After Securitization: Who Owns America Now?

Everyone is familiar with the chart of US debt that goes up to about 350% of GDP in 2008. Below is the same slide looked at another way [1]:

Granted, the chart is cash on cash, so it doesn’t include un-funded pension commitments etcetera; put those number in and the situation looks much worse. But when you are going bankrupt its cash that counts.

What really went up out of control over the past ten years was the amount of private sector bonds that were issued; much of that was securitized. That ramp up of debt (about $20 trillion over ten years) was much more than US Federal Government is borrowing or is set to borrow, and unlike that stuff, the old stuff went straight into the pockets of Main Street so they could spend, spend, spend.

People worry about how all the new debt that the Administration is running up will get paid back, the promise there, is that the American Government will be able to tax its citizens in the future so they can pay it back.

But the reason (in the first instance) that the government is going to borrow and spend and borrow and spend (and send the bill to the US Taxpayer), is that the same US taxpayer can’t pay back the $20 trillion it borrowed and spent and borrowed and spent….Err!

Of course, the agencies who issued AAA ratings on that $20 trillion of debt are never going to downgrade US government debt, because that debt is not securitized by collateral, it’s securitized by the promises of the same people who didn’t pay the last lot back.

So that’s OK then. Collateral has been replaced with promises made by politicians on behalf of their voters who have a track record of not paying back money they borrow; so there’s nothing to worry about.

The Mad Hatter in Alice in Wonderland had nothing on those guys. But there’s more. Have a look at this chart:

That’s a chart of the amount of money that went in and out (net) of USA every quarter going back to 1990 either buying or closing out debt; the data is on the BEA website.

Notice the black line, that’s the stuff Moody’s, S&P and Fitch stamped “AAA Quality Made in America with Pride.” Notice the “appetite” of foreigners for that is somewhat diminished. Notice also the appetite for the stuff on offer by the Treasury (red line) is not actually going through the roof; there are reasons for that.

(1) They are not selling it cheap enough, and (2) there is a suspicion amongst the buyers that the words “AAA Made in America with Pride + Double Stamped with the Seal of The President of USA,” don’t actually count for what they did in the old days.

That’s what happens when you let some people sell melanin tainted milk; that sours the whole market for everyone. But, of course, Alan Greenspan would have called that the “free market” regulating itself, so that’s OK then.

Likely the only people who are buying are the Chinese and Japanese governments who already hold $3.5 trillion of US Government debt (and we won’t even talk about how much of the toxic stuff they own). That goes down to the adage, “if you owe the bank $100,000 you got a problem. If you owe them a million, they got a problem”.

But there comes a point when a lender says, “I don’t care if I take a 50% haircut on that $3.5 trillion, I’m not going to lend you any more."

Add up the numbers on the BEA website back to 1960 and the net position of foreigners in total (government and private sector debt – (lines 65, 66 and 69)), is $16.5 trillion, that’s 30% of the total debt in USA, owned by foreigners.

OK, that sounds pretty “safe,” if the foreigners stop buying that will mean they might have to take an $8 trillion haircut. Serve them right, eh? That will teach them for lending America all that money and causing a bubble.

The problem is they will get to keep the collateral, that’s the way it works, you borrow money, you put up collateral, if you don’t pay the money back the person who lent you the money get’s the collateral.

So who owns America?

It gets worse. Those foreigners are going to want their money back one day, but forget about printing monopoly money and paying them off with that. They might have been stupid enough to buy the melanin tainted stuff, but there are limits, so as soon as that looks like it’s the plan they are going to start coming after their collateral.

So hyperinflation, which is how Germany got to weasel out of the reparation payments that were forced on them by the Treaty of Versailles, is probably not an option. The only other option is to stop borrowing like crazy and using the money to pay bonuses to incompetent bankers (it might also not be a bad idea to stop sending armies to all corners of the world on treasure hunts). If absolutely necessary, do it at a much higher coupon rate, which conventional wisdom says most likely will lead to deflation (of course what's happening dow is not deflation it's disinflation).

So it will get harder to pay the debt back (if you bought a house on a 100% mortgage in 2006 and you lost your job, you will understand what I’m talking about).

The Administration is trying to steer a middle road. The theory is that if you take one economic dogma that didn’t work and cross it with another economic dogma that didn’t work, well, that ought to work.

What they don’t realize is that collateral damage of that path. In the cold light of day, until the malinvestments that were made are sold off at fire-sale, the US economy will splutter along, from one clunker idea to another clunker idea.

