Cartoon Capitalism
I’m often extremely pessimistic on the state of the US economy. In public settings my doom and gloom predictions seem to depress people so I tend to restrict my rants solely to my blog. So it makes me happy when I read an article that agrees with my thoughts on the state of affairs.
CARTOON CAPITALISM
by Bill Bonner
America’s largest mortgage finance companies, Fannie and Freddie, have so much water in their lungs it will take at least $25 billion of the public’s money to save them. Possibly $300 billion. Were it up to us, we’d leave them on the beach.
But, last week, the U.S. Senate bent down and pressed its large mouth onto those gaping traps of the mortgage twins – gurgling into them a corrupt breath of life. Since the two hold one out of every two mortgages in the nation, in effect, Congress is nationalizing the U.S. housing stock itself. Henceforth, citizens will pay not only their taxes to the government, but their mortgage payments too.
In America itself, how this came to be is the subject of little concern. But despite the lack of interest, it is the subject of the next 500 words or so.
At a speech in Vancouver, James Kunstler seemed positively delighted. Finally, gasoline over $4 a gallon was going to do what generations of artistic scorn could not – destroy Fannie and Freddie’s collateral. Kunstler’s critique of American suburban vernacular architecture is that its products are not real houses at all – but “cartoon houses.” They have porches that look like real porches from a distance, but they are too narrow to sit on. They have shutters too – nailed to the wall, making them completely useless. They may have “picture” windows…looking out on nothing…or no windows at all. And they wouldn’t exist at all were it not for cheap credit and cheap gasoline.
Of course, the same may be said of America’s – and Britain’s – entire economies during the last 20 years. The loose credit that built cartoon houses also constructed cartoon economies; they look like real economies, but they are essentially perverse, consuming wealth rather than creating it.
For proof, we return to Fannie and Freddie. Here were two companies that appeared to be helping Americans own houses. But since they were created, homeowners’ equity – that portion of the house actually owned and paid for by the homeowner – fell from 70% to below 50%. Currently, Americans’ total equity is lower than their mortgage debt. As a whole, the nation’s homeowners are “upside down,” in other words. Nearly 9 million Americans have zero or negative equity already – and house prices are still falling.
How comes this to be? The answer is simple: lenders lent more than the houses were worth to people who couldn’t pay it back anyway. This Looney Tune approach to finance radiated to all points of the economy. People pretended that they earned more – spending more and more money to buy more and more goods and services – but wages did not really increase. Then, they bought houses – believing the roofs over their heads were investments, rather than consumer items. With no down payment, no proof of income, and zero interest loans – for most of the new buyers, home ownership was merely a dangerous conceit. Now that the roofs have caved in, it is a staggering burden.
The “consumer economy” was always a mockery. No serious economist ever suggested that you could get richer by consuming wealth. But that didn’t make consumerism unpopular. The more people consumed, the more GDP went up. GDP measures output, not wealth creation; but who could tell the difference? In a cartoon economy – no one. Besides, spending made people feel as though they were getting richer.
Then, whenever the consumer threatened to come to his senses, the feds rushed to “stimulate” him – by giving him more of what he least needed, more credit. More spending kept the cartoon economy running – allowing the consumer, the businessman and the speculator to add to his burden of debt. In 1971, when the United States went off the gold wagon, household debt was less than 50% of GDP. Now, it is more than 100%. And now, the poor consumer’s knees buckle; he will be forced to work the rest of his life just to keep up with his debt burden, let alone pay it off.
Even the rentiers were bamboozled by their own claptrap. Stocks rose from ’82 to 2000…fell heavily to 2002 and bounced back. For the last 10 years, shareholders have gotten little for their effort. In July of ’98, the FTSE hit a high of 5,458. This month, it has reached 5,625. And in America, if stock prices were quoted in gallons of gasoline, the Dow would take the driver no further in 2008 than it did 40 years ago.
The cartoon capitalists did it all backwards; they are supposed to exploit the workers, not be exploited by them. But while consumers and investors were going nowhere, corporate managers and Wall Street hustlers were getting rich. The two Bozos running Fannie and Freddie, for example, pocketed about $32 million between them last year – during a period in which the companies lost almost $5.2 billion – not to mention the losses to shareholders. And on Wall Street, managers paid out $250 billion in bonuses in the 4 years leading up to the credit crunch. The firms declared a profit and paid bonuses when the bets were made; they didn’t wait to see how they turned out. Thus did the big banks and big brokers become capitalists without capital, dependent on the gullibility of investors to keep them in business. And when investors began to wise up, they turned to the public for capital support.
