Is America Bankrupt?

Following Enron's [and Worldcom's] demise Congress enacted Sarbanes-Oxley (SOX) to ensure the transparency of management practices for public companies. Enron's financial engineers had created off-book derivatives that worked just like an off-shore toilet: they would dump all their "phantom" debt there, but unfortunate for Enron's executives, the flusher didn't work. The debt was actually real. Enron was able to hide its debt so long as its energy revenues were growing. Once that stopped the house fell down.

Whether it be SOX, GAAP or FASB, many if not most mortgage-backed securities have not been reported or posted through any central clearing, so that no one knows for sure how much of this debt there is, actually. Also, their valuations carry heavy future value and discounting to net present value is not a clear exercise. There's no central regulatory clearing for much of this paper. Which in large part has led us to this current crisis. And so we ask whether such unregistered securitizations amount to "fractional reserve banking." Fact is, "money" is only created when there's an interest rate yield...I loan you $1, you repay me $1 ten cents. When short terms rates are 0%, as they are right around now, no money's being created, and most one's making any real money.

The global system, as exceedingly nuanced and complex as it is, could do with more accountability rules and transparancies. The very nature of securitization itself is to create "off balance sheet" leverage. Hence, many of these securities never found themselves registered on any publicly accessible balance sheet anywhere, hence by some estimates there's an estimated $62 trillion of CDOs, CDSs, SIVs and other variants of such securities floating around the globe's pensions and in other institutional portfolios. Indeed, subprime mortgages showed the highest rate of default, and these were largely made by non-traditional lenders that entered the market just after 9/11 and practiced asset-based (versus income-based) lending. They were able to do so when the Fed lowered interest rates dramatically after 9/11. The result was a now infamous asset dollars flowing into highly demanded/short supply assets. (Absent the asset bubble thanks to cheap dollars, might Iraq never have happened?) The Fed in essence simply post-poned the day of reckoning, which is now upon us. (One wonders if securitization itself is the problem, and needs to be reconsidered and its process redesigned.)

Now, many mortgage banks and lending institutions are reluctant to "take the hit" and seriously write-down these over-priced assets still on their books. California Congressman Darrell Issa believes such institutions should be forced to write down the values of these over-priced assets, albeit gradually. This is one variant of "mark to market," which with behemoth institutions is likely a better policy than relying on yield curve determinations made by private investors. He suggests that servicers and mortgage holders be compelled to allow short sales to the current default borrowers now living in those homes, perhaps by amending current bankruptcy law. FDIC head, Sheila Bair agrees. "Modify and issue 1099's for the difference," she suggests. Obama appointee, Professor Elizabeth Warren concurs with Issa that "there be a change in the bankruptcy code--it will force a wake up call," she says. One in 7 mortgages are soon to be in default, according a recent GAO Report. The bottomline is, carrying non-performing overvalued assets on the books--hoping for a market rebound--is denial, wishful thinking, and delaying any recovery.

Opponents say such steps will pose a moral hazard and give incentive for good mortgagees to default. They say default borrowers shouldn't be rewarded, no matter what. Yet is there really any intelligent alternative? We are living in 'Chi-merica' (Chindifying America). America's manufacturing supply chain for many industries is now in China. And many services are now being outsourced to India. Here, all the tax dollars spent on public roads and bridges over many years don't show up as off-sets on any grand balance sheet--instead, they've been expensed. (Which explains why conservatives over the years have been so eager to 'privatize' public assets.) Our global capitalist system has over-relied on asset appreciation--not real net earnings--to support inflated pension schemes and current levels of debt service. Hedge funds and unrestricted foreign ownership of U.S. assets have exposed vulnerabilities. Debt issuance rationales have typically relied on future earnings projections, which in a flattening earnings global scenario cannot and will not pan out. In China, all businesses must have a domestic partner--and only citizens can own real estate, which even so operates on a 100 year land lease. Mexico has a similar policy.

Yet, in the final analysis, America's paper is not worthless so long as willing ambitious American workers have steady jobs (to repay U.S. treasuries...IOUs). The real wages of U.S. workers, I submit, have been "Chinafied." In other words, a well-trained knowledge worker in China earns the equivalent of about $300 U.S. dollars (8 RMB/yuan = $1 U.S. dollar) per month. Why should a business analyst in China earn $300/mo., while a business analyst in the U.S. earns $5,500/mo.? (Indeed, it is an apples-to-oranges comparison given the many government subsidies in China that allow for the payment of lower real wages to workers, and also their near zero legacy/benefits costs.) In the U.S. many once privately held liabilities have been transferred to the public sector (i.e. Pension Guarantee...). For the most part, there's no real qualitative or productivity discrepancy, but rather "distortions" in the earning/price indices, which are now being "played out" and will continue until assets values (and overall debt) adjust to real net wage levels (resulting from globalization). Is there a global bottom, in this high volume, low margin world? Is there such a 'reality' as global equilibrium? The oceans have their tidal about global capital flows? The distortions, largely, are a function of credit and excessive cost of money.

