Tuesday, June 23, 2009

The Spectre of Default

Governments the world over are hoping to publicly borrow their way out of the stupendous mess created by the private financial sector. They are thus engaging in a monetary and fiscal experiment of Titanic proportions, steering a patchwork ship of State constructed from traditional Keynesianism and radical free-market ideology. Unfortunately, they are either blind to, or are nervously whistling past, the largest iceberg field in the history of economic navigation.

We are not going to escape unscathed.

Let's quickly set out what went wrong: oceans of debt blew asset bubbles for everything from clapboard houses and dinky mortgages to smelly shares, hedge funds, LBOs and 2/20 private equity funds. If an "asset" as much as fogged the mirror it was sliced, diced, indexed and leveraged to the hilt, transformed into a creative financial "product". A private banker friend told me two years ago that his nouveau riches customers from as far afield as Bangalore, Dubai, Sao Paolo and Moscow cared about one thing and one thing only: how many times can I leverage this baby up? At the top, if the answer was less than 40-fold they just sniffled and turned their noses away. (That's 97.5% margin, in case you were wondering..).

What happened next, predictably enough, was a debt crisis of historic proportions - and it's still going on. Amazing isn't it, how the newest generation of suckers always jump with glee into the oldest trap in the world* ?

Debt In The Yihaa !! Era

Governments, particularly in the U.S., are now desperately trying to avoid their biggest bugaboo: persistent asset deflation through debt destruction. Why? Because most assets are held by that tiny minority of the population for whom the golden rule applies (he who who owns the "gold" makes the rules). The vast majority of the rest have debts. To get a sense of the vast divide, in 2007 half of all American families had a net worth of $58,000 or less. By contrast, the top 10% had a net worth of $4,000,000 on average.

Chart: Federal Reserve

For a pluralistic republic like the U.S., does it make any sense to salvage the top 5-10% of the population's assets by placing more debt on the shoulders of everyone else - who already own next to nothing? Would it not be better to work out a debt default and reduction plan, instead of pumping the debt bubble even bigger?

But, mention debt default by (intelligent) design during a polite conversation and watch it grow hot and indignant - that's the moralistic Protestant Ethic weaving through most of us, I guess. Putting it another way, the Spectre of Default haunts, increasingly with as much fear as the other one did, back in 1848.

I am starting to believe that what America ultimately needs is a modern-day Solon and a healthy dose of seisachtheia.


* A short aside about the benefits of a comprehensive education in financial history: an acquaintance just told me he is convinced the economy is on a solid rebound track. When asked how he came to this conclusion, he proudly assured me had taken one (1) year of economics at college, some 20 years ago. Yes, indeed, there's one born every minute... So, at least, read a bunch of books before sententious certainty sets in, eh?


  1. Ah, so you measure someone's knowledge with how many year economics study they have taken?

    Economics is astrology. It is NOT a science, its a bunch of models and other mumbo jumbo based on absurd assumptions.

    The VERY LAST person you'd want to listen to about financial advise is an ECONOMICS PHD.

    How many economics PHDS are in the world's 100 richest people? ZERO.

  2. And how many of the world's 100 richest people will STILL be confiscating 95+% of the world's riches once the REVOLUTION really gets started, anonymous ?
    THEN we won't be worrying any more about WHO has WHAT degree, will we ?
    Gotta control wealth accumulation. That, Thai, is what ORDER SHOULD be about...

  3. if the average net worth of the top 10% is $4m, assuming at least $1m is locked in primary and vacation homes, a negotiated debt reduction for the rest 90% will all but wipe out this home equity for the rich.
    if a home is worth $500k with no money down mortgage, how much is it worth with a 20% down traditional morgage? above what level, the average net worth is greater than $100k, so this $500k home is affordable?

    in short: this debt game is a typical ponzi where the last ones in get suckered by the con artists.

  4. But if I understand this correctly (and I MAY NOT... I flunked economics in college, and am self educated...) the REALLY EVIL thing about the Ponzi scheme, and particularly as it relates to home owners, is that the crunch ARTIFICIALLY devalues what really has, and should have value, thus turning it into something apparently worthless.
    Not exactly what you want to have happening to YOUR HOME/HOUSE, is it ?