What kind of scam is this? It may look like capitalism from a distance. But this is not real capitalism; this is cartoon capitalism – run by clowns, who sell freak investments to chump investors, and encourage the lumpen householder to ruin himself.
Enjoy your weekend,
Bill Bonner
The Daily Reckoning
Bill Bonner is the founder and editor of The Daily Reckoning . He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis . I strongly recommend his latest book, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics.
Since I mentioned that Fannie Mae and Freddie Mac were going to go bankrupt, their stocks have plummeted 50%. I think its time to start shorting other financial sectors like consumer credit card companies.
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August 1st, 2008 at 6:02 pm
lol You are a true cynic, Bill, but I did love this post. Entertaining stuff whether I agree with it or not.
I’m not too worried, the 2000-2002 Tech Wreck was scarier than this recession. The scariest part of the tech wreck for me occurred right before the crash. Do you remember the euphoria in 1999 and early 2000 near the end of the greatest expansion that the US stock market had ever experienced? Pundits claimed that the tech boom created a new paradigm in business, “we would never have to experience another recession again because of the exponential growth potential of technology companies”. That sounded like complete insanity to me and the crash that followed proved that people often lose their objectivity during strongly bearish AND strongly bullish conditions.
Stagflation in the 70’s was also scarier than this recession. Stagflation was baffling for investors and economists when it first occurred in the 1970’s. How could we be experiencing stifling inflation while we were also experiencing a prolonged recession? Theorists worried that recession coupled with inflation could only lead to one logical conclusion, a complete economic meltdown. At the time, there was no historical data to refute that conclusion. Of course, that didn’t happen, but it sure created scary market and economic conditions for several years.
Wait… I was going to try to post some optimism to cheer you up. Oh well, I guess the bright side is that it could be worse. (-:
Cheers!
Odd Lot
August 2nd, 2008 at 11:04 am
LOD
I am confused. You say you are pursuing an MBA at UCLA and you have a strategy to “Live Off Dividends”, yet you rail on (or share others doomster rantings) about the damned American economy. You can’t have it both ways. Either we are going to hell in a hand basket and should all expatriate to another country like Jim Rogers has, or, we are going through a predictable bump caused by economic excesses from which we will recover soon. It is one or the other.
Your game plan to “Live Off Dividends” is very sound and I congratulate you. I follow a similar course myself and am heavily invested in high cash flow, high yield investments that I reinvest to compound my returns. Like you, I am invested in Canroys, energy, materials and high return tech stocks, along with financials. Yes, I got the timing on the financials wrong, but I am positive they will survive and thrive once the worst of them are merged or buried.
But if the American economy is totally corrupted by a capitalist system that has made it the economic model for the world but is now irrepairable, then why are you investing in American companies and why are you still living in America to attend UCLA? Make a decision and stick with it. Don’t speak out of both sides of your mouth.
I think I can argue convincingly, that capitalism is all about fear and greed, risk and reward. Capitalism is about allowing people, within some limits, to pursue their ambitions and dreams. Once in a while, success begets greed and apathy by regulators allows the greed to get out of control.
I completely agree that Fannie and Freddie were given too much leeway by a Congress and regulators that were misled by overly liberal philosophy (everyone in America should be a homeowner whether capable of paying a mortgage or not); apathy and greed by the overpaid, political crony executive managers; and by the arrogance and ennui of our top regulators (Greenspan in 2003 tells the nation that low interest fixed rate loans are passe’ and everyone should take out an ARM with teaser rates).
But I completely disagree that consumerism is a problem for America or any capitalist economy. On the contrary, it is the fuel that makes the engine run. For an example of an economy with insufficient consumerist tendencies, one need look no further than Japan. They save like the dickens, and work hard at world class production, but if foreigners don’t buy their goods, there is no one at home to consume. The economy stagnates (and has for 20 years). For an economy to grow, someone has to buy the output in ever greater quantities. That is the magic of the American economy. But it is true, that savings rates must stay positive to continually provide a capital source for growing productive capacity. The American economy was doomed to a (temporary) upset when savings rates went negative in 2005. But if we survived the Great Depression, we will survive this.
August 3rd, 2008 at 8:59 am
This is one of your best posts yet, I’m British and I’ve seen the damage is credit can do to people. As a side note I now live in Italy and when I tell people here that in America they have fake shutters they don’t believe me!
August 3rd, 2008 at 5:42 pm
I disagree with the way the economy is being run. The way I see, short-sighted ideas are being implemented to bail out a select few at the expense of the country on the whole.
