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McKinsey On Sovereign (De)Leveraging And Untenable Debt Loads

Tyler Durden's picture




 

McKinsey has released a very detailed report which focuses on the "final frontier" of the global credit bubble: the migration of private sector leverage over to the sovereign balance sheet, and the viability and sustainability of this process. This is not a new topic on Zero Hedge, and as Greece just experienced today, unless a country is well equipped with the dynamic duo of a reserve currency and a printing press, surging sovereign debt usually ends with just one outcome...

The McKinsey consultants have performed an in-depth empirical study tracing the history of (de)leveraging in both the developing and developed world, at both the corporate, financial institution and consumer levels, and the corresponding offset at the sovereigns. Amusingly, analysts read the "improvement" in the credit picture at various private sectors, while completely ignoring the vertical spike in new sovereign debt issuance. If you were wondering why everyone is on pins and needles every time there is a new UST auction, now you know: in the zero sum game of credit transfer, any improvement in the former is purely as a result of the largess of the later. A funding crisis in Greece, which at this point seems a certainty will likely start off the long-awaited European domino action which will begin at the FX level, and slowly migrate to default risk for all European countries. Once that happens, risk will promptly migrate away from Eurozone, and travel west over the Atlantic. In that regard, we still consider US CDS as very cheap, despite their doubling from the first time we suggested investors take a look.

Back to McKinsey - lot of pretty charts, which we suggest readers peruse at their leisure, coupled with insightful commentary.

Here is what happens to global leverage when you leave deranged money printers with aspirations for zero % cost of debt in charge of the whole show:

Further to today's bank earnings, a chart that demonstrates that while bank leverage has fallen from the historic average, it is still a massive 20+ for US Broker/Dealers. This is why a 5% loss in principal ends up wiping out all the equity used by the likes of Bank of America. Japan, at nearly double the US financial sector leverage, is just a crisis waiting to happen.

The major issue that administrations (should) have with deleveraging is that GDP growth following such a period is significantly stunted. Take away government stimulus (which in the U.S. you can safely say is a done deal after last night's Mass results), and GDP will promptly return to its negative trendline shortly.

Next: a very useful visualization of the relative and absolute composition of debt across different countries. The UK and Japan are in a heap of trouble.Amusingly, Greece is not even on the chart, yet all the focus falls on the small Mediterranean economy. This will soon change.

Japan's domestic reliance on debt funding (93% of total) is well known. Alas, other countries are not so lucky.

Not surprisingly, as financial institution leverage declined, household leverage took its place. Look for all these numbers to revert as saving become a key prerogative.

In America, the bulk of consumer leverage occurred precisely where the pain right now is most acute - middle-income households.

What would any leverage analysis be without at least a mention of the CRE "pocket of leverage."

And when discussing sovereign credit bubbles, one must always go to the source: Japan. At 471% total debt (including government, financial, non financial and household) to GDP, Japan is Keynesianism at its worst.Some variation of sovereign default/repudiation in the island country is inevitable.

Yet can America go far before hitting Great Depression economic levels? Oh yes. Government debt is nowhere near where it was during the Second World War as a % of GDP.

Yet the course is pretty much set- as the US attempts to repeat its stunning 100%+ debt/GDP ratio, here is how this would play out for the rest of the economy:

Full McKinsey report can be accessed here.

 

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Wed, 01/20/2010 - 13:21 | 199449 Oracle of Kypseli
Oracle of Kypseli's picture

Should we then load up on Yen puts?

Wed, 01/20/2010 - 13:22 | 199450 bugs_
bugs_'s picture

Outstanding.

Wed, 01/20/2010 - 13:28 | 199456 Jus7tme
Jus7tme's picture

Interesting to see that in the US, private debt of 2008 was 240% of GDP, and public debt was 60% of GDP.

And still the right-wingnuts have spent the last 30 years ragging on the public debt and encouraging a 4x larger private debt. They must think private debt = good, public debt = bad. Not that I am surprised.

But as Tyler indicated in the intro, the game now is for the private sector to transfer the debt to the public  balance sheet (via the Federal Reserve, of course). Nice going for all the banks, is it not.

 

 

 

Wed, 01/20/2010 - 13:43 | 199474 BS Inc.
BS Inc.'s picture

Difference is, if you lever up and default, that's your problem. If the government does, it's everyone's problem.

Of course, that's a "wingnut" response, right?

Wed, 01/20/2010 - 14:20 | 199545 Anonymous
Anonymous's picture

Apparently if you lever up and default the bank just gets bailed put with tax payer money. So it's still everyone's problem.

Wed, 01/20/2010 - 17:45 | 199844 BS Inc.
BS Inc.'s picture

Dude, I didn't vote for that to be the policy, but it is. I guess while we're at it we should just pile on one bad policy onto another, right?

Wed, 01/20/2010 - 14:22 | 199550 Anonymous
Anonymous's picture

Yes

Wed, 01/20/2010 - 14:37 | 199567 Jus7tme
Jus7tme's picture

Unfortunately, if you lever up and default, it is *everyones* problem, as you have seen.

And don't start talking about letting the banks fail. You understand that FDIC would lose more taxpayer money that way than they are currently doing by bailing out the banks, right?

