The Daily Reckoning PRESENTS: It has recently been asserted that the United States government is financially “bankrupt.” While that sounds about right to us, Whiskey and Gunpowder’s intrepