Life after CDS

One of my closest friends and colleagues in the Netherlands wrote to me this week reminding me of a conversation we had years ago.  Jan J.Ph.M. de Dood, Director at Rabobank Noord-Holland Noord has been advocating for fundamental transformation of the banking system not as an isolated industry endeavor but as a critical utility serving all human enterprises.  Together with his colleague Marieke de Vrij, he published The Future of a Truly Sustainable Economic Order  in which they lay out an accessible assessment of where society is at the moment and where we might consider transforming our behaviors and systems if we wish to establish a more sustainable economy.  As many of Marieke’s and Jan’s analyses and suggestions are plainly articulated in their piece, I will simply commend its reading to you.  Take some time, follow the hyperlink and take in their insights.

The conversation we had in Amsterdam a few years ago had to do with organizational behavior that arises from the explicit and implicit expectations we manifest by virtue of the titles and roles we use.  At the time, Jan served as Chief Risk Officer at Schretlen & Co, an investment bank and wealth management unit of Rabobank Group.  In our conversation, we were discussing what would happen if financial institutions had a Chief Synergy Officer at a role equivalent to (or above) the Risk mandate. 

“What if,” I suggested, “a bank would be as concerned with the economic and credit success of their borrowers are they are forced to be about the risk of credit failure?”

What would a Chief Synergy Officer do?  This question opened up a wide-ranging conversation about the ecosystem of banking.  Imagine a situation in which a bank would lend money to a farmer growing wheat, to a miller who grinds grain into flour, and to a baker (a nice example if you know Rabobank’s roots).  Each of these actors has economic utility requirements that are fundamentally shaped by factors that are beyond their direct control and that happen in variable durations. Wheat is harvested in its entirety once each year.  The farmer’s “wealth” is an annual pulse.  The miller receives the abundant harvest and has the role of processing and storing the grain and flour for distribution to users of flour.  Unlike the farmer, the miller has some sequencing control over when grain is ground into flour and when the supply is expanded or contracted.  The baker sells bread each morning and purchases flour from the miller once each week. 

A Chief Synergy Officer at a bank would do a few vital functions.  Realizing that “credit quality” is a function of the healthy flow of currency in systems of exchange, the CSO would identify the entire value chain and seek exposure to, and the health of, all units within that exchange.  By participating in the farmer’s business, the CSO would understand that “risk” and “abundance” is a commodity function tied to weather, for example.  By participating in the miller’s business, the CSO would understand that the “risk” and “abundance” has to do with the price controls possible in setting the price of staples.  By participating in the baker’s business, the CSO would understand that “risk” and “abundance” is linked to the daily annuity of multiple individual transactions which perpetuate the flow of value exchange within the system. 

But in addition to the closed loop system of the wheat to bread cycle, the CSO would keep a watchful eye on: 

• new irrigation or crop management technologies which could benefit the farmer and limit the “risk” of climate related production failure; 
• better energy systems to improve the efficiency of the mill or climate control the warehouse of flour; and,
• better property locations to improve the baker’s store front placement (or oven venting for the scent temptation effect) to increase traffic to the bakery.  

Rather than proprietary trading against clients – a practice that is routinely done by today’s leverage optimized banks – a CSO would actually trade into the benefit of borrowers to increase their collective chances for sustainable success.  In this world, there would be no Credit Default Swap (CDS) but rather a Productivity Enhancement Option (PEO).  Returns could be improved by virtue of market vigilance for enterprise enhancement rather than hedging the risk of failure. 

To be clear, the present system has its Paleolithic version of this system in the most inefficient and crude fashion.  The opportunistic association between private equity and banking achieves a fungal version of this model with one notable deficiency.  In the present system, the system most often serves the rentier (banker) and his constituents at the expense of the farmer, the miller, and the baker and the bread-eaters.  The bread-eaters receive the crumbs from this system after the feast is consumed through their meager, manipulated pensions.

Jan de Dood and his colleagues are showing the world the pathway in banking that Robert Kendall demonstrated in Cole Publishing.  By serving an industry ecosystem in which the goal is to build the success of actors within that ecosystem, the potential for wealth and health within that system goes up.  Those who subscribe to the “profit at all costs” model fail using their own metrics (unless they corrupt the system by covert accommodation from elected political benefactors).  The model suggested by Jan and deployed by Bob don’t require bailouts – they have celebrations of success.  As Marieke and Jan observe, this more constructive approach is as close as our capacity to think differently. 

Think differently.

Economic Innovation – Beyond Infinite Growth

Economic systems can be an outward manifestation of confidence and trust – the collective agreement between persons to store and transfer value.  When these systems explicitly acknowledge the full range of costs (the accounting for all values of input) and benefits (the utility derived from interaction and consumption), they can serve as a constant reminder that we are participants within, not lords over, the abundance of our entire ecosystem.  In a human-scaled system we would explicitly acknowledge the values derived from, and expressed through, commodities, customs & culture, knowledge, money, technology, and well-being.  We would commit to honor productive utility rather than the illusion of perpetual and unsustainable growth.  We would define wealth as the state in which maximum utility is accessible while preserving all future options for all future users without degradation or exhaustion.

