Planet Ponzi

by Mitch Feierstein

  Now, I’m an American hedge fund manager, so you wouldn’t expect me to share Lenin’s politics and I don’t. On the other hand, there are some telling parallels between his day and ours. Lenin was frustrated because the various micro-battles of Russian workers against Russian capitalists seemed to neglect the broader political story. In the same way, we’ve watched the world go bankrupt once (in 2008–9), and I’ve argued that we’re about to see the same thing unfold all over again, only this time more nastily.

  Naturally, recent events haven’t gone unnoticed. Politicians debate deficits. Banking regulations are rejigged. Bonus payments provoke annoyance and stern op-eds in the major newspapers. But there’s a weird disproportion between the scale of the wreckage on the one hand (vast, gargantuan, the biggest in world history) and the scale of response on the other (timid, piecemeal, ineffectual).

  This book has been two things. It’s been an exercise in financial mathematics and contingency and scenario planning: looking round the world, country by country and sector by sector, and totting up the likely scale of damage coming our way. That’s a dry exercise, a little technical at times, but nevertheless worth doing‌—‌particularly when, at the end of your labors, you notice that the world is about to end. But this book is also a call to arms, a summons to political action. It’s my own (American, hedge-fund) version of Lenin’s pamphlet. And the central message is the same. It’s time to end the tinkering. It’s time to look up from those various important micro-battles and attend to the big picture, to challenge the culture, to hurl out one whole generation of politicians and the assumptions which they and we have come to accept. Time also to challenge Wall Street’s way of doing business, to reject it as unethical‌—‌to name it as morally and financially bankrupt. Naturally, there are a host of individual changes to make: reforms to banking rules, changes to government accounts, and the like. But none of that matters as much as the headlines. And the headlines are simple. We need honesty in government, honesty on Wall Street, and honesty in the media. And transparency. And regulations that bite. And accountability that’s visible.

  Voters and taxpayers have to understand the issues so they can insist on the necessary changes. If politicians try to sneak on to Planet Ponzi again by the back door, they need to be thrown so far out of office they splash down somewhere in the south Pacific. If bankers try to boost returns by selling worthless assets for phony profits, they need to be fired, and probably prosecuted, and ideally have past bonus payments clawed back. And although this sounds revolutionary, we should remember that Planet Ponzi is only three decades old. For most of American history‌—‌for most of British, or German, or Japanese history, if it comes to that‌—‌Planet Ponzi had no traction. Governments turned to debt in time of war; and not itty-bitty wars but real life-or-death, existential struggles. Everything else was financed out of current income, while debt was steadily and relentlessly paid down. Countries, such as Sweden, that have pursued that logic with calm resolution find themselves with no net government debt at all. They are countries who have paid off their mortgages, who have savings in the bank, who could face any future disaster with brimming resources and calm confidence.

  Likewise, there is nothing inherently evil in the financial sector. For most of recorded history, bankers did what they were meant to do. Banks accepted deposits and lent money. Investment banks sold securities and made markets for bonds and equities. Those things had their place in a complex, mixed economy. Those involved earned a little money for themselves. They added a little to national welfare. Everybody was better off.

  Then, sometime around 1980, things changed. The culture changed. Wall Street became a place where Salomon Brothers, the leading firm of its day, could cheat the US government on a colossal scale. It became a place where awful subprime securities were sold by salesmen who knew these things were awful‌—‌and nobody went to jail. It became a place, indeed, that could bankrupt the entire world’s banking system‌—‌yet still, mesmerizingly, astonishingly, inexplicably, nobody has gone to jail. Indeed, the very same people who did these things are gazillionaires. They made their money by bankrupting the planet and we’ve let them keep it, all umpteen gazillions of it.

  It wasn’t always like this. Wall Streeters always had fancy jobs that paid more money than people earned elsewhere and which were imperfectly understood by those outside the financial world, but those disparities weren’t utterly out of line with other inequalities. Lawyers also had abstruse jobs with big pay packets. So did ad execs and heart surgeons. It’s only recently that the lawyers and the admen and the surgeons came to look like poor country cousins compared with the plutocrats of Wall Street.