 

Wed, 01/20/2010 - 15:11 | 199612 Anonymous
Anonymous's picture

There was a time in this country when individuals had the right to fail, and could do so without systemic risk. It was a self regulating process, because risky behavior was rewarded and punished appropriately. But then we had a change of heart, decided that free markets were too cruel and it was much more humane to socialize risk. Seventy five years later, the transformation is nearly complete and we are approaching that socialist utopia where every threat must be addressed through government intervention and every failure must be borne by society.

But, of course, the socialization of the consequence of risk doesn't decrease risky behavior, it increases it. So, you are technically correct that default is now everyone's problem, because we have chosen to make it so. What you don't understand is that the only way out is backwards. Increased socialization, regulation, and government control are not the solution. They are the problem and always the road to serfdom.

Wed, 01/20/2010 - 16:06 | 199674 rootless cosmop...
rootless cosmopolitan's picture

Perhaps, he does. I don't, though. Explain it to me, please. Why would the taxpayer lose more, if the insolvent financial institutions weren't bailed out? Currently, bailing out financial institutions means their bond holders and the CDS counterparties are being made whole, and shareholders can recoup a part at least, all at the expense of public finances. Instead, if they had to take the losses they deserve for taking the risk before, in a scenario, in which shareholders were wiped out and debt was orderly restructered and purged at the expense of the creditors, why would taxpayers lose more money than currently? First shareholders, than creditors, than the public. This would be the right order. Public finances would be the last resort in this scenario, now they are the first resort.

rc

 

Wed, 01/20/2010 - 17:32 | 199818 Jus7tme
Jus7tme's picture

>> Why would the taxpayer lose more, if the insolvent financial institutions weren't bailed out? 

Because the banks have much larger losses hidden in their books, through the much-maligned asset-Mark-to-Fantasy FASB regulation (FAS 157 in its current amended form).

The whole (unspoken) point of the bailout is to let the banks EARN themselves out of the hole, but now also indirectly at taxpayer expense because the Fed has driven deposit interest rates to zero to increase bank profit margin.

What is wrong with the bailout is not that it exists, but that the taxpayer is not getting paid the proper profit on their bailout investment. We should practically own all the TBTF banks by now, and there should be no bonuses AT ALL until FAS 157 is re-instated in its original form.

Summary: Bailout is cheaper than failure, but bailout has to be done CORRECTLY in order that the thieves do not profit from it. Therein lies the rub.

Wed, 01/20/2010 - 18:40 | 199954 Budd Fox
Budd Fox's picture

That is the WHOLE POINT!!!

Even a mentally deranged half brained regulator or politician could have easily realized that NO BONUS WHATSOEVER must be paid out. ALL the money have to go in capital reserves and that FOR ALL THE TIME the Mark to Fantasy remains. And if anybody tells you they cannot retain talent like this...weell, fuck the talent!!

Fire them and replace them with monkeys...for what results that talent has produced so far!!!

 

Wed, 01/20/2010 - 20:23 | 200085 Jus7tme
Jus7tme's picture

Budd, I'm in complete agreement with what you expressed here.

Wed, 01/20/2010 - 23:52 | 200325 baserunr
baserunr's picture

The problem with the bailout is that it exists, period.  The "lender of last resort" made the loans to keep these insolvent institutions afloat.  And the "lender of last resort" has profited handsomely.  Unfortunately, this lender is not using its own money when it makes the loans. It uses the taxpayers.  And  the taxpayers have no stock in this bank.  This bank should not even exist, it should not even be in the position to be the lender of last resort.  Last resort lenders charge exhorbitant rates, and break body parts if you don't pay them back.

The TBTF's should have been left to fail. The system would have taken a huge hit, and maybe crashed.  But lessons would have been learned for generations about how businesses should be run, and what debt, leverage, and investments are all about.

Wed, 01/20/2010 - 17:49 | 199854 BS Inc.
BS Inc.'s picture

Really? I forget which year it was exactly, but as I recall it was just before they changed the personal bankruptcy law, but one year recently had record personal bankruptcies. That year went off without any real problems for me, so how did private leverage leading to default hurt me, except in the most abstract possible way?

The whole "we're all in this together" crap is usually pushed by people who can't handle the responsibility implied by us not all being in this together.

 

 

Wed, 01/20/2010 - 19:01 | 199978 Jus7tme
Jus7tme's picture

Yes, really:

The IMF said in January that it expected the deterioration in US-originated assets to reach $2.2 trillion by the end of next year, but it is understood to be looking at raising that to $3.1 trillion in its next assessment of the global economy, due to be published on April 21. In addition, it is likely to boost that total by $900 billion for toxic assets originated in Europe and Asia.

via:

http://www.calculatedriskblog.com/2009/04/report-imf-to-warn-of-4-trilli...

So you can plainly see that the actual losses are much higher than the bailout amounts, and if the banks went bankrupt the ensuing panic would cause a large fraction of the losses to be realized in a very short time. I hope you can agree that this would be a bigger problem than putting 700B on the line for TARP.

I repeat: The bailout had to be done, but it did not have to be done Hank-Paulson-Tim-Geithner badly,  but that is what happened. We should now FIX that.

Wed, 01/20/2010 - 14:09 | 199529 Apocalypse Now
Apocalypse Now's picture

Notice that the graph stopped at 2008, we are much higher as of the end of 2009 on the debt to GDP graph.