Two of 5 jobs until recently were connected to the real estate industry. This explains in part high recent unemployment figures. Many workers wonder: How does the stock market impact present and future employment? Many employees of public companies are just now realizing that as share prices of their companies drop, the debt-to-equity ratios of their companies goes up. In other words, leverage increases as share prices drop. Companies tend to borrow in relation to their net worth, not unlike home borrowers that refinance. Equity [and value] tend to be market-driven. (Home prices--like shares--are a function of demand, which equals cost/ availability of money and credit, job security--which is a global phenomenon nowadays--and comparative factors, i.e. supply of qualified buyers, inventories, etc.). Hence, diminishing share prices increases the likelihood of lay-offs. Indeed, as the equity side of companies drifts downward, proportionally more dollars are required to service existing debt. Which is another reason why consumers lack confidence to go out and spend. They're concerned about pink slips in January of next year. Globalization and outsourcing have indeed brought downward pressure on wages of U.S. workers. And the current account deficit (another all-time record high) affirms the fact that America as a service economy must re-examine its ability to generate real wealth. Many services have been reduced to commodity status. How about design and innovation?

If a large chunk of America's treasuries--held by China--were to end up near worthless paper (never mind the small amount of remaining gold in Fort Knox), China is in deep trouble. In fact, the entire global fiat money system is based on faith. Given China's diminishing surplus it's able to buy less U.S. paper. The fundamental question, given our excessive debt, is: what, really, is 'money' our era of fiat money? (The Economics 101 definition of M1, M2, M3, M4 no longer seem to be entirely accurate.) Is money a function of 'time,' i.e. $300=x/hrs. of labor? Think about it, after a $700+ billion bail-out (with more on the way) what is 'money'? What is 'securitized debt,' really? (It's an entirely different question than...what is the nature of money/securitized debt...? The CBO estimates that interest on the national debt will soon reach $750 billion per year by 2019. We're now in what amounts to a "liquidity trap," without sufficient real earnings, hence demand. The corollary of our debt debacle is...the very credit system itself. Are there viable alternatives to a credit-based system (and our global credit issuing institutions)? For years many analysts have pointed to "interest" as the root of all imbalance...the interest charged by the Fed to the Treasury in exchange for issuing currency. Is this a rational point? And, finally, to account for the asset base of public sector: how much, say, is a federal highway worth...on some balance sheet, when it's not revenue producing? (We haven't really valued these public assets as offsets.)

One thing's for sure: the "Laffer Curve" of supply side economics--once hailed as "voodoo economics"--has proven itself to be fundamentally flawed. It postulated that markets self-equilibrate. But they don't. A market is simply a clearing: it reconciles supply with demand. It does this based on various rule sets, as perameters. The deregulation that began in the Reagan-era gave rise to laissez-faire and Enterprise Zones, and they really haven't worked. Why? Because they're "top-down," disconnected big business approaches. People dream of becoming rich, but they must eat and feed their families first. Altitude has a way of blinding the elite, just as too much wealth can dull one's sense of urgency needed for entrepreneurship. These approaches generally don't properly seed things, and instead rely on various "magical" mis-conceptions of entrepreneurship, as though wealth is created from ideas alone. Recall monetarism and the Chicago School in Argentina? It didn't work there because it suggested that incentives alone motivate, which is not entirely correct. Wealth and capital formation have tended to stay at the top with these approaches, benefitting large and mid-cap enterprises. (Perhaps micro credit will become part of the solution, even in wealthier states where there are huge wealth disparities.)

Hence, perhaps today's solution is more Keynesian (aka "Liquidity Trap"): to restore purchasing power (aggregate demand)--to create both jobs and community reinvestment pools to create local "bottom-up" capital formations--by reducing dollars now going toward debt service is one method to be considered. The community credit union model--not just a redevelopment agency--would be another innovative approach. Extreme conservatives will view this as "socialism," but in fact, markets like people are imperfect and prone to disequilibria and require periodic major recalibrations. America should likely have implemented an industrial policy years ago, like China, Japan and Europe did. Such strategies have not exempted them from business cycles, but many of their industries now require less retooling than ours do. (Let's not forget Vice President Cheney's infamous secret "Energy Policy Meeting" with Ken Lay and others back in 2002. Some of such policy--or lack thereof--is responsible for Detroit's woes today.) And also, America's current account deficit is proof that outsourcing, NAFTA, and WTO cause system-wide problems when "fair" trade is not in fact "fair"--indeed, America needs reciprocity in terms of honoring and abiding by "fair" trade agreements.