  5. Debra,
    anything, not just a home, is worth what the next greatest fool is willing to pay for it.
    with levered assets, such as homes, the value is reflected by fundamentals to a lesser degree than by the availability and affordability of credit. now we all know that credit has been plentiful and quite cheap during 2002-2007. now it is only cheap, but not plentiful.
    without full recourse provisions, loans with less than 20% equity contribution from the buyer are tixic waste now.
    add another affordability backstop such as that the payment shall not exceed 20% of the gross income, and you further shrink the pool of buyers. 20% down, 20% of gross income payments AND full recourse, are standard loan provisions in europe.

    a home has a rental income value, and rent equivalent value. it is not an asset (does not produce anything, has high upkeep costs, is taxed anually, depreciates), is not an investment, it is a shelter. ironically the australian statistics bureau uses exactly the word shelter for a home.

    as with any other asset, a home may have appreciation potential if new buyers can be enticed in the market and can be supplied with more leverage that existing homeowners.

  6. Great article hell.

    "Amazing isn't it, how the newest generation of suckers always jump with glee into the oldest trap in the world* ?"

    Actually, when one understands the mechanism behind this it is not so outlandish at all.

    The masses have been propagandized/programmed their whole life by the MSM. As such, most are not capable of independant thought.

    I prefer to think of it as a collective mass psychosis. This is why the elite can maintain such a high disparity between incomes and get away with it.

    However, in the end, the piper must be paid and this is why I always state this whole baby is going down hard. Period and Case Closed.

    Joe M.

  7. But What do I Know?June 23, 2009 at 8:42 AM

    I would suggest that economists are more like medieval scholastics than astrologers: they are segregated in an ivory tower arguing over abstruse formulas and philosophical constructs that have little or nothing to do with the real actions of the society around them--except when the quarreling Powers in their society decide to include them in their entourage because their writings and speeches can be molded to desires of the mighty. Then they can find the ways to pronounce what their sponsors want to hear to further their own quarrels over power, and are viewed jealously by their fellows for their supposed influence.

  8. I'm not sure if readers of this post are familiar with the work of Michael Hudson, an economist teaching at the University of Missouri.

    Hudson explains how modern economists have generally lost sight of the way compound interest inevitably leads to a debt level that cannot be serviced by the real economy. This leads to defaults and the seizure of underlying assets by the creditors who made the loans.

    Historically, as far back as Babylonian times, rulers would periodically issue debt forgiveness in order to restore balance to their economies. In our current political/economic environment, this would be seen as "inefficient government meddling". The economy, as everyone knows, reaches equilibrium naturally, as long as government gets out of the way. :)

    Hudson has two great papers on his website, which I highly recommend.

    His website is http://www.michael-hudson.com/. Scroll down to "Notable Articles" and link to "Mathematics of Compound Interest Part 1 Part 2 , April 2001".

  9. Thee Earl of ObviousJune 23, 2009 at 10:04 AM

    sententious ?

    You and your $5 words. Accelerated business degrees and Suze books have indeed made everyone think they are an Oracle of Scottsdale.

    I know a guy who is an anesthesiologist. Highly educated. Yet he listens to and quotes Suze.

  10. Michael,

    Thanks. This just goes to show there are exceptions to everything, even for an economist.

    Speaking of compounding interest, we are compouding now in the multi-trillions of dollars.

    An event unknown in the history of modern man. The US, as an entity, will not survive this thing.

    Joe M.

  11. I, for one, will defend Hell's 5$ words to the death as I LOVE THEM.
    As for medieval scholastics, I really love that one. Thanks, But what do I know for handing it to me on a plate.
    For Dink, and Thai, sweeties, THAT'S WHY WE HAVE GOD : to allow some to debate in/on the beautiful ivory tower so that others can carry on their buying and selling on the side.
    Now you see what happens when you get rid of God ; man carries on his debate in the beautiful ivory tower ABOUT ECONOMICS, and not about GOD, and meanwhile the ship goes down...
    Is this really what we wanted ?
    In any case, the ivory tower debate problem will not go away just because we want it to, and this is a big part of the problem...

  12. "does it make any sense to salvage the top 5-10% of the population's assets by placing more debt on the shoulders of everyone else - who already own next to nothing?"

    Well, when you put it that way....:)

    @ Debra,
    "For Dink, and Thai, sweeties, THAT'S WHY WE HAVE GOD"

    Good news! I was visited by an invisible guy last night who told me that all the world's woes are caused by womenfolk. So now I'm a believer and I've been delegated the authority to confiscate all your stuff and adopt you as a pet. Really, the invisible guy told me that you have to what I say or else you'll get in trouble.

