Tuesday, June 2, 2015

The 43%


A debt income ratio (often abbreviated DTI) is the percentage of a consumer's monthly gross income that goes toward paying debts.

Consumer Financial Protection Bureau:

The 43 percent debt-to-income ratio is important because, in most cases, that is the highest ratio a borrower can have and still get a Qualified Mortgage.

I was gonna end it right there, but no. I want to gripe about the number. I want to gripe about the whole process.

The 43% number comes from the consumer protection bureau. They imposed that number on us... to protect us?

How does that work?

I think they're trying to protect the economy, not the consumers. Hey, I'm all in favor of making sure the economy keeps functioning, and that it starts functioning better than it has, sure. And that's good for consumers; it's good for me. But don't be a hypocrite about it. If you're protecting the economy, admit you're protecting the economy. Don't make it sound like you're protecting consumers by forbidding us to borrow one more dollar. That's hypocrisy, and it's bullshit.

Forty-three percent?

Oh, I resoundingly agree that the best way to protect the economy is to prevent the excessive accumulation of debt. But, uh, 42.5% is somehow okay? It's the extra half a percent that creates all the problems? I don't think so.

Anyway, they are impinging on our freedom to get ourselves in trouble with debt. No matter how good the motive, no matter how good the objective, no matter how good the implementation, they are impinging on our economic freedom. I'm not a political guy. You don't often see me use the word "freedom". But you know there are many many people who will holler that word till they are blue in the face.

Those people will object to the policy. And that's a problem, because it reinforces the polarization of our views. It impedes resolution of the problem.

Here's what's wrong, here's what's economically wrong with the 43% policy:

It fails to consider the reason debt ratios are so high. It does nothing to change the economic forces that push debt ratios higher, nor to discover what those forces are. It only imposes a limit. And because it does not deal with the underlying forces, the policy that imposes the limit is bound to fail. You can expect the limit-value to creep upward, just as debt ratios have. And then, when there's another crisis, everyone will be surprised. Again.

We have to deal with the underlying cause of the problem. Excessive debt accumulation is the problem, and we have to deal with that. But excessive debt accumulation is the water on the kitchen floor. We have to turn off the tap and unclog the drain. We have to discover the underlying forces pushing debt upward, and we have to point those forces in the other direction.

The problem is the excessive accumulation of debt -- public and private debt. Mostly private debt. I used a McKinsey graph the other day, found the link in this old post of mine, really liked a quote I took from McKinsey then. I repeat it now:

history shows that, under the right conditions, private-sector deleveraging leads to renewed economic growth and then public-sector debt reduction.

That's how it works.

All these years of failure to reduce the Federal debt and deficits. People say the government doesn't want to reduce that debt. I'm telling you, that's wrong. It's not that "they" don't want to reduce the Federal debt. It's that the plan we've been using can not work. The only plan that will work is the plan to reduce private sector debt, and then take advantage of the opportunities created by that plan to reduce the public debt (if that still seems necessary).

That is an indirect approach, and maybe it requires more thought than some people can muster. But it's the only plan that will work -- unless you wish to bring life as we know it to an end, and replace it with a dark age.

So we need to reduce private debt. The question that must be asked, then, is: What are the economic forces that drive private debt upward? The question that must be asked, and answered.

The answer is policy, of course. More accurately, the answer is the mindset that lies behind policy. Our economic policies almost unfailingly encourage the use of credit. Our policies encourage growth, which means they encourage spending. But we don't want inflation, so policy provides a quantity of money that is inadequate for the growth our policies hope to achieve. Because the quantity of money is inadequate, the growth is always disappointing. And because of the inadequate quantity of money, people borrow more in order to increase their spending.

The combination of policies is a problem. The one policy encourages spending, and the other fails to provide an adequate money supply. So borrowing increases. And accumulated private-sector debt increases as a result of the borrowing.

But you know what? This explanation does not matter. Perhaps I have it all wrong, as Jim always says. No matter. The simple fact is that there is a massive accumulation of private sector debt.

