What business on Earth can operate at a Trillion dollar loss for three years in a row? The one Uncle Sam chairs.

Yes. It’s true. The AP reports:

The [US] deficit in 2011 would drop to $1.27 trillion under the administration’s plan, the third straight trillion-dollar-plus imbalance. The budget gap would fall to $828 billion in 2012 but would remain at levels surpassing any previous deficits through 2020.

I am trying very hard to understand how the US economy will genuinely rebound with this much debt over the next decade. The plan is to pay down the debt when good times return, but how many politicians will forgo new programs (in their districts) to cut a payoff check to creditors holding US Treasuries?

I am in Palm Beach this week. Everywhere I look I’m reminded of the insane Social Security and Medicare entitlements which will vest over the next 15+ years. From which level of the Ponzi triangle will the money come?

I know the sun will eventually rise. But there are a lot of clouds on the economic horizon.

Required Reading for Every US Citizen

As of the end of spring 2009, I still get carpet bombed with the same question: “How did this financial crisis happen?” No matter how many times I repeat the same two minute recap, apparently people need to see the facts in print (to their credit, the story does have a lot of actors, locations, and other variables). Alas, the savior to your dry mouth and bewildered faces has arrived: Barry Ritholtz’s Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy.

Bailout Nationis the Educated Idiot’s Guide to the Financial Crisis. Barry does an excellent job of chronologically tracing through the history of economic cycles, the greedy a*holes who always destroy asset prices, and the ignorant elected/appointed officials who amplify the destruction. He shows us how we started snowboarding down a slippery slope (without a helmet) when the government bailed out the first private corporation, Lockheed Aircraft, ruined by so-called captains of industry. He gently guides us through the creation and mechanisms of the Federal Reserve. He cites speeches in which Fed Reserve Chairmen Alan Greenspan and Ben Bernanke completely contradict themselves. He points out that the Commodity Futures Modernization Act of 2002 “removed derivatives and credit default swaps [the financial weapons of mass destruction that torched the global financial system] from any and all state and federal regulatory oversight.” He objectively reveals that “the tragic financial events of 2008 and 2009 are not an unfortunate accident. Rather, they are the results of a conscious SEC decision to allow these firms to legally violate net capital rules that had existed for decades, limiting broker-dealers’ debt-to-net-capital ratio to 12-to-1 [and subsequently allowing them to lever up 30, 35, even 40 to 1].” And then, like Great Grand-Pappy who lived through the first Great Depression, he gives it to us with the simplest of common sense:

“There was a reason why some people in the past had been denied credit: They simply could not afford the homes they tried to purchase. Any mortgage structure that ignores the borrower’s ability to service the loan is destined for failure.”

If you watch too much CNN or FOX news, or you religiously follow one political party, you will need to keep some horse-sized blinders nearby as you are enlightened to the numerous facts that get covered in a dung pile of spin by tabloid imbeciles on the major networks. But if you genuinely want to see the truth in all its naked glory, then prepare for an adventurous trip explained by a master story-teller.

Successful hedge fund manager Bill Fleckenstein’s Foreword summarizes the book perfectly:

“This book is the history of how the United States evolved from a rugged, independent nation to a soft Bailout Nation, one in which too few question why we ask the taxpayers ‘to allow financial firms to self-regulate, but then pony up trillions to bail them out.’”

Although I don’t want to give too much more summary of Barry’s book, I will say he is one of the few who thoroughly show how everyone is to blame. In the media, the politicians blame Wall St., Wall St. blames the public, and the public blames the political party they didn’t vote for. The beauty of Barry’s book is once we truly understand the causes of our economic problems (which lead to social and household problems), we can start addressing how to prevent this repetitive cycle from perpetuating. Armed with the facts from Bailout Nation,we can prevent crises before they happen rather than wasting precious time and money cleaning up after unnecessary shit storms. I am part of a generation that has lived through two bubbles and market crashes since graduating college. If we are to have any faith the system is worth working for, we must end this pattern. We all know what Pavlov proved.

Barry’s keen insights, thorough lawyerly research, and witty explanations make this book a must-read. In fact, I expect college professors to utilize the book as a great tool to educate students in an entertaining way. For example, Barry is full of sweet one-liners such as “If you could fog a mirror, you qualified for a mortgage.” Sad, but true.

Although the release of the book was a tad delayed (because original publisher McGraw-Hill didn’t want Barry to expose subsidiary Standard & Poor’s key role in the crisis), it’s the perfect summer read for those who are looking for thought provoking knowledge wrapped in a “who done it” suspense tale. Unfortunately, this comic tragedy has affected real people in the real world.

In the movie The Matrix, the protagonist Neo is offered an existential choice: take a red pill and enter the world of truth, or take the blue pill and return to the ignorant world of lies. If you are ready to jump in to the truth with eyes wide open, read the red book (it’s really red) and follow Barry down the rabbit hole. You will be glad you did. Like Morpheus said to Neo in the Matrix: Welcome to the Real World …

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Although the Emperor currently wears no clothes, his naked children are the ones who stand to suffer most. The New York Times reports:

With the national debt now topping $12 trillion, the White House estimates that the government’s tab for servicing the debt will exceed $700 billion a year in 2019, up from $202 billion this year, even if annual budget deficits shrink drastically. Other forecasters say the figure could be much higher.