But the plan is clearly to try and forestall anyone buying toxic assets or commercial property.

That’s what the TARP, PPIP, and the Stress Tests were about. The outcome of those was the regulators allowed banks to hold toxic assets on their books at more or less what they paid for them, and count those values towards their capital adequacy and their solvency, even better the Fed accepted those values as collateral for the discount window. Nice for the banks; they could borrow at 0% and buy 10-Year Treasuries at 3.5%, or speculate, and “earn” their way out of the hole, (and pay themselves big bonuses). But that does nothing to re-start the market for securitized debt that America has become so dependent on.

The recent initiative by FDIC to allow the same deal for commercial loans (particularly to real estate), might protect the “chosen few”, but it does nothing to re-start the markets.

Of course, the average American, who ultimately will be paying for all this, does not get that type of break.

So far, this experiment in lunatic Monetarism crossed with Keynes (or something, whatever it was it wasn’t smart), has produced two million final stage foreclosures (that’s the one where they kick you out on the street), I calculate there are four million more to go.

Imagine how many foreclosures there would be if defaulters could roll over their loans up to 100% LTV with the “V” calculated at what it was in mid 2006?

Sadly, the government inspired forbearance on toxic assets and commercial property doesn’t extend to people who will ultimately be paying for all this. That’s a case of a few Big Fat Piggies being a lot more equal than a herd of scrawny undernourished little piggies. Of course, what counts these days in America are lobbyists, not votes, and whoever heard of that nonsense about, “No taxation without representation."

But that’s just the tip of the iceberg.

Under the current policy, the US Administration has to borrow money, as much as it can get its hands on, because some terrorists planted nuclear bombs all over America and they are holding the country for ransom.

Those are called Credit Default Swaps (CDS) – Warren Buffet called them “financial instruments of mass-destruction.” And, to think, we went all the way over to Iraq and spent $700 billion and counting to go after WMDs, when in fact they were buried in a vault under Wall Street.

The reason that the US Government has to keep throwing money that it doesn't have at this problem is because the US financial serve-yourself industry (mainly), bought and sold insurance that the $20 trillion would not default.

A great article on this was written in September 2008 by Shah Shah Gilani, Contributing Editor of Money Morning. Shah Gilani, spent his life working on a CDS nuclear bomb assembly line; he knows how they work, and more important he knows how to defuse them. He had a 15 point plan, which if it had been implemented then might have eased the pain.

If it was implemented now it might ease the future pain (although needless to say there are no signs of that happening, the administration is much too busy arguing about how much nuclear bomb assembly line workers should be paid). Like Roman Emperors fiddling while Rome burns.

By the way, that isn’t insurance like the stuff you and I buy to protect us in case our house burns down.

With that sort of insurance, first the government regulates people who sell it. That’s so in the event that your house burns down you can be pretty sure that the insurance company will pay your claim, second the insurance companies mandate that you can’t buy insurance after the fire starts, and third they mandate that you can’t buy insurance on your next-door neighbours house and then burn it down, and collect on the claim (that’s called having an insurable interest).

That’s not how the CDS market works. First, there is no regulation (free market rules), so there is no obligation to prove to anyone that you have the means to pay out claims, if claims are made.

Second, you don’t have to have an “insurable interest” to buy that “protection”, and third you can buy insurance after the fire started (which if the person selling the insurance is a crook or is too dumb to notice that a fire started, you can buy dirt cheap). That’s how come there are about $68 trillion of insurance claims that would have to be paid out if that $20 trillion went bad…Err…perhaps there is an incentive for someone to start a fire?

That’s what happened with Goldman Sachs (GS) and AIG (AIG), which is why TARP paid them 100% of their claims on the CDS that they bought (a) on instruments that they had minimal exposure to anyway (b) after it became clear the fire had started. And the reason they paid out (apart from perhaps the fact that one of the people involved in the negotiations probably had most of his considerable personal wealth tied up in Goldman Sachs), was because they were holding a nuclear bomb, and they threatened to set it off it they didn’t get their way.

So much for not negotiating with terrorists. A good account of those moments can be found here.

So who owns America?

Sounds like it might be some foreigners plus some other people with some nuclear CDS bombs? Get used to it.

What's Next?

The old economic model relied on rich people with access to funds making money out of inflation at the expense of poor people who don’t have access to funds. Perhaps it’s time to let the people who can create real economic value grow America out of the hole?

