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Thread: the Pareto Principle seems to offer one of the best explanations ...

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    Default the Pareto Principle seems to offer one of the best explanations ...

    ... of what has been happening, and what is likely to happen next ...



    (snip)"I now suggest that when housing-related losses in equity and recessionary job losses stemming from the credit/housing-bubble debacle impoverish 4% of middle-class Americans, that will heavily influence 64% of the remaining middle-class. And when 20% of middle-class Americans have suffered significant financial losses in equity, income and benefits, that will trigger a New American Revolution (TM)--a bloodless revolution, but a Revolution nonetheless.

    So how many people are in the American middle-class? Let's start with a diagram courtesy of the FDIC on home ownership, for that is a fairly reliable guide to membership in the middle class. Why? Not only is a house the basis of most family's wealth, it is also the bedrock of retirement and whatever wealth the older generation can pass on to its children and grandchildren.

    What this graph reveals [ see link - sic ] is that home ownership peaked at 69% in the bubble, and the 5% who really couldn't afford to buy a house except with exotic/toxic subprime/no-doc/etc. loans, will likely lose their homes as the recession deepens, dropping homeownership back to its historical average of about 64%.

    Please note that many who are losing their homes bought long ago with conventional loans. But since they extracted most of their equity during the bubble via refinancing and HELOCs (home equity lines of credit), they are now as underwater as the subprime buyers who bought a house with no money down.

    So how many people are we talking about when we posit that 20% of the middle-class dropping into financial insecurity will spark a political uprising? "(snip)

    (snip)"I know this is mind-numbing, but we're talking numbers so we have to source all this and put it together. Let's summarize the big numbers:

    population of the USA: 303 million (as per US Census website, link above)

    number of households: 105 million

    Housing units: 126 million

    primary residence single-family houses: 75 million
    (25 million owned free and clear, 50 million mortgages)

    Second-Home Market Surges, Bigger Than Shown in Earlier Studies (March 2005):


    An examination of 2003 data from the Census Bureau shows there are 43.8 million second homes in the United States, including 6.6 million vacation homes and 37.2 million investment units, compared with 72.1 million owner-occupied homes.
    As with all data from various sources, it's easy to get confused. Let's note that almost two million new housing units were built every year during the bubble-boom, so that explains how 2003 data can list 72 million owner-occupied homes and later data states 75 million. Let's also note that the Census Bureau's 126 million "total housing units" includes second homes, investment units and large multi-unit apartment complexes.

    Interestingly, there are 20 million vacant dwellings in the U.S., of which only 7 million are vacation homes. So much for any perceived "shortage" of housing, of any type.


    Now let's turn to Summary of Latest Federal Individual Income Tax Data.

    There are 132 million tax returns filed, which not surprisingly is about the same number of jobs in the "official" (non-black market/undocumented worker) economy.

    42 million file a return but don't pay a dime. 90 million file and pay something. The top 1 percent of taxpayers (income over $364,657) earned approximately 21.2 percent of the nation's income yet paid 39.4 percent of all federal income taxes.

    90.6 million of the tax returns came from people who paid taxes into the Treasury. That leaves 42 million tax returns filed by people with positive AGI who used exemptions, deductions and tax credits to completely wipe out their federal income tax liability.

    The top-earning 25 percent of taxpayers (AGI over $62,068 ) earned 67.5 percent of the nation's income, but they paid more than four out of every five dollars collected by the federal income tax (86 percent). The top 1 percent of taxpayers (AGI over $364,657) earned approximately 21.2 percent of the nation's income yet paid 39.4 percent of all federal income taxes. That means the top 1 percent of tax returns paid about the same amount of federal individual income taxes as the bottom 95 percent of tax returns. The top 10% of taxpayers earn 46% of the total gross income.


    OK, let's put this all together. 26% of the nation's population is at or near poverty level. That's about 27 million households. (Let's use households rather than population because it correlates to housing units. These low-income wage earners-- 42 million--pay no taxes.)

    13 million taxpayers earn almost half the total gross income, so let's call them wealthy, i.e. "not middle-class." Some households have two such earners but just for simplicity let's say 27 million households are impoverished and 13 million are wealthy, which leaves 65 million households in the middle-class.

    That aligns rather nicely with the FDIC homeownership rate, which states there are about 67 million homeowners.