Wed, 01/20/2010 - 14:32 | 199562 Anonymous
Anonymous's picture

You're right.

Watch the movie.

http://www.iousathemovie.com/

Wed, 01/20/2010 - 14:40 | 199573 Jus7tme
Jus7tme's picture

Absolutely correct, but as pointed out in the intro to this posting, that is because the private debts are being is being transferred to the public. The *original* problem was the exces of *private* debt.

Wed, 01/20/2010 - 14:57 | 199596 Anonymous
Anonymous's picture

You're right.

Watch the movie.

http://www.iousathemovie.com/

Wed, 01/20/2010 - 13:29 | 199458 Chopshop
Chopshop's picture

fantastic piece.  great analysis !

Wed, 01/20/2010 - 13:42 | 199472 Anonymous
Anonymous's picture

More Than One Way to Solve a Budget Crisis

Among the banks rejecting California’s IOUs are six of particular interest: Citibank, Union Bank, Bank of America, Wells Fargo, U.S. Bank, and Westamerica Bank. These banks are interesting because they are six of the seven depository banks in which the state of California currently deposits its money. (The seventh is Bank of the West, which loyally said it would accept the IOUs indefinitely.)

Banks operate under federal or state charters that grant them special rights and privileges. Chartered banks are endowed with a gift that keeps on giving: they can “leverage” the value of their deposits into anywhere from ten to thirty times that sum in interest-bearing loans. This “multiplier effect” is attested to by many authorities, including President Obama himself. He said in a speech at Georgetown University on April 14:

“[A]lthough there are a lot of Americans who understandably think that government money would be better spent going directly to families and businesses instead of banks – ‘where’s our bailout?,’ they ask – the truth is that a dollar of capital in a bank can actually result in eight or ten dollars of loans to families and businesses, a multiplier effect that can ultimately lead to a faster pace of economic growth.”

The website of the Federal Reserve Bank of Dallas explains:

“Banks actually create money when they lend it. Here’s how it works: Most of a bank’s loans are made to its own customers and are deposited in their checking accounts. Because the loan becomes a new deposit, just like a paycheck does, the bank . . . holds a small percentage of that new amount in reserve and again lends the remainder to someone else, repeating the money-creation process many times.”

Combine this with another interesting fact: according to the California Treasurer’s report, as of May 2009 the state had aggregate deposits and investments exceeding $55 billion. Of this sum, $1.1 billion was held in demand deposit accounts (non-interest-bearing accounts allowing unlimited deposits and withdrawals) and $16.5 billion was in NOW accounts (interest-bearing accounts allowing unlimited deposits and withdrawals). According to the Treasurer’s office, the non-interest-bearing demand deposits are held at the seven depository banks named earlier, while the NOW accounts are held at Citibank and Union Bank. Applying a “multiplier effect” of ten to the total sum on deposit at these seven banks ($17.6 billion), the banks collectively have the ability to make $176 billion in loans. At 5%, $176 billion can generate $8.8 billion in interest for the banks.

Rather than showing their gratitude by reciprocating, however, six of the seven depository banks have refused to honor California’s IOUs. Worse, three of these six actually received federal bailout money from the taxpayers, something that was supposedly done to keep credit flowing to the states and their citizens. Citibank got $45 billion in bailout money, Wells Fargo got $25 billion, and Bank of America got $45 billion, not to mention guarantees of $300 billion for Citibank and $118 billion for Bank of America. When Governor Schwarzenegger asked for a loan guarantee for a mere $6 billion to bolster California’s credit rating, on the other hand, he was turned down. Californians compose one-eighth of the nation’s population.

When the state’s appeal for aid was rejected by the banks, California State Treasurer Bill Lockyer said he was “disappointed.” He and other state leaders should show their disappointment with their feet. California could pull its deposits out of those depository banks refusing its IOUs and put them instead in its own state-owned bank, following the lead of North Dakota, which now has the only state-owned bank in the country. Set up in 1919 to escape Wall Street predators, the Bank of North Dakota has been generating low-interest credit for the state and its residents for nearly a century. North Dakota is one of only two states (along with Montana) currently able to meet their budgets.

A state-owned bank could be fast-tracked into operation in a matter of weeks. With over $17 billion available to deposit in its own bank, California could create $170 billion or more in credit -- enough not only to meet its budget shortfall but to fund many other much-needed projects; and rather than feeding an ungrateful Wall Street, the bank’s profits would return to the state and its people.

Wed, 01/20/2010 - 14:49 | 199586 Jus7tme
Jus7tme's picture

>> Set up in 1919 to escape Wall Street predators, the Bank of North Dakota has been generating low-interest credit for the state and its residents for nearly a century. North Dakota is one of only two states (along with Montana) currently able to meet their budgets.

Quite interesting, but I doubt Californians have the monetary discipline required to run a bank. Look what happened already.

Wed, 01/20/2010 - 15:03 | 199603 Carl Marks
Carl Marks's picture

Let's see if I have this right. Calif. can't pay its debts in the fiat currency of the FED so it issues IOUs or its own fiat script in "payment." The banks then add this toilet tissue to their deposit base and create 10x more toilet tissue in loans? Would you accept TP in lieu of dollars? Dude, your last name doesn't happen to be Madoff does it?