Just because I think that privatization of profits and socialization of losses is wrong, I should move out of the US and not get an MBA here? How does that make any sense. If anything, if you disagree with my ideas you should stop reading this blog!!!!
This blog is about my attempts to create a life where I can one day live of dividends and not have to work. In way is it incongruent with furthering my education and expanding my horizons. I believe you should try opening your mind too.
August 3rd, 2008 at 6:29 pm
“If anything, if you disagree with my ideas you should stop reading this blog!!!!
”
I am glad you put a wink emoticon on this post. Otherwise, the post would be especially embarassing. From this post I gather that you only want readers and people who comment that are in complete agreement with you??!! That is sad if true. The reason for the net is open and honest debate.
The point I was trying to make and guess I missed the mark is that if one thinks the American economy is doomed (as does the writer of Cartoon Capitalism apparently), then why bother living here. Better to move to a place with a “free market”. It is not rational to try and seek gain (dividends) from a capitalist system that is corrupt and broken.
You continue to repeat an idea that keeps going around in circles. I don’t think it is very original as I hear it from journalists, pundits and bloggers alike. This idea that somehow the Feds are privatizing reward and socializing risk is not well considered.
Yes, risk has been socialized. At a fundamental level, that is the way our society works. Insurance is socialized risk. The FDIC and FNMA are two examples of socialized risk. Until the past few months, that was what everyone wanted.
But more bothersome is this idea (sounds like left-wing liberals to me) that “bailouts” privatize reward (aka, make fat cats, fatter). But, what reward has been privatized? Who is getting rich on this financial crisis? The guy down the street whose house has been foreclosed? The holders of Bear Stearns stock? People whose deposits at Indymac were beyond the FDIC limits and therefore forfeited? Come on! We have had a 50-60% drop in all the financial stocks. All those shareholders (me included) have paid dearly for the risk we took. We are not getting “rewarded”.
This crisis is hitting and hurting everyone. We got into this situation because the regulators were asleep at the controls the past 10 years. And now that the financial system is in the middle of crackup, we should continue to do nothing and let “market forces” take care of the situation? That is asking for a Depression with 20-25% unemployment, bank failures and foreclosures that surpass the 1930s. Is that a good idea? That is what I hear you espousing.
This is not directed at you personally, LOD, just at people in general who want the government to stay out of a situation the government created. I am for small government and free markets. But I also want to see some controls in place so the financial markets not anarchaic, some Wild Wild West scene. Thankfully, Congress, the President, and key regulators like Paulson and Bernanke finally woke up to their responsibility before matters got worse. We will see if they reacted too late.
August 3rd, 2008 at 9:11 pm
Here’s what I think is wrong with the bailout of Fannie Mae and Freddie Mac:
1. the persons who’re losing their homes shouldn’t have been buying homes that they couldn’t afford in the first place.
2. I don’t think it fair to provide “insurance” to people against reckless speculation and greed. Buying a house that is more than 5 times your annual income is over-living and the banks deserve to go bankrupt for stupid practices. Thats pure capitalism. Bailing them is not capitalism. Its the opposite. As a commenter rightly said, America did survive the Great Depression and the people become stronger because of it.But right now, it looks like we’re going to coddle and pamper morons who lack financial intelligence and responsibility – You’re afraid of 20% unemployment. That may not happen this time. Instead everyone will see a 20% reduction in their standard of living. The average person on the street will still get screwed.
3. the CEOs of the two companies took home $32 million last year. There were another 20 people who made at least $1 million each. They all should go to jail or at least pay back the money they made before the taxpayer chips in a dime.
4. As they say, forewarned is forearmed. Knowing that the US is in a long term economic decline can help you make wise investment choices. You can invest in gold etfs, foreign currency CDs and go short financial stocks. Just because someone recognizes a trend and is disappointed about it doesn’t require them to move. Jim Rogers’ move is pretty extreme but as you can see – even Dick Cheney has at least 25% of his wealth invested in foreign countries and a major part of the rest is in Haliburton (which gets no-bid contracts from the government and is thus assured to make money).
And I promise we will see 100+ banks go under in the next few years, people houses will get foreclosed on, and unemployment will rise above well above the already-grossly-underestimated 5%. Its not that I’m “espousing” this viewpoint. I just see it as a better alternative to foreign countries dumping the dollar and refusing to buy our T-bills.
Punishing human greed and stupidity is what keeps people honest. Paulson and Bernanke are just delaying the inevitable. Bailing everyone out and letting them get away without any repercussions isn’t good for the US economy or the US society as a whole.
