crisis

By Ian Campbell

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Following another weak U.S. jobs report, fear abounds. The sense is that the global economy is teetering and central banks can’t do much more. The point is that in the developed world they should not do more. Monetary policy risks becoming harmful if pushed further.

Mario Draghi, the President of the European Central Bank, hinted at the limits of policy on July 5. The interest rate doesn’t work so well when demand for credit is lacking, he said. In other words, you can create pools of cheap money but you can’t make nervous borrowers drink. Nor did it seem that he was thinking of other spurs, such as quantitative easing. It’s “not obvious there are measures that could be effective in a highly fragmented area”.

The hard truth is that Draghi is ill-placed to stimulate growth in the euro zone. Confidence is the problem. The ECB cannot resolve a crisis of insolvent and uncompetitive states locked in a union with solvent and competitive ones. Only politicians can do that. Then the growth horses might drink.

The Bank of England is trying, but it’s hard to imagine the newly launched 50 billion pounds of quantitative easing, taking the total to a colossal 375 billion pounds, will do much for growth. Of course, the BoE could emulate the U.S. Federal Reserve and buy mortgage-backed securities. But UK house-buyers might still be reluctant to drink.

In emerging economies, central banks are far from the end of the stimulative line. China has just cut its lending rate to 6 percent; Brazil is now down from 12 percent last summer to 8.5. Emerging economies can and will ease further, profiting from falling global inflation. But that helpful fall in inflation could itself be undone if the West chooses to push harder on the monetary string. Further QE would push up bonds, commodities and equities, pleasing financial markets – but driving up oil prices and hurting consumers.

China grows faster but most Cubans are better off

By Martin Hutchinson

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Raul Castro could use his visit to China to pick up a few tips. True, the Caribbean nation hasn’t done so badly despite being isolated by U.S. trade sanctions. It is still richer than China, less unequal and less corrupt. Still, a smattering of China-style reforms, particularly allowing freer movement of prices, could produce a useful boost to growth and prosperity.

China is the great growth story of the 21st century, while Cuba is often deemed a basket case. That’s not entirely fair. China is economically freer than Cuba, according to the Heritage Foundation, but Cuba is less corrupt and ranks much higher on the United Nations’ Human Development Index. Cubans have a higher life expectancy, and more years of schooling. Moreover, Cuba’s per capita GDP, measured in current U.S. dollars, is still somewhat higher even after China’s recent growth, while its incomes are significantly more equally distributed.

Economic policy under the Castros has interspersed periods of ideological crackdown with moments of liberalization. After Soviet subsidies ended in 1989 the economy shrank by 35 percent, but Raul Castro’s ascension to power in 2006 has brought further modest reform. Cuba has not opened up its agricultural sector as China did, maintains more extensive price controls than China, does not allow a free market in housing and remains relatively restrictive and arbitrary in its attitude to foreign investment.

There are some big differences. China’s relative poverty mostly reflects its vastly larger population and the level to which its economy sank under Mao Zedong. Copying some of China’s agricultural policies, its acceptance of the price mechanism in housing and elsewhere and its ability to work with foreign investors could provide a major boost to Cuba and its people.

There’s always the concern that opening up the economy could return Cuba to the ultra-unequal society of its 1950s past and some other Latin American countries. That’s something China itself is wrestling with. But Castro should take a pinch of China’s gradualism as well as its reform. Small-scale opening could help Cuba’s economy without destroying its social fabric. Castro can learn from China’s examples, both good and bad.

New mortgage seizure plan is the nuttiest idea yet

By Daniel Indiviglio

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

A California county’s new plan to seize underwater mortgages from investors may be the most dangerous housing market intervention yet. If it catches on, bondholders could face billions in losses – and taxpayers, too, if local authorities start targeting loans backed by the federal government. That would whack up mortgage costs and may leave Washington as the only lender.

The plan is simple enough. San Bernardino county wants to invoke existing eminent domain laws to seize mortgages that are bigger than the current value of the homes they’re lent against. That’s a radical departure from the way eminent domain is usually deployed – to commandeer land for public use, such as to build a road.

The county would then sell the loans to a fund called Mortgage Resolution Partners. The deal is a no-brainer for all concerned: the investment group makes a profit on the safer new mortgages – to qualify, borrowers have to be current on their payments. The homeowners get a loan that’s now worth less than their home, so also end up with some equity. And the local politicians look smart and may win some extra votes.

But that doesn’t allow for the true cost of the program. Assume it’s implemented across the country and includes not just private-label mortgages, as is the case in San Bernardino, but the far larger market of those backed by the U.S. government. That opens up the scheme to a large chunk of the $1.2 trillion-worth Americans owe on their mortgages above the current value of their homes, according to Zillow’s first-quarter Negative Equity Report.

That would cause enormous losses for bondholders and taxpayers alike. At the extreme, private investors would probably abandon any intentions of financing a private mortgage market in the future, leaving the U.S. government as the only entity willing to shoulder the risk.

iPhone anniversary marks triumph over crisis

By Robert Cyran

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Apple rolled out its iconic iPhone five years ago, just as Bear Stearns subprime hedge funds sounded the alarm on a systemic trauma. Financial woe often impedes development. But the iPhone is proof that innovation can defy the odds and overcome hard times.

The advance of technology is hard to stop. R&D budgets do get slashed in downturns. The growth rate of patent filings has slowed during the recent crisis. But companies that don’t invest, or that do so poorly, can suffer. Research In Motion and Nokia learned the lesson all too well. Their market values have plummeted over 90 percent since mid-2007.

More importantly, desired products, whether new plastics in the 1930s or smartphones now, tend to thrive regardless of the economic climate. About 40 percent of Dupont’s revenue in 1937 came from products introduced during the Great Depression. Almost 60 percent of Apple’s sales are now generated by the iPhone.

Apple’s focus on high-end customers hasn’t hurt. Even reduced disposable income at a certain level still leaves plenty left over for a new bauble. But the iPhone offers value for the considerably less affluent, too. It replaces digital cameras, personal organizers, guidebooks, dictionaries, satellite navigation systems and music players. That list isn’t inclusive and is bound to grow.

The contrast with the financial crisis is a stark one. Apple’s market value has increased by about $430 billion since the iPhone was introduced. The device represents a majority of the company’s sales and an even greater proportion of profit, and has contributed greatly to the popularity of the iPad. That makes it safe to ascribe a healthy amount of the gain to the iPhone.