The Shadows of the Crisis: Past and Future

Should the Fed have intervened on LTCM?  My answer is no.  It set up the seeds of the present crisis, and encouraged the Fed to meddle in places where there is no significant legal basis to do so.  If they had let LTCM fail, the debts of the system would have shrunk more, and the system would not have failed, as it seems to be doing today.  It would have been a salutary check that would have brought us back to reality.  (Now, would that they had not loosened so much in 2002, 1995, and 1991, but that is another story….)

The failure of LTCM did have some positive effects on me.  It made me more skeptical about arbitrage, leverage, and illiquidity, at least to the degree that one has to be paid to take on these risks.  Also, that hedge funds as a group posed some systemic risk, even if none were as big as LTCM.

But now consider a problem in our future.  Is Social Security a Ponzi Scheme?  (I like Eddy and Jim, so this is not about either of them… I have been writing about this for 15 years.)  I don’t typically call it that, not because there aren’t some elements that resemble a Ponzi Scheme, but because it loses the writer credibility on the broader issues involved.  Rhetoric matters, and even tone of voice matters.

In analyzing Social Security and Medicare, the first thing one must do is unify them with the US Government, and consider them as a whole.  The US Government has moved two two plans off-budget and on-budget at their convenience in order to make the deficits look smaller.

When one looks at the system as a whole with current US Government borrowing, one sees the imbalance.  Many say, “The trust fund won’t run out of money until 2042,” or “Inflows will exceed outflows until 2022.”  The trouble is, we are at the peak now of inflows over outflows.  Starting four years from now, when Obama is a lame duck, that overage will shrink.  As the overage shrinks, taxes will have to be raised, or borrowing will have to rise.  And all of this is on top of what we have done in 2008, and will do in 2009, where the deficits are as aggressive as in wartime.  From an old CC post:

David Merkel
Every Little Help Creates a Great Big Hurt
8/23/2007 5:09 PM EDT

So there are some that want the US Government to bail out homeowners. Need I remind them that on an accrual basis, we are running near record deficits? Never mind. In another 5-10 years, it won’t matter anymore, because foreigners will no longer fund the gaping needs of the US Government as the Baby Boomers retire.

But so as not to be merely a critic, let me suggest an idea to aid the situation. Income tax futures. We could speculate on the amount the US Government takes in, and the IRS could use it for hedging purposes. One thing that I am reasonably sure of: tax rates will be higher ten years from now, and I would expect the futures to reflect that.

Position: long tax payments

I have focused on the latter half of the 2010s as my period for when the US will face a crisis, because then it will become obvious that the US can’t make good on all of its promises.  Well, the government is testing the boundaries of crisis now.

What everyone who relies on Social Security and Medicare should know is that those programs are subject to the will of Congress.  They could eliminate them tomorrow and no one could sue for damages.  “Wait, I paid into that for 40 years!”  Sorry, you paid extra taxes for 40 years, the law had no provision guaranteeing results for any individual.

All of that said, I am reminded about what former Senator William Proxmire said about Social Security.  (I met him at my High School when I was 16 — when I shook hands with him, there was no one else there, just me and him; I felt honored, particularly as he was a rare politician at that time who would not spend aggressively to win elections.)  He said that all Social Security benefits would be paid, but the purchasing power of those benefits would be limited.  That is a common sense warning from a man who knew that you can’t get something from nothing.

That brings us back to the present.  You can’t get something from nothing.  Why should you expect the government to rescue us from this crisis?  Who will lend us the the money/resources?  What return are they expecting?  What happens if we default?

I’m not specifically worried about Social Security anymore, because we are presently testing the boundaries of what the US Government can borrow at present.  I don’t precisely know where that limit is.  In implicit terms, we are past the debt limit if one includes that Social Security deficit.  But foreign powers, OPEC and China, can fund the US for their own reasons, even when US creditworthiness is scant.

If I were advising the governments of Saudi Arabia or China, I would tell them: sunk costs are sunk.  Do what maximizes value for your people from here.  That might break the current cycle where they support the US.

What I have written here outlines what we might expect over the next decade.  I hope and pray that matters prove better than what I expect.


  • Eric says:

    You lost me when you said you like Jim Cramer. Seriously, all hyperbole aside, it is a demonstrable fact that Jim Cramer frequently misleads his readers into thinking that he’s been on top of major market developments when he’s really messed up badly. He’s someone who will put his own interests ahead of the truth when necessary. Just one quote proves my point: “Was there anyone out there who more loudly announced this credit crisis before it happened than I did?” — Jim Cramer, April 1, 2008. Unfortunately, there are a lot of “journalists” out there who know how much power Cramer wields. And so, wary of their own position in the punditry world, they play friendly and say how much they like him. I’d like 30 minutes alone in a room with these guys, a voice recorder and a syringe of Sodium Pentothal — we’d see what they really think of James Cramer.

  • Canuck says:

    In respect to the much shortened time frame in which the events you so presciently suggested might occur, I would posit the exponential growth of the Fed’s balance sheet has similarly acted to exponentially shorten the feedback effect of the monetary stimulus.
    In like fashion, the fiscal disequilibriums you cite, may be resolved considerably more quickly than anyone might anticipate.
    I suspect we won’t need to hold our breaths for a decade.