  So change is necessary; and change is possible. The question we’re left with is: what change? We start with government.

  Change in government

  The first thing government needs‌—‌the main thing, the central issue‌—‌is honesty.

  The US government likes to draw attention to its ‘debt held by the public’ figure, which stands at around $10 trillion. And the figure is fine, as far as it goes‌—‌except that’s not very far. There’s all the other stuff we looked at. Debt held by the government. State pension liabilities. Fannie Mae and Freddie Mac. The FDIC. Medicare liabilities. Social security liabilities. Financial guarantees and other contingencies. A whole plateful of extras which cumulates to something like $80 trillion, if you believe the government, or $200 trillion, if you believe Laurence Kotlikoff.

  These confusions are wholly unnecessary. The government should publish audited accounts, every single year, that show all the government’s assets on the left-hand side of the balance sheet and all the government’s liabilities on the right. That’s how it works everywhere in the private sector. That’s what the British government has started to do. That’s what any organization with complex finances needs to do in order to understand its own financial position. Every government in the world should do the same. There are no excuses for doing anything else, no excuses for not doing it now.

  Second, the whole analysis of government budgets and deficits needs to be torn from the hands of politicians. Although the Congressional Budget Office is notionally independent, that independence is tightly constrained. If a law says that certain tax cuts are due to expire, the CBO is obliged to draw up projections on that basis, even though everyone on the Hill and elsewhere knows that the cuts are likely to endure indefinitely. So those rules need to go. The CBO, or some successor entity, needs to have real independence and a substantially enhanced budget. It needs to create projections that reflect the private sector consensus‌—‌and ‘worst case’ projections that reflect what happens if things go wrong. It needs to have enough resources to commission its own original investigations. It needs the authority to determine what it’ll investigate, and how, and when. And it needs to issue regular bulletins that announce a ‘fiscal gap computation’ of the sort pioneered by Laurence Kotlikoff. That type of computation is the only way of crunching the numbers that can’t be manipulated, because it considers all liabilities, not just debt obligations. That one innovation would force a huge and positive change in our political climate. It would provide an non-negotiable baseline metric for fiscal conservatism. Under a sound government, the fiscal gap would close. No ifs, no buts, no opportunity for manipulating the system. Under a George W. Bush or a Barack Obama, that computation would show an unmistakably widening gap‌—‌in public, for all to see.

  Third, this policy of honesty needs to be driven into every corner of government. States need to produce honest assessments of their liabilities. Accounts need to be drawn up, audited, and published. Where there are enormous holes, state governors and legislators need to be held to account. The same goes for campaign finance. The current US legislation on ‘campaign limits’ impose no real limits whatever. Campaign spending needs to be properly transparent, subject to rules that have bite‌—‌and those rules need to be enforced.

  If honesty is the fir
st requirement, action is the second. Costs and revenues need to be brought into alignment. On the tax side, there needs to be a massacre of exemptions. All existing loopholes need to be closed and a fair, simple, and balanced system introduced. Tax rates can stay where they are, or even fall, but taxation should be there to make money for the country, not for tax lawyers. At the moment, too many companies and individuals are escaping their fair contributions to the nation’s coffers. At a time of budget deficits, there’s nothing conservative about maintaining exemptions.

  Likewise, everyone knows there is a fundamental problem with the cost of US health care, yet nobody makes any serious attempt to fix it. That inertia simply has to end. American businesses can’t sustain the cost of looking after their employees. The uncertainty surrounding future healthcare costs is a huge disincentive to invest and hire, particularly for the smaller and medium-sized companies we depend on for growth. Nor can the government any longer sustain the cost of Medicare. Individuals are being ripped off by a bureaucratic system that charges huge prices to deliver unacceptably poor care. I’m not an expert on the health industry. I don’t pretend to offer a specific solution. But no country in the world matches American health spending and nearly all first world countries have significantly better health outcomes, so it’s pretty obvious that things can be improved. It really comes down to a problem in business management: how to re-engineer the system to deliver more and cost less. That means looking at the plumbing and fixing it. It also means facing down the health-insurance cartel and their highly paid lobbyists, who will do all they can to resist change.

