Monthly Archives: May 2009

Madoff Gets a Bum Rap!

Bernard Madoff has been widely excoriated for running the largest Ponzi scheme of all time. If only it were true.

Bernie took money from investors while promising solid, but not spectacular returns. He used money from later investors to pay off earlier investors and skimmed off a bit for yachts, jets, villas, and other goodies too numerous to mention as his take for keeping it all afloat for years.

Now, I understand that fifty or sixty-five Billion dollars seems like a lot of money to most folks but it is chump change compared to what is actually the world’s largest Ponzi scheme. Congratulations, because you are part of it!

It is called Social Security. The government took money from early workers (beginning in the 1930’s) and gave them great returns. Among the first was a woman who paid in less than fifty dollars and then collected benefits until she died at the age of 100.

Bernie Madoff skimmed off money for his personal expenses; your government has effectively done the same thing. Your dollars have paid for national defense, welfare, food stamps, roads and bridges, waste, fraud, and abuse, and a host of other things. Bernie didn’t put IOU’s in the till for the things he bought. Your government did put in IOU’s, but the money is gone, accounted for, and spent.

Bernie made a lot of people happy with the fine returns he provided for many years. FDR and successive congresses have made voters very happy by providing lots of goodies from the federal treasury for many years.

Bernie has gone to jail because he could not find enough new investors to keep it all going. The same thing will happen eventually to Social Security. Younger workers will revolt.

The Trustees just told us the money will be gone sooner than they thought it would last year. They are talking about when the IOU’s run out. But there are only tax payers to pay the IOU’s and those same taxpayers will have to pay for current government expenses at the same time they begin paying off the IOU’s in just a few years.

This is what is known as a train-wreck and it will happen sooner than you expect. The only difference is that no one will go to jail. The guilty parties are voters who have kept on, and keep on, electing politicians who rob them of their freedom while promising “security” in return.

Those who make this bargain end up with neither. Bernie Madoff is probably collecting his Social Security payments while in jail. If only we could lock up Congress with him!

Green Shoots and Great Subterfuge

Much has been made of supposed “green shoots” in the economic reports that indicate things are getting better. Banks actually made profits in the first quarter. Housing numbers are not as bad as they seem. New claims for unemployment came in lower than expected.

These are actual reports but are better seen as “spin” than as signs that things are turning around. Bank profits were based on silly things like this: Banks could repurchase their debt for pennies on the dollar and the difference between par and pennies is thereby booked as a profit even though they did not actually repurchase any of their debt.

New claims for unemployment are made weekly and the numbers are well known to be quite volatile. Economists are pretty much universal in their agreement that unemployment will continue to rise even after a recovery has actually begun. That is the normal pattern of every recession. The rate of unemployment can be expected to rise for at least a year and will probably reach 12%, if not higher.

Housing starts are the lowest they have been in the fifty years records have been officially recorded. Sometimes I think we might be better off without all of the government and private institutional reports telling us what is going on. The spin says most of the drop in housing was in multi-family, not single family units. Gee, don’t you feel better now!

One of the great questions I still wrestle with is whether we will have inflation or deflation. I believe the reality is that we cannot yet know the answer to that question. Some economists believe we need to encourage inflation to help debtors to be able to repay their debts. The pressure on prices is now downward because more people are inclined to save and fewer people are borrowing and buying. Housing, automobiles, and many other things, especially durable goods, are falling in price.

Niels Jensen believes governments worldwide will need to borrow at least to  33 Trillion Dollars because massive government borrowing has always followed banking crises. That is about fifty times the amount set aside by the original TARP bill. The massive borrowing will crowd out private sector borrowing and that will mean very slow economic growth in the private sector economy for at least the next several years.

Massive borrowing needs may mean high interest rates for savers, or it may mean that the slow economic growth will leave interest rates at low levels for years to come as we try to grow out of these problems while starving the economy of investment capital. Either result will not be good for the stock market.

The green shoots of the economy should have two words written on them: Caveat emptor!

De-leveraging, What it is and What it Means

De-leveraging is the process by which consumers are paying down their debt (mortgages, home equity lines of credit, auto loans, and credit cards) or having it written off by lenders or discharged in bankruptcy. Consumers have taken  thirty or more years to get into the position in which they owe too much in relation to what they own and they will not get out of this position quickly.

There will be at least three results of consumer de-leveraging. Two are baked in the cake. The third is a result of government actions taken so far and it could be changed.

1. Lower Consumer Spending

When consumers pay down loans and increase savings, they will spend less. Consumer spending has recently made up about 70% of GDP, but this was not always the case.  In the past, consumer spending was generally 60% to 65% of GDP and that is the direction we are likely to move again. That means fewer $4.00 cups of coffee and fewer $40,000 new cars.

2. Lower Corporate Earnings

Most of corporate America depends, directly or indirectly, on consumer spending so a reduction in consumer spending will also mean lower or slower growing corporate earnings. That means slower growth in the stock market and lower returns in the 401(k) plans that millions of Americans will be depending on for their retirement.

3. Slower Growth in the U.S Economy

To understand why this is optional and not mandatory, we need to understand why consumers borrowed too much and that there is another way out of the financial mess. First, economic slowdowns are as normal for the economy as breathing is for you and I. Inhale – growth; exhale – contraction and liquidation of bad investments. This cycle has been going on for hundreds of years in the U.S.

However, politicians in their ever present desire to keep getting re-elected, figured that if they could eliminate the pain (unemployment and bankruptcies) associated with recessions, they could stay in office forever. So, among other things, they created the Federal Reserve System and gave it, as one of it’s tasks, maintaining full employment.

The Fed, dutifully cuts interest rates every time there is an economic slowdown. Instead of poor investment decisions being revealed for what they are, more money is borrowed and more bad decisions are made. Problems that should be corrected through liquidation and bankruptcy are simply compounded into ever larger problems and ever greater debt. That is how we got into an unsustainable housing price bubble.

Right now the Fed (and the Treasury, Congress, and the Administration) are hoping that near-zero interest rates and massive government spending and bailouts will get the economy going again. Considering that we got into this problem with too much borrowing, what are the chances that even more borrowing will get us out of it? Ask the next former alcoholic you meet that question.

Low interest rates helped to get us into this mess and only higher interest rates will lead to the savings that we need to get out of it. Low interest rates and high government borrowing crowd out private investment and that will result in slower growth in the U.S. economy, a lower standard of living for Americans, and a self-perpetuating cycle of government deficits that must be fed with massive borrowing.

We have been down this road before. Think Jimmy Carter. We got out of that fix by shrinking the size of government (barely) and lowering tax rates. Deficits rose in the short-term but the rapid economic growth incentivized  by lower taxes and decreased regulation produced a doubling of tax revenue in only a few years.

While we could go that way again, all indications are that we are re-playing the Hoover/FDR policy prescriptions of the 1930’s that will increase the size, scope, and cost of government  and that will prolong and deepen the recession. Their policies helped turn a recession into the Great Depression.

We do have an option here. We just have to hammer on our elected officials to take the other route. The current war on prosperity will produce more poverty and less freedom. De-leveraging does not have to end this way.