There is a link between the actual US debt numbers, as opposed to the reported numbers, interest rates, quantitative easing, currency valuations and the $600 trillion in derivatives the banks have that underlie the US economic system. Looking at various circumstances and probabilities, a group of astute hedge fund industry insiders has been tracking the nexus of debt – meaning the “real” numbers – and contrasting this to the potential for economic implosion. This is grim but critical work with no guarantees regarding timing or outcomes – just a dispassionate look at the numbers.
Paul Singer has been one such market wonk to express concern.
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Consider the diagnosis of the problem before all else
To consider his identification of the problem, put Singer’s politics to one side for a moment and forget about any solutions to the problem. Just consider if Singer has the right diagnosis.
Singer joins Boston University professor Larry Kotlikoff in saying the US government doesn’t accurately account for its debt. The problem is smart people understand the real issue, they are tracking the real numbers and it will impact outcomes.
Essentially the debate boils down to accurately counting the numbers in regards to account payable and receivable. The accounting numbers for the government should not be bendable to the point of breaking and should hold up to generally accepted accounting principles.
A cornerstone of generally accepted accounting practices centers around booking liabilities when a promise to pay has been made
Saying the “real” numbers “are not fantasies,” in his confidential investment letter Singer wrote the obvious: “Only someone who has never run a business could say with a straight face that such obligations are not really liabilities and need not be included in the accounting.”
It is here Singer touches the core of the issue. The US Government does not consider liabilities it has already committed to as a liability on a balance sheet. Here is a basic example. A printing company purchases paper, and the cost of that paper is an obvious liability: A promise to pay in the future is considered on all balance sheets. Simple. The US government doesn’t apparently like simple or tried and true accounting standards. The liabilities that it has promised seniors in Medicare are known to require payment just like the printing company must pay the paper company real cash at some point in time. This is not to blame seniors or look at potential solutions, just consider the numeric facts to diagnose the problem. In two to three years, the liability of the obligations promised seniors – from pensions to government benefits – will be at an all time high, with resources at a low. Not planning on this is irresponsible, it could lead to serious trouble. In fact, hedge fund manager Ray Dalio of Bridgewater has publicly expressed concern that a “1933 Germany” could occur in the US. This isn’t crazy talk. It’s simple probability analysis, a quantitative look at facts and logical potential conclusions.
Paul Singer And Other Smart people follow the real numbers
Dalio, Singer and Kotlikoff are smart people. They can’t be fooled accounting tricks the same way MF Global Holdings Ltd (OTCMKTS:MFGLQ) bond holders were confused at slight of hand to occurred in the summer of 2011. Its logical analysis of numbers that lead to implosions when these numbers are ignored.
Corzine in MF Global Holdings Ltd (OTCMKTS:MFGLQ) was documented to have received multiple warnings that his actions could lead to “issues.” But for some reason he eludes justice, as a blocked investigation can be independently documented. If Corzine eludes justice, that would make him the first “too big to prosecute” individual. That’s right. Forget about institutions. The US Government is officially getting into the business of providing “too big to prosecute” status to even former bank executives. Wow, that’s amazing power.
Compare big bank derivative exposure 2008 to now
But I digress. It can be said that the banks won’t face accountability when the big implosion occurs and the next crash will be much worse. 2008 was a warm up. It takes nothing more than looking at the big bank derivatives exposure to understand the magnitude of the exact same problem that drove 2008 is positioned again to implode.
“Nearly six years after the crisis, financial institutions are still overleveraged and opaque, with derivatives on their books topping $600 trillion of notional value globally,” Singer notes in his letter, then starts to provide solutions.
“Margin rules should be enacted that require unmatched derivatives between dealers to be margined exactly the way such positions are margined for customers, with no exceptions whatsoever,” Singer ironically noted. This is brilliant from the perspective that margin to equity is a little known but highly prized measure of risk utilized by professional investors. Apply this same standard to the Fed and other institutions and it’s hard to refute that a problem exists.
When will structural breakdown occur?
When will the problem manifest itself in a structural break down? It can’t be predicted exactly. In 1998 Brooksley Born predicted an implosion the same way a bridge engineer does. She didn’t know when it would occur, but she saw the structural flaws. It took ten years for unnecessarly complex derivatives that lacked transparency (a core principle of accepted derivatives management) to implode. These are the signs of a fraud, and the run-up to 2008 isn’t that much different from now.
Economic policy created by financial lobbyists: Singer
“The current system was created by lobbyists as a patchwork of changes and obstructions to change,” Singer noted, apparently pointing a finger at the financial serves lobby which only serves those willing to pay its high price to access near total control. “When examining the question of why the stress tests and value-at-risk (VAR) measures failed in 2008, it is important to understand that regulators and institutions that relied on them could not even comprehend how to model and analyze the potential range of securities-price movements and loss-contagion in this world of interconnection and massive leverage.”
From utilizing the incorrect tools utilized to measure the real risk numbers, Singer then mused a day when the “orderly liquidation” provisions of Dodd-Frank are triggered. This would require a governmental institution to unwind the most complex OTC derivatives structures in history. Good luck, Singer says, as most government officials have knowledge limited to plain vanilla banking. These guys are too big to fail, too big to prosecute and – when the implosion occurs – too big to unwind. That’s a trifecta.
“Financial system less safe than 2008”
There is a connection between the safety of the global economic structure and allowing the financial lobby control of economic rules.
“The global financial system is arguably less safe than it was in 2008,” Singer states, as he considers the potential for “unfettered use of leverage” to lead to “systemic collapse.” He is not alone in these thoughts. These are not people wearing tin hats, but rather some of the sharpest minds in finance – that are not controlled by a powerful big bank wet blanket that stifles debate.
Those who think this is exaggeration, just ask one question
Those who think the scenario Singer describes is an exaggeration “should ask themselves the following question: After decades of advancements in human knowledge and purported innovations in the global financial system, why did 2008 turn into the worst financial crisis since the Great Depression?”
Think about this and consider the bridge mechanic.
“The answer is that the system was unsound, largely due to excessive leverage and the complexity of financial instruments. In the 80-plus years since the 1929 crash and the subsequent Depression, there clearly have been a large number of geopolitical and financial events, yet none of them caused financial collapse until 2008.”
Previous stock market collapses were due to economic circumstance. 2008 was due to structural issues that were identified by Paul Singer, Born, Paulson as well as a few authors and an economic think tank that provided the US Federal reserve with its warning before 2008.
“We do not think policymakers have learned anything much from the financial crisis, but that fact can truly be demonstrated only as time passes,” Singer writes.