Planet Ponzi

by Mitch Feierstein

  That’s a creditable record, yet you can’t judge the future by the past. Financial shocks tend to be violent, not gradual; abrupt, not predictable. And the mathematics behind that FDIC guarantee look frightening. Insured deposits total some $6.2 trillion. The insurance is legally binding (unlike the promises made with respect to social security or Medicare, for example), so that $6.2 trillion can’t simply be withheld if it were ever called upon. That colossal commitment is currently supported by just $10 billion, or around 0.16% of potential liabilities.12 In an era of banking crisis, of concerns about liquidity and capital sufficiency, that’s an insanely low level of support. Indeed, the FDIC’s own financial statements reflect the likely insufficiency of funds, with the fund balance in negative territory for 2009 and 2010. And bear in mind that deposit insurance represents just one of the government’s implicit or explicit guarantee programs.

  The true picture

  In the end, there is no single precise measure of the US government’s indebtedness. That’s partly because it’s hard to compute liabilities, partly because any projections are necessarily very long-term and uncertain. Nevertheless, the Congressional Budget Office itself recognizes the catastrophic state of the country’s finances. Departing from its normal carefully neutral language, it commented in a recent update document that ‘beyond the 10-year projection period, further increases in federal debt relative to the nation’s output almost surely lie ahead if certain policies remain in place … [If current policies remain intact] the resulting deficits will cause federal debt to skyrocket.’13

  ‘Skyrocket’ is correct. Whether that debt will stop at the stratosphere or whether it’s going to keep on going into outer space we don’t yet know. What we do know is the scale of the problem we have already accrued. One economist, who has made a lifetime study of fiscal gap computations, is Laurence Kotlikoff of Boston University. He uses CBO data to determine the present value of our unfunded commitments‌—‌that is, he uses government data to model the country’s true level of indebtedness. That type of computation is the only mathematically and financially complete way to calculate overall debt. On this basis, Kotlikoff puts the true level of US indebtedness somewhere in the region of $202 trillion.

  The blunt truth, of course, is that the US is bust. It cannot, even remotely, fulfill its obligations. In the first chapter of this book I quoted Kotlikoff’s sobering words about the coming crisis, but at that stage you didn’t have enough background to understand precisely what was involved. You do now. And what Kotlikoff had to say was this:

  Let’s get real. The U.S. is bankrupt. Neither spending more nor taxing less will help the country pay its bills …

  How can the [$202 trillion] fiscal gap be so enormous?

  Simple. We have 78 million baby boomers who, when fully retired, will collect benefits from Social Security, Medicare, and Medicaid that, on average, exceed per-capita GDP. The annual costs of these entitlements will total about $4 trillion in today’s dollars. Yes, our economy will be bigger in 20 years, but not big enough to handle this size load year after year.

  This is what happens when you run a massive Ponzi scheme for six decades straight, taking ever larger resources from the young and giving them to the old while promising the young their eventual turn at passing the generational buck.

  Herb Stein, chairman of the Council of Economic Advisers under U.S. President Richard Nixon, coined an oft-repeated phrase: ‘Something that can’t go on, will stop.’ True enough. Uncle Sam’s Ponzi scheme will stop. But it will stop too late.

  And it will stop in a very nasty manner. The first possibility is massive benefit cuts visited on the baby boomers in retirement. The second is astronomical tax increases that leave the young with little incentive to work and save. And the third is the government simply printing vast quantities of money to cover its bills.

  Most likely we will see a combination of all three responses with dramatic increases in poverty, tax, interest rates and consumer prices. This is an awful, downhill road to follow, but it’s the one we are on. And bond traders will kick us miles down our road once they wake up and realize the U.S. is in worse fiscal shape than Greece.14

  There is, weirdly, some good news buried in this avalanche of disaster. If a system is broken, it has to be fixed; and this system is broken so completely, so absolutely, that the fixing is closer now than ever before. What’s more, it’s obvious what needs to be done. Tax revenue has to increase. Entitlements have to be cut. There is no alternative. If a politician tells you there’s some other solution available, he or she is either lying or stupid.

  It also becomes obvious that those politicians who pretend there are other solutions don’t truly care about the things they pretend to care about. If Democrats genuinely cared about protecting the elderly, the poor, and the sick, they would want to reform welfare programs so they weren’t headed for bankruptcy. They would be promoting bills to rein in entitlements, for the longer-term benefit of the constituencies they claim to represent. If Republicans genuinely cared about fiscal conservatism, they would recognize that current tax revenues are hopelessly insufficient to deal with our obligations and would be bringing forward measures to slash tax exemptions, loopholes, and other dodges. (Those things are all more important than raising rates, though some tax rates may also need to rise.)

  Well, if Republicans don’t, in fact, care about fiscal responsibility and that Democrats don’t, in fact, care about the poor, sick, and elderly, who do they care about? That question is the one we turn to next.

  5

  How to win friends and influence people

  One of the notable features of Ponzi schemes‌—‌the point of them, in fact‌—‌is that they make their promoters very, very rich. Charles Ponzi bought a bank and thought about buying a battleship. (He wanted to turn it into a floating shopping mall.) Bernie Madoff wasn’t daft enough to buy a battleship; he was simply content to live the gilded life of New York’s super-rich, without a care for those whose stolen money he relied upon. If we’re claiming that the US government and (as we’ll come to see) Wall Street are running huge Ponzi schemes, we should expect to find some beneficiaries: the Charles Ponzis, the Bernie Madoffs.

  Following the collapse of the mortgage market in 2008, it’s been common enough to point an accusing finger at the bankers who caused it. I don’t disagree with that accusation‌—‌quite the opposite‌—‌but a Ponzi scheme as wide and as deep and as old as the one we’re considering is hardly likely to have been promoted by a mere handful of bankers working in one subsection of the financial markets. We’d expect to see a broader group of individuals involved‌—‌and reaping some stunning rewards. Any data that suggested such a group existed would be powerful evidence contributing to the overall hypothesis.

  Evidence such as the graph in figure 5.1, for example. This chart plots the income (including capital gains) of the top 1% of US earners as a proportion of total national income. What it shows is that, from the late 1970s onwards, the income share taken by the super-rich has grown enormously‌—‌so much so that their share of total income today is nearly two and a half times what it was in the mid-1970s. And that’s just their share: naturally, since total incomes have grown substantially over the same period, their incomes measured in absolute terms grew very much faster than that.

  Figure 5.1: Income of the top 1% earners in the US, 1950–2008

  Source: Thomas Piketty and Emmanuel Saez, ‘Income inequality in the United States, 1913–1998,’

  Quarterly Journal of Economics, 118 (1), 2003, pp. 1–39. A longer and updated version is available in A. B. Atkinson and T. Piketty, eds,

  Top Incomes over the Twentieth Century: A Contrast between Continental European and English-Speaking Countries (Oxford University Press, 2007).

  The tables have been updated to 2008 and made available online at g-mond.parisschoolofeconomics.eu/topincomes.

  The increase in the incomes of the rich has been widely noted, widely reported. Yet t
he appropriate political conclusion to draw is hotly contested. Trickle-down theory, for example, suggests that if the rich are left to get very rich, their efforts will benefit the poor and middling in society. That explanation, unfortunately, is not a very good one. As figure 5.2 illustrates, the poorest in society have seen the lowest income growth, a mere 11%, across the entire 27-year period since 1979. Those in the middle‌—‌the second, third, fourth, and most of the fifth quintiles‌—‌have done OK. They’ve worked hard, gotten a little richer, seen a little improvement in their standards of living. But those at the top, the putative ‘Ponzi class,’ have grown vastly richer. In real terms (that is, adjusted for changes in the cost of living) the richest 1% have seen their annual after-tax income rise from a (prosperous) $337,000 to an astonishing $1,200,000.1 Bear in mind that that’s an income figure. Not a lottery win. Not some one-time bonus or payoff. Those who make their nests in the very top branches of the American income tree expect $1.2 million each and every year‌—‌well, how else would you keep up the payments on your yacht?

  Figure 5.2: Average annual US household income after taxes and benefits, 1979 and 2006 (2006 dollars)

  Source: Congressional Budget Office.

  At this point, the trail starts to get quite interesting. In previous chapters, we’ve noted that the US government has run up debts of somewhere between $75 trillion (if you believe the government’s figures) and $202 trillion (if you believe independent experts). The data presented so far in this chapter show that a very small group of people have become very, very rich indeed. If we were sleuths‌—‌if we were playing Columbo, or Marlowe, or the invincible Poirot‌—‌we would, however, be forced to note that the coexistence of a serious crime (the bankrupting of America) and the presence of some possible beneficiaries (the very wealthy) doesn’t itself prove that the two things are connected. So we need to dig a little further.

  Fortunately, some of that digging has already been done. The nonprofit and nonpartisan Center for Responsive Politics has patiently compiled statistics on political lobbying since 1998, using data made available by the Senate Office of Public Records. The sums involved are not small and, as you’d expect from the accelerating nature of any Ponzi scheme, are growing fast. At the start of the millennium, the amount of money spent lobbying Washington every year was around $1.5 billion; over the following ten years it’s more than doubled, to around $3.5 billion annually. The total spend increased right through the banking crisis, right through the recession. As you’d expect, our friends on Wall Street are more than happy to play their part in keeping the pressure on legislators: the securities and investment industry has invested some $874 million in lobbying between 1998 and 2011, the insurance industry a further $1,617 million.2 (We’ll explore some other curious facts about these industries in a later chapter.)

  More important than the sums of money themselves is what they buy you. In 2010, researchers Hui Chen, David Parsley, and Ya-wen Yang systematically explored the effect of lobbying on the financial results of major corporations.3 Their raw data are interesting enough. Take, for example, the simple question of which companies spend the most on lobbying. Chen et al.’s top ten, listed in table 5.1, include a number of interesting names, many of which are already familiar to us.4

  Table 5.1: America’s best lobbyists

  Source: Hui Chen, David C. Parsley, and Ya-wen Yang, ‘Corporate lobbying and financial performance,’ April 28, 2010, available from the Social Science Research Network (www.ssrn.com).

  We haven’t yet arrived at Chen et al.’s punchline, yet the data are already eye-opening. General Electric has the gall to pay no tax in the United States, yet outspends all rivals on influencing our legislators. (Oh, and it thinks its status in the US business community buys Jeff Immelt, GE’s chief executive, the right to be part of President Obama’s inner circle. A perfect choice, right? If the company paid any taxes, it might have a conflict of interest. As it is‌—‌no conflict.)

  Next on the list, Altria (the owner of Philip Morris) makes its money by selling lethal and addictive products to American citizens, and spends a lot of it on ensuring it is given a hearing by our lawmakers. Lockheed is wildly over budget on a critical weapons program but shame, apparently, doesn’t stop it from buying favors in Washington. As for the bailout twins AIG and General Motors, I have to admit that no investment I’ve ever made has come close to matching the stunning multiyear returns which they managed to generate. For an entry ticket that cost just $8.5 million in 2005, AIG secured funding of $183 billion just four years later, a annual return of 1,111%. The folks at General Motors, poor saps, obviously played their hand badly, because they received federal funds of just $52 billion, an annual return only just over 800%.5 General Motors, by the way, has still not repaid its loans to the US government, and I for one am skeptical that it ever will.6

  You might well be tempted to dismiss some of these comments. You could argue that the banking crisis was unique, a once-in-a-century disaster that demanded and received a once-in-a-century response. You could argue that Lockheed Martin and Northrop Grumman are makers of weapons, and therefore certain to be tied closely to their major customer, and inevitably involved in a number of large, costly, and complex projects, some of which will go wrong. Well, perhaps. But it’s striking how successful lobbying can be, across a very broad range of industries and issues. Take for example this story, reported by the Washington Post in 2006:

  A few years ago, a coalition of 60 corporations‌—‌including Pfizer, Hewlett-Packard and Altria‌—‌made an expensive wager. They spent $1.6 million in lobbying fees‌—‌a hefty amount even by recent K Street standards‌—‌to persuade Congress to create a special low tax rate that they could apply to earnings from their foreign operations for one year.