Time magazine’s August 12 issue declared that Germany must save the Eurozone and the euro by abandoning their restraint on consumption.  With Mittlestand firms continuing to hold on to values of fiscal discipline and persistent quality, the author argued, Germany’s productivity has ‘caused’ some of southern Europe’s contagion and instability.  I suppose in a world where we prefer Twitter fueled street uprisings and infinite expansion of central bank balance sheets tenuously propping up the capitalist illusion that has, in its current manifestation proven its own failure, this assessment makes sense.  However the author’s imposition of a growth-by-consumption paradigm is one of, but certainly not the exclusive, economic model that can be considered. 

Americans (and the rest of the deluded world) forget that the conditions of surrender at the end of the Second World War included massive reparations of German technology (magnetic data storage, dyes and chemicals, aeronautics, encryption, communications, nuclear engineering, medicine) without which we may still be using IBM’s Selectric typewriters and teaching our children how to change the ribbon, listening to our 33 LP vinyl phonographs and answering our land-line phones.  Careless neglect of the memory of Operations Paperclip, Epsilon, Alsos, and Lusty – including the arrests of key scientists and their subsequent rendition-evoking “invitation” to join the U.S. military and industrial research programs – perpetuates our self-determination myth that has no basis in reality.  Time’s Rana Foroohar is not fully culpable of drawing temporally expedient conclusions – I’m sure she hasn’t studied the German expropriation that defined much of the technology of the last 70 years of industrial development – but she does nothing to point readers in the direction of a more complete view.

Why do we need revisionist history as a central tenet of our current economic paradigm?  The answer is quite simple.  Our imperialist form of scarcity-inspired capitalism doesn’t work as advertised.  Why would I conclude this?  Well, that’s easy too.  Without massive price support, our agriculture sector collapses – thus the U.S. Farm Bill and its equivalent throughout the G-20.  Without tax loss harvesting, our venture capital system doesn’t work.  Without Federal Reserve, Central Bank and tax-payer intervention our banks fail.  Without protectionism (including over-ruling decisions made by our protectionist USITC), our innovation can’t stand up to global competitors.  Without tax exemptions, our charity starves.  Without international scientists and graduate students (many of whom come from communist or socialist states who are indentured in labs in exchange for education), U.S. science chills.  Does this mean that there is nothing salutary in our economic paradigm? No.  But it does mean that the illusion requires an awful lot of props that should be anathema to the principles we espouse.

Is it in the principle or the practice where the economic illusion dissociation really emerges?  Well, on that score, the lines get a little blurry.  Our consensus of economics and their essential nature are born of natural philosophy infused with faith.  Faith, you ask?  Absolutely.  From Aristotle to the Confessions of St. Augustine the explication of the universe and its origins assume finitude, “beginnings” and duality.  From Newton to Maxwell to Planck, science emulated religion and set forth dogma and “Laws” around which inquiry was replaced by adherent confirmations and reproducible observations in controlled conditions.  The laws of thermodynamics, for example, explicate the relationship between heat and work in systems defined by boundaries defined by irreversible flows.  Newtonian physics presumes conditions in nature without examination of the essential nature of nature.  Embedded in these catechisms is the precept of statistical equilibrium without consideration of the dynamics and substance of Source.   Economics, our cult du jour, callously thumbs its nose at the Laws defining natural philosophy of the past with the falsifiable paradox of perpetual growth.  Rather than seeing systems as operating cycles of productivity and latency with interchangeable flows, we’ve imposed an ‘ideal’ of linear perpetual growth from which profits are extracted through explicit and implicit friction.  When we don’t see evidence of its success, we change the metrics (current central bank intervention) or fall back on the fable of mystifying booms and busts (the explanation given for unemployment, expansions and recessions, and ‘resource curses’).  

Our adherence to ‘Laws’ limit our capacity for systemic innovation.  And our convenient neglect of evidence that is observable but unquantified in our controlled experiments condemns us to illusion perpetuation.  If we don’t correctly understand systems, we assume a beginning without precondition.  We can haphazardly combust fossil fuels because we presume their existence to be ‘free’.  We rip forests down and carve up the land to extract elements because they’re there and they’re ‘free’.  By the application of ‘work’ (which is why we cannot escape our addiction to ‘labor’ statistics) we render ‘useful’ the elemental commodities which, without our intervention are ‘worthless’.  Yet, despite the irreversibility underpinning our natural philosophical presumptions, we maintain an illusion of perpetual growth to fuel the monster of our own creation – uncorrelated, persistent growth demanding, capricious debt. 

