A Farewell to Arms

The Daily Reckoning PRESENTS: Adjustable Rate Mortgages, or ARMs, are now some 11% of the value of mortgages originated during 2004-05 and are estimated at more than $430 billion. In the right hands, ARMs are legitimate bets on the direction of interest rates. But, in the wrong hands, these ARMs are likened to homemade car bombs – liable to blow up in the wrong place, at the wrong time. Read more from Bill Bonner…

A Farewell to ARMs

“We are the hollow men
We are the stuffed men
Leaning together
Headpiece filled with straw…”

– T. S. Eliot, The Hollow Men (1925)

When we were still in our 20s, we volunteered, briefly, for the presidential campaign of California Governor Jerry Brown. Our job was to write the epistles that raised money for the campaign. Right away, at our first meeting, we realized that the candidate had no business in politics at all – let alone running for president of the United States of America. He thought too much, and he didn’t know how to lie.

“What do you want out of this?” he asked us directly. We were taken aback. Politics operates with winks and nods, not with eye contact and a handshake. A real politician knows what people want: power and money. He doesn’t have to ask. And he knows how to buy them; he never has to come right out in the open and quote a price.

“How about ambassador to France?” we countered, only half joking. But Jerry Brown couldn’t take even half a joke. He looked us in the eye, hesitated, and then said, “OK.”

The deal done, the president-to-be announced that part of his mission would be to colonize space, whereupon the campaign blew up on the launch pad, and our plush pied-a-terre in Paris at taxpayers’ expense with it.

But Jerry Brown left us with something all the same. “Read Illich,” he told us.

Ivan Illich (1926-2002), a one-man melting pot, a Jewish-Catholic-Croatian-Mexican-American social philosopher and one-time priest, wrote a number of books, now all but defunct, that were classics of alternative thinking in the 1970s. Two of the most influential were “Medical Nemesis” (1971) and “De-schooling Society” (1975), which proposed that the experts who manned our schools and hospitals were actually getting in the way of education and health.

Illich was a radical thinker in some ways; in others, he was a reactionary who thought medieval society was more conducive to man’s well being than anything in the modern world. Reading Illich, one is never quite sure if one has on one’s hands a zealot of the Counter-Reformation, or of the Second International. But whatever Illich might have thought he was doing, what he really did was give us an idea about the way institutions everywhere work. What he showed us was that all institutions begin by looking out for their clients, and end up looking only after themselves.

“Medical Nemesis” describes how medical institutions turn people into consumers of health-care products, rather than healthier people. And “De-schooling Society” shows us how educational institutions turn them into consumers of higher degrees, rather than smarter people. Indeed, universities might actually make people stupider than they were before they entered, because they now know more of what isn’t so. In economics, for example, much of what is taught at university is wrong – and wrong-headed in the most profound way. The graduating economist is actually stupider than the man on the street. What he thinks he knows for sure…ain’t necessarily so. And the institution in which he learned what isn’t so, like the Soviet economy, has become a value-subtracting enterprise.

Illich might have been describing the financial industry. If ever there were men whose expertise subtracted from the sum of human knowledge, it is the savants of finance, those whose keenest ambition seems to be to sell investors products, rather than make them money. Who really makes money, after all, in hedge- funds or mutual funds? We know the answer – the people who run them. For everyone else, funds – whether hedged or mutual – are generally a value-subtracting business; investors who make their acquaintance, even passingly, end up with less money. What about stocks and bonds?  There, too, the only people who make money are those who push the products or run the corporations.

But today we point the finger not merely at Wall Street. All institutions are subject to corruption, not only those that grub for money. In time, all institutions get hollowed out.  They all become peopled by men with headpieces filled with straw, self-serving managers who do to them what the Israeli army is doing to Southern Lebanon. And thus, we get revolutions, bankruptcies, civil wars, hostile takeovers and hedge-fund meltdowns.

The hollowness is everywhere. We soon run out of fingers: health care, education, defense, the dollar, democracy, employment, the “things” you buy and the thing you buy the things with – money itself.

Yes, the dollar too has been hollow since 1971. There is nothing in it, even as it is, but with every passing year it becomes still more consumptive. Its managers and promoters have long ago mined out its substance. All that is left is a shell…a scrap of paper…an echo…a ghost of real wealth.