August 4th, 2008 at 4:51 am
LOD
Much better post. Thanks. That is more in the spirit of debate / dialogue and helps illuminate a situation. I would ordinarily let this exchange rest. But this is too important and needs further discussion.
I understand the points you make and sympathize with them. I feel the same way regarding government and taxes. However, I do feel that the situation we are now confronted with, a situation created by our greed and the stupidity / self dealing of our government officials, is so serious it requires us to swallow hard and do what we least want to do.
I would like to respond to your points individually.
1. Agreed…but they did. Now, most of them are losing their homes (those who overpaid and had too little equity). But it was our government, the regulators, who let this happen, both by lack of enforcement and oversight of Freddie, Fannie and the banks, or by cheerleading (the Democrats in Congress blocked Republican efforts to reign in Fannie and Freddie). Our government has to clean up its messes. If we don’t like what Congress did, we should boot them out of office. Instead, it looks like the Dems will be stronger than ever in 2008.
2. Agreed, the banks do deserve to go bankrupt. The bigger question is can we afford to let them all go bankrupt. Our economy operates on debt financing. Wrong or right, that is just a fact. If the banks all fail, so will the economy. It is naive to think there are others out there to fill the void. There are not. And if Congress breaks its promise of an “implicit guarantee” that the Federal government stands behind Freddie and Fannie, the big institutional and sovereign (government) funds around the world will not come back to America again. And we do need them to fund our debt, again, wrong or right.
Are you sure you want to see a 20% reduction in your standard of living? That is easy to say and hard to do. Think hard before you wish that for yourself.
3. The CEOs at Fannie and Freddie should be fired. There should be some criminal prosecution of both those executives and the Congress people who supported their appointment to those positions. I agree with this. I don’t think the government can have it both ways and Fannie and Freddie need to be privatized. But I am a fiscal conservative. You will not get the Dems and liberals to agree with this because they view home ownership as a national right, not a privilege. So, they make sure that those two institutions are propped up with tax dollars. I would love to see this changed. But to break our contract with “investors” (foreign governments) that funded the lending operations based on their quasi-governmental status and implied guarantee is wrong. So, lets save Fannie and Freddie now and change the rules later once the crisis is over. Former Treasury Sec., Larry Lindsay, is on CNBC making this same point right now.
4. I agree on this last point, though I think it was inevitable and only a matter of when, not if. The BRIC countries were destined to move to the front of the global economies based on population, lower living costs / wages, nad plentiful natural resources. I think it is great that China wants to move to the top of the world economic order. Let them pay the bills that go with that status, like being the world’s cop. All of this said, I already have 25% or more of my investments away from America and will probably increase that percent to 50% the next 5-10 years. We are destined to be like England, France or Italy and our national wealth will mostly be invested outside our own country.
5. On your last unnumbered point, I agree that 100+ banks will go under the next few years. But that happens in just about any economic situation. That is the dynamism of capitalism. And I think foreclosures will continue, but hope they won’t accelerate because the Feds do the right things to stop the meltdown.
In theory, everyone who has a mortgage could at some point find it attractive to stop paying their mortgage. I have lived in my house 15 years and owed about 50% of its value at the top of the market. That is normally pretty responsible / conservative. But, if prices in my town were to drop by 60% as the home market continued a downward spiral, I would probably stop making mortage payments. Why throw good money after bad? Then, even my home would be foreclosed. By the time this happens, you will not want to be living in America, I promise.
I don’t think I am one of the Stupid, Greedy people of whom you write. But if we don’t put a floor under the housing market, I will be Punished the same as those you think should be. And how fair is that?
August 4th, 2008 at 7:02 am
Brian
first of all, thanks for this debate. the stupid, greedy people are mainly
1. bankers, mortgage houses
2. speculators like myself who leverage 40-50 times their annual income to invest in real estate with exotic loans. ( i was less stupid than greedy and I bailed on most of the properties in summer 2005).
3. the people who bought way more house than they could afford – like someone I know who made 60k a year and bought a 600k house. Come on, that’s really stupid. Historically, the banks have lent only 3 times annual income. Of course the question is whether its the borrowers fault or the banks! But regardless of who’s fault it was, people like that went into foreclosure last year when the ARMs adjusted and their payments jumped 30%.
I don’t wish for a 20% reduction in my standard of living. I just see it as a by product of the devaluation of the dollar resulting from the Fed Reserve printing more money prop up $1 trillion worth of defaulting loans.