    Other analysts (see above links) place the number of middle-class households at 50 million, which may be more accurate. Consider who owns their home free and clear; some are wealthy households, no doubt, but many are elderly retirees who paid off their 30-year conventional mortgage and who may now be living on modest "non-middle-class" incomes. (The median household income in the U.S. is about $46,000/year).

    Since there are about 25 million homes owned free and clear, we can surmise that many are owned by people who are old enough to have paid off their 30-year mortgages and are now living on Social Security and pension/retirement incomes.

    If so, we have to divide the 65 million middle-class homeowners into those who are receiving government entitlements (Social Security and Medicare) and those who are paying through the nose in taxes.

    So let's posit that there are about 50-60 million middle-class taxpaying homeowners/ households. There are about 50 million mortgages, and that aligns pretty well with the guesstimate of 50-60 million middle-class households.

    According to the Pareto Principle, 4% of the middle-class losing their equity, jobs and healthcare will have an outsized effect on 64% of their brethren. That suggests that once as few as 2 million formerly middle-class households lose their equity (they could hang onto paper ownership of their home, but if their mortgage exceeded the value of the house, then their wealth has effectively vanished), or their jobs and healthcare, then a political earthquake will be unleashed.

    And once 20% of the middle-class--10 million households-- have experienced major degradation in equity, income and healthcare benefits, then the New American Revolution (TM) will begin. "(snip)
    Last edited by Melonie; 04-09-2008 at 12:39 AM.

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    Default Re: the Pareto Principle seems to offer one of the best explanations ...

    part two ...

    (snip)"Today let's consider the drivers of middle-class impoverishment and the psychology of hope/entitlement being smashed.

    1. the crash of home equity to zero or less than zero. Stories are popping up in which "upper middle-class" people with homes which were recently worth $800,000 to $1.4 million being shocked that their home equity lines of credit have been cancelled: Lenders retreat as housing market plummets.

    What is remarkable about these stories is the owners' strong sense of entitlement-- that the "free money" doubling or tripling of their equity in the bubble was now "theirs" for all time, and that it should be available, as it was from 2002-2006, as a permanent "slush fund" for their home improvement projects, new cars, etc.

    These folks are shocked, shocked, that their homes could drop by $400,000 or more--after all, this is a "good neighborhood where house prices never drop." In other words, the operating preconception of the upper middle-class is that a decline in equity is limited to ghettos and tacky exurbs. The market is proving this preconception false.

    So let's state this very clearly: equity dropping to functional zero (i.e. you can no longer extract any equity regardless of your personal beliefs about your home's value) is not limited to subprime/toxic/liar-loan mortgage holders.

    Another very common situation is the middle-class household which has owned their home for years or even decades, and as a result had built up significant home equity. But then college, divorce, a job loss, extended illness, parent-care or some other major life expense came up and the family extracted the equity to handle the crisis/costs.

    Like almost everyone else, they didn't worry too much because the bubble was continually granting them more equity every year. But now that values are plummeting, their remaining equity has dropped to zero.

    Let's also be clear about the distinction between theoretical equity and extractable equity. Let's say a house was worth $200,000 at the top of the bubble in Q4 2005/Q1 2006, and the owners had refinanced/HELOC'd up to a $160,000 mortgage. They feel very secure holding 20% equity.

    Oops, home values drop 10%--yes, even in their "nice neighborhood with good schools." Their residence is now worth $180,000 and equity has dropped to $20,000. Still, that's a nice "safety cushion", right?

    Only there's a big, ugly fly in the ointment: no lender is dumb enough to extend them credit based on the last 10% of equity. The banks have finally caught on to risk and the bubble popping, and their "risk models" have been adjusted to the likelihood that the house could drop not just another 10%, wiping out all the remaining equity, but 15% or more, putting the owners (and any lender dumb enough to have extended them additional credit) underwater.

    This is important: the homeowner may reckon they still hold theoretical equity of 20%, but their extractable equity is zero. Lenders are rushing back to the 20/80 model in which a 20% down payment is considered prudent, and so 20% equity is essentially zero.

    Please don't email me that your credit score is 800 and there's a lender right now willing to lend you 90% of the value of your mansion. That may well be, but the average middle-class household doesn't have a credit score of 800. You are an outlier, just like the person who plunks down 50% cash when purchasing a house. Sure, such buyers exist, but we're talking about 50-60 million households' typical circumstances, not the outliers.