  13. So how is it that debt increase seemingly occurs during a conservative tenure in government, whereas it holds steady or very slight decrease during a more of left of center government.

    What does this tell us and where is the comments on that.

    Oh well never mind... the numbers lie I guess.

    ferocicous beaver

  14. Concerning the first comment about economics being astrology. I think that I should point out that:

    1. Very few mainstream economists predicted the credit crunch

    2. A great many astrologers predicted some sort of financial calamity in this period (2008-2012):
    - Pluto entering Capricorn
    - the t-square between Uranus and Saturn last seen 1930-33 (or something like that)

    Now I am an enlightenment progressive so I think

    1. Astrology is hocus-pocus
    2. Economics is ruling class ideology – politics not science

    That being said, credit where credit is due: Astrologers 1, Economists 0

  15. foreseeable debt jubilees would lead to escalating interest rates on new loans as the date of forgiveness approached.

    They would create a credit crunch in expectation of the jubilee


    three cheers to the astrologers, can we replace Bernanke with Mystic Meg

  16. Instead of "I for one", why not say, "I"?

    Cost: I penny.

  17. So, shtove, instead of lighting into me, why not YOU defend $5 words ? Cost : NOTHING.
    Dinky, come over to the saloon so we can shoot this one out, THIS is not the place...
    I have a one or two medium friends who are rather good at predicting things...
    But HELL has shown us that you don't need to be a medium to have predicted/predict what's going to happen with all this mess...Only a question of TIME.

  18. Re: various

    Economics is not a hard science in the sense of math or physics. Rather, it requires a healthy combination of experience, historical knowledge and appreciation for crowd psychology. One year of Econ 101 taken 20 years ago at college falls very far short of that..

    $5 words: as a businessman I will do a deal with you; should you object to my using them please deposit a fiver for every such word I do NOT use. In no time, I shall be as rich as The Oracle :)



  19. I find it very interesting that anon brings up the Astro-Angle. I just read today we have a triple eclipse that begins on 7-7-09 and completes in only 30 days.

    Historically, this portends very bad mojo.

    I would not discount Astro or History at this point.


  20. The problem is not wealth accumulation (by legal means), the issue is that this wealth accumulation has taken place through big business (be it Wall Street, multinational corps., etc.) being in bed with big Government at the Federal level; you see it's much easier to bribe one central Government than 50 individual ones at the State level. Restore Federalism, drastically reduce the size and scope of the Federal Government, and voilà problem solved.

    In essence go back to the Constitution.

  21. Hell objects to the term "Sheeple" for the American public. How bout compliant ignoramuses? Entertainment-drunk sleepwalkers? Propagandized puppets? Come up with your own definition but you ain't got much of a republic left, if the only education or understanding of history comes via infotainment TV (>85% of the population?).

    Goldman Sachs announces the largest bonuses in their history, thanks to the American taxpayer, any nary a whimper from the public. I don't blame GS, why shouldn't they reap the rewards of an ignorant public. "Never give a sucker an even break." Serfs indeed.

  22. Sorry you guys, but I beg to differ on your somewhat sheeple ideas of where propaganda comes from, and the evils of wealth accumulation, while we're at it, Camabron.
    I'm sure that Hell can tell you that propaganda is not solely the product of the mass media ; as it turns out, the mass education system is pretty good at churning out propaganda on "nos ancêtres les gaulois" for us, "the founding fathers" for you.
    The entertainment system is responsible for the fact that people no longer want their history served up as a continuous spectrum of unembodied dates (those NUMBERS again...) they want access to some flesh and blood PEOPLE in learning their history.
    And for wealth accumulation : LEGAL or not, that is NOT the problem... Who cares whether it is legal or not ? Corruption has been around since man began, and it will not go away because of our idealism. Gotta control wealth accumulation, legal or not, I repeat.

  23. The price of everything and the value of nothing.....

    Francoeur on Kemf

    "..... Ecologists, he adds, have not often conducted an inquiry into the "ecological misery" that parks the poor next to industrial neighborhoods, polluted and at risk, next to highways or noisy activities, in the most insalubrious houses and in sectors generally the least well-served by public services, including public transportation. It is wrong, he says, to act as though the economic system must grow more to bring these people out of poverty or to allow more poor people to attain greater wealth. The economic system works in the other direction, by monopolizing wealth and power at the expense of those who have the least, and of the middle classes that dream - ever more vainly - of hoisting themselves into the cocoon of the present financial oligarchy, Kempf maintains...."

