Get Ready You will Need some Financial Coaching For Boomers
There are enough signs of the apocalypse already: the global financial crisis, reports that one in four mammals are at risk of extinction, the Cubs (briefly) making the playoffs. So maybe it’s no surprise that a huge milestone (or tombstone perhaps) slipped by without much notice. The national debt broke $10 trillion on Sept. 30, but honestly there was so much going on that we can forgive everyone for being distracted. Including us.
Ten trillion is an almost unimaginable number — so colossal that the even the people who worry about debt had trouble anticipating it. The National Debt Clock in Times Square, for example, didn’t even have room for that many digits. On Sept. 30, they had to squeeze the “1″ and the dollar sign into the same box.
How much is a trillion dollars anyway? Like we all learned in school, it’s a thousand billions, and as the old line goes, “a billion here and a billion there and pretty soon you’re talking about real money.” But the difference between a billion and a trillion is staggering.
With a billion dollars, you could keep about 45,000 people in a four-year college for a year — or, depending on their behavior, in jail. The College Board says private tuition and fees average $22,218 per year; the Bureau of Justice Statistics says the average cost per inmate is $22,650 per year. With a trillion dollars, you could cover tuition for 45 million people — and in 2006 there were only 17 million students enrolled in college nationwide.
You could think of lots of good ways to spend $10 trillion, but the point is that we don’t have it — we owe it. And hold on, folks, there’s more. Just to name a few:
This problem is getting worse. We’re adding to the debt at mind-boggling rates. In fact we’re spending more on interest on the national debt than we’re spending on the Iraq war. For 2008, the deficit was projected to be more than $400 billion - but that was before the Wall Street bailout. Not only did the Congressional Budget Office project a $400 billion deficit this year, they also anticipated a $400 billion deficit, next year, and the year after that, with further deficits for the next decade. The numbers could be much worse than that. The financial crisis and the recession that will almost certainly follow will reduce tax revenues because people who are unemployed and businesses that are losing money don’t pay taxes. So those figures are optimistic.
We’re borrowing to pay for the Wall Street bailout. True, as many have pointed out, the government may actually make money on the bailout in the long run. The bad debts the government buys should be worth something at some point, so the final bill may well be less than $700 billion. But that may be years off — the money we have to shell out up front will be paid over the next two years. At no point during the ragged, torturous congressional debate did we really talk about how the government’s going to pay for this. No one’s talking about tax increases or spending cuts to cover it. And when politicians don’t specify how they’re going to pay for something, that means they’re going to borrow. And, by the way, those little “sweeteners” — the Congressional earmarks for children’s wooden arrows, racetracks and the rums of Puerto Rico — are paid for with red ink too.
The irony of the government borrowing to head off the consequences of bad debts speaks for itself. The good news is that the U.S. government is one of the few institutions out there that can borrow. Banks won’t loan to each other, much less businesses and consumers, but the U.S. Treasury bond is one of the few safe havens left. And many would argue that this is not the time to quibble - when you’re trying to put out a fire, you don’t worry about where the water is coming from. But after the fire is put out, the debts are going to remain.
We’ve got more big bills on the way, and no plan to pay them. The Government Accountability Office estimates that rising health care costs and the retirement of the baby boomers mean a cool $53 trillion in “unfunded liabilities” ahead of us over the next several decades . By 2040, if nothing changes, the government won’t have any money for anything other than Medicare, Medicaid, Social Security and paying interest on the money we’ve already borrowed.
You know, of course, how the bank insists that you have a specific schedule to pay back your car loan or mortgage? (Never mind that this isn’t working out for lots of people right now). Well, the government doesn’t have one. The plan for paying off the national debt can be summed up as “maybe someday we’ll have a surplus again, and we can pay it down.” As for that $53 trillion in liabilities, that depends entirely on whether we as a nation can come up with a politically viable plan to fix Social Security and Medicare. You know how well that’s gone in the past.