Wed, 01/20/2010 - 13:48 | 199487 THE DORK OF CORK
THE DORK OF CORK's picture

Fantastic piece but if I may add one caveat - when America last went past 100% debt levels it won the war and therefore enjoyed its spoils ,there is no easy pickings out there now and a global war will destroy all remaining capital.

The situation now is not unlike the end of the Edwardian era when globalisation had reached its maximum and yet now there is no reset button (thank God)

But then again the elite of that age believed a global war was impossible because of its interdependence - I fear that we will test that theory once again

Wed, 01/20/2010 - 14:00 | 199509 Ripped Chunk
Ripped Chunk's picture

Not a bad forecast.

Mankind's history:

Can't get along with each other ever.

Can't figure out economics ever.

Response:

Start a world war.

 

Wed, 01/20/2010 - 14:04 | 199519 Anonymous
Anonymous's picture

USA won the war with its industrial capacity intact, with great surplus, and deficit countries owed USA interest and principal from war debts. Additionally, the rebuild of Europe and Japan meant excellent employment and full utilization of resources.

In other words, USA was in a position to repay all debt and expand.

Presently the USA has misallocated its capital, spent deeply into debt for non-productive consumption, has deep structural deficits, hollowed industry, generational unemployment.

AND THE DEBT IS NOT BEING DEFAULTED OR PAID DOWN, MERELY TRANSFERRED TO THE PUBLIC BALANCE SHEET.

The world cannot emerge from the systemic rot of this financial system if it adheres to the laws upon which the system was built.

Default, monetize are the only options. All roads lead to Armageddon.

Wed, 01/20/2010 - 17:46 | 199849 Ripped Chunk
Ripped Chunk's picture

Yes

Thu, 01/21/2010 - 05:20 | 200472 Anonymous
Anonymous's picture

----The situation now is not unlike the end of the Edwardian era when globalisation had reached its maximum and yet now there is no reset button (thank God)

But then again the elite of that age believed a global war was impossible because of its interdependence - I fear that we will test that theory once again---------

Well, well, the situation was radically different from what it is now.

In that age, ganglords had each their own turf or were trying to acquire one.
Two consequences. First:the ganglords'turf was nearly exclusive. Ganglords protected their turf assets, especially from the greed of the other ganglords.
Second: when a ganglord was tempted by tapping in the assets of another ganglord to buy domestic appeasement, well, it had to face the other ganglord who was reluctant to yield his possibility to appease his own good people.

Hence wars.

After WW2, ganglords surrendered the exclusivity on their turfs. And adopted a predatory behaviour.
It is way less dangerous for ganglords to gang up on the weaker, which are freshly released turfs, rather than confront each other.

As long as the poorer countries in the world have wealth left to be transfered to the richer countries to achieve domestical appeasement, there will be no wars among rich countries.

The day poorer countries are emptied from their assets, it will be another story. But that is certainly not tomorrow.

Wed, 01/20/2010 - 13:56 | 199501 Dr Manhattan
Dr Manhattan's picture

In a May 22 article in Time titled “Billions in the Red: Fiscal Reckoning in CA,” Juliet Williams reports that since California voters have now vetoed higher taxes and further state government borrowing, Gov. Arnold Schwarzenegger has indicated that he intends to close the budget gap almost entirely through drastic spending cuts. The cutbacks could include laying off thousands of state workers and teachers, ending the state’s main welfare program for the poor, eliminating health coverage for about 1.5 million poor children, halting cash grants for about 77,000 college students, slashing money for state parks, and releasing thousands of prisoners before their sentences are finished. Schwarzenegger bemoaned the fact that the state could not print its own money but said it could only spend what it had.

But the state can create its own money. After all, banks do this every day. Certified, card-carrying bankers are allowed to do something nobody else can do: they can create “credit” with accounting entries on their books. As the Federal Reserve Bank of Dallas explains on its website:

Banks actually create money when they lend it. Here’s how it works: Most of a bank’s loans are made to its own customers and are deposited in their checking accounts. Because the loan becomes a new deposit, just like a paycheck does, the bank . . . holds a small percentage of that new amount in reserve and again lends the remainder to someone else, repeating the money-creation process many times.”

President Obama has also acknowledged that banks create money, through what he calls the “multiplier effect.” In a speech at Georgetown University on April 14, he said:

“[A]lthough there are a lot of Americans who understandably think that government money would be better spent going directly to families and businesses instead of banks – ‘where’s our bailout?,’ they ask – the truth is that a dollar of capital in a bank can actually result in eight or ten dollars of loans to families and businesses, a multiplier effect that can ultimately lead to a faster pace of economic growth.”

Money in a government-owned bank could give us the best of both worlds. We could have all the credit-generating advantages of private banks, without the baggage cluttering up the books of the Wall Street giants, including bad derivatives bets, unmarketable collateralized debt obligations, mark to market accounting issues, oversized CEO salaries and bonuses, and shareholders expecting a sizeable cut of the profits. A state could deposit its vast revenues in its own state-owned bank and proceed to fan them into 8 to 10 times their face value in loans. Not only would it have its own credit machine, but it would control the loan terms. The state could lend at ½% interest to itself and to municipal governments, rolling the loans over as needed until the revenues had been generated to pay them off. According to Professor Margrit Kennedy in her 1995 book Interest and Inflation-free Money, interest composes, on average, fully half the cost of every public project. Cutting costs by 50% could make currently-unsustainable projects such as low-cost housing, alternative energy development, and infrastructure construction not only sustainable but actually profitable for the government.