    To summarize: here are the middle-class households who are in danger of losing all their extractable equity:

    Any family which put less than 20% down when they purchased their house in the 2002-2006 time frame.

    Any family which extracted equity during the bubble such that their equity was reduced to 20% by 2006.

    Any household in bubble hotspots (Florida, California, etc.) with 20% remaining equity as of Q1 2008 (present).

    Various pundits are amusing themselves with guesstimates of "how much more housing will drop before we hit bottom" and numbers of 15% (laughably optimistic) are being tossed about. As more knowledgeable commentators have noted, "reversion/regression to the mean" suggests another 40% - 60% decline in house prices is likely. "(snip)

    (snip)"Yesterday we posited a Pareto Principle effect would kick in once 4% of the middle class suffered financial losses which impoverished their family. Have 2.4 million (4% of 60 million) households already suffered a complete loss of equity? By most accounts, homeowning households with zero or negative equity already exceed 8.8 million--over 10% of all U.S. homes.

    Moody's Economy.com estimates that 8.8 million homeowners -- about 10.3% percent of all U.S. homes -- will have zero or negative equity by the end of this month. Another 10-15 million households are at risk of becoming "upside down" if prices continue falling. So we almost have our Pareto principle (20%) number: if prices keep falling (a given) then somewhere between 20% and 30% of all homeowners will have negative equity.



    2. The other 800-pound gorilla in the fiscal-crisis room is healthcare. The Powers That Be are reluctantly admitting that a recession is underway. And what happens in a recession? Spending slows and businesses either fold or lay off employees to cut expenses.

    And what happens when you get laid off? You lose your healthcare benefits. And what separates the poor from the middle-class? Healthcare benefits. Once the middle class starts losing jobs and healthcare, without equity they are essentially impoverished.

    Self-employed people like me know how incredibly costly healthcare is, either cash or insurance bought on the "open market." The average salaried worker has no idea just how much it will cost to duplicate their employer-provided health insurance in the "real world."

    Sure, if you're 25 and single, your health insurance is minimal, on the order of $150/month. But if you're middle-aged with kids, try $700-$1,000/month depending on how gold-plated your insurance coverage is.

    Here's the key question: how many middle-class workers will lose their jobs in this recession? The official unemployment numbers are nearly useless for a variety of reasons, but let's start with the "official unemployment rate" of 5%. In an economy of 130 million jobs, that's about 6.5 million people.

    Now millions more work in the underground (cash) economy, and millions more have exited the job market/given up/retired early/taking care of grandchildren but would like a part-time job, etc.

    In good times, most of the unemployed are "in between" jobs; most find another job within 6 months. The "hard-core" unemployed--those saddled with felony convictions, low education, addictions, poor health, etc.--are another story, one we'll set aside for now. But in bad times, i.e. recession, people don't find another job. Then they drop off the "official statistics" and essentially disappear.

    Thus we may be presented with an "official" unemployment rate which no longer counts millions of laid-off workers who once had middle-class jobs. If you're unemployed longer than 6 months, you're no longer counted. If you take a part-time job "just to tide the family over" then you're employed. If you take an occasional temporary gig (temping), then you're employed, too.

    But if your family loses its healthcare coverage in a job shuffle, then you're no longer in the middle class. You're one of the working poor now. As we all know, the key to survival as a middle-class American is: someone in the family has to have healthcare benefits which cover the entire family. If nobody has healthcare benefits, then the family income has to be high enough to afford $700-$1,000+ per month for insurance plus in most cases a 10-20% co-pay.

    How many middle-class U.S. households can lose one wage earner's paycheck and be able to pay a new $800/month bill? Very very few.

    In the Good Old Days, practically every corporate job provided healthcare coverage. Now is not the Good Old Days. If you're lucky to merely get laid off as opposed to losing your job when your employer goes out of business, you might get hired back on a "temp" or contract basis. Nice, but no benefits.

    The fortunate families are those in which one wage-earner works for a government agency or municipality. The government gigs always provide gold-plated coverage for the family, so these folks have no worries--until the agencies and cities start laying off workers as tax revenues shrivel. Millions of homeowners are rushing to have their property taxes lowered as real estate values drop, and the net result is a dramatic decline in tax revenues.