Neither Barack Obama nor John McCain is talking about this problem. In fact what they’re saying right now will make the problem worse. If you saw the first presidential debate, you saw Jim Lehrer try to pin these guys down on how the Wall Street bailout would affect their plans. You also saw them both duck the questions. The nonpartisan Tax Policy Center says McCain’s plans would increase the national debt by $5 trillion over the next 10 years, while Obama’s would increase the debt by $3.5 trillion. Right now one of the biggest unspoken campaign promises for both men is to offer you lots of tax cuts and/or new programs the country doesn’t have the money for.
Like everyone else, we’re praying that the U.S. bailout and the world’s central banks can put out this financial fire, fast. Realistically, the country is going to be adding a lot to the national debt over the next few years. There’s no way around it, and frankly balancing the budget during a recession is difficult and may not even be advisable. But once we’ve got the private sector’s bad debts under control, we’ve got to get the federal government’s debt under control, too. The long-term problem for the federal government is predictable, inevitable — and completely solvable, if politicians show some leadership and the public starting demanding some real answers.
![[AIG chart]](http://s.wsj.net/public/resources/images/P1-AN932A_AIGp1_NS_20081209222814.gif)
When you buy a derivative you are buying a contract that is similar to an insurance policy. Unlike a futures contract in which you agree to pay a certain price for future delivery of gold, corn, or whatever, nothing is ever delivered in a derivatives contract - except a payment from the seller of the contract to the buyer should the contract described event happen such as the default of a particular bond. Derivatives are essentially just highly speculative bets that are not secured by anything tangible and this is what makes then so dangerous and volatile - especially in highly volatile markets.
The Wikipedia definition of Derivatives is as follows:
“Derivatives are financial instruments whose values depend on the value of other underlying financial instruments. The main types of derivatives are futures, forwards, options, and swaps.
The main use of derivatives is to reduce risk for one party. The diverse range of potential underlying assets and pay-off alternatives leads to a wide range of derivatives contracts available to be traded in the market. Derivatives can be based on different types of assets such as commodities, equities (stocks), bonds, interest rates, exchange rates, or indexes (such as a stock market index, consumer price index (CPI) — see inflation derivatives — or even an index of weather conditions, or other derivatives). Their performance can determine both the amount and the timing of the pay-offs.”
http://en.wikipedia.org/wiki/Derivative_(finance)
The single biggest problem with derivatives is that most all derivatives contracts are UNLISTED PRIVATE CONTRACTS BETWEEN COUNTERPARTIES and there is thus no way to establish “market value” of derivatives. They are not trades on exchanges and are essential subjectively valued “Level 3″ assets that only have value if another party can be found to buy them. If derivatives were required to be STANDARDIZED AND LISTED ON OTC EXCHANGES they would not be such a danger to the economic system as there would be “market value” and they would become much more “fungible” like commodities (which are totally fungible) and there would be transparency.
If you really want to understand why derivatives are so impossible to value and so complex, try reading an actual sample derivaties contract:
ABD AGREEMENT OTC-DERIVATIVES
http://print.onecle.com/contracts/navteq/abn-amro.derivatives.2004.shtml
You will quickly see, even if you are an experience financial person or lawyer, why derivatives are so impossible to value because of their vast incomprehensible complexity with a “trigger” hinged on uncertain external financial events - and that is the most fundamental problem related to the whole $500 billion to $1 quadrillion nominal value derivatives nightmare.
The derivatives bubble is the single biggest credit bubble in the world with some estimates putting the total nominal amount of $1 quadrillion. By the most conservative BIS estimates it is well over $600 trillion. However, there is a huge difference between the actual amount of money involved in the derivatives misadventure and the “nominal” value which is like the face value on a life insurance policy. The actual money involved is more like the premiums paid on a term life insurance policy and is probably no more than 2% of the nominal value. Even at 2% that still means that there are over $12 trillion involved in the derivatives betting game. There is no question but that the derivatives gambling casino will go bust.
GTM
The best solution is to simply void all derivatives contracts and return the premiums paid on them and unwind the entire derivatives markets in its entirety. All it is financially is a betting parlor with best on which way indexes, or interest rates, or whatever will move. There is no financial value in such arrangements and all is does is to create vast risk of losses (in the guise of doing exactly the opposite by “hedging them”) and this entire derivatives market worldwide should be unwound and shut down in an orderly fashion before it implodes or explodes.