But yet, prices for things are still quoted in dollars. People have nothing else to go on.  They know the price of everything, as Wilde said, but the value of nothing. They believe nothing but prices. A college education works out to $20,000 to $50,000 per year and that drug treatment for arthritis might cost about $11,000 or $12,000 a year. A flat-screen TV, they reckon, is $1,500. A stock in such and such a company is quoted at such and such a price. The image is taken for reality. Consumers lack the imagination and time to figure out that the goods they buy are as hollow as the paper they use to pay for them.

Since 1971, wages too have been hollowed out. The workingman has to have his wife at work too just to make ends meet. He sees the money coming in; he can measure it in dollars. What he can’t measure is the real effect on his family’s life when both he and his wife have the worries of the workaday world on their shoulders. With no dollar price on the problem, it is ignored. Yet, though income is higher, expenses soon rise to meet it. Housing and energy keep going up, and now the poor man finds he needs the help of the mortgage industry just to keep going.

In the dream world of the early 21st century, there has never been a better business than the credit business. The credit merchants borrow at institutional rates lower than at any time in their lives and re-lend to a public with an insatiable thirst for debt. The borrowers don’t seem to care about paying back; it’s enough that they can make payments. And the lenders don’t seem to care about not getting paid back; it’s enough that they can pass off more debt, first to the decent credit risks and then to the sub-prime borrowers, until they are doing little more than selling gaudy Cadillacs in the ghetto, with no money down. And there is scarcely a gaudier piece of junk than an adjustable-rate mortgage. In the right hands, ARMs are legitimate bets on the direction of interest rates. But in the wrong ones – and who in America’s suburban ghettos understands yield curves? – they are homemade car bombs…liable to blow up in the wrong place at the wrong time.

And who would want such dangerous ARMs except the fools most likely to blow themselves up? That they are adjustable is their selling point. But like the rest of the fancy merchandise on the market – the I.O., or interest only mortgage, Neg Am, or negative amortization, and even the 50-year mortgage – ARMs are in fact diabolical devices intended to speed marginal buyers on the glittering road to hell. ARMs give the weakest buyer the luxury of pretending to buy what he really can’t afford. He pays a low rate while cash flow is tight and hallucinates that rates will be even lower when he goes to refinance. Any wonder that now, finding themselves both ARMed and endangered, the poor consumers drag into credit counseling, long of face and short of finance? But at least they’re not alone.

ARMs are now some 11% of the value of mortgages originated during 2004-05 and are estimated at more than $430 billion. Nearly 18% of such homes also have zero or negative equity. Despite this and despite the 40- and 50-year mortgages that have joined the scene, combined new and existing home sales have declined for seven consecutive months. And that does not reckon the impact of the resetting of mortgage payments, once the initial “teaser” rates offered by ARMs go up, as they inexorably will.

What can explain why legions of otherwise smart people do what will inevitably bring them to grief? Why would borrowers take on debt they cannot afford and lenders take on creditors who cannot pay?

If Illich was right, they do it because they must, because like all institutions, even the housing business eventually comes to exist not for its clients, but for itself. The dream of homeownership becomes hollowed out by the people who run the business of homes: builders, mortgage-lenders, and finally, even consumers themselves. For it is consumers, ultimately, who put down the ersatz money they don’t have – to purchase the synthetic houses they can’t afford.

But then, dear reader, that is what revolutions, busts and bankruptcies were designed for.


Bill Bonner
The Daily Reckoning
July 28, 2006

Editor’s Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons).

In Bonner and Wiggin’s follow-up book, Empire of Debt: The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor to expose the nation for what it really is – an empire built on delusions. Daily Reckoning readers can buy their copy of Empire of Debt at a discount – just click on the link below:

The Most Feared Book in Washington!

“Vancouver is a great city, largely because it has so few native-born Canadians in it.”

We were sitting in a Japanese restaurant named Tojo’s, overlooking the city, when we made this observation. The sky was so clear you could almost read the license tag numbers on cars driving up the distant mountains. Then, as the sun went down, the whole city sparkled with lights, like Hong Kong.

And the fireworks began. Rockets, booms, shimmers…

We wondered what the occasion for the bash was.

“Nor-ing spe-al,” said our charming waitress. Dressed in traditional Japanese dress, she could have been an extra from a World War II movie.