For too long extreme conservatives, like former U.S. Senator Phil Gram, thought private managements of publicly traded companies "knew better." Now taxpayers are faced with serious consequences of these "private" mis-managements, accountable only to their shareholders. Serious consequences such as a looming inflationary depression. "Too big to fail," has too often meant "unable to coordinate an entire industry for radical restructuring." By the way, where is Big Oil in terms of the auto industry? Silent, to be sure. At the 2008 World Economic Forum in Davos, Switzerland, George Soros called for a "Global Sheriff" (aka a Currency Board) to monitor various inefficiencies in financial markets. He was laughed at for suggesting such--never mind the IMF's bleak performance record in recent years. As it turns out, however, he was prescient, and correct in his analyses starting as long ago as 12 years. In reference to re-examining assumptions, he says, "I contend that financial markets are always reflexive and on occasion they can veer quite far away from the so-called equilibrium. In other words, financial markets are prone to producing bubbles."

In his book "Financial Darwinism," Leo Tilman suggests we need "greater risk transparencies." Will any of us be surprised if the State of California is the next "shoe to drop"? A pre-packaged repudiation /bankruptcy-like scheme [managed by the Feds] may be the only way to mitigate its huge CalPers and Ballot Initiative legacy costs. Some huge major bankruptcies loom...due to unfunded pension liabilities and excessively high debt service requirements. And tough choices will be made...between funding for schools and other present services, versus excessive public pensions. Not all debt is equal--it may make sense, as the treasury issues new debt, to refinance and replace some of the older legacy debt. A major debt-to-equity conversion is needed (which China must help with) if any stimulus package is to work. Once again, we need to restructure debt, seriously, even if it means discharging and repudiating a great deal of it. Debt holders will need to be willing to accept equity in replacement of their debt, no matter how painful. This, in order to avoid total default.



some more rules

Folks read the user guide and the FAQ in the about link.

Gregman you need to format your posts

Also don't be a blog hog.

Also, format links where you site references. For example, you quote the GAO, please link to the study you cite.

One of the goals on posts as least (comments anything goes) is to have well cited and referenced posts. The big sacrilege is to write economic fiction so being able to verify those links is important to readers. It brings credibility to what you are saying (and CDOs, derivatives is something we have talked a lot about on EP, what a ponzi scheme!)

There are lots of tools to help you format posts but writing straight text is very difficult to read without formatted links, sections with headers, etc.

We ain't going anywhere but you shouldn't be filling up the blog space with tons of posts at once.

You're ok but one more and you'll be in trouble.

Finally, the Instpopulist is for shorter posts those types of things of "this pisses me off" to "did you see this"...

I think this is OK as a blog posting

Once it was formatted that is (could somebody go back and format the other one on how local hospitals got refinanced into rent-based businesses? I think that too is an important part of the big picture that I simply haven't heard about at all). However, I've got a couple of quibbles with some of your theory:

Fact is, "money" is only created when there's an interest rate yield...I loan you $1, you repay me $1 ten cents. When short terms rates are 0%, as they are right around now, no money's being created, and most one's making any real money.


This is actually a very real point, but more importantly, a very modern point that only applies to fiat currencies.  In normal capitalist and traditional economies, money is made by value added production- that is, by increasing the real value of some item, then selling it for the difference you can get between what you paid for the item and what it is now worth.  

But with fiat currency and fractional reserve banking, bankers found a way around that- interest rates, that is, usury.  But in September, we learned what happens when the main way to make big money is usury- it's an unsustainable system that comes crashing down around your ears.

Because of this, I have a tendency to side with the sound-money people.  I'm not a gold bug yet (partially because the price of coined gold is still trading at several times spot price, indicating that there is some fiat currency "magic" going on in that market as well), but I'm becomming more and more of a tangibles consumer; instead of keeping my money in the bank, I prefer keeping it in a 2 year supply of canned goods (rotated), a house that actually has some equity still (surprisingly), and items that will help me survive a total US Default such as native plant landscaping, a cheap used boat, a used pop up tent trailer, and a class 3 hitch for my wife's van, as well as sacrificing to pay off all of our consumer debt.

The more I think about it though, the more I have to say we need a better balance between sound money and fiat currency.  "Hard to transport" gold bar backed debit cards with a minimum currency amount of an atom, perhaps, so that as deflation or inflation hits, all that really changes is the number of significant bits on a number in a data cluster someplace?  That are government backed instead of bank backed and fully transparent so that anybody who you are doing a transaction with can verify you have the correct number of atoms for the transaction before agreeing to it?

Maximum jobs, not maximum profits.

No KS tax refunds. State workers?


KS just joined CA.