The state of play at the moment is that the Fed is pumping money into a pipe but none is coming out at the other end. That’s why to get even a spark of GDP growth what was needed was cash handouts to consumers (cash for clunkers and $8,000 home-buyer tax-credits), because either the banks won’t lend or consumers won’t borrow, or both.

So what would Lord Keynes say about that? How about, “the operation was a success, but the patient died?” Right now the only people making hay with all that cheap money are the speculators.

Perhaps this is Japan all over again, where zombie banks were allowed to live and “earn” their way out of trouble speculating with 0% interest rates. And yet deflation took hold. Except, of course, in Japan there was a current account surplus, and the main sources of debt were internal.

In December 2007, Warren Buffet spoke at a fundraiser for Hillary Clinton in San Francisco two remarks stick in my mind:

"We're like a very rich family; we own a farm the size of Texas but want to consume more" than the farm generates, he said. "Every day, we sell off or mortgage a piece of the farm."

If the policy continues, over time, the rest of the world "will own more of our farm" and future generations will resent that they spend part of their workweek paying off those costs of consumption, he said.

How Did This Happen?

Securitization had a big part to play; in March 2006 Nomura published a manual called "MBS Basics."

It started off:

“Stop for a second and think about some of the things that made America great! Maybe you thought of...(there followed a long list which bizarrely included The Teamsters and The National Guard)..”

and concluded:

“You probably didn't think about mortgaged backed securities (MBS), but you should have!”

Oh Yeah?

Notes:

[1]: The first chart used data on overall debt (from Morgan Stanley), data on bond issuance from Thompson Reuters (as shown in Mark Zandi’s presentation the Financial Stability Unit in July), and the timeline for the National Debt from Wikipedia, the “private sector “other” (blue) might include some debt from government entities).

Disclosure: No positions

Comments

[derryl:]

Great article Andrew. A very crisp perception of our recent financial history, starring MBS and its red headed stepchild CDS, and brought to you of course by the good folks at GS et al.

Nov 03 04:24 PM

[User 353732:]

1. America does not send Armies around the world on treasure hunts. If that were so, the Chinese would not be the biggest investors in Iraqi oilfields.
American blood so the Chinese can have Iraqi oil does not sound like a treasure hunt does it?

2. Americans cannot pay back private debts because the US Regime is destroying their capacity to do so via egregiously bad and malicious policies that tax , penalize and mock work, frugality, entrepreneurship, small businesses and middle class values while glorifying debt, consumption, entitlements, worthless government scrip and the privileges of a tiny, grasping and utterly corrupt elite. If Americans cannot redeem private debt they certainly cannot redeem public debt.

3. Americans have 3 choices: slavery, piracy ,honor.

Historically, polities and peoples who have vast debts they cannot repay with money, are forced to repay with work and forfeiture of assets by creditors. This is economic slavery. The current US Regime will be quite content with this, provided they can be the Herods and Quislings to the foreign debt holders.
.
The US Regime could steal the money from foreigners and use force to defy the world. This is piracy. It takes courage , daring and a willingness to hang or be quartered if caught. The US Regime lacks any of these attributes, so piracy is out.

Finally, Americans could choose honor. This entails purging or expelling the current US Regime, reclaiming the Constitution and historical American virtues. This leads to a nation, once again, dedicated to innovation, incentives, production, savings, investing and exporting. In turn this means that National assets and incomes grow rapidly and impressively. The consequence is that the National asset to liability ratio and the debt service to income ratio and the dollar to wealth creating capacity ratio are all restored to sane and sustainable levels.
.
The real choice then is: Either the US Regime goes or the American people go. Honor or slavery. Not choosing is ,of course, a choice as well since it means opting for enslavement via inaction.

Nov 03 04:41 PM

[expatsp:]

Great article as always, but isn't there a bit of a contradiction when you talk about collateral? If collateral on all the U.S.'s external debt is essentially the promises of citizens who can't pay back what they borrowed privately, then doesn't the U.S. have the option of screwing foreign investors, even if they start "coming after their collateral"?

Nov 03 04:43 PM

[Andrew Butter:]

1: If it wasn't a Treasure hunt (doesn't mean they found anything); I have no idea what it was, either way it doesn't sound like it was a good Return On Investment.

2: My thoughts exactly, particularly the bit about the corrupt elite.

3: I agree there is an honorable way out and the sooner Americans go with that the better off they will be, and the world too; American were conned into taking on too much debt, they didn't need it, they don't need it now.


