There’s Class Warfare, All Right,” Mr. Buffett said...

There’s class warfare, all right,” Mr. Buffett said, “but it’s my class, the rich class, that’s making war, and we’re winning.”

This is the first post in what I plan to be a series of posts on the history, status and immediate future of the welfare of average American citizens and households. 
I will start with two extracts -- the first from a conversation with Warren Buffet reported in the NYT, the second from "Sudden Debt", one of my favorite bloggers:

In a conversation with Mr Buffett  (NYT 2006)

Mr. Buffett compiled a data sheet of the men and women who work in his office. He had each of them make a fraction; the numerator was how much they paid in federal income tax and in payroll taxes for Social Security and Medicare, and the denominator was their taxable income. The people in his office were mostly secretaries and clerks, though not all....

It turned out that Mr. Buffett, with immense income from dividends and capital gains, paid far, far less as a fraction of his income than the secretaries or the clerks or anyone else in his office. Further, in conversation it came up that Mr. Buffett doesn’t use any tax planning at all. He just pays as the Internal Revenue Code requires. “How can this be fair?” he asked of how little he pays relative to his employees. “How can this be right?”
Even though I agreed with him, I warned that whenever someone tried to raise the issue, he or she was accused of fomenting class warfare....

There’s class warfare, all right,” Mr. Buffett said, “but it’s my class, the rich class, that’s making war, and we’re winning.”

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From "Sudden Debt" one of my favorite financial bloggers:

Sunday, September 26, 2010

Default Is Class Warfare

Many people believe that debt is more-or-less equally distributed across all social classes and therefore cancels out amongst them.  The example that is frequently, if totally erroneously, used is that Joe Janitor borrows money from Pete Policeman who has deposited his savings at a bank.  Unfortunately,  this type of financial reality only exists in the movies - for example in "It's A Wonderful Life"  with its Bailey Building and Loan Association.  ...

However, "real" financial reality is much closer to a much older work of fiction: Dickens' "A Christmas Carol"  and the chasm separating Ebenezer Scrooge from Bob Cratchit.  That is to say, a small percentage of people (the "monied" class) hold as assets the debts of everyone else.

With this in mind, I maintain that the assumption, service and ultimate default of debt is best analyzed  and understood not in terms of straight economics but as aspects of political and social science, at least where household and public debt is concerned (public debt being another form of personal debt, since it is assumed in the name of the people).  Straight economics - if there ever was such a thing - is completely inadequate to help us understand the dynamics involved, particularly when debt exceeds a certain percentage of income and becomes onerous.

Most every politician and economist will forcefully say the same thing: default is equivalent to disaster.  Really?  Why?

If the "bottom" 90% of the people owe their debts to the "top" 10% and can no longer generate enough earned income to service them and maintain a decent lifestyle, isn't default a great benefit to them?  Doesn't the destruction of debt - if properly handled, mind you - create social and economic justice for the vast majority of the people?  Or should the 90% keep slicing off pounds of flesh?

Yes, default means that the top 10% will suffer a radical diminution to their accustomed living standards, but is this so bad?  To paraphrase: "Where Are The Peoples' Yachts?"

So far in this crisis we have fought fire with more fire as our collective governments have forced the people to assume even more debt, purportedly to "salvage" the likes of AIG and Greece.  But it isn't them who are being "saved", of course, but their creditors.  How fair is that?

One of these days "the people" will wake up and realize that properly managed debt default is far and away to their advantage but I am not holding my breath.  Social-political leaders and their media mouthpieces are default atavists - or, more precisely, are paid to be."

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With those two quotes in mind let's begin by looking at American debt.

Before the financial crisis, at the end of 2007, I estimate about 90% of American households owed about 90% of private American debt to much less than than 10% of American households.  I will attempt to refine that statement as I proceed with these posts.

Since the end of 2007, under the guise of "protecting the financial system" the US Federal Government, by a variety of strategies, has guaranteed to pay much of the debt "owned" by the wealthiest families in America, while contributing virtually nothing to reduce the debt burden on middle debt middle class families who owe that debt, and through no fault of their own are now jobless or cannot maintain a decent standard of living.