Which brings me back to Germany.  Not surprisingly, Germany’s industrial productivity is heavily informed by natural philosophy underpinnings.  Like the scientists and philosophers who rationalized the observable world in the Holy Roman Empire under the patronage of Friedrich Wilhelm I and Leopold I, German industry has more often used economic utilities as a means, not as the metered ends.  The relationship between capital and industry has been one of liquidity between boundaries of metaphoric and actual thermodynamic processes and states.  Into that reality, deterministic chaos and entropy (in the form of central bank accommodation for profligate States) has been inserted leading to a toxic imbalance.  German industry needs German banks.  German banks, bloated with obligatory exposure to non-creditworthy bonds, are facing existential threats.  Compelled to support unsubstantiated promises of future fiscal discipline (buying sovereign rubbish bonds and having to call them “assets”) while attempting to maintain their role as credit providers to industry, they are now in a precarious and unstable state.  If, on the one hand, they become increasingly the agency of European Central Bank illusions, their capacity to offer credit into industry will be diminished.  Alternatively, if they reduce their complicity in interventions, they highlight a reality that is politically unacceptable in the EU and in the global trading dynamic generally – namely, evidence that Germany is stronger than many would like them to be.

Rather than fearing this, as Rana Foroohar and Time would have us do, why don’t we take a step back and see what essential elements are working in Germany.  Maligned as unhelpful in the consumer-insanity based global economy, Mittlestand attributes like production value over volume, accommodative (including forgone or deferred) profit-taking rather than employment shocks, exceptional value of education and research, actually sound like things to emulate – not fear.  Consumer frenzies fueled by planned obsolescence could be replaced by things working!  Wow, that doesn’t sound too bad!   We may actually encounter and embrace, from time to time, the nearing-extinction principle of “Enough”.  Why wouldn’t We The People desire this?  It wouldn’t fit the patriotic narrative we’ve had indoctrinated into our social psyche.  It would mean that we may be encouraged to be more thoughtful in what and how we consume.  But, in the end, we may just find that credit-worthy productivity (and systems built around that) is more desirable than decadent profits at the expense of the planet and its inhabitants.  And we could certainly profit from such a transformation.

Make It Simple

I have lost count of the number of people who have written to me after a blog post.  “David, please make it simple.  I have to read your blog with one eye on the screen and the other in a Thesaurus or on Wikipedia.”  I don’t know when we were taught to be intimidated by money in our society but I’m pretty sure that it was not accidental.  Create a system of indenture; co-opt every human endeavor within that system; and, use terminology embedded in small font and, voila, you’ve got slaves to the celebrated illusion of capitalism that has never been truly and transparently attempted on the planet.

I would suspect that the first encounter most of us had with money was the “responsibility” laced allowance in which parents paid children for doing basic household chores.  As early as the 1830’s, the Progressives encouraged parents to give their children money to teach “fiscal restraint” and “charity”.  Behaviorists advocated the habitual enticement in the form of allowances or pocket money to induce socially acceptable behavior.  In post-Depression America and post-War Britain, an estimated 50% or more of children of white collar workers received allowances while only 15% of their blue-collar or agriculture peers had any such experience.  Churches got in on the act by including charity collections in Sunday schools and children’s gatherings placing the expectation on children to be in a position to adopt the practice of tithing.  This religious tax, once meant for the sponsorship of clergy and relief funds, was long ago co-opted by the institutional patronage required to support real estate and corporate programs operating under the moniker of religion. 

Ironically, during this first introduction to money, none of us were told what money was.  We knew that it could be granted or withheld capriciously.  We knew that it was “important” and with it we must be “responsible”.  But these constructs were devoid of any explanation.  In adolescence, the idea of working for money was introduced – in same cases out of familial support and in some cases to enable greater autonomy of behavior.  With money, one could individuate:  go to the movies; get clothes that were more to one’s liking; gain status as a sustainer in a family; etc.  At no point was money explained.  And then, for many, the first sizable encounter with large sums of money came with education and with that education – debt.  Still no education!  No real knowledge of how monetary systems work (or not).  Just the certainty that, having been invited into debt, “getting a job” would be a necessity to become a responsible adult.  How’s that for insanity?  To get an education to get a good job, someone has to be indebted – student, parent, or society – for which an obligation of indenture is explicitly formed – get a job!  Besides being circular in its illogic, it’s no wonder that I could sit this week with a group of women in D.C. who, at mid-life, had little to no actual financial literacy despite being highly educated.  What they knew was that they needed money to sponsor their lives and their causes but they had no idea what they actually were asking for with that blind insistence. 

Make it simple, Dave!

O.K.  Most of you are wearing your chains modestly well but you are slaves!

