A sophisticated presentation from the New York Times, The Debt Trap. Especially the interactive chart of a century of debt and savings (under “lifetime”), that puts today’s staggering household debt burden into perspective.

One looks at that chart and says, wow, what a bull market in credit. Consumer credit in various forms has been around for millennia, but it seems like it really exploded after World War II. The effect of rising consumer credit and falling savings rates is to accelerate consumption.

Going back in time, people saved to buy a house. Then, as we move along the timeline, they just saved for a down payment, but expected to save the rest later as a function of their mortgage payment. Then they didn’t need to wait to save a down payment. Then they didn’t need to save the balance - to amortize the mortgage balance. Over time, they expected the appreciation of the house to not only cover the interest, but to supplement their incomes. At each step, people expected to be able to buy a house earlier and earlier in the life cycle of their household. Price also became less of an issue at each step, and so houses became bigger and more costly. Most recently, price sensitivity even became inverted, as a more expensive house was seen to generate more dollars of appreciation and bigger tax savings.

We see the same phenomenon in other lifetime purchases, such as a college education, which have clearly gone through similar structural shifts. Particularly the price-raising part, in the case of colleges. So we had more and more debt, moving earlier and earlier in the household life cycle over a long period of time.

If you drew a household life cycle as a timeline, you could divide it into three segments, a savings segment, a debt servicing segment and a retirement segment. As debt has increased, the debt servicing segment has spread out to take over the other two segments. When we reached the point where a newly formed household expected to buy a house immediately, in addition to servicing their student loans, and would likely end up at retirement with outstanding debt still to service, we reached some kind of a limit. “You can’t get blood out of a turnip”.

I was watching the Suze Orman show last night. The show has this “can I afford it?” segment. I was particularly struck by the guy who was making $7,000 a month who wanted to buy a new Bentley convertible for $212,000. He was, admittedly, debt free except for an existing car lease of, I think it was, $695. He claimed to be able to finance the Bentley at 6.5%. I fired up my trusty HP-12C which shows that the monthly payment on a 48-month loan would be $5027.57. So his total car payments would be $5,700 or so. And then, of course, there are operating costs. How was he going to eat? People just do not understand the implications of buying on credit.

Consumption has to balance with income over the household life cycle. That is, if I buy a Bentley Continental, I have to cover the depreciation on that puppy from my income or my savings. So that may mean less money to spend on other things now, or I may choose to burn my savings and have less to spend in retirement. People have chosen to burn their savings on consumption, in general. That lack of savings for retirement is the demographic part of the debt trap that many analysts have observed.

The other part of the debt trap is that, so long as the debt servicing part of the lifecycle continues to expand, consumption is being pulled forward. But it eventually reaches a limit, when consumption is pulled so far leftward that it cannot move any further. I would argue that we have reached that point. Then aggregate debt cannot expand further than the present value of aggregate income for all households. In effect, real consumption cannot expand faster than real income. In fact, it has to shrink because retirement savings are clearly insufficient. As the baby boomers move through, the average household in the mix becomes older - further along the timeline - and transfer payments from younger households are going to have to be made in order to feed and house the elderly who have over-consumed and lack savings to sustain them.

The debt-servicing segment of the household life cycle will have to be shrunk to some equilibrium value, on average deferring consumption. As this equilibrium point is found, aggregate consumption will fall drastically. The tailwind that increasing debt has given to economic growth will reverse to a howling headwind. Other developed countries will suffer similar circumstances. Countries, such as China, which are in a different phase of economic development, still emphasising savings over debt, will be moving to equilibrium from the other side, giving them much stronger internal growth.

But, you retort, all this debt is just paper accounting, isn’t it? It is just money that we owe to ourselves, after all. The economy has been pumping out all the goods and services that we need, why won’t it continue to do so, indefinitely? Sure, savers aren’t going to get rewarded in goods and services as they expected, because the borrowers won’t be repaying. But, over all, why should consumption fade when the capacity to produce all the SUVs and cellphones and bottled water that people want is obviously there? Manufacturing productivity keeps rising, doesn’t it?

Ah, I respond, then let me count some of the ways that productive capacity will decline.

• Malinvestment. Over this long secular trend, massive investment has been made in things like housebuilding and the associated financial services that will not be needed in the future. Shifting the economy to produce other things will subtract productive capacity from the economy while the shift is being made. We have enough SUVs. And probably enough cellphones and bottled water, too.
• Underinvestment. Bridges are falling down and highways are cracking. Why is the price of oil so high? Because of insufficient investment in energy production. Energy production capacity is declining, which is affecting the supply of goods and services in that they become scarcer and hence more costly. Inadequate maintenance of infrastructure saps productive capacity. Everything is wearing out and not being replaced. Another shift in the economy to produce different goods and services.
• Overconsumption (or underproduction). The US is no longer self-sufficient in anything. We consume more than we can make. It is simply untrue to say that this debt is money we owe to ourselves, much of it is owed to foreigners who have delivered goods and services to the US. All you need to see is the impact of defaults on foreign banks and investors reported in the press almost daily. That debt needs to be serviced, and it is serviced by goods and services that we send overseas in return for those that we have received in the past. Production will shift to increase emphasis on goods and services our foreign creditors will want.