By so doing, the Federal government has

• Accelerated its ongoing, sometimes unconscious, three decade old project of moving wealth from the very poor and the middle class to the very wealthy. 
• Indebted the next few generations of middle class Americans to pay the often fraudulently manufactured debts of their antecedents.

Now let's look at some numbers:


Debt is the sum of repeated borrowing, so I will start with looking at charts of
American borrowing by sector and then get to "debt", the result of borrowing, in later posts.

Every quarter the Fed publishes a detailed "Flow of Funds" report  which reports and reconciles American borrowing and debt in considerable detail.  The detail is summarized into 6 main sectors:

1. Household
2. Business
3. Federal Government
4. State and Local Government
5. Financial (the FIRE sector)
6. "RestofWorld".   

 Item 6 is very small, adds nothing to our understanding and clutters up charts, so I will almost always ignore it

 Chart 1 (click for larger charts) gives the annual history of American borrowing by sector for the last 34 years.

Chart 1

As we see in Chart 1, total US borrowing began to rapidly increase in the early 1980s, leveled off in the mid 1980s, began to explode monotonically in the early 1990s, and even faster in the 2000s.  The reasons for this borrowing explosion are well understood.  In the three years before the crash Americans were borrowing about $3.5 trillion/yr with banks and households leading the pack at more than a $1 trillion/yr each.

Chart 2 reports annualized borrowing every quarter from the beginning of 2007 (pre crisis) to mid 2010 which is the latest data we have

Chart 2

These charts paint an interesting picture:

1. When total borrowing started to rise rapidly in the 1990s, it was private borrowing (the financial, household and business sectors) which was responsible for the rapid rise.  The public sector (Federal government and State and Local government sectors) remained relatively quiet). 
2. The primary cause of the rapid rise in total borrowing was the FIRE sector, followed by the household sector
3. The primary reason for the crash was the precipitous drop in borrowing by the FIRE sector, followed by the household sector.
4. It was only in 2008Q2, in response to the collapse of the financial sector's ability to borrow that the Federal government stepped in and increased its borrowing to save the banks, and thus indebted future generations of Americans.  (TARP was passed at the urgent request of the Bush administration by a Democratic legislature, thus "socializing" private debt).
5. Americans went from borrowing a total $5 trillion/yr in Q3 2007 (brown line) to  $2 trillion in Q2 2008 to "negative borrowing" in Q1 2009.  Again the major culprit in this dramatic decrease was the financial sector.  
6. "Negative Borrowing":  "Borrowing" is the difference between debt at the beginning and end of a period.  If debt is lower at the end of a period, borrowing is "negative".  In the case of household debt, banks have written off a certain amount of debt owed them by householders.  The householder may or may not still be liable for the loan,

From Chart 3 below, which examines the year and a half between 2009 and Q2 2010, we see that

1. The Federal government is now borrowing about $1.5-2 trillion/year.  This amount gets pumped into the pumped into the economy in a variety of ways. 
2. The Household sector has gone from borrowing about $1 trillion/yr (Charts 1 and 2 above) to "deborrowing" (reducing debt) at the rate of about $250 billion/yr -- a swing of about $1.25 trillion/yr. 
3. The FIRE sector is shedding debt at the rate of about $1 trillion/yr -- more on that later.
4. Total borrowing by all sectors has dropped from an average of about $3.5 trillion in the 2004-2007 era to about $0.5 trillion -- a drop of $3 trillion, which is more than 20% of GDP.  

Chart 3

And that is enough for today

I am left with the following questions and my current answers.  I will pursue the questions and re-examine my answers in future posts.

1. If we Americans needed to borrow a total of $3.5 trillion/yr to maintain a GDP growth rate of about 3-4% pre crisis, how do we expect to get back to a 3-4% growth rate without the same level of borrowing?  I do not believe we can.
2. If American households needed to borrow about $1trillion/yr to meet their perceived needs pre crisis, and if now many more Americans are unemployed, how can the economy (GDP) grow, if all fiscal stimulus (federal assistance, deficit spending, call it what you will) is removed?   I do not believe it can.

These are not political questions or answers.  They are simple mathematical and logical extensions of recent history.
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