As a “responsible adult” you buy life insurance.  Why?  So that your family can pay off your debts when you’re dead.  Really, that’s why most of you buy it.  And many Americans buy term life insurance (insurance that is only good while you’re paying premiums and accrues no terminal value).  In data collected by the National Association of Insurance Commissioners, in 2010 alone, $1.1 trillion in term life insurance was bound.  At the same time, $112 billion in credit life insurance was in force.  The average life insurance policy in the U.S. is about $160,000.  With funeral costs running about $8,500, this leaves the balance of benefit for, you guessed it, the debt you didn’t pay off in life.

As a “responsible adult” you invest in real estate.  O.K., kind of.  What you really do is attach your labor indenture to a contract that flows much of that money to the bank (oh, and did I mention that the bank required you to get credit insurance?).  By the time you pay off your mortgage – a diminishing prospect in the current refinancing regime – you will have paid more to the bank than the real estate was worth by as much as 150% (or more).  So who won? 

As a “responsible adult” you will put money into savings.  Your bank – not you – will have your money insured for their benefit through the much misunderstood FDIC scheme.  And you will be paid a fraction of what your bank will charge for the use of your money.  And when they use it, they don’t use it.  They use it ten times over.  That’s right, your dollar deposit gets to be used by others 10 times at the interest payment the bank imposes.  You get paid once.  They get paid 3-5 times what they pay you 10 times over.  Who won?

As a “responsible adult” you will donate money to charities and non-profits.  Good news here, right?  Well, let’s not get too excited.  About 39% of what you give for others actually goes to others – just not the “others” you thought you were helping.  It actually is going to administer the charity. 

Make it simple, Dave!

O.K. Between taxes (40%), credit-related fees (25%) assuming you’re living among the top 20% of fiscally responsible citizens, and “charity” (5%), your existence is a majority indenture to the interests of others.  And if you’re capable of using the remaining 30% wisely – for things like eating, being mobile, and communicating – you’ll put 5-10% into “investments” which, at the moment do not earn enough to make up for the management fees you’re being charged.  In short, this whole racket, from start to finish is a mess.  You’re in the middle of it.  And the system is structurally unstable meaning that, when central banks decide to stop flooding the market with money, you’ll run the risk of inflation (rapidly rising prices), increasing taxes (governments doing less service for more of your money), and highly volatile investment markets (think about the mid-June equity swoon when Ben Bernanke said he might relax the Federal Reserve’s intervention). 

Make it simple, Dave!

Here’s the little problem.  The simple part is that the current taxation-state, indebted government, indentured labor routine has effectively enslaved the populace across much of the planet.  The average informed citizen knows that they’re part of the predation but doesn’t want to confront that reality.  The majority of humanity is chasing the illusion of fiscal footing and, in so doing, doesn’t take any time to reflect on the structure that is in place to insure that they do not progress.  Even elite capital market professionals, when asked basic questions like: what is a derivative contract?; how is solvency of government sponsored enterprises truly calculated?; what is the real capital exposure measured by rating agencies and what does ‘investment grade’ actually mean?; can neither answer nor clearly articulate where they’d go to find the answer.  The hard part – the part that defies ‘making it simple’ – is the fierce defense of the system of predation mounted by humanity – the prey – when they are confronted with the fact that they’re enslaved.  And that one, that core Stockholm Syndrome paradox, is the one that defies simplicity. 

These posts are simple.  They are direct.  And they’re not written in cartoon or Crayon.  That’s because you, the reader, are intelligent.  Co-opted, exhausted, but intelligent.  And with any luck, you’ll make the simple choice.  To continue to be more informed.  And with that information, choose to disengage from the utilities of your indenture. 

On the L(Edge)

This week we found out the use of covert information for individual advantage is officially a bad behavior…officially. Well, that’s so long as you’re not part of the Administration's Citizen Espionage Cabal in which case the misuse of secret-court-sanctioned covert collections is in the best paternalistic interest of the citizens who are incapable of knowing what is right or wrong and need a benevolent spy to insure that they are not seditious or subversive. And we’ve learned this because we have been treated to a steady drumbeat of the allegations of misdeeds perpetrated by Steven Cohen’s SAC Capital Advisors. For those of you who are trying to keep track of which criminal activity is criminal and which is “stimulus” to “support the economic recovery” you need one simple rule to keep it straight. If it’s authorized by the Administration, it’s good, legal and beneficial for the promotion of all of our collective interests. If it’s taking advantage of those stimuli monies by private traders not in the official Letter of Marque Privateering club, it’s criminal. Wasn’t it so much easier when you could see the Jolly Roger and say, “Oh, that’s a pirate!” before your wealth was stolen?

The indictment clearly highlights, among the alleged wrong-doing, “solicitation and use of illegal inside information”, (clearly you need a secret court to adjudicate as legal what is unconstitutional) on “a scale without known precedent in the hedge fund industry.” By accessing Inside Information, SAC Defendants provided “high conviction” trading ideas giving management and investors an “edge” over other investors.  In doing this, they made “millions of dollars of illegal profits and avoided losses at the expense of members of the investing public.” 