If all this seems too radical and unprecedented to venture into, consider that one state has had its own bank for 90 years; and it has not only escaped the credit crunch but is doing remarkably well . . . .

Wed, 01/20/2010 - 14:08 | 199526 Anonymous
Anonymous's picture

You cannot sequester the "bad debt" into legacy banks and start afresh with newly capitalized gov't banks. The debt has been assumed by the federal gov't on its balance sheet and must be paid or defaulted.

The resulting economic depression sullies the entire pool of economic actors as those qualified to assume debt see little possiblity of return in excess of interest demands (therefore won't borrow) and the unqualified wish to devote it to money-losing ventures or surreptitious appropriation to prior debt service.

No way out, no escape.

Wed, 01/20/2010 - 13:58 | 199504 Anonymous
Anonymous's picture

No one has mentioned that USA GDP is assumed to be vastly overstated and that its high water mark numbers are used as the reference gauge. Tax receipts from corporate (-35%+) and individual (-20%+) are telegraphing the extreme duress in wealth creation. USA public debt is fixed in principal with interest rates biases to an upside rise while income in form of taxes is variable with an extreme downward bias.

That divergence is going to make a 60% debt-to-GDP number crush easily past 100% near term. The entire world (syncronized in their business cycles and riddled similarly with high-leverage debt) will follow suit.

It is only a matter of time until sovereign defaults snap the strain the global system is under. Domino defaults will proceed apace.

If Japan pops, what safety net will catch or forestall the catastrophe? If all the ZIRP, monetization, leverage of Fed to 43:1 was implemented just to prop and stabilize the housing/CRE crash, what is left upon sovereign defaults?

Answer? None. Endgame fast approaching.

Wed, 01/20/2010 - 14:02 | 199512 Dr Manhattan
Dr Manhattan's picture

Lincoln did not invent government-issued paper money. Rather, he restored a brilliant innovation of the American colonists. According to Benjamin Franklin, it was the colonists’ home-grown paper “scrip” that was responsible for the remarkable abundance in the colonies at a time when England was suffering from the ravages of the Industrial Revolution. Like with Lincoln’s Greenbacks, this prosperity posed a threat to the control of the British Crown and the emerging network of private British banks, prompting the King to ban the colonists’ paper money and require the payment of taxes in gold. According to Franklin and several other historians of the period, it was these onerous demands by the Crown, and the corresponding collapse of the colonists’ paper money supply, that actually sparked the Revolutionary War.2

The colonists won the war but ultimately lost the money power to a private banking cartel, one that issued another form of paper money called “banknotes.” Today the bankers’ debt-based money has come to dominate most of the economies of the world; but there are a number of historical examples of the successful funding of economic development in other countries simply with government-issued credit. In Australia and New Zealand in the 1930s, the Depression conditions suffered elsewhere were avoided by drawing on a national credit card issued by publicly-owned central banks. The governments of the island states of Guernsey and Jersey created thriving economies that carried no federal debt, just by issuing their own debt-free public currencies. China has also funded impressive internal development through a system of state-owned banks.

Here in the United States, the state of North Dakota has a wholly state-owned bank that creates credit on its books just as private banks do. This credit is used to serve the needs of the community, and the interest on loans is returned to the government. Not coincidentally, North Dakota has a $1.2 billion budget surplus at a time when 46 of 50 states are insolvent, an impressive achievement for a state of isolated farmers battling challenging weather.3 The North Dakota prototype could be copied not only in every U.S. state but at the federal level.

Wed, 01/20/2010 - 14:04 | 199521 Jean Valjean
Jean Valjean's picture

Hello Ellen, I've read you elsewhere.

Wed, 01/20/2010 - 14:33 | 199563 Anonymous
Anonymous's picture

Good for you, here;

http://webofdebt.wordpress.com/

Wed, 01/20/2010 - 17:08 | 199776 Jean Valjean
Jean Valjean's picture

Debt free money is intriguing but you seem to assume that the Treasury would be more responsible than the Fed.  I don't think you can assume that.  Whichever one has the ability to create money will become corrupt.  don't you think?

Thu, 01/21/2010 - 10:24 | 200590 Anonymous
Anonymous's picture

As if we need somehow need private banks to create our money because we just can't be trusted. So they get to enjoy a free lunch, crash the system and leave the bill on us. This is crap.

It's insane. We gave the PRIVATE Fed and banks the power to create our money, then loan it back to us charging interest? Then we have to pay income taxes to pay the interest on the debt? 40% of our collective productivity is tied to debt service which increases the price of everything we buy.

Since 1913, debt "is" money. Private debt has increased virtually every year from 40% of GDP in 1960 to 300% now at $47 trillion (2009 Steve Keen numbers). Without ever increasing debt, there would have been virtually no growth in GDP or employment. The only way to keep the system going is by inflating asset prices like housing and stocks and other fraudulent ways to increase debt (hello derivatives).

The flaw is the concept of making money with money using compounding interest. Allows rich people to sit back and watch their money magically grow but this only happens because of ever increasing indebtedness from the bottom 80 to 90% of people and falsely inflating the prices of existing assets. Banks buy our politicians and count on our continuing to be dupes.