In summary, the economy will change, and will lose productive capacity while changing. The change will be massive, as it will represent a reversal in a hundred-year-old trend. It is the end of an empire built on credit.

Markets are euphoric today because the price of crude oil has fallen a few dollars. Ignored in the general rejoicing, apparently, is the record low (16) reported in the NAHB homebuilder confidence index. Basically this says that no-one is showing up to look at new houses, let alone buy them. Shouldn’t be surprising, but don’t lose sight of the fact that this is the big asset class - real estate. I looked at the CMBX indices last night, and , sure enough, spreads are rising in all the commercial mortgage indices as well. Many are at record highs, especially the low quality ones. This reflects the massive overbuilding in commercial real estate, especially retail. We haven’t heard much from this sector, but we will soon.

Wells Fargo reported a decent quarter this morning. Bulls pumped the shares 25%, claiming that WFC was home safe, while ignoring the one-time effect of changing the charge-off date for equity lines from 4 months to 6 months delinquency as of April 1st.

I must say, watching the market action this morning, that it is remarkable (which would be why I’m remarking on it) how little concern people have about the ongoing disintegration of the financial system. Over the weekend, the second largest mortgage lender (Indymac) was taken over by the FDIC, and the government nationalized mortgage lending for all practical purposes. Somehow, this is seen as a good thing for investors. I suppose it is a de jure recognition of a situation that has existed de facto ever since the collapse of the mortgage securitization market, but even so I hardly think that it is a cause for optimism. I could understand a buying spree if the market had priced in a collapse of mortgage lending, but that it clearly not the case.

Apple did good business with the 3G iPhone, apparently, so people still have money for toys. One wonders for how much longer.

In another sad echo of the past, the SEC is starting a witch-hunt in order to eliminate bearish rumors. Any and all bullish false statements are OK, of course.

Well it turned out that the Friday denial by the Fed was a lie, as the announcement this evening is that the Fed board approved discount window lending to Fannie and Freddie. How anyone has an confidence in any statement of the government, especially the Fed, when they are willing to just flatly lie is beyond me. Paulson is also asking for a bigger line of credit with the Treasury for the GSEs, and authority to buy equity in them. As Gretchen Morgenson says in the NYT, “Bill Coming Due“.

Because the federal government established the companies, investors view them as backed, at least implicitly, by taxpayers. And that implied guarantee is what drove Fannie and Freddie’s business models.

The advantages the companies gained from this unique arrangement were huge. They had to keep less cash on hand than traditional lenders, for example. They also made more money on their mortgages than lenders because they paid less to borrow money in the bond market. These profits enriched Fannie and Freddie shareholders over the years and bestowed significant wealth on the companies’ executives.

Now it looks as if the bill for that largess is coming due. Of course, it will be borne by the usual bagholders: United States taxpayers. You and me.

Anyhow, futures are being bought on speculation that this is all good, and will make things “better”. Nonsense. It is panic. It is just another in the endless series of “bailouts.” If I held shares in the GSEs, which I don’t,  I would be looking at any rally as an opportunity to become an ex-shareholder. These bailouts would not be happening if there were any capital left in the GSEs after a proper and honest accounting. And by the way, if I had any bank deposits not covered by FDIC insurance, I would be remedying that exposure forthwith. Real estate in its various forms accounts for something like 60% of bank lending, and the losses are going to be staggering. Not just residential mortgages, but the developer loans with their capitalized interest and the wild and wooly “covenant-lite” corporate lending that has been going on. The nasty thing about these loans is that they can drag on without technical default for a long time, but when they do fail eventually they will provide little or no recovery.

The great deleveraging is well underway. Jim the Realtor has posted a good piece by Brad Inman of Inman News. He outlines the consequences of the credit crunch that is now unfolding. His conclusion is that the housing market will be starved for capital. And he is right.

Remember, the economy has been dragged into modest growth with the weakest increase in employment since forever by an enormous injection of new credit. Total credit market debt has grown from $38 trillion in 2004 to $50 trillion in Q1 2008, a one-third increase. That growth is in the process of reversing itself. Figure out the likely consequences. Bailouts will keep the institutions operating. They won’t stop the deleveraging.

Indymac Bank was taken over by the FDIC.

The banking regulator said it closed IndyMac after customers began a run on the lender following the June 26 release of a letter by Sen. Charles Schumer, D-N.Y., urging several bank regulatory agencies that they take steps to prevent IndyMac’s collapse.