    "...That's why, he says, we must "bring down the rich" rather than pull up the poor, in order to begin to respect the thresholds of irreversible deterioration of the planet's resources...."

    "...He takes aim, moreover, at the concept of sustainable development and the alibi it now constitutes for governments and companies that use it to justify other drains on resources in the name of this new rationale that is supposedly harmless for the planet. Sustainable development, he writes, has become "a semantic weapon to remove the dirty word, 'ecology.' Moreover, is there any need to still develop France, Germany, or the United States? The concept has meaning, he concluded in an interview yesterday, but only in developing countries, because it can help them to avoid a development as brutal and lawless as the one we have effected in the West. But in the West, he says, the first of our environmental responsibilities "consists of reducing our consumption of material goods" to attain a level of well-being based rather on values, knowledge, in sum on immaterial, but nonetheless very real, riches...."

    A A Gill comments:

    "...The final, unpalatable, zero-tolerance truth is that hedge-fund managers, bankers, cynical architects, and insecurity-exploiting designers are far more damaging to the unstylized life of a city than all the junkies, prostitutes, panhandlers, urban cowboys, bag ladies, homeless, and graffiti kids they replace...."

    We are not alone.....



  24. Eco, I am sure there is a point at which even you would disagree with such bunk; the logical extension of such views is that we ask Robert Mugabe to become king of the world.

    Or is this what you are saying???

    And Hell, while we are in a "turn the other cheek" mindset regarding debt, how about we ask the Chinese and Japanese to do the same with us?

    I am sure this will change the behavior of party people in America.

    There is a reason the protestant work ethic exists, even if it is slows the rapid resolution of this whole mess.

  25. At least Hell has the perspective of a scientist. Yet I do agree with one of the other commentators on this point:

    How many of the top 1000 wealthiest people on the planet have an economics PhD?

  26. I raised my eyes, and ZOOM, there went another one of those PROPAGANDA words/expressions : zero tolerance...
    That said, I agree most definitely with most of what the authors on Econolicious's comment have spelled out, EXCEPT, the idea of reducing consumption of material things.
    We need to reduce/get rid of the consumption and thus the PRODUCTION of cheap, tawdry badly made things that are a disgrace to the very "idea" of work (yuck, that idea word, I'm gonna have to be careful...)
    And Thai, may I drily observe that it sounds like you are into defending YOUR wealth accumulation, perhaps ? Protestant work ethic, gimme a break please..

  27. Averages in this case may be a bit misleading. After all, it only takes a few Gates, Waltons, and Mars families to skew the averages to the upside.

    Since were using 2007 government data, I going out on a limb here and guessing median net worth of US households hasn't improved much in the last two years. Especially for those in California and Florida where home equity has been vaporized.

    This is where I'm having a problem with the idea of deflation/debt default. There has to be a ton of bondholders out there not wanting this to happen, and perhaps willing to endure a currency devaluation to insure that it doesn't (for sovereign debt as well). Blood from a turnip and all.

  28. Deb, you misunderstand my point.

    To quote Hell from his next post: "It would make no sense whatsoever to provide debt relief, only to see borrowing come roaring back."

    My point is that debt relief as Hell has been defining it in all his many posting is really the same thing as a change in human behavior.

    If there is no change in human behavior, but a simple paper debt relief, then there will be no real debt relief AND the planet just might be destroyed in the process.

    Hell is clearly at a juncture in these series of posting and he knows it. He sees he has two mutually incompatible moral dilemmas (a kind of cognitive dissonance as it were) and he is trying to come up with a solution that rectifies the incompatibilities and stills works within his own personal moral matrix.

    I think he knows his proposals still have major problems but don't misunderstand that my stating this is a criticism of them/him as I can't see a solution that works either.

    What Hell hasn't come to grips with yet is the notion that leadership requires personal sacrifice- a very important element of the called protestant work ethic you deride. He doesn't want to sacrifice one moral value for another- he still thinks he can have his cake and eat it too.

    ... No foul as we are all guilty of doing the same thing.

    We will obviously continue this and more discussions on future threads.