The simple solution is to design policies that accelerate the repayment of debt.


jim said...

I hate to say it Art but you got the motives behind the 43% thing all wrong.

You are wrong that this is an attempt by govt to limit lending or limit freedom. it is actually an attempt to increase lending. Let me explain.

First of all neither a bank or Freddie or Fannie would approve a loan to someone with a 43% DTI. Under traditional lending standards a prudent lender will not lend if it pushes the DTI to above 28%-33% (depending on other factors like credit score and collateral). This new rule making is mostly for privately backed lending. In other words, loan sharks, payday lenders and subprime lenders and other private lenders.

During the housing boom there were $6 trillion of US mortgages financed by private investment channels. And then it dropped to zero in 2008. Before the mid 90's the amount of mortgages financed by private investment was also close to zero. At the time that the flood of private money started the US mortgage market was $3 trillion and then the $6 trillion in private investment poured in on top of the conventional methods of funding mortgages.

The private lending market had no govt regulation or oversight.
The only thing that exercised any legal control over the market was the Reps and Warranties and Repurchase agreement in the contracts between the private investors and the lenders they were funding.
See here: http://www.hg.org/article.asp?id=24951

Currently, the US courts are clogged with lawsuits trying to resolve
the Reps and warranty and Repurchase disputes on nearly all the privately funded mortgages that were still functional when the music stopped in 2008. The privately funded mortgage market is dead. All that is left is the zombies wandering the halls of the US courthouses.

The politicians believe that if they set some basic ground rules for lending the the privately backed lending channels can be raised up from the dead. The 43% rule is just one of the new rules. Nobody is bound by the 43% rule. If a lender breaks the rule he won't be thrown in jail. The only consequence of breaking the rules is that if a disputes arises and it goes to court, the judge can very quickly dispense with the case if some rule was broken.

The Arthurian said...

Nevertheless, the simple solution is to design policies that accelerate the repayment of debt.

Auburn Parks said...


What on Earth does the amount of money people have saved in Govt term deposit accounts (TSY securrities) have to do with any of this? And what possible benefit could come from actively making the private sector poorer by reducing either the relative level of this type of private savings (% of GDP) or by the Govt running budget surpluses and lowering the nominal level? You still seem to be confused about the nature of the diffferences between Govt finance and private debt. Why would you ruin a perfectly good piece by bringing up the meaningless worry of reducing public "debt"?

The Arthurian said...

auburn, your persistent focus on one small aspect of the economy causes you again and again to miss the point of my writing. your remarks are predictable and boring.

Oilfield Trash said...

Blogger Auburn Parks said...

What on Earth does the amount of money people have saved in Govt term deposit accounts (TSY securrities) have to do with any of this?


It is important.

Due to the development of financial instruments the FIRE sector can transform government bonds into a very liquid medium of exchange (MOE) for the private sector.

This allows the FIRE Sector to hold interest-bearing assets that are risk-free and increase private sector purchasing power in the economy. It is not just about NFA.

The private sector effectively monetizes government debt that the Federal Reserve doesn’t, so the inflationary effects of higher deficit policies increase just as they would if the Federal Reserve bought TSY to take a loose monetary stance.

The point is due to the way the FIRE sector is regulated budget deficits can be characterized as an endogenous credit-money expansion rather than a monetary expansion to maximize seignorage revenue.

This is why IMO Freddie and Fannie MBS took off and grew so fast.

The FIRE sector basically engineered a synthetic treasury. MBS was for all practical purpose was an interest bearing risk-free (AAA rated) asset.

MBS therefore became a very liquid MOE as a clone to Treasuries, which allowed the FIRE sector to monetize mortgages. Throw in some Fed interest rate reductions and the relaxation of credit underwriting standards by commercial banks and you get the exponential increased in private debt.

This all went well until the people holding these Treasuries clones realized they were not as risk free as advertised.