Friday, February 27, 2009

Margin Debt Plunges - The Age of De-Leverage

No matter how you interpret it, the recent plunge in margin debt in the US is thought provoking (see chart below).

Latest data from NYSE show a vertical drop: from a high of $381 billion in mid-2007 to $186 billion in December 2008, with most of the decline occurring in just the last three months. Margin debt has likely declined even further in January and February. De-leveraging writ very large, indeed.

For a more instructive longer-term perspective it is better to look at a log-scale chart (see below).

One (fundamental) interpretation is that The Great Pump-Up, which lasted over thirty years, is finished and the Age of De-Leverage is fast upon us. Though I don't expect the latter to last as long as the former (economic declines being swifter than expansions), I nevertheless think that the de-leveraging process will last more than most people believe. And this, despite the (un)heroic efforts by Fed and Treasury to rapidly pump trillions of fresh debt into the system. All they are achieving so far is to replace a portion of the debt going terribly bad (eg sub-prime mortgages and speculative trading leverage) with government debt. Unfortunately, private debt is rotting away much faster than the feds can replace it.

I wonder.. When will the people of the new Obama administration cotton on to the simple fact that the whole debt-fuelled Permagrowth structure is rotten, not just one small portion of it? When will they wake up and realize that Bernanke, Paulson & Co. (and now Geithner) are not providing fresh solutions, but simply making the old problems even worse?

C'mon folks, PLEASE! Step out of the box and look at things from another angle. Whatever you think, dare to think the opposite. For one, stop comparing today with the Great Depression - that's a ridiculous, fear-mongering scare tactic used by the finance community to convince the public to supply bail-outs by the trillion.

Today's US economy bears no resemblance whatsoever to the 1930's. Capital and labor intensive industries like manufacturing and farming account for a far smaller portion of GDP and the social safety net is much bigger (deposit and pension insurance, Social Security, Medicare, food stamps, etc). It's the debt-laden asset-based FIRE economy which is in deep trouble today and it should be allowed to shrink back to a relative insignificance.


  1. "Today's US economy bears no resemblance whatsoever to the 1930's."

    Exactly and we are in far worse shape because of it. The only historical comparison I can find goes back to The Revolutionary War and The Civil War.

    In both cases, the fate of the nation hung in the balance. This financial crisis is so bad with so much debt involved, so few workable solutions offered by the power structure the only way out is collapse.

    We will have to rebuild from the ashes and the fate of the US hangs in the balance once again.

    Joe M.

  2. Yeh but, aren't we supposed to be in debt as much as we can in this system. Y'know, for every $ I earn I can borrow five or so more. That's the smart way, everybody told me so, all my life. That's why I'm five times richer than those savers. And when things go wrong, (deflation), those same stupid savers are going to pay for it, because then I don't have a cent of course. They'll have to bail me out or everything will crash and burn, I'll see to that. And when everything is fine, (inflation), savers are paying too!! Because then I have much more money than they have, my asset appreciation will outrun them easily. hahahaha!
    Nah, you guessed it, I'm one of the stupid saver and so far I don't think I'm on the winning side.

  3. Here's the scenario....

    You've been loaning this person (Jake) more and more money for quite some time. Not a big deal since you create the money out of nothing. The money is created against the debt he takes on. You profit by siphoning off the interest and are a happy camper.

    Jake's standard of living gradually falls as the benefits of his labor are steadily siphoned away in interest expense. He doesn't really pay attention as its hidden in the gradual increases of the costs in the goods he acquires. Eventually it gets to the point where you are loaning Jake money to cover interest costs.

    Alarmed that your game might come to an end, you steadily lower Jake's interest costs (since the money is free to you anyways) in an effort to keep Jake producing and keep your interest coming. Jake responds by borrowing in ever increasing quantities as he is now fully addicted to debt. You remove all restrictions - accepting whatever collateral he proposes at whatever value he can assign to it.

    Finally Jake gets to the point that he can no longer keep borrowing. Jake has reached the tipping point and can no longer sustain the interest costs of his current debt.