We could create a public banking system for interest free govt spending and even your mortgage. End the waste and cut the bankers out of the middle.

State Banks is a great idea. Better yet,

We should cut everyone's mortgage in half.

How? By absorbing the FED into Treasury, create a US Public Bank and take back the money power from private banks and give everyone what banks now get - access to the discount window - 0.5% loans for mortgage (re)finance to credit worthy Americans. We already own Freddie/Fannie, toxic waste and underwrite 90% of mortgages now anyway. Same interest free loans for govt debt. Talk about a massive "permanent" stimulus! End wealth concentration. A real ownership society!

CUT THE BANKERS OUT OF THE MIDDLE.

Thu, 01/21/2010 - 10:27 | 200593 Anonymous
Anonymous's picture

As if we need somehow need private banks to create our money because we just can't be trusted. So they get to enjoy a free lunch, crash the system and leave the bill on us. This is crap.

It's insane. We gave the PRIVATE Fed and banks the power to create our money, then loan it back to us charging interest? Then we have to pay income taxes to pay the interest on the debt? 40% of our collective productivity is tied to debt service which increases the price of everything we buy.

Since 1913, debt "is" money. Private debt has increased virtually every year from 40% of GDP in 1960 to 300% now at $47 trillion (2009 Steve Keen numbers). Without ever increasing debt, there would have been virtually no growth in GDP or employment. The only way to keep the system going is by inflating asset prices like housing and stocks and other fraudulent ways to increase debt (hello derivatives).

The flaw is the concept of making money with money using compounding interest. Allows rich people to sit back and watch their money magically grow but this only happens because of ever increasing indebtedness from the bottom 80 to 90% of people and falsely inflating the prices of existing assets. Banks buy our politicians and count on our continuing to be dupes.

We could create a public banking system for interest free govt spending and even your mortgage. End the waste and cut the bankers out of the middle.

State Banks is a great idea. Better yet,

We should cut everyone's mortgage in half.

How? By absorbing the FED into Treasury, create a US Public Bank and take back the money power from private banks and give everyone what banks now get - access to the discount window - 0.5% loans for mortgage (re)finance to credit worthy Americans. We already own Freddie/Fannie, toxic waste and underwrite 90% of mortgages now anyway. Same interest free loans for govt debt. Talk about a massive "permanent" stimulus! End wealth concentration. A real ownership society!

CUT THE BANKERS OUT OF THE MIDDLE.

Thu, 01/21/2010 - 11:54 | 200693 THE DORK OF CORK
THE DORK OF CORK's picture

Cutting the interest and principal payed to capital that misallocated it in the first place only solves half of the problem which is lack of demand , if that is the only solution then inflation on consumer goods will enter orbit , the other part of the equation is investment for the future which needs to be nourished for the long term as capital in this strange short term world only follows the quick buck.

Wed, 01/20/2010 - 14:18 | 199541 THE DORK OF CORK
THE DORK OF CORK's picture

Enough with this Channel Islands stuff - without the protection of the crown it would have been eaten alive in Europe - Britain provided the protection financed by tax, those little islands sole function was to insulate certain characters from the nations tax , they were and are a parasite island

Wed, 01/20/2010 - 20:11 | 200062 trav7777
trav7777's picture

ND's model might work for other surplus producer states.  ND is a major oil exporter right now (in state terms) and that is mostly why their model works, lots of revenue.  Same was true for Alaska for many years.

It's unlikely that net consumer states or those whose GDP is largely derived from FIRE ponzis could have such a situation.  In fact, the State Bank of CA may have ended up being involved in the same types of RE ponzis as the Fed was feeding, but at least the damage would be confined to one place.

Really, sound regulations and policies are the only things that prevent banks from doing fractional scams and feeding ponzis to drive their own origination and securitization fee models.  However, it would be nice to arb or carry trade at the State level; would put a stop to a lot of the shenanigans much more quickly as one state saw inflation rates out of control and the citizenry began to make an easy migration to better locales.

Wed, 01/20/2010 - 14:06 | 199523 crzyhun
crzyhun's picture

Where we are...."All Dearest Leaders men horses,  et.al. could not put Humpty Dumpty back together again." What a fall.

Wed, 01/20/2010 - 14:17 | 199539 Species8472
Species8472's picture

Government debt is now here near where it was during the Second World War as a % of GDP.

But it didn't stay there long, reduced by

Paying some of it down? or

Rapid expansion of economy that increased GDP?

Will we now do one or both of those things over the next decade?

Wed, 01/20/2010 - 14:48 | 199584 Anonymous
Anonymous's picture

We won't do either. We won't grow the economy at any great pace as excess capacity is large and there is no need to build out anything to meet any future growht in demand (which there won't be in the next decade as people spend less and the deleveraging continues). as such unemployment is not going to drop by any significant margins and all around this you have to overlay the demographic bombshell that is the aging and retirement og the babyboom.

The boomers are all moving into their 50s and 60s. Not great consuming ages, unless you count health care. They are starting to save for their hoped for, but probably unattainable retirement dates. Their kids are all leaving the nests and they'd like smaller homes but there is no one waiting to buy their McMansions.

Unemployment and underemployment will lead to tax receipts frequently not hitting targets. States and localities will come under more dire foscal pressures and more and more will threaten or outright default. The Feds are going to have to step in to help but their tax receipts will have dropped as well.