Our cab driver was from India, the staff all Japanese. They were operating an expensive samurai sushi restaurant with a large outside terrace.

“Excuse me,” said another friend to a waiter. “I ordered yellow tuna.”

“Dis, yella tuna,” replied the samurai.

“No, it’s bluefin…” our friend persisted.

“Bluefin…yella…mix togerer. Good. You eat,” was the response.

Doug and your author, both products of the Irish Diaspora, were surrounded by foreigners. One of our dinner companions was from Italy. Another was from Pakistan.  The busboy was from Sri Lanka.

“Yes, this is a great city…I’m moving back here,” Doug announced. “Not to stay here all year. I like Asia too much for that. But this is almost like being in Asia, and with snow-capped mountains all around you.

“You know, we’re so lucky. We can live anywhere we want. I feel sorry for the average guy in America. He’s stuck. Like you, the older I get, the less I know for sure, but it certainly looks to me as though we’re in the early years of a great bull market in commodities. And that will be just fine with me. But then, I don’t live out in the suburbs and drive a huge land-barge fifty miles to work every day…and I don’t have a mortgage being adjusted upwards.”

America of the land-barges is the place where, in theory, every man is created equal. But each equal man is dealt an unequal hand at birth. He plays it the best he can. For the last two centuries, Americans have picked up their cards and found aces high. By 1900, they had the largest economy in the world. They were on the winning side in the two biggest wars in history. And they walked away from each conflict with a bigger slice of world commerce.

Still, all institutions age and decay. In the 1950s, the United States was already on top of the world. By the late ’80s, its only military competition had thrown in the towel. But the starch of the early 1900s was slowly replaced by the elastic of the late 1900s. Everything began to stretch and bulge – the constitution, the dollar, public and private finances…everything from the behavior of teenagers to the girth of their parents.

And then, the deck was shuffled and the cards dealt out again. They don’t realize it yet, but it looks as though this time around, Americans will be on the losing side of history.

“The whole world can’t live at the standard that we Americans have come to expect,” Byron King explained yesterday. “There’s not enough cheap energy.”

Americans have lifestyle that many in the world envy and few can afford – not even Americans themselves. Faced with rising oil prices, rising mortgage rates, and stiff competition from Asia, standards of living for the bottom two-thirds of U.S. society are probably going to slip. More below…

First, more news our friends at EverBank…


Chris Gaffney, reporting from St. Louis:

“The European markets have moved the dollar up versus most of the currencies this morning as they are predicting the GDP and labor costs in the second quarter will show a strong economy with accelerating inflation.”

Learn more about the GDP in today’s Daily Pfennig.


And more opinions from Vancouver…

*** “You can imagine what has happened to property prices here,” continued our old friend Doug Casey. “I used to own a great house on the water in West Vancouver. I sold it far too soon. It is probably worth $15 million by now. I always sell too soon. I had a ranch near Aspen, too. I made a good profit on it, but I could have made a lot more.”

“Better too soon than too late,” said a companion.

*** And finally, we come to the last of the Big E trends – the Empire. We Americans don’t like to think of our country as an empire. Instead, we imagine it as a kind of proto-democracy; we picture it as Norman Rockwell painted it, with honest, thoughtful people coming together in local schoolhouses in town meetings where important issues are discussed. We are too modest for empire, we say to ourselves. Besides, empires need emperors. We don’t have an emperor; we have an elected president, meant to do the will of the people. And we have a society that believes in individual liberty, not collective glory.

And don’t empires need people in funny hats? We Americans don’t wear hats…except maybe baseball caps that advertise where we went on our summer vacations. What’s more, America is a democracy…of, by, and for the people. We don’t remember anyone every running for high office on an Empire platform, so it stands to reason we couldn’t have an empire. We never voted for it.

But it’s a strange and wonderful world we live in. Sometimes we get what we did not intend and what no one in particular ever wanted. If you watch the next presidential press conference, you will see the American eagle on the lectern. A symbol of empire, it comes from the Roman era, when the eagle was on all the Roman standards. And if you listen to the president’s remarks, you will find that he spends a lot of time talking about war in exactly the same places where the Romans did their fighting – the edge of the empire, Mesopotamia, where Roman soldiers died by the thousands taking and retaking ancient Babylon. And it is Mesopotamia, too, where the soldiers of the British Empire washed up again, on the same riverbanks…done to death by the same desert tribes.

Then, at the end of the press conference, especially when some new offensive has been announced, you will hear how liberty and modesty die – to the sound of thunderous applause.

America began as Rome did, humbly. It began as an idea – that anyone who wanted to could come to this New World and make do as best he could. You needed no passport, no visa, no blood test, no police record. You just showed up and you were on your own.

The rot set in almost immediately. Before long, it led to a war between the states to determine who got to tell whom what to do. Then, the country tried to turn itself into the kind of nation-state that had proved so successful in Germany and France. A pledge of allegiance to the flag was composed. Social Security and other collectivist programs were put in place. They were no different from Bismark’s social welfare programs in Germany. Yet, even while dumbly imitating the Old Country, people out on the plains were trying to convince themselves that they were a race apart – 100% New World. They squinted suspiciously at foreign-sounding names and customs. A congressional candidate even tried to smear his opponent by reading from the menu of the fancy restaurant at which the man dined. “Cuisse de grenouille,” he would say out loud, stretching the words out like a corpse, to let listeners get a good look and be appropriately appalled. “Do you know what that is? Frog legs. My opponent eats frog legs!” He did not have to say anything more, not in a country where the only foreign language taught in the schools was English.

But side by side with America-the-nation, America-the-empire was developing rapidly, too. As World War I progressed and the British found themselves exhausted by the expense, they looked across the Atlantic for help. Woodrow Wilson foolishly took the bait – a lead role in the imperial theatre in exchange for wartime aid. Naturally, the world-weary Europeans stabbed the naïve Princeton professor in the back as soon as he landed at Le Havre. And the stage was set post-haste for an even more calamitous war. In that one – and then the Cold War – America played yet bigger and more spectacular roles in the world theater, until, with the fall of the Soviet Union, there was no one left to up-stage her. America was now the sole hegemon; the world’s unique superpower, a country, with such an overwhelming military advantage over the rest of the world that it was compelled to play an imperial role, like it or not.

And soon, it seemed to like it. But, a taste for empire is, of necessity, a transient one, for we have to ask ourselves – what happens to them? The list of defunct empires is about as long as the list of defunct currencies. Tout passe. Tout casse. They all go away, in other words – they all breakdown.

The Roman Empire itself lasted for nearly a millennium – it is true. But it did so only by reinventing itself…by becoming almost an entirely new empire from time to time. There were civil wars, mass murders, coups d’etat, rebellions, insurrections, revolutions. Blood ran in the streets of Rome often – and long before the city was sacked by barbarians.

When Octavian took over from his great uncle Julius Caesar in 43 BC, for example, he had 130 senators put to death. The idea sounds appealing still to many of us today. In ancient Rome, it was almost de rigeur. Octavian had as many as 3,000 leading citizens bumped off. Old Cicero, who once mocked him, tried to make his getaway in a litter. He was overtaken by a centurion on the seventh of December, 43 BC. He was reading the “Medea” of Euripides. He put down the book, it is said, stuck his head out of the window and volunteered, “Here, veteran, if you think it is right, strike.” The centurion cut his head off.

But eventually, it is the empire itself that loses its head. It rots, just like everything else in life, and dies. And it dies in entirely predictable ways, becoming too expensive to operate…or attracting too many parasites, hangers-on, and hustlers. The costs rise, while what you get for your money goes down. The empire weakens and collapses from the inside…if it is not first defeated from the outside.

Here in the United States, we don’t see any external enemies fit to bring our empire down. But on the inside, we are not so sure. Each year, the internal rot seems to get worse. Rome may have lasted nearly a thousand years, but Rome wasn’t thrice crippled with the Federal Reserve System, the dollar, and the U.S. Congress. Between the three, the country is probably broke already. The measure of our indebtedness – $65.9 trillion – far surpasses any ability we have to pay. It amounts to more than $200,000 for every man, woman and child in the country. That means revolution, or more likely, inflation. Debt and lifestyle – both will erode simultaneously while millions of households go broke.

Of course, we can also imagine much worse, for superpowers do not normally go so gently into that good night.

Either gracefully or clumsily – one way or another, the trend has to run its course. So, you see, dear reader, everything is predictable. We just don’t know how it will turn out.

The Daily Reckoning