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Op-Ed: The Illusion of Wealth


The last eight years were a fantasy, created by massive debt, manipulation and deceit.


Michael Lewis, author of the classic Liars Poker captured the absurdity of TARP in a letter to Secretary Paulson last week:

As much as I admire all of your decisions I can't help but notice that the main qualification of the bankers to whom you have been giving money, so that they might make smart loans, is that they have gone almost bankrupt by making stupid loans.

As your mind is subtle, I can only assume that you secretly believe that the American economy right now needs not smart loans, but more stupid ones - and thus that you have targeted the bankers who have proven they can make them.

I, unfortunately, have not flirted with bankruptcy, or made any stupid loans. But here's my point: I haven't been given the chance! Allow me to prove my financial ineptitude to you. I swear to you that when I return for my second round of assistance I will have proven myself fully qualified to receive it.

By giving money to bankers who have made many stupid loans you have made life harder for bankers who have never made stupid loans. By aiding the dumb banks you prevent the smart ones from replacing them. It may be that just now smart bankers are the last thing we need - but one day they may come in handy, and so we should do what we can to keep them from getting discouraged

Paulson has indicated that he's done dropping turkeys from the helicopter. He's counting the days until January 20th, so he can get out of town and relax with his $700 million fortune. At least he'll enjoy a comfortable retirement, whereas many Americans won't.

Federal Reserve Gone Wild

As of May 15th, 2008 the Federal Reserve Bank of the United States had $881 billion of assets, $840 billion of liabilities, leaving $41 billion of capital. Federal Reserve Chairman Ben Bernanke has fired up the printing presses and helicopters since then.

Bernanke has created the Term Auction Facility, Term Securities Lending Facility, Primary Dealer Credit Facility, Commercial Paper Funding Facility and Money Market Investor Funding Facility, among others in the last 8 months. He also started paying interest to banks on reserves. The goal of unfreezing the system has been a wretched failure. Banks are finding it easier and safer to borrow from the Federal Reserve, earn interest on their TARP capital and not make any loans. All of the facilities and programs are a crutch that discourages banks from doing business. Why would a rational banker make loans to businesses and consumers as we're entering the deepest recession since the 1930s? This is where our country and government have become warped and dysfunctional. The Government is now encouraging reckless lending as the solution to previous reckless lending.

In the space of 2 months, Chairman Bernanke has doubled the balance sheet of the Federal Reserve. When he and Secretary Paulson were selling their rescue plan in front of Congress in September, they stressed transparency, oversight and openness. Yet the chairman has since withheld the names of all financial institutions that have borrowed from the Fed - and will not reveal the collateral that they have put up for those loans.

Bloomberg News has sued the Fed under the Freedom of Information Act to force it to reveal where $2.2 trillion of taxpayer money has gone. The Bloomberg lawsuit argues that the collateral lists ``are central to understanding and assessing the government's response to the most cataclysmic financial crisis in America since the Great Depression.'' Investment Manager Ted Forstmann was correct when he said, "It's your money; it's not the Fed's money. Of course there should be transparency."

Click to enlarge

Contrast openness and transparency with the words of Chairman Bernanke in talking to the House Financial Services Committee:

"Some have asked us to reveal the names of the banks that are borrowing, how much they are borrowing, what collateral they are posting. We think that's counterproductive."

Or those of Congressman Barney Frank, as quoted in Bloomberg:

"I talk to (president of the New York Federal Reserve BanK) Timothy Geithner and he was pretty sure that they're OK. If the risk is that the Fed takes a little bit of a haircut, well that's regrettable."

Now, my local paper lists the people who were arrested for DUI on a weekly basis. The idea is that if you know that your neighbors will see this, you won't drink and drive. Bernanke is encouraging banks to drink and drive. How does complete secrecy restore confidence in the system?

Not that I feel any more secure with Barney Frank leading Congress on all financial issues. I wonder what a Washington insider like Frank's definition of "a little bit of a haircut" amounts to. A 5% haircut on $2 trillion would be a mere $100 billion. Chump change in Washington.

Negative Wealth Affect

As the bureaucrats, professional lifetime politicians, corporate lobbyists and media spin doctors figure out how to waste our tax dollars, real people in America are suffering dramatic declines in their net worth. The chart below shows consistent growth in American household net worth since 1945, with only a slight drop during the dot-com Crash. The net worth of US households peaked at $58.7 trillion in 2007. We're now in the midst of the greatest decline in the history of the United States.

The balance sheet of American households tells an interesting story. Americans experienced a dual boom in stocks and real estate between 2002 and 2007. Real estate assets grew by 51% and financial assets by 55% over this period. These increases gave rise to a positive wealth effect. When people perceive themselves to be richer due to the increase in the value of their home and actual increases in investments, they're more likely to spend. This perception, along with a strong employment market led Americans to make dreadful financial decisions.

Even though real estate rose by 51%, mortgage debt rose by 75%. What Americans are learning is that real estate can decline, but debt lasts forever. Much of that extra mortgage debt was used to buy TVs, cars, kitchens, bathrooms and vacations. None of these luxuries have the potential to appreciate. Based on the decline in housing and the stock market, I have produced an estimate of the current national household net worth. By my conservative estimation, household net worth has declined by over $10 trillion since the beginning of the year and is now back to 2003 levels. By the time this recession is over, we will have eliminated all of the net worth created during the entire Bush reign. It was all an illusion, created by humungous amounts of debt, fraud, manipulation and deceit.

Source: Federal Reserve

American consumers are under intense stress. Now that there's no equity left to borrow against their houses, they're doing what they do best: Whipping out one of their 30 credit cards. The credit card writeoffs will be the next tsunami that hits our banking system and will be subsidized by more taxpayer funds. According to John Mauldin, credit card debt has exploded in the last few months:

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