In concrete terms, an additional $500 billion a year in interest expense would total more than the combined federal budgets this year for education, energy, homeland security and the wars in Iraq and Afghanistan.

These interest payments directly substitute for money otherwise spent on real goods and services to benefit our society. Worse, they are future commitments that will harm young people and future generations. This is a complete betrayal of the American dream.

I am 32-years old. I have been told that if I work hard and follow the rules I should earn enough capital to pay for my current expenses (food, shelter, water, healthcare, transportation, etc.) and have enough money to fund my childrens’ college education as well as my retirement. Along the way I will pay taxes toward my social security benefits and other programs which should benefit me as my contributions vest.

This theory is a storyline for the real life version of Punk’d. With boomers about to overwhelm the system and the aforementioned debts requiring higher future taxes along with the skyrocketing cost of healthcare, energy, and college education, there is no rational way my generation can save enough to properly retire (assuming you are not in the top tier of wage earners).

Over the past few hundred years, many hard working people immigrated to the US so they could escape a socioeconomic trap. Today I am sad to say the same trap has now been set right here in the land of opportunity. And no matter how much BS politicians and think tanks spew, once young people see their shackles a certain group of smart ones will decide not to play the fool for past misdeeds and greed.

So, as I look in the mirror and see the Emperor’s children also have no clothes, I wonder how much time will pass before we witness a brain drain. I already hear low level murmurs from bright people who are exploring foreign jobs and living opportunities. Is this the first swell of a tsunami or simply vented anger?

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Evidently, AIG is a company that plays “it” safe (whatever the hell that means) and knows how to manage risk better than anyone else in the known universe. Don’t believe me? Take their word for it. We let corporations falsely advertise all the time, and here is a perfect example of the cost (click here or the picture to watch the video):

(Hat Tip: Adam Burrows)

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Interested in another fun commercial? Try this post:

General Motors: Truth in Advertising Campaign

This article was our first contribution to Minyanville (which we are humbled to be part of) and originally appeared at Minyanville on July 6th, 2009.

At the time of Oscar Wilde’s only published novel, The Picture of Dorian Gray, the philosophy du jour was a hedonism that held that the only things in life worth pursuing were physical beauty and sensory satisfaction. Wilde tells the story of a physically beautiful man named Dorian Gray who sells his soul to ensure that only a painted portrait of him will grow old. As Dorian participates in novel acts of debauchery, the face in his portrait ages over time; his own physical face and body stay forever young.

Fast-forward 81 years to 1971, when the dollar stopped representing gold and began living on a prayer. Since that time, the greenback has lost 81% of its value through inflation. And as the frightful chart below shows, it’s also lost 94% of its value since the original gold standard was first manipulated by the government in 1933.

Source: Zerohedge.com

In Wilde’s tale, Dorian Gray — after 18 years of thrills without consequence — fears someone is trying to kill him for one of his especially egocentric acts. His terror motivates him to change his decadent ways and he promises to act morally from that moment forward. Unfortunately, his promise doesn’t stop his portrait from continuing to age.

In a fit of rage at this realization, Gray furiously ravages the painting. When the police arrive, they discover Gray himself “stabbed in the heart — and suddenly aged, withered, and horrible.” Beside him is the portrait; the image of the youthful Gray has been mysteriously restored.

Although The Picture of Dorian Gray is considered one of the last works of gothic horror fiction with a strong Faustian theme, we’re living through our own non-fiction narrative — one that includes a deal with the devil.

We, my fellow citizens, are Dorian Green: We’ve defined our pursuit of happiness as a perpetual quest for an ever-increasing standard of living. To finance our dreams, we’ve sold the value of our labor for a tsunami of debt; we’ve made a bargain in which our currency decomposes so we can pretend to be forever young.

What elevates our story to the level of tragedy is the extent to which the current and future inflationary cycles will further reduce the value of our currency — representing all of the labor and contributions of our society as a whole.

I don’t raise this point to frighten people, but rather to encourage everyone to live and invest in the world with their eyes wide open. Those of you who understand the macro effects of our debt-boom-bust cycle will preserve and increase your wealth; some of you will make fortunes. But those of you who pretend our problems — crippling debt, for example — won’t really affect us will find your wealth “withered and horrible.”

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Today Bloomberg reported: Federal Reserve Chairman Ben Bernanke said large U.S. budget deficits threaten financial stability and the government can’t continue indefinitely to borrow at the current rate to finance the shortfall. Since most of our citizens still haven’t figured out that 13 minus 11 equals fiscal destruction, it’s a great time to watch and recommend the outstanding film I.O.U.S.A.