    So the question is....Jake owes you a great deal of money. Jake is insolvent meaning he can no longer support the interest costs of the debt let alone pay you back principal.

    What do you do?

    You can forgive the debt - which could be a write off or the gift of debt free money; or

    You can seize the assets which, at any value, is still a very nice return since you created the money out of nothing; or

    You could seize the assets and put Jake to work directly for you. Jake becomes a slave to you. He keeps the assets producing and you now take all the benefits of his labor. You give him just enough to sustain himself and keep him producing.

    What is your choice?

    ...say hello to the iron fist and enjoy getting your chip implant!

  4. We all know truth has 3 steps.
    Ridicule, Brutal denial, and then general aceptance. Stupidity between the steps is the only issue is all that is going on as such.

  5. So Yophat you are suggesting a government bailout in the form of compulsory employment for those in debt?


  6. We all know truth has 3 steps.
    Ridicule, Brutal denial, and then general aceptance. Stupidity between the steps is the only issue is all that is going on as such.

    Exactly the process professors go through. If you had the balls 10 years ago to even suggest deflation they would humiliate you in front of the other students.

    That was my MBA experience. Getting bitch slapped and being charged for enlightenment.

  7. Obama: rational, analytical, pragmatic, the anti-Bush. What we need is a radical, like Bush only honest, responsible, dedicated to justice the welfare of country.

    Let's hope Obama learns fast enough to make the necessary radical move.

  8. Very interesting points, Yophat.
    Like the fact that we are NOW implementing slavery in a modern form, but since the WORD slavery is not pronounced, everybody can self-righteously say to himself/herself that we are truly a democratic society where slavery was abolished before the Civil War.
    Very convenient. A bunch of hogwash, but convenient nevertheless...
    One of the other key words that I read in your comment was the word INTEREST.
    Yeah, like usury...
    Reading Freud taught me that when you throw something out the door, it often finds a way of coming back through the window.
    Those theological battles fought over USURY are still being fought. And the barriers that the Protestant theologians broke down are haunting us still.
    A long period of unemployment has also taught me that 9 human beings out of 10 cannot survive without work, and that the issue of working for a living, although extremely important, is not the essential one (a word of apology to all of the REALISTS out there...).
    The essential one is that human beings do not really know what to do with time that is not occupied in one form or another.
    And that they really NEED to occupy their time with MEANINGFUL occupations that are productive, but not productive in the cheap, tawdry sense that marxism and other economic/materialist ideologies have reduced the word to.
    So, while slavery is a problem, it is only the tip of the iceberg.
    The real problem is voluntary servitude, and its consequence, alienation.

  9. Oops, I forgot, Marcus.
    I totally agree with your comment.
    We need radical economic and metaphysical thinking from our new president.
    Not ho-hum more of the same, don't offend anyone, it's the American way thinking.
    That got us to where we are now...

  10. I hear you but what is the alternative then? Do you have a solution in mind? Then write about it and show us exactly what should be done because I believe in your analysis but I just like to see some concrete ways of facing this financial meltdown.

    Evelyn Guzman (If you want to visit, just click but if it doesn’t work, copy and paste it onto your browser.)

  11. hel,

    I like you posts because you give numbers, not words. We can go on and on about the evils and weakness of our FIRE economy, but facts give us real perspective.


  12. Hell and others:

    Have you looked at or considered Margin Debt as a Percentage of Market Capitalization of the NYSE?

    Has is really corrected as much as the base numerical values would suggest, or it is just inching down?

    I'm just reflecting on your chart of the margin debt outstanding and the current levels of the DJIA and S&P500, which are at levels last seen in Dec. 1996 which correspond significantly lower margin debt levels...

  13. While it is not a perfect comparison of Margin Debt as a Percent of NYSE Market Cap, here is a link chart of the S&P500 vs NYSE Margin Debt from 1983 thru 2008.

  14. As always another great post Hell!

    But I might remind you that health care is a pretty capital and labor intensive "industry" (though certainly more labor than capital). There are an enormous number of towns in America where the central hospital is by far and away the largest employer in the region (I work at a few of them).