  The effort faltered at first, but eventually the bet paid off big. In late 2004, President Bush signed into law a bill that reduced the rate to 5 percent, 30 percentage points below the existing levy. More than $300 billion in foreign earnings has since poured into the United States, saving the companies roughly $100 billion in taxes.7

  An investment of $1.6 million? A payoff of $100 billion? That doesn’t sound like any commercial or financial investment I’ve ever made, or ever come across in the normal, ethical course of business. That’s the kind of return which has the whiff of a Ponzi scheme to me. The same whiff hangs around Fortune magazine’s estimate that Lockheed earned a return on its political investment of 163,536% since 1999, or that Boeing clocked up returns of 142,000%.8 And bear in mind that the $100 billion which Pfizer and others saved in tax was money that the US Treasury did not have. Remember that the costs of the weapons contracts achieved by Lockheed and others have to come from the public purse. No wonder federal tax revenues are at a fifty-year low, that the deficit is at an all-time high. No wonder corporations play an ever smaller part in contributing to the welfare of Americans. No wonder the federal government has a debt crisis of planet-swallowing proportions.

  Either we’re dead right or we’re crazy.

  But let’s get back to Chen’s study. Rather than extrapolate from individually astonishing anecdotes, Chen and his colleagues systematically explored the question of whether lobbying was associated with better-than-expected financial returns. The researchers were careful. They explored various different measures of financial return and specified their model in a number of different ways. But their conclusion was robust no matter which way they chose to look at things. In their words, the data ‘are consistently positive and continue to support the conclusion that lobbying expenditures are statistically significantly positively correlated with financial performance.’ Bluntly put, lobbying works. It boosts profits and stock prices. Chen’s data also demonstrate that the more you lobby, the more money you make. This is an arms race where the more you spend, the more you win. Poor old Exxon Mobil‌—‌suffering under the lash of its 0.4% corporate tax rate‌—‌simply made the mistake of not spending enough. No doubt the folk in i
ts executive suite are currently figuring out how to do better.

  Companies, however, are not the ultimate beneficiaries of all this hard work. Companies, after all, are merely legal entities, obligated to pass their profits through to their stockholders in the form of dividends and capital appreciation. It would, therefore, be natural to presume that ordinary shareholders end up gaining from all this lobbying effort. Though US citizens might lose the benefit of corporate tax revenues and find themselves overspending to a crazy degree on weapons programs and the like, at least they might expect to see their share portfolios and pension funds blossoming. What the left hand loses, the right hand gains.

  Only, strange to say, that isn’t what happened. If you invested $1,000 in the S&P index on January 1, 2000 and took it out on August 17, 2011 (the day I’m writing this paragraph), you’d find it was worth just $812. If you’d reinvested dividends as you received them, that would have bumped up your return, but you’d still be looking at a strangely small amount after more than a decade of investment. (By way of comparison, gold has returned over 525% in that time frame.)

  One of the rules of poker‌—‌and of the bond markets, and of life‌—‌is that if you don’t know who the sucker is, it’s you. Take a look again at figure 5.1 at the start of this chapter. The rewards of our modern American economy flow to a tiny subset of people. If your household is in the 90th income percentile (if, in other words, you do better than 89% of all households in America), your income over the last three decades will only just have kept pace with the average.9 According to data released by the Census Bureau, real median household incomes in 2010 haven’t budged from where they were in 1996. Indeed, because healthcare costs have increased by some $5,400 over and above the rate of inflation, you could argue that real income has effectively declined in the period.10 It’s a truly terrible record. Understanding exactly where the money went will preoccupy us for much of this book, yet some clues are so obvious they hardly need a Poirot to decipher them.