On Nov 03 04:41 PM User 353732 wrote:

> 1. America does not send Armies around the world on treasure hunts.
> If that were so, the Chinese would not be the biggest investors in
> Iraqi oilfields.
> American blood so the Chinese can have Iraqi oil does not sound like
> a treasure hunt does it?
>
> 2. Americans cannot pay back private debts because the US Regime
> is destroying their capacity to do so via egregiously bad and malicious
> policies that tax , penalize and mock work, frugality, entrepreneurship,
> small businesses and middle class values while glorifying debt, consumption,
> entitlements, worthless government scrip and the privileges of a
> tiny, grasping and utterly corrupt elite. If Americans cannot redeem
> private debt they certainly cannot redeem public debt.
>
> 3. Americans have 3 choices: slavery, piracy ,honor.
>
> Historically, polities and peoples who have vast debts they cannot
> repay with money, are forced to repay with work and forfeiture of
> assets by creditors. This is economic slavery. The current US Regime
> will be quite content with this, provided they can be the Herods
> and Quislings to the foreign debt holders.
> .
> The US Regime could steal the money from foreigners and use force
> to defy the world. This is piracy. It takes courage , daring and
> a willingness to hang or be quartered if caught. The US Regime lacks
> any of these attributes, so piracy is out.
>
> Finally, Americans could choose honor. This entails purging or expelling
> the current US Regime, reclaiming the Constitution and historical
> American virtues. This leads to a nation, once again, dedicated to
> innovation, incentives, production, savings, investing and exporting.
> In turn this means that National assets and incomes grow rapidly
> and impressively. The consequence is that the National asset to liability
> ratio and the debt service to income ratio and the dollar to wealth
> creating capacity ratio are all restored to sane and sustainable
> levels.
> .
> The real choice then is: Either the US Regime goes or the American
> people go. Honor or slavery. Not choosing is ,of course, a choice
> as well since it means opting for enslavement via inaction.

Nov 03 06:27 PM

[Andrew Butter:]

Absolutely, it's called Jingle Mail.


On Nov 03 04:43 PM expatsp wrote:

> Great article as always, but isn't there a bit of a contradiction
> when you talk about collateral? If collateral on all the U.S.'s external
> debt is essentially the promises of citizens who can't pay back what
> they borrowed privately, then doesn't the U.S. have the option of
> screwing foreign investors, even if they start "coming after their
> collateral"?

Nov 03 06:28 PM

[User 312974:]

"User 353732" is putting out pseudo-intellectual drivel. "Americans have three choices: Slavery, Piracy, Honor". What? Try writing English, Sir. Slavery is a state of being. Piracy is a larcenous act on the high seas. Honor is conduct predicated on a set of consistent values. Categorize your clever words. Do not mix apples and oranges. Next, your insane, repetitious hatred of our elected government is absurd even if you think you dressed it up in what you think is some kind of "insight". You, Sir, need to think through your own verbiage. It is noise. Nothing to hang one's hat on. All First Amendment entitlement and no responsibility.

Nov 03 07:04 PM

[Zell:]

I guess "User 353732" is starting to ruffle some elitists. User 312974's first comment attacks the "verbiage" so as to dis-credit the "Content". Does this still work???


Nov 03 07:04 PM User 312974 wrote:

> "User 353732" is putting out pseudo-intellectual drivel. "Americans
> have three choices: Slavery, Piracy, Honor". What? Try writing
> English, Sir. Slavery is a state of being. Piracy is a larcenous
> act on the high seas. Honor is conduct predicated on a set of consistent
> values. Categorize your clever words. Do not mix apples and oranges.
> Next, your insane, repetitious hatred of our elected government is
> absurd even if you think you dressed it up in what you think is some
> kind of "insight". You, Sir, need to think through your own verbiage.
> It is noise. Nothing to hang one's hat on. All First Amendment
> entitlement and no responsibility.

Nov 03 07:42 PM

[Gregman2:]

There's an old Chinese saying, "He who owes is King." The fact is, so much of the debt you list will ultimately need to be charged off. As with many of the formal unfunded liabilities...they'll need to be discounted.
So, in terms of discounting to net present values...the actual numbers are much less. FYI;-)

Nov 04 08:51 PM

[Andrew Butter:]

Sure, but when you are charging off debt, it's hard to get more.


On Nov 04 08:51 PM Gregman2 wrote:

> There's an old Chinese saying, "He who owes is King." The fact is,
> so much of the debt you list will ultimately need to be charged off.
> As with many of the formal unfunded liabilities...they'll need to
> be discounted.
> So, in terms of discounting to net present values...the actual numbers
> are much less. FYI;-)

Nov 05 01:51 AM