I think a 60% temporary decline in housing is preferable to a 20% reduction in standard of living, but I guess I’m in a minority here.
Credit/Money for housing is already drying up. the 105% loans of 4 year ago are gone. Infact, its difficult to do an 80-20% loan anymore as no one wants to lend on a 2nd loan. Fannie mae does does 97% loans but PMI ads to the cost and the rates are higher than they were in 2004.
Instead of falling swiftly and achieving an equilibrium, the Fed is just prolonging the decline. Housing in San Diego is stilling drifting downwards. Last month the number of foreclosures exceeded the number of sales by 40%. This tells me that the Fed is failing in preventing foreclosures. Similiar to how lowering the interest rates in Japan didn’t boost the economy at all, and in fact may have extended the recession. If this is the Fed’s idea of a soft landing, I don’t want it!
Prices in Riverside county in California, have already dropped 75% in many neighborhoods. These people are not fleeing the country – they’re just moving to Orange county!
I doubt everyone will start leaving just because their house price has dropped. After all, forclosures will result in a spike in rents, so moving out of your home may not result in any long-term financial gain.
Regardless of its economic problems, the US is still a pretty darn good place to live (I’ve lived on 3 continents). It pains me to see the way the economy is heading. But just as all good things must come to end, so must all bad things. The question is how much further do we have to go. My opinion is rather pessimistic in that the worst is still to come.
Thats why having alternate sources of income is so important!
August 4th, 2008 at 7:33 am
Yeh, great dialogue. I don’t think we are that far apart, just different experiences. I am about 20 years older than you and remember the go-go 60s and the stagflation 70s. I was investing at the time of the 87 panic and during the RTC bank reorg. I live in the Midwest and never got into the real estate investment thing. I actually was begging a couple of friends and a family member who did, not to. I warned them this would happen, and they did not listen. Now they have lost a lot of money.
I was waiting for the Japanese argument to come up ;o) While there are similarities, there are even more differences. Japan’s stock market had a 100 p/e in 1989. It was more overinflated than ours in 2000. And their RE prices were even more ridiculous with Tokyo peaking at 1M yen or $10,000 per sq. ft. (we are outraged now at $600). So, they have had to be much more draconian in their response in order to save their economy and jobs (they will do anything to maintain 100% employment).
But the big problem for Japan, as I mentioned in this blog earlier, is their population does not like to consume. The older generations remember the aftermath of WW2 and are impulsive savers/ investors, rather than spenders (which is how the markets got so overinflated). So, when interest rates are dropped, or rebates given, they don’t go out and spend, they instead continue to save in their 0.5% Postal accounts (equivalent to our 401Ks). The younger generation your age and younger) is more willing to spend / consume, but does not yet control the economy as our baby boom generation now does (a generation that has known only prosperity in the aggregate since we were the only winners in WW2 vs all the other economic losers).
I maintain that any capitalist economic system depends on consumption to operate. When that spending contracts, it endangers capitalism. In order to keep the boat from tipping over, it is government’s role (as we, the majority in America define government, anyway) to entice consumption through rebates, lower taxes, government spending programs (back to work programs) and keeping interest rates attractive to encourage borrowing.
And when we are in a great expansion, like in the 1990s, government needs to slam on the brakes and cut back on spending, reducing monetary expansion (sopping up excess dollars). This is where we failed in the 1990s. Clinton’s administration takes credit for balancing the budget, but they did nothing other than collect the huge capital gains taxes as ESOP options were exercised. If they had really been on the ball, they would have cut back on government spending programs through the mid to late 90s and taken money out of the economy by raising interest rates.
Instead, Greenspan juiced the money market every time there was a bump somewhere else in the world (Mexican peso crisis, Asian Flu, Russian ruble crisis, etc). This led to an economic expansion that could not be put back in the bottle. The stock market decline in 2000 was merely a rotation of money from one type of investment, tech stocks, to another, materials and energy stocks and real estate.
Capitalism without some government guidance / regulation, is an ugly thing. It may work, as it did in the 1800s, but it will make people seasick and has all kinds of unwanted side effects, like over-concentrations of wealth and unfair / abusive markets. We just saw what can happen when government (Bush’s) goes “laisez faire” or hands off. BTW…this is the same mistake made by conservative Republican governments in the 1920s that led to the Great Depression. Additionally, in a knee jerk conservative fashion, the conservative Fed hiked interest rates in 1930 which really crushed the economy and dried up all lending. That is a prescription for disaster.
I am a huge fan of capitalism, but capitalism with a heart and a head, not something just run by testosterone and adrenaline.