  • Eric — Cramer did one really nice thing for me. He invited me to write for RealMoney, and that’s what got me into investment writing.

    Canuck — Hope you are right, but our dear government has buried the problem for over 25 years now.

  • Eric says:

    David, I don’t dispute that people in the punditry world owe Cramer their starts. But that only underscores my point. Consider how strange it was for Aaron Task to sit down next to Henry Blodget for the first time. Task owes his start to Cramer just like you do. But Blodget, because he had little to lose and owed Cramer nothing, had the guts to openly (and correctly) question Cramer’s “guru” reputation. I’m saying that Cramer gets away with murder because darn few people are willing, out of fear or gratitude or whatever, to point out how he cherry picks from his constant stream of predictions to create the impression that he’s been on top of things every step of the way when he’s actually been awful. Do you disagree?

  • Eric, at RealMoney I often corrected Cramer in polite ways. I don’t own a television, so I don’t see him on CNBC. But judging by how Cramer’s writing has shifted over the years, he has become less accurate as the media he responds to (television now, mainly) has become more short-cycle.

    Good investment writing requires a perspective that considers longer time horizons. It also requires a willingness to seriously consider the other side of an argument. It should be interesting, but usually not sensational.

    Cramer is a bright guy who has taken on an impossible task — trying to make good investing exciting for the masses. First, the masses don’t truly have the stomach for it. Second, Cramer does not clearly point out the time horizons for his recommendations (something that I recommended a number of times at RealMoney). Third, good investing involves a degree of tedious work, which does not easily transfer to TV.

    TSCM at some point really cranked up Cramer’s production schedule — both web and video, because they found that their profitability benefited in the short run from more content from Cramer — the trouble was that in the long run, it harmed their prize asset. Read his early stuff, much of it is very insightful. I learned a lot from Cramer on trading 1999-2002.

    So, why I am I not writing at RM at present? It started by being too busy — I started the blog to give me my own voice, oddly, encouraged by some who were polite critics of Cramer (who liked me). The second phase was reading RM and realizing that I did not have an easy place to contribute there; I wasn’t sure what good I would be doing amid the noise. The third phase was realizing that there wasn’t much I was reading there any more. I joined the site because I loved it and couldn’t get along without it. I can get along without it today — I haven’t read it in two months or so.

    Cramer is easy to bash, but my character is not the one that takes the bat to the pinata. In the article cited, I half agreed with Jim. I spend my time trying more to point out what’s true, rather than engage in debates focused on the person, rather than the ideas that are there.

    Finally, from what I know about Jim, I know he means well. I think he is stuck in a position where he is trying to accomplish the impossible.

  • Terry says:

    Well, now back to the topic at hand. I have found myself regularly nodding my head in agreement as I read your posts, Dave, because I am skeptical about our current economic condition as well as Fed & Treasury policies throwing money (yours and mine) at it.

    NTL, I remain a bit more optimistic than you about the longer term. Although I’m not smart enough to figure out exactly how, I think we will find a means to once again hold the beast of reduced economic reliability at bay. For one thing, I don’t see an alternative place for foreign governments (& others) to invest that may be better than the US. China? Europe? Japan? I don’t think so.

    Still, it could be an ugly global economy for longer than I expect. If the US doesn’t lead us out of the global funk, who will?

  • Eric says:

    And… problem is that he’s constantly leading people to believe that’s he’s actually succeeded. I can’t state it any more plainly than that. I would say we could “agree to disagree”, but that would suggest you’ve addressed my point. Oh well. I’ll drop the whole issue with this quote: “Nothing Jim Cramer says helps people make better decisions.” David Swensen, Chief Investment Officer, Yale University.

  • Eric, I think we agree more than we disagree. It’s pretty well established that his track record as a pundit is poor. He does say some valuable things, but there’s a ton of noise around his statements, making it impossible for any novice to find the good bits.

    In general, people would be better off turning off all investment TV, and read more books, which is why I review books here. It’s also why I tended to write more long and and deep articles at RealMoney dealing with how to understand, rather than what stock to buy now.

    One more note: I wrote my series on using investment advice with Cramer in mind.

  • Paul in Kansas City says:

    I want to disclose that I have corresponded with Cramer for many years so I can be correctly accused of “teacher worship”. He is a great guy on a personal level so it is hard to be objective. FWIW He has helped me immensely (as have David and Howard Simons on RealMoney); I’d throw in some other bloggers such as Jeff Miller who’s analysis is a must read. I am not hung up on pundit track records because as David has pointed out it is an impossible task. From my point of view the most important thing I have learned from David, Cramer, Howard, Jeff, etc. is how to make more informed decisions (endless improvement needed on my part) and take 100% responsibility. It is easier for me to take that road because I have an advisory business so passing the buck to david,cramer etc, doesn’t fly. I don’t know Jeff but I can vouch for the effort and goodwill extended to me by the above gentleman. david; thanks again for your work. It has made probably one of the most stressful moments of my life (professionally) much more bearable.

  • I have had a problem with the way cramer dispenses financial advice like he knows the financial scene and the direction of the market. he may be a great guy on a personal level, but professionaly he has negatively affected tons of people. Be careful of who you get your financial advice from.