This activity was happening, according to the indictment at the same time Goldman Sachs was independently advising the Government of Mongolia to assume 12% debt on the development of one of the world’s largest copper reserves to “purchase” illiquid equity in their own national resource despite the fact that they were also advising people to buy into Ivanhoe and Rio Tinto – the beneficiaries of the structure developed to bankrupt the country.  This was happening at the same time that the World Bank and the IFC were advising governments around the world to enter into indentures that would destabilize governments for the sake of accessing natural gas reserves and minerals.  This was happening at the same time that rating agencies were defrauding investors using inflated credit quality ratings.  This was happening at the same time that the LIBOR price-fixing behavior was happening with nary a glance.  This was happening while the criminal enforcement division of the Internal Revenue Service was privately acknowledging billions of dollars of corporate taxpayer abuse of the In Process Research & Experimentation Tax Credit – one of the largest tax frauds by government estimates – while the Treasury turned a blind eye towards evidence provided by whistleblowers.  Unprecedented?  Seriously.  Steven Cohen’s indictment is a rounding error for the abuses listed above.  And the U.S. Department of Justice action on ANY of these other matters is…, well, umm…, oh, that’s right – these other ones are in our National Interest!

I don’t know Steven Cohen and I don’t know the individuals named in the indictment.  I am intimately aware of the industry.  What Steven did was wrong but the hedge funds that purchased real estate right next to equity and bond trading switches so that they can trade in and out of positions at the speed of light (literally) are perfectly legal.  High frequency, low latency trades; proprietary trades trading against high net worth wealth management account clients’ asset allocation; and, misrepresentation of pension solvency (and the insurers thereof) – these multi-billion dollar defrauding activities are beyond the scope of investigators.  No criminal indictments.  Just political donations.

It may be the case that SAC ran afoul of the law and for that I am certain that law enforcement (including criminal convictions) is appropriate.  But I’m getting quite tired of the selective enforcement of laws in which the language contained in indictments actually specifically indicts the un-prosecuted behavior of sanctioned actors.  This is the part that really is an offense.  And worst of all, the public is led to believe that the judiciary is actually doing its job while the real crimes go undetected.  We The People, the ones who pay taxes for the authorization of the Department of Justice, are being defrauded by “Justice” and nobody’s the wiser for it. 

“The accumulation of gold in the treasury of private individuals is ruin of the timocracy; they invent illegal modes of expenditure; for what do they or their wives care about the law?

Yes, indeed.  And then one, seeing another grow rich, seeks to rival him, and thus the great mass of the citizens become lovers of money.

Likely enough.  And so they grow richer and richer, and the more they think of making a fortune the less they think of virtue; for when riches and virtue are placed together in the scales of the balance, the one always rises as the other falls.  True.  

And in proportion as riches and rich men are honoured in the State, virtue and the virtuous are dishonoured. “  

Plato had it right.  And we need to be as wise today as he was when he dictated The Republic.  Sitting in the Shenandoah Mountains with my aunts and uncles at yesterday’s family reunion I was reminded that intelligent, thoughtful citizens are living in entire oblivion to the nature and structure of the perpetuation of financial high crimes.  That needs to change and you, the reader, need to make sure that you share information that can illumine what is being done in secret in our names.  Until we shine light on the real corruption, we’ll be hanging over the edge without knowing our own precarious state.

Fabricated in Detroit

On December 11, 2010 I wrote a blog post on Article 1, Section 10 of the U.S. Constitution entitled “Debtor in Possession… well at least Possessed.”  In the wake of that posting, many professional investors and advisors (those who have a vested interest in picking the pockets of pensioners) suggested that my conclusions were overstated and the risk to bonds was not as great as I stated.  The Honorable Rosemarie Aquilina, Judge for the Ingham County Circuit Court in Michigan sided with my precedent-setting blog post.  Sorry Chrysler and Eminem – “Imported from Detroit” doesn’t get you free from the long arm of the law.  And for those of you have been sleeping, when a Circuit Court judge finds it necessary to add, in her own handwriting on the court order, “A copy of this Order shall be delivered to President Obama.  It is so Ordered.”, my warnings on the fixed income pension crisis are not black swans anymore – they’re a whole flock of buzzards getting ready for the carcasses. 

Michigan Attorney General Bill Schuette immediately announced that he’s appealing Judge Aquilina’s ruling at the Michigan Court of Appeals.  Governor Rick Snyder’s trying to limit the collateral damage from Detroit’s filing and Kevyn Orr, Detroit’s emergency manager is left looking like President Nixon at a Chinese table tennis match.  At issue is the constitutional provision in Michigan barring a Chapter 9 bankruptcy that prohibits actions which “threatens to diminish or impair accrued pension benefits.” 

