Its Just Math

by Bobby Casey, Managing Director

debt

Over the past few days, I have debated a couple of people about what I consider to be the death spiral of the US economy. Of course Europe and Japan are in a similar position, but for the past few days, the debate has centered on the US economy.

There are many theories explaining the reason for the decline in America. The media would have you believe it is caused by greedy businessmen hellbent on world domination through evil capitalism.

Ironically, it seems the savior to this dire situations is government. The government is the socially accepted all-powerful benefactor that can save the world from the evils of capitalism.

The reality couldn’t be farther from the truth. I have discussed a few of these situations in the past, but let’s highlight a couple of them now.

End of the Gold Standard

In 1971, President Nixon ended the gold standard by refusing to allow foreign currencies to be exchanged for gold. Up until that point, all world currencies had a fixed exchange rate to the US dollar and the dollar had a fixed exchange rate with gold, effectively providing an asset-backed currency system for the world.

That eliminated any currency risk between countries and simplified global trade. In 1971, that all ended. Shortly thereafter, the financial derivatives market was established to solve this problem, allowing companies and countries to hedge their currency risk in the futures and options market.

And so began the proliferation of financial derivatives and huge amounts of speculation, all thanks to President Nixon.

Government Incentives for Housing

In 1977, under the Carter administration, the Community Reinvestment Act (CRA) was passed, which reduced discriminatory credit practices against low income communities. Basically, the government imposed its own form of social justice on lenders and forced them to allocate resources into under-served low income communities.

In other words, the government provided incentives to provide mortgages to ‘less than ideal’ borrowers and simultaneously provided disincentives to NOT loan to them. Imagine if the government stepped in and forced you to take on clients who have historically proven to be financially incapable of paying their bills?

Clinton puts the CRA into Hyperdrive

In 1992, President Clinton took office and one of his campaign promises was to make home ownership affordable to everyone. That same year, the Federal Housing Enterprises Financial Safety and Soundness Act (FHEFSSA) was passed that mandated specific goals for Fannie Mae and Freddie Mac for low income lending.

If you are not familiar, Fannie Mae and Freddie Mac are Government Sponsored Entities (GSE) created by Congress in 1968 for the purpose of providing liquidity to the mortgage market. Simply put, they buy pools of mortgages from banks and sell them on the open market as Mortgage Backed Securities (MBS).

The FHESSA formalized lending requirements for low income communities by ranking banks on compliance. Banks with a high rating got preferred rates from Fannie Mae and Freddie Mac while lower rankings meant their pools of mortgages were sold and a significant discount.

In other words, banks were required to have a certain number of mortgages in the low income communities in order to qualify for preferred rates. Not complying meant they were uncompetitive with other banks.

This, along with many other factors, created an artificial demand for housing thus driving up prices. Basic micro-economic theory tells you that if demand rises, so do prices.

Bankers and Politicians in an Incestuous Love-Fest

Before many of you start sharpening your pencils for the deluge of hate mail I am certainly going to receive, understand I am not giving the banks a free pass. The government provided the incentives, but the banks had lobbyists in Washington whispering in the ears of congressmen pushing for this legislation that was sure to line the pockets of bankers and DC parasites alike.

Just keep in mind though, without government intervention in the housing market, this bubble would not likely have ever existed, or at least not to this extent.

I really could go on and on about how the government provides incentives for home ownership;

Artificially low interest rates that incentivize debt over savings

Mortgage interest tax deductions that incentivize debt over savings

HUD programs that pay rent premiums to housing investors

and on and on…

Suffice to say, you have been taught your whole life that home ownership is the “American dream”. In reality, you have been a victim of self-imposed slavery through media propaganda and government incentives.

These factors led to a massive rise in home prices and we all know how that turned out.

Along Comes the Lone Ranger to Save the Day

As previously stated, we have all been led to believe the evil speculators have created this mess and now we need the government to come in and save the day. Let’s take a look at some of the numbers below (as of today from US Debt Clock):

  • US National Debt – $16,000,000,000,000+
  • US Debt Per Citizen – $51,000+
  • US Debt Per Taxpayer – $140,000+
  • US Federal Spending – $3,500,000,000,000+
  • US Federal Income Tax Revenue – $1,100,000,000,000+
  • US Federal Payroll Tax Revenue – $800,000,000,000+
  • US Federal Corporate Tax Revenue – $229,000,000,000+

Keep in mind, these numbers are as of today. Debt and spending continue to spiral out of control. The budget deficit is projected at $1T+ per year for the foreseeable future. That number continues to add to the existing numbers.

Right now, the net interest on debt is a bit over $256B per year, or about 1.6% interest on debt. At a minimum, we will see $1T+ in debt added to the balance sheet each year for the next 5 years.

But let’s take a look at these comparable numbers from 2008:

  • US National Debt – $10,000,000,000,000+ (60% increase)
  • US Debt Per Citizen – $34,000+ (50% increase)
  • US Debt Per Taxpayer – $95,000+ (47% increase)
  • US Federal Spending – $2,900,000,000,000+ (21% increase)
  • US Federal Income Tax Revenue – $1,100,000,000,000+ (appr. equal)
  • US Federal Payroll Tax Revenue – $800,000,000,000+ (appr. equal)
  • US Federal Corporate Tax Revenue – $317,000,000,000+ (27% decline)

Just for the benefit of mental masturbation, let’s project 2018 based on these numbers:

  • US National Debt – $25,600,000,000,000+
  • US Debt Per Citizen – $76,500+
  • US Debt Per Taxpayer – $205,800+
  • US Federal Spending – $4,200,000,000,000+
  • US Federal Income Tax Revenue – $1,100,000,000,000+
  • US Federal Payroll Tax Revenue – $800,000,000,000+
  • US Federal Corporate Tax Revenue – $167,000,000,000+

At this level using the existing 1.6% cost of debt, interest expense alone goes to $409,600,000,000. What if interest rates rise 200bp? Interest expense rises to $921,600,000,000. That is nearly the entire US Federal Income Tax Revenue figure.

What if it moves up 500bp putting it on equal ground with much of Europe? Imagine if we go back to 1980 when interest rates were 18%+?

I am not even taking into account the unfunded liabilities of Social Security, Prescription Drugs, or Medicare. At the moment, those amount to more than $121T, or over $1M per US taxpayer!!!

Let that one sink in for a moment….$1M per US taxpayer. Did you vote for that? Think your vote still counts?

US Median Income is Dropping

According to the US Census Bureau, real median household income fell for the 2nd year in a row to $50,054. That’s an 8.1% drop from 2007.

As the article title states, it’s just math. Taxpayer debt is growing. Household income if falling. Poverty rates are increasing. It’s a recipe for disaster that will lead to declines in standard of living and increased crime in the US.

How Does it Play Out?

My view is that the US is in an economic death spiral. Can it pull out of the spin? Maybe, but not likely. The problem is now political. It is also an ideological problem.

Americans have grown comfortable and complacent. They are lazy and don’t feel they really need to work hard or take a set back in order to move forward.

The US has had it so good over the past few decades and people have very short memories. They think, “it cannot happen here”. It is a combination of arrogance and ignorance that produces this mindset.

Let me be very clear here – The US Government is Doomed to Massive Failure.

It will eventually lead to sovereign debt default. It may be 5, 10, or 20 years from now – who knows? But it will happen. It’s inevitable at this point. It’s just math.

However, I am hugely optimistic for the future. I see this upcoming government collapse as a cleansing that will allow proper functioning of the markets and creation of real value to mankind.

But in the meantime, I suggest you take some precautions to protect yourself and your family as well as ensure your financial well-being during the turmoil.

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