  Needless to say, any such re-engineering won’t feel good. It will be attacked not only by the vested interests of the insurance and health bureaucracy, but also by politicians seeking lobbyists’ dollars and votes. Those politicians will want to pose as protectors of the ordinary American, yet they’ll be no such thing. Ordinary Americans have not been protected by the politics of Planet Ponzi. They’ve been destroyed. Their living standards have stagnated, their homes and savings have lost value, their jobs have been lost or become precarious, their kids’ prospects have deteriorated, their banks have become unsound, their government is bumping up against the limits of its creditworthiness, their currency is being debased, and foreign competitors are gaining ground, unable to believe their luck. Recall that comment of Arthur Levitt, former chairman of the SEC. He said that individuals ‘never knew what hit them.’ Individuals aren’t even aware of the battles that they’re losing, aren’t aware of what’s at stake, aren’t aware of the cumulative damage already done and still being done.

  If honesty and transparency are to become the first watchwords of government, they need to become the watchwords of voters too. A bankrupt system isn’t capable of being saved. You can’t cut entitlements that will never be delivered. Tough action needs tough politicians. It also needs tough voters.

  The same lecture applies to social security. The long-term liabilities being generated by the system as it currently stands need to be eliminated. That means we need either to pay more or to accept a cut in entitlements‌—‌or, better still, a bit of both. Other countries have taken tough and credible action on this front; there’s no reason why it can’t be done in America.

  As with health care, the only plausible way ahead involves some cooperation between Democrats and Republicans. We need a bipartisan commission, with real authority and proper funding, to explore reforms and make recommendations‌—‌and an administration and a Congress with the guts to enact those recommendations. No partisan sparring, just doing what needs to be done. Tough politicians backed by tough voters. That’s how you create solutions.

  Change in regulation

  Simultaneously, Wall Street needs to be restrained. That means a new Glass–Steagall Act, redesigned for the twenty-first century. One type of bank will the old-fashioned, Main Street sort: the type that takes deposits, makes loans, and generally handles the business of individuals and firms. These banks should be prohibited from entering into most risky transactions. Financial weapons of mass destruction need to be strictly monitored or prohibited. Capital needs to be kept at safely high levels. Deposits would continue to be insured by a re-capitalized FDIC. Supervision of these banks would need to be close, intrusive, and relentless.

  Outside that firewall, however, Wall Street should be allowed to be Wall Street. Capital requirements should be increased, but for the most part the Masters of the Universe should be left to play with their toys. With one proviso, however. The new banking regulations should explicitly prohibit government assistance for the industry. Bailouts should be made slightly more illegal than dealing crack cocaine. If a firm gets into trouble‌—‌it dies. Its shareholders should be wiped out. Its junior creditors would take their hit. If necessary, the pain would reach all the way up to senior creditors.

  As a matter of fact, I’d like to see a rule whereby anyone who has earned more than, say, five million bucks from a firm would have their personal assets placed at risk if the firm failed due to their incompetence, or following losses incurred when they were at the helm. That way, you wouldn’t have to face the sight of multimillionaire bosses walking away intact from the wreckage of their failed firms. You wouldn’t want to make them destitute‌—‌but if you left them with half a million bucks or so in personal assets, they’d still be vastly richer than most Americans. They could buy a nice-looking bungalow someplace not too expensive‌—‌I’m thinking Detroit, Baltimore, Oakland, Flint‌—‌then take a nice productive job that contributed something to society: pizza-delivery, mailman, roofer, nurse. We’d all be winners.