Now, I’m not saying I told you so but I did thus inform you years ago!  We’ve got a real problem on our hands and the Detroit filing – a reality that President Obama desperately tried to cover with a thin veneer in his acquisition of the Presidency – is neither isolated nor the most consequential.  What makes this one somewhat ironic is that conservative pundits and many Republicans thought that unions put Obama into 1600 Pennsylvania Ave.  Detroit will give us another interesting view of the President turning his back on that very population at the whim of his true benefactors: “The Powers That Be”.  Detroit wasn’t spared in the auto bailout.  The financial institutions exposed to distressed financing of the auto sector that had a lot to lose were paid off handsomely (and anonymously)! 

So this record-setting $18 billion bankruptcy is fascinating on its face.  In the actual filing Detroit states that:

It has over 100,000 creditors;

It has “More than $1 billion in assets”;

It has “More than $1 billion in liabilities”;

It has over 60,000 parcels of land and more than 7,000 vacant structures which pose “a threat of imminent and identifiable harm to the public health or safety”; and,

Detroit has been in a state, “of 60 years of decline for the City, a period in which reality was often ignored.”

It’s this last line that really jumps off the page.  Call me Cassandra (think Trojan Horse) but the reference to “60 years” is particularly fascinating and vindicating.  What was it in 1953 that put Detroit on the collision course with today?  Ian Fleming introduced us to James Bond in Casino Royale, Watson and Crick unwound the helix, the CIA authorized the use of LSD to test human cognitive potential, Hugh Hefner published a nude photo of Marilyn Monroe in his first issue of Playboy.  A more careful view of history may suggest that this reference hearkens back to the contentious polarization of relationships between management and unions which, under President Harry S. Truman, was punctuated with events like his veto of the Taft-Hartley Labor Management Relations Act of 1947.  In his veto, he played the part of Cassandra to today’s Trojan Horse with his preamble, “I have no patience with stubborn insistence on private advantage to the detriment of the public interest.”

Private advantage insistence over public interest!  Seldom could such a ringing indictment of our current fiscal state be more succinctly stated.  And seldom have fewer paid attention to principles of fostering constructive understanding between management and labor evidenced in Truman’s veto.  Ironically, however, one must consider what’s lurking behind the masquerade in Michigan.  Does the court, the Attorney General or the Governor actually have the pensioners’ interest in mind or are they, once again, mere marionettes on the fiscal strings animated by benefactors who will profiteer from this bankruptcy?  Tragically, when the City Manager seeks to put General Obligation Bonds (munis for those of you who are in the capital markets) on the same level as unsecured creditors and retirees, you realize that “safe assets” are getting far more volatile than sellers would want you to believe.  PowerShares VRDO Tax-Free Weekly Portfolio (PVI) and PowerShares Insured National Municipal Bond Portfolio (PZA) reportedly have significant (over 3.5%) exposure to Michigan’s bond headaches according to S&P.  And while retirees read the headlines wondering what this means for them, bond traders are placing bets against their future liquidity.

I’ve said this too many times but today begs recitation.  Economies built on debt (uncorrelated, perpetual growth-dependent, leverage) must fail.  Whether it’s the U.S. Treasury’s debt currency model that mandates perpetual GDP expansion or Detroit’s 60 year descent into insolvency, the jury is in and capricious debt speculation has once again failed.  It took World War II to mask the first 30 year maturity default; Nixon’s gold default to mask the second; and, planes into the World Trade Center on 9-11 to mask the third sovereign default.  Bottom line, we’ve never proven that debt works in the long run and the actions we take to cover our illiquidity events are dramatic and far-reaching to say the least.  In last week’s post I warned of the looming specter of pension harm that is casting an ever-growing shadow across the G-20 economies.  Detroit is merely the canary in the coal mine and, with any luck, some of you will wake up before the methane knocks you out.

“I got a question for you.  What does this city know about luxury?  What does a town that’s been to hell and back know about the finer things in life?  You see, it’s the hottest fires that make the hardest steel, add hard work and conviction.  When it comes to luxury, it’s as much about where it’s from as who it’s for.  This is the Motor City.  And this is what we do.” – Wieden & Kennedy / Eminem

It’s going to take more lawyers charging millions and more slogans than Wieden & Kennedy (that’s right, the same guys that Just Do Nike) can muster to paper the mess that Detroit’s in now.  But none of that will fix the real problem.  Until we align capital to measurable productivity (including contractions), we’ve got more promises to break.  And We The People must wake up from the trance or there’s more wheels to fall off.

Until QE3 Do Us Part

 If we are careless, we’ll look at the last two weeks of market volatility and conclude that as goes Ben Bernanke’s bipolar Fed-speak, so goes the economy.  At his Wednesday conversation with economists, Ben told the National Bureau of Economic Research:

 “I think transparency in central banking is kind of like truth-telling in everyday life.  You got to be consistent about it.  You can’t be opportunistic about it.”