The answer will be the same as it always is - print baby print.

As deleveraging quashes demand and the velocity of money continues to tank inflation is a pipe dream. But that's a temporary situation. When the velocity of money ramps up the Fed, the treasury and the politicians in DC won't be able to do a damn thing to stop the coming onslaught on the dollar.

I have 1 quadrillion Zimbabwean dollars sitting on my desk. I figure I can eventually add to my collection of QUADS with USDs, Pounds, Euros, Yen and all sorts of assorted fiat currencies from across the globe.

Paper money is dead already. We just haven't seen the OBIT yet. As I envision the future we will laugh at the paper scrip as we all have an electronic card that gives us access to our value stored in gold/PMs or some basket of tangible assets held at some repository/bank.

Let's say I deposit 100oz of gold into my account and buy a $3 coffee. The repository fractionally divides my gold holding and credits the coffee shop $3 worth and deducts $3 from mine account. I know there are such things already sprouting up and I suspect this is close to what we all end up with in the future but first we must destroy the perception that paper money has any value and that will take the inflationairy tsunami that is headed this way.

Wed, 01/20/2010 - 14:26 | 199554 Anonymous
Anonymous's picture

The tangible assets over tangible equities is interesting,shall we read that transactions are taking place at these prices levels or shall we read this?
http://www.occ.treas.gov/ftp/release/2009-161a.pdf
or shall we look at prices to cash flows?

Wed, 01/20/2010 - 14:33 | 199564 pak
pak's picture

Terrific charts. Very illustrative.

"Amusingly, Greece is not even on the chart, yet all the focus falls on the small Mediterranean economy. This will soon change."

Oh yeah.

BTW, Russia is basically running of money by early 2011..

Wed, 01/20/2010 - 14:41 | 199575 Reggie Middleton
Reggie Middleton's picture

Further to today's bank earnings, a chart that demonstrates that while bank leverage has fallen from the historic average, it is still a massive 20+ for US Broker/Dealers. This is why a 5% loss in principal ends up wiping out all the equity used by the likes of Bank of America. Japan, at nearly double the US financial sector leverage, is just a crisis waiting to happen.

I beg to differ. One really has no idea what the effecive leverage of banks are when they have assets and liabilities off balance sheet, represented by who knows what sort of machinations that can end up in multiples of what the on balance sheet leverage levels may say.

If I were a bettin' man, I would wage effective leverage to be greater than 20x if all off balance sheet items are included.

Wed, 01/20/2010 - 16:51 | 199749 Anubis
Anubis's picture

Yes, that's an important aspect. Citigroup alone had around 1 trillion off balance sheet at years end. God knows what's hiding amongst those items in the various financial institutions. Very little or no information is being provided to the markets on the nature of these assets. The FASB, IAS, etc quarrels of recent years add to the fact that a lot of pressure is being excerted by the finance industry to keep things silent on the matter.

 

Wed, 01/20/2010 - 17:49 | 199856 Ripped Chunk
Ripped Chunk's picture

Only a trillion?

So funny

Wed, 01/20/2010 - 14:49 | 199585 Anonymous
Anonymous's picture

I would just caution everyone that, having worked at McKinsey for a few years, I don't believe anything that comes out of that organizations. They pretend to follow a "scientific" process of proving hypotheses, but they never do any testing to disprove a hypothesis, and throw out any information that is inconsistent with the initial hypothesis, calling it "unreliable". The whole thing about a scientific process is folly anyway, since it's impossible to test the predictive power of anything they put out. But having seen the sausage being made, and having made some of it myself, under protest when I needed the paycheck, I don't eat it.

Wed, 01/20/2010 - 17:51 | 199860 Ripped Chunk
Ripped Chunk's picture

Well, of course!

You don't think reporting a negetive outcome to a client will warrant those massive fees do you?

Wed, 01/20/2010 - 22:52 | 200239 Privatus
Privatus's picture

But, but this scholarly work is produced by McKinsey "Fellows" and published by the Mckinsey Global Institute ("MGI") which receives no funding from academia, business or government. How could MGI possibly have an agenda? It's science, man, objective as all get out. Science does not have an ax to grind (<<cough>>Hide the Decline<<cough>>). But seriously, having experienced the salutary effects of their consulting "work" in various corporations and other chain gangs, I conclude that McKinsey are rent-a-view turd polishers, amoral charlatans and a ratings agency for business mediocrity. They will continue to thrive.

Wed, 01/20/2010 - 15:15 | 199616 Anonymous
Anonymous's picture

Unbelievable. I have read 2 different places today that the govt will probably try assisting the housing industry and banks later in 2010 by having a program where principle is reduced so that the borrower is barely underwater and doesnt walk away from his loan. This is crazy depression here we come.

Wed, 01/20/2010 - 15:22 | 199622 SWRichmond
SWRichmond's picture

Re: Exhibit 1:

Isn't Japan the second-largest foreign holder of U.S. Treasuries?  I wonder if that will come into play when Japan defaults on its own foreign debts, and needs forex?  Might that affect Treasury supply?

Just sayin'.