  There’s a further implication of these changes. Bankruptcies for financial firms in the US and elsewhere haven’t worked because the current court process is way too slow. In most industries, that hasn’t been a problem. Airlines have sailed the skies, GM’s factories continued to bash out SUVs, Enron’s pipelines continued to pump gas, all while the parent companies were dragging their weary way through bankruptcy proceedings. Banks aren’t like that, however. Their businesses depend on trust, and if trust dies‌—‌as it can in the space of a weekend‌—‌the business has died too. In aerodynamics, you say that a plane stalls if its airspeed falls below the minimum necessary to generate lift. At that point, you no longer have a plane; you have a chunk of metal falling out of the sky. It’s the same deal with banks. The second they hit stall-speed, they’re no longer banks at all; just a pile of financial obligations and some fancy real estate.

  There’s only one way to solve this problem and that’s via the ‘living will’: effectively, a prepack bankruptcy plan which can be triggered on Friday and completed by Sunday. Naturally, if you move at that speed, there are legal niceties which are going to be trampled underfoot. That’s too bad. Those legal niceties benefit lawyers and accountants and absolutely nobody else. Fast, decisive bankruptcies are essential to a well-functioning financial system. That also means that no firm will ever again be ‘too big to fail.’ If a firm fails, it fails. Too big to fail is too big to exist. Creditors who lent their money to a failing firm will get the most appropriate possible reminder about why credit analysis matters. And in the meantime, taxpayers will be able to watch the whole drama unfolding on the weekend news, knowing that they themselves won’t contribute a single dime.

  These rules will accomplish much of what is needed, but financial markets are complex enough‌—‌and fast-changing enough‌—‌that more detailed regulation will always be needed. The basic architecture of the regulators themselves is probably fine as it stands. What doesn’t work, however, is the basic structural weakness of the system, which pits underpaid, under-resourced regulators against hugely wealthy firms replete with thousands of smart people and expensive lawyers, constantly seeking ways to play the system. And there’s another twist to this imbalance. Ideally, you’d think that regulators and legislators would be natural allies: working together for the common good. In practice, however, regulators are so easi
ly bought by the money, glamour, and influence of Wall Street, the watchdogs continually find themselves neutered by their masters.

  There’s no good solution to that problem, but there is perhaps an acceptable one. Regulators need to have their budgets trebled or quintupled. (Wall Street should pay those costs, one way or another.) The pay of senior staff should be trebled or quintupled. That wouldn’t make it competitive with Wall Street, but it would make the contrasts less glaring. In exchange, regulators would need to accept that, once they had reached a certain level of seniority, a return to Wall Street would be prohibited for ten years. The revolving door would be locked shut.

  In addition, regulators should be given much greater discretionary powers. Congress could lay out the broad principles by which Wall Street should be regulated, but regulators should be left to determine the detail by themselves. That wouldn’t stop Wall Street lobbying like crazy every time regulation took an unwelcome turn, but it would place a substantial obstacle in the path of that lobbying effort.

  And finally, regulation should come with teeth. It’s true that the SEC and others have become much better at seeking, and securing, huge fines when rules are infringed, yet there’s a kind of phony quality to those punishments. Who on the management team actually suffers? Who loses their job, who suffers financially, who goes to jail? The answer, almost always, is nobody at all. When a specific individual is forced to make a payment, the size of that payment is pitifully small. So, for example, the SEC brought aggressive action against Citigroup, alleging that the bank had failed properly to disclose some $40 billion of subprime assets on its balance sheet. A billion dollars is, as I’ve had cause to mention before, a lot of money. Forty billion dollars is a vast amount of money: a sum that the average American household would take 800,000 years to earn, a period roughly four times as long as the human race has been in existence. Citi settled that action at a cost of $75 million, an amount that inflicted some injury on its shareholders, but had only the most minimal of impacts on those who caused the damage. In addition, the company’s chief financial officer for the period in question agreed to pay $100,000, without admission of wrongdoing. A hundred thousand bucks would take the average American household two years to generate, but for Gary Crittenden, the CFO in question, who wasn’t an average American and whose household earned $10 million a year‌—‌before taking account of bonuses, pension contributions, and the like‌—‌a hundred thousand bucks was equivalent to about three days’ pay. That was his penalty.2