He went on to clarify:

“I think if you think about the recent developments and the information that we’ve provided to the public about our thinking — I guess I would ask you to consider the counterfactual, if we hadn’t said anything. The information we provided about, for example, our contingent data-dependent plans for the asset purchase program, we’re actually pretty close to our understanding of what markets expected for that program. But suppose we had said nothing and that time had passed and that market perceptions had drifted away from our own thinking and our own expectations for policy. In addition, during that time, again in the counterfactual where we don’t provide any information, it’s very likely that more highly levered risk-taking positions might build up, reflecting, again, some expectation of an infinite asset purchase program.”

Transparency is kinda like truth-telling.  If you’re not really transparent, are we to expect that the premium on the truth is kinda like your opacity?  The ‘accommodative’ monetary policy that the Fed continues to pursue is disguised under the argument that zero interest rate environments and asset purchase manipulations at $85 billion a month will stimulate employment and build momentum in the economy.  In reality, Ben’s obsession has more to do with cheap money to support wealth dislocation by enhanced leverage than it does with unemployment.  Cheap leverage for private equity buy-outs and M&A do not stimulate employment.  To the contrary, leveraged transactions typically lead to consolidation efficiency and job cuts.

To justify his ‘optimistic’ view on the economy, Ben pointed to housing – another asset bubble in the making courtesy of artificially low interest rates – and debt-financed automobile purchases.  The former is particularly fascinating given the fact that the Fed is buying a lot of mortgage securitizations.  The lower the interest rates, the lower the terminal asset value of the mortgages that they’re buying.  Now if they were a buy-and-hold investor, this would be problematic.  But they’re not.  They’re a buy-while-intervention-is-expedient investor and they’ll be a dump-when-politically-expedient seller.  In other words, the quality of the assets they’re creating through the illusion of low interest and the 30 years that those assets will be ‘underwater’ from a yield perspective doesn’t bother them.  But it should be highly troubling to the public for two reasons.

First, manipulation of the mortgage securitization market is a contributing factor to the 2008 recession.  Cheap money (then it was second mortgages being “cheaper” than consumer credit) doesn’t create stable economic conditions.  If buyers are only buying because credit is cheap, then manufacturers are prone to establish a “normal” condition that’s not resilient in economic shocks.  This problem has manifest several times in the past 15 years.  But that’s the least of what should be worrisome.  Far more problematic is the perfect storm that the Fed’s policy has put in motion for pensioners and retirees over the next 15 years.  Let me explain.

Investments in liquid stocks have seen an apparent growth over the past 5 years.  With prices rising from their 2008 lows and with leverage-fueled dividends, apparent asset value has increased.  This should be seen as good news.  However, lurking beneath the surface of this ‘growth’ has been a leverage Charybdis waiting to yawn its terrible mouth open to unleash a deadly whirlpool into which the populace can fall.  While profits rose on the corporate down-sizing efficiencies and cheap leverage, top-line organic revenue has not followed suit.  Made worse by ‘accommodative’ monetary policies in other G-20 countries (something Ben also addressed obliquely), exporters face highly volatile markets and are not growing new business as quickly as their perceived ‘value’ has inflated.  In other words, we didn’t get more workers more productive over the past 5 years.  Rather we got fewer workers more efficient.  Second, long-term assets (the fixed income kind) have been depressed.  From your CDs that barely cover the postage to report on their meager performance to your 401(k) fixed income accounts with PIMCO and Templeton, what was modeled to generate 2-3% has barely eked out half that value after fees (which haven’t changed enough to compensate for the degradation in performance).  And at the bottom of the yawning chasm – far beyond the watchful gaze of most investors – insurance companies (life, mortgage, and pension) have been holding onto loads of cash that has not kept up with the mandatory returns that they need to fulfill their future obligations. 

This last point is the one that could really take out the next generation.  What made the first hundred years of the Federal Reserve work was its inextricable accommodation to match asset duration between the banking and life insurance and (insured) mortgage sector.  Take away life and property insurance and you don’t have the U.S. real estate market.  Take away these markets and you don’t have long-term investments.  And have insurance companies fail to keep up with their actuarial investment requirements and you don’t have liquid insurers in a decade or so.  Conspicuously missing from the Chairman’s comments were any references to the Pujo Committee and its investigations leading up the authorization of the Fed.  What was supposed to be a mechanism to break the banking monopoly on financial and monetary policy in 1912 actually turned into a mechanism which now is entirely an asset monopolist on both the U.S. Treasury and the mortgage market fronts.  And worst of all, this particular monopolist is actually undermining the future in triplicate.