Wed, 01/20/2010 - 16:03 | 199670 Anonymous
Anonymous's picture

Very little private debt has been shifted to the public balance sheet. What you have is a bunch of polyannas who are adding in debt guarantees to the federal debt and claiming it at full/total severity. Further, when the government buys mortgages from banks using borrowed funds it doesn't just add a liability to the balance sheet, it also adds an asset. Most of those assets are still performing, and the outlook for those assets is improving to boot.

Wed, 01/20/2010 - 16:50 | 199746 Jean Valjean
Jean Valjean's picture

So you can borrow your way out of a debt crisis?... until...?

Wed, 01/20/2010 - 16:04 | 199671 Anonymous
Anonymous's picture

Let not forget in these figures that we have states and municipalities which also accumulate debt and are backstopped by the federal govt.

Wed, 01/20/2010 - 16:16 | 199687 Hitman
Hitman's picture

Useful article in some ways.  Particularly nice to see some of the historical data. 

 

However, the analysis of leverage for banks, and the conclusion that bank leverage has fallen below historic averages in most countries (including the U.S.) based on GAAP estimates for assets seems pretty suspect to say the least.

 

Conclusions such as “With the household sectors likely to deleverage in several countries, consumption will probably grow more slowly than before the crisis” (p 14) seem a little watered down even for an academic paper.

 

I also laughed when I read “the right tools could have identified the unsustainable buildup of leverage in pockets of several economies in the years leading up to the crisis.”  (p 14).  Wow – what a revelation!!  The financial crisis could have been avoided if somehow there had only been tools that could have helped the Fed to identify unsustainable leverage.

 

Oh well…at least it’s good to know that this crisis will not need be repeated in the future as the Fed and other honorable stewards of our economy are certainly going to use these tools from this point forward.

Wed, 01/20/2010 - 16:17 | 199688 Anonymous
Anonymous's picture

Scary thought is...boomers are the lion's share of asset and wealth holders. Later generations are either deeply in debt, negative-or-little equity, or seeking to rebalance their personal accounts by debt pay down or default.

Boomers want to retire. They want to downsize that largest asset (the home) and make it more liquid in order that they may use the income for retirement.

Put their houses on the market, just as the fraud and housing crash put another double-that on the market.

Now extrapolate to the equities, IRAs, 401ks, as everyone over the next 20 years seeks to liquify their possessions.

Tip of the iceberg people. Tip of the iceberg.

Superglut. Supercrash in demand. ZIRP. Supermonetization.

Not hard to see the end result when debt, demographics, and demand are considered.

Oh and one other...destruction.

Wed, 01/20/2010 - 16:17 | 199689 Anonymous
Anonymous's picture

Scary thought is...boomers are the lion's share of asset and wealth holders. Later generations are either deeply in debt, negative-or-little equity, or seeking to rebalance their personal accounts by debt pay down or default.

Boomers want to retire. They want to downsize that largest asset (the home) and make it more liquid in order that they may use the income for retirement.

Put their houses on the market, just as the fraud and housing crash put another double-that on the market.

Now extrapolate to the equities, IRAs, 401ks, as everyone over the next 20 years seeks to liquify their possessions.

Tip of the iceberg people. Tip of the iceberg.

Superglut. Supercrash in demand. ZIRP. Supermonetization.

Not hard to see the end result when debt, demographics, and demand are considered.

Oh and one other...destruction.

Wed, 01/20/2010 - 17:56 | 199867 Ripped Chunk
Ripped Chunk's picture

Population trends illustrate EVERYTHING.

Its how the trends are studied and interpreted (incorrectly) that cause instability in true markets.

Unfortunately we don't have true markets and the population trends have not been studied and interpreted properly.

The ball has been dropped for a generation.

 

 

Wed, 01/20/2010 - 16:26 | 199705 masterinchancery
masterinchancery's picture

Highly misleading debt analysis, because the US now has enormous amounts of off-balance sheet debt associated with the Fannies and Freddies of the world, and even more enormous Medicare/medicaid/social security obligations that are unfunded. 

Wed, 01/20/2010 - 17:02 | 199766 Jean Valjean
Jean Valjean's picture

What irks me is the idea that GDP growth due to inflation or GDP growth due to efficiency improvement can be distinguished and are equivalent to society.  Throughout history EVERY bit and more of GDP growth that was due to efficiency improvement has been STOLEN through inflation.  It's like Charlie Brown, Lucy and the football.  The business or industry that developed the efficiency improvement is left with...nada.  Sooner or later, Charlie will stop trying.

Wed, 01/20/2010 - 20:43 | 200102 Anonymous
Anonymous's picture

The Fed creates the debt, but not the interest, thats why we always we are going to be in debt. Its a debt based economy, plain and simple. Also, some of the stats that you are using are not trustworthy.

We need a new financial system that competes pararell with the private bankers. Everythimg else is smoke and mirrors. Look at China and their banking system.

Thu, 01/21/2010 - 15:39 | 201051 Anonymous
Anonymous's picture

The charts are showing government reported (think enron) statistics. John Williams at Shadowstats has done a great job of excavating something more closely resembling an apples to apples comparison if anyone wants to analyze the similarities between this downturn and the great depression.

Sun, 04/04/2010 - 23:49 | 286158 JeffB
JeffB's picture

If you count the "off-budget", "unfunded liabilities" of Social Security, Medicare, and Prescription Drugs, I believe the total federal liabilities actually come to about 800% of GDP:  http://www.usdebtclock.org/

 

 

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