    Also, do you think there was anything special about 1974 that led to what you call "The Great Pump Up"?

    I ask because I know an economist in New England who has stated for years that all this debt mess has been caused by a law signed by Gerald Ford (as an outcrop of Watergate) in 1974 that changed the way congress earmarked funds- in effect the signing of that law eliminated what had functioned as a line item veto since the founding of our republic.

    I have never been able to repudiate or validate this claim and I am curious if you know an more?

  15. I agree that the Great Depression, for a variety of unspecified reasons, is not the best example to use by way of comparison with today's economic debacle. For a variety of reasons it gets used as the benchmark against which we measure today's misery. It certainly is easier to conjure the Great Depression than the 1870s Panic, which, seems a better period to use for a comparison with today's epochal meltdown.

    What's more, the few who lived through both it and the Great Depression apparently felt the 1870s Panic was the more fearsome collapse. Of course the Great Depression ushered in WWII which will always give it an especially dreadful status in the annals of history. And the fact that there are people alive today that recall it makes it far more compelling as well.

    I tend to agree that the Great Depression is trotted out with a lot of fear mongering, clearly for purposes of allowing the great loot to continue. But my sense is that comparisons aside, no one is calling our present circumstance a Depression...yet. They will though, probably by the beginning of what will no doubt be a hot, literally and figuratively, summer.

    In any case, that we seem well on our way to a global "Greater Depression" seems a monumental tragedy because it did not have to happen. Or did it? It really depends on how one approaches that question.

    And while I don't know who may emerge to lead us in the right direction, if anyone, it almost certainly won't be President Barack Obama, who, sad to say, seems rather out of his depth right about now. This may seem harsh, but by my lights, Mr. Obama seems more fit to be, oh, say, the nation's greeter in chief than its Commander in Chief. And even as someone who enjoys being right, I would very much love to be wrong about my assessment of President Obama. But short of a strong repudiation of his present approach and the advisors who are behind it, I don't think I will be wrong. In the meantime, his honeymoon period is fast coming to an end.

  16. H:

    You said:

    Today's US economy bears no resemblance whatsoever to the 1930's. Capital and labor intensive industries like manufacturing and farming account for a far smaller portion of GDP and the social safety net is much bigger (deposit and pension insurance, Social Security, Medicare, food stamps, etc).

    After reading Jesse's new post today Pension Funds Imploding, it looks like my idea of having Social Security expanded into a full pension is looking better all the time.

    The Pension Benefit Guaranty Corporation (PBGC) is now often paying only 30% of what retirees were promised. Based on this, it looks like one of your pillars of social support (that supposedly makes this time so different from the 1930s) look more suspect all the time.

    Every time a large corporation goes bankrupt, it puts more strain on the PBGC. Jesse's article points out another risk to private systems.

    My solution may not be a cure-all, but I think it would be safer than the system we have now.

  17. Dangerous stuff, Okie.

    Thinking back to that Jared Diamond video, he stated that the most sustainable societies are those where the elite/leaders will feel the same consequences of their decisions that their electorate will feel.

    Seniors make up a huge voting block so we can consider them the leaders in a sense. And presuming they're retired, they won't feel the consequences of higher taxes on wage income. Plus they have a shorter lifespan for the consequences to develop.

    Democracy can be so odd sometimes. "Lets vote for politicians who will make national promises that give us a big payoff in the future! And lets not monitor them at all over the decades! Or do any math!"

  18. dink:

    How would you propose to stop the effective embezzlement of current pension funds?

    Another possibility is to make said funds trusts that are priority debts in bankruptcy cases. However, I see this as merely a stopgap, rather than a longterm solution. I think that it is too risky to leave pensions in private hands given the state of the law (and human nature). The PBGC is a good concept, but it is woefully underfunded and subject to the same moral hazards that other financial products are subject to.

    As for funding, the taxes would have to come from the class of people who are currently benefiting from the current system. I have been thinking the same thing Bill Maher has been voicing lately in a YouTube video: do a Putin and make the oligarchs give it all back.