Preservation of the current interest rate environment has not worked nor will it in the indeterminate future.  In fact, the longer it persists, the bigger the implosion.  This ‘bubble’ won’t pop – instead it is a giant vacuum that will suck future economic interests into a downward spiral.  We’ll have to make up new names – not Recession and Depression but Coriolis and Charybdis.  And, to be clear, the present course has been set for so long that we’ll necessarily have to pay to unwind it.  And that, unlike Ben’s speech, is not conditional, situational truth.  It’s the cold, hard facts.  At the undoing of QE3, equities will fall, insurers will default, and real estate will collapse again.  And we’ll keep sharing this fate until we embrace an economy that fosters productivity-based policies rather than monetary manipulative accommodation.

The Golden Lure: Factor Ficiaries

Oh the good I could do with millions of dollars!  Never mind how I get them.  If I had them, then I would…

Just a few short centuries before the great time change, Aeschylus (525-456 BCE) gave us one of our more venal terms: “Philanthropy”.

“For he, thy choice flower stealing, the bright glory

Of fire that all arts spring from, hath bestowed it    

On mortal men. And so for fault like this      

He now must pay the Gods due penalty,       

That he may learn to bear the sovereign rule

Of Zeus, and cease from his philanthropy.”

Prometheus Bound (lines 6-11)

Ironic, don’t you think, that the first use of philanthropos tropos in literature is associated with a chained Titan hero being punished by the gods for loving humanity too much?  Prometheus, having given humanity the divine utility of fire thereby unleashing civilization and the arts, was bound in chains and riveted to a rock so that an eagle could feast on his liver each day (the liver would magically regrow through the night for the eagle’s next chomping). 

Following the well-trodden path of metaphysical catechist annexation, Judaism (tzedakah), Islam (Zakat), Christianity (charity), Hindu (dāna) all promoted the importance of using material wealth as a means of evidencing concern for “others”.  The principle of charity as a means of manifesting social justice in the present and prima facie evidence of goodness in the great beyond has been a fixture in cultures for thousands of years.  In the over 1.5 million “charitable organizations” in the U.S. alone over $2 trillion dollars are parked awaiting deployment.  Pope Benedict XVI in his Papal Encyclical Caritas in Veritate, quite carefully articulated the centrality of charity as a means of evidencing and transcending social justice in genuine expressions of love for humanity.  Carefully reading his exposition, you see a recapitulation to the Pope Paul VI Encyclical Populorum Progressio view which states that a globalized society, “makes us neighbors but does not make us brothers.” Benedict and Paul conclude that it’s the gods who are responsible for making us genuinely care.  So there’s a paradox: deities punish a hero for loving humanity too much and the same deities are the only pathway to evidence philanthropy!

I was around a lot of money in the last several weeks.  Loads of it!  And I was struck by two seemingly disparate issues expressed by the people who had it.  First, they were really upset that they don’t know how on earth to invest it to make more of it.  Do you put it in Treasuries, gold, equities, real estate?  What’s going to be the best hedge against Black Swans, irrational exuberance, and other metaphoric specters?  How do I know that I’m not having my pocket picked by my wealth managers who are prop trading against my portfolio?  And second, they didn’t know how to give it away.  NGOs, charities, random acts of… well, randomness? 

One of the most desperate communities needing philanthropy – and I mean a genuine sense of the love of humanity – is philanthropists!

Now the title of the post, “The Golden Lure”, is meant to be what at least a few of you “caught” when you first read it.  We know the reciprocal ethic of, “Do unto others as you would have them do unto you,” referred to by many as the Golden Rule.  But through the prism of materialistic charity (the myopia attending disproportionate monetary wealth) the reciprocity is missing.  In a world of “benefactor” and “beneficiary”, the ‘factors’ are seen for what they have – not who they are – and the ‘ficiaries’ are seen for what they lack – not who they are.  The more mournful the caricature of lack (think children and puppies here), the greater the lure.  Tragically, the currency utilized to satiate the endless cycle of futile charity is held in disproportion most often because the impoverished were unseen prior to predatory endeavors.  Had we engaged resource stewards with suitable honor, we wouldn’t have the IMF and World Bank’s much ballyhooed “resources curse”, for example.  We’d have less billionaires but we’d also have less sex slavery, human trafficking, and permanently dislocated refugees “needing our charity”. 

Philanthropists, like their mythical progenitor, are riveted to the golden rock of their enslavement only to have their livers pecked out by each tale of woe born of monetary resource asymmetry.

So here’s an idea.  Why don’t We the People wake up from this 2,500 year trance?  If we are in possession of excess in one dimension of wealth – money for example – why don’t we examine where we failed to fairly price the contributions of others and seek to remedy that imbalance?  Maybe it’s with our money.  Maybe it’s with our time, communities, technologies, knowledge or any of the other Integral Accounting dimensions.  Rather than relying on the morning eagle’s feeding torment to rob us of our joyful engagement with humanity, why don’t we enlist humanity to chip away at the rock thereby reducing its anchoring qualities?  Then one day, when the eagle comes, we can teach it to fish and it can eat for a lifetime.