    So what I am suggesting is this: 20% of the middle-class--approximately 10 million households--could lose their middle-class status via home equity declines and loss of healthcare coverage, even as the "official unemployment" number provided a Potemkin-Village assurance that "unemployment is still low."

    10 million households sounds like a lot, but let's recall that there are 130 million jobs at present. If 10 million people lost their jobs, that would be a 7.6% unemployment rate--not even close to the "official rate" in the 1981-82 recession of over 11%. "(snip)

    (snip)"To summarize: an official unemployment rate of, say, 7.5% could easily mask a reality in which 10 million formerly middle-class households are now in the ranks of the working poor.

    Now let's discuss the middle class sense of entitlement. For a variety of reasons-- mostly stupidity and general orneryness--I have been self-employed/operating a small business for most of my working life. Those of you in the same boat know the drill--your sense of entitlement is pretty limited. You hope for customers, and try to take care of those you have. You pay outrageous taxes and fees for the privilege of retaining modest freedoms, and are used to paying for everything: your own medical care and insurance, your own retirement (if any), and all the rest.

    It's still a free market when you're in business for yourself. Businesses go under and wipe out the owner's savings, livelihood and esteem on a regular basis, even in good times.

    Writing payroll deduction checks to the Feds every week for your employees' tax witholdings--five figures on those checks, my friend--gives you a different perspective, to be sure. So does paying your employees medical insurance, Workers Compensation, Temporary Disability and unemployment insurance costs. After years of that I am now happily a sole proprietor--no employees, just quarterly taxes and gargantuan property taxes to pay. It's like child play compared to the benefits costs for employees. Sure, my net income is poverty level, but life is a trade-off.

    For the self-employed, entitlements are reserved for the poor and the elderly; we're the ones who are paying for the entitlements, not receiving them.

    But those who have had good-paying jobs in the corporate or government sectors seem to be prone to "creeping entitlement" disease, in which healthcare and other benefits are "rights," along with rising equity and 401K retirement accounts.

    The loss of benefits and middle-class status will not pass unnoticed. Heck hath no fury like an entitled person scorned, and people who were born to expect a lifestyle equal to or better than their parents will not go quietly into the night when they have to stand in line at the county hospital for healthcare, like all the other working poor.

    Instead of ever-rising equity and the HELOC every year or two for new cars, fancy vacations and all the other luxe perks of the bourgeois, now they find themselves scraping by with no equity, a shrinking retirement (if they haven't pulled it out already) and insane medical bills. Sure, bankruptcy is a solution, but where does that put you? More or less on square one in a recessionary economy.

    Here is the clincher: the poor don't vote, and the young don't vote, but the middle class votes. The poor are either too busy being poor or too overwhelmed by problems to have time for luxuries like political organizing. The wealthy just move to Costa Rica or stop reading the paper for awhile because it's "depressing." But the middle class is used to having a voice, and being heard by politicos is one of their entitlements.

    Marx expected the proletariat (factory worker) to rise up, but he was wrong; political movements such as unions and regulations on "The Jungle" of rapacious Capital effectively co-opted the Revolution Marx forsaw. So who co-opts an angry, suddenly disenfranchised middle class? Unions? Regulatory improvements? A third political party?

    I don't have an answer, but the Pareto Principle suggests that when the middle class sees their friends and co-workers descend into the working poor, and they sense their own systemic vulnerability to the same fate, then a politically righteous anger will arise which cannot be ignored or brushed aside with the usual phony PR shows and regulatory touch-ups like "medical savings acccounts."

    Brilliant! Here you have 10 million households with no savings and a huge decline in income, and you set up "savings accounts" with "tax credits." So 50 million people won't owe any tax instead of only 42 million not paying a dime, and that's going to solve the U.S. healthcare crisis? That is beyond laughable.

    Is it possible the middle class won't fall for the usual shuck and jive, that they will finally demand real change, and vote out the usual suspects of both parties as the toadies they are? Perhaps not, but I wouldn't underestimate the staying power and the welling rage of those who feel entitled to what is no longer attainable in the Current Political and Financial System.

    This is the same human characteristic which might cause China to convulse in social disorder in the coming decade: when hopes for a better, more luxe life die, they die hard, and they take down the political structure which led to hope's demise. "(snip)
    Last edited by Melonie; 04-09-2008 at 12:37 AM.

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