  19. But Okie, I don't see how this solves the basic consumption problem. Changing consumption behaviors from a system where 1 person gets 1000 to a system where 1000 people getting 1 is still the same basic consumption. Either way we still consume 1000.

  20. I think you are missing the point about debt. Our money is debt. The solution they don't want to face is that everyone is going to have to take a haircut to get out of this and it can't be ended by how they are trying to end it. I don't know if anyone has figured this out, but the money borrowed or put in now is nothing more than money to backstop what has already been loaned or borrowed and they have shifted the losses to the populace from the banks. Indirectly they are going to steal the deposits from those the banks owe and give them back to the banks, who own the government. Obama got $700 million from someone and it wasn't from the widows and orphans fund nor was it for the league of black churches. My bet is it came from Goldman Sachs and other banking organizations. Isn't it strange that he nominates and Wall Street cheers Geithner, who probably had more to do with creating this mess than any individual on the scene the past 8 years.

  21. Okie, I have known Jesse online for 8 years and he might recall some of the writing I did about this stuff back in 2003. The SF Fed put out a study on the underfunding of pensions back then. I think the shortage was something like $400 billion at the time. They had some kind of limit, like a 20% shortage before they had to ante up and there was time to get the money. The problem with pensions in times like these is that enough money has to be put up at the current interst rate to produce a certain amount of income for life. If you haven't figured it out, the lower the interest rate prevailing, the more money has to be put up. Thus, the lower the inflation rate, the cheaper they get off because higher inflation rates create higher interest rates and produce more current income out of an amount of money.

    So, the world created a policy where it would use inflation to screw its employees and lighten the load. Then they came up with another idea, use delusional long term stock market projections to lower the funding and even move money out of pensions onto the bottom line. Much of the earnings growth of the 1990's was created out of this act, where the companies literally looted the funds. What has happened now is the money is either gone or short and the companies are dodging bullets on funding or the government operation is getting the bill. I believe what we are going to see once this is all over is government insurance is just one more way to get to a peak of a bubble and into a depression.

  22. @ Okie

    "How would you propose to stop the effective embezzlement of current pension funds?"

    Bad people took advantage of people's trust. I don't like bad people, but I have no idea how to stop them from existing. Since bad people can't stopped, maybe the best way to stop future scams is to teach potential victims a little skepticism. I'm not saying we should get rid of trust altogether, but maybe temper it a bit. Perhaps some sort of legal document that people sign acknowledging that the person they are doing business with may be deceiving them and they have done, and will continue to do, due diligence in monitoring the situation.

    Argh. Okie, you're such a decent and honorable pattern of pixels that I always feel like a jerk when I disagree with you. I swear I don't condone evildoers or blame victims. Wish I had the solution.

  23. Dink and Okie- agreed.

    What about a world wide system like ebay where people's reputations follow them everywhere they go?

    In a way it would turn the world into a small town again. And while it would cause all the problems of a small town on a global scale, still trust like Nepalese Diamond cutters or Hasidic diamond merchants have developed might be possible again.

    It wouldn't be fool proof, but if people who go involved in this kind of stuff had to have it follow them for the rest of their life, I think a lot fewer people would be willing to risk their reputations.

    Right now reputation is one of the most legally entities on the planet. Those protections have an upside but they also have a real downside.

  24. Thai and Okie,

    That eBay-esque reputation feedback tracking system is a fun one to think about.

    What age would tracking begin? Could you post a rebuttal or explanation? Impartial third-party arbitrators you could appeal to if someone is being unreasonable in their accusations?

    Felonies should be public record for anyone to see, but perhaps potential employers should only be able to view filtered info. People with whom bodily fluids may be potential exchanged with could be given access to health records.

    @ Thai,

    So there's this local organic food co-op I go to once a month or so called PCC. I go looking for my favorite "Garden of Eatin'" tortilla chips and suddenly I see "Have'a" chips. My mouth drops and I nearly yell out "Krishna chips!!!". They're pretty tasty.