The film breaks down our fiscal crisis into four severe deficits:

1. The Federal Budget Deficit
2. The Savings Deficit
3. The Trade Deficit, and
4. The Leadership Deficit

The first section explains that when our government spends more money than it earns, financial and social instability is inevitable. Apparently, like any genuine addict, our entire society is living in denial about the effects of our Federal Budget Deficit. The older generations are enjoying government services which will be paid for by their children, grandchildren, and great-grandchildren. Their actions say: “Your financial slavery to our national debt (to be paid for with future taxes) is not my concern.” As one person says in the film, it’s analogous to an individual running up a huge credit card debt and then leaving it to their offspring when they die. Selfish? Irresponsible?

The second section explains the Savings Deficit. Basically, Americans don’t save money. This behavior directly amplifies the problem with the Federal Budget Deficit because when people don’t have money saved, the government usually ends up paying for things like healthcare, food, shelter, etc. The government could say “F you,” but that leads to social unrest. And the NUMBER ONE thing a government cares about is keeping order. Everything else is a distant second. So, we are in a vicious cycle.

The third section explains the Trade Deficit. Currently, we import and consume more goods than we export and produce. To make up for this deficit, our suppliers lend us money (i.e., they purchase US Treasury Bonds) which the government pumps into the economy. This is like a retailer which gives you a store branded credit card to buy their goods. So long as you can find money from someone else to pay the debt to the retailer, all is swell in Pleasantville. However, when the game of hot potato ends, someone’s hands get burned. In our situation, the more money we borrow from other countries like China, the more of our tax dollars we will send them. Worse, when that process gets maxed out, our creditors will force us to either sell assets (land, houses, cars, etc.) to pay them or simply start selling our debt. If they sell our debt too fast, our currency will lose value. If our currency loses value, inflation sets in. Once this horrible cycle starts, we will all be working much harder to acquire the same things we have now. Not fun.

The final section of the film highlights the bipartisan contribution to our Leadership Deficit. Rather than talk straight about our illness and the prospective paths to fiscal health, FOX News and CNN focus on petty dramas and blameshifting. We have radio talk show hosts and other entertainers heavily influencing both political parties. We have people who are such diehard fans of a political party, that there is no hope of rational conversation. We are at the point where as a country we must realize that governors, presidents, legislators, etc. are people who make mistakes. In this case, they’ve made some huge ones. But, they have the power to fix those mistakes if we focus their election-centric brains on what we need. Unfortunately, like any good parent knows, it’s hard to be the bad guy when the medicine doesn’t taste good. And our current crop of representatives (if they represent our best interests, please shine some light for me) are more interested in their political careers than our country’s well-being. Clearly, this contradiction must be ripped out like the heart of the guy who got sacrificed in the original Indiana Jones.

With all that said, this movie has wonderful charts and graphics to transform complicated realities into simple understandings. I highly recommend this film if you are:

• interested in transcending partisan politics so our society understands the truth of our problem;
• explaining our fiscal problems to friends, family, or co-workers;
• debriefing someone who is an unbeknownst member of the FOX, CNN, or MSNBC cults; or,
• trying to teach your children fiscal responsibility or simply explain how out national budget is f*ed.

I guarantee that anyone who watches this film will be more enlightened after 125 minutes.

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This article was originally printed in the April 2009 Issue of our Premium Newsletter.

The Washington Post recently noted “If counted out in $1000 bills, a million dollars would be a stack 4 inches high. To reach a billion dollars, that same stack of $1000 bills would have to be 358 feet tall. To reach a trillion dollars the stack would stand 67.9 miles high.”

Given that the current bailout obligations have the Republic on the line for $11.7 Trillion (see next page), that means Michael Jackson can spacewalk on $1000 bills stretching 815.5 miles high from Earth’s crusty shell. Or, we could knock that stack on its side and stretch it like a compacted Slinky from the New York Stock Exchange on Wall St. to the charming dirty south of Savannah, GA. How’s that for a finale to this fine mess?

On a more serious note, this amount of trillions means we are in some serious organic fertilizer over the long term. Popular finance blog Fund My Mutual Fund puts this debt in economic perspective:

[T]he ENTIRE U.S. economy is $13-14 Trillion. Our federal deficit is now $11 Trillion (and we’re now on pace to add $2 Trillion a Year with all the new spending/plans). The entire market capitalization of the Wilshire 5000 (the broadest measure of the stock market) was roughly $8 Trillion last I checked … call it $9 Trillion if you wish.

Wow. Talk about a house of cards. Seems to me that three realistic paths are ahead. In the best case scenario, we get the economy stimulated and pay down the debt over the next generation or longer while subsidizing the boomers’ entitlement programs (a super-sized obligation now that their retirement assets are significantly smaller). In the base case, we create another artificial economy that bubbles up and ultimately collapses again. In the worst case, the U.S. defaults on its debt and goes bankrupt. Only 1-800-Psychics knows how this plays out, but regardless of the details the real-life tragic comedy will surely qualify as “The Thrill of a Tril’.”

Another thought to ponder as the trillions add up: if you had a sweet annuity that paid $1 million dollars every day since Jesus died, you would be only 75% of the way to $1 trillion. This obviously begs the question of how much the credit default swaps would cost to protect that “A.D” annuity and whether counter-party risk then becomes a theological issue.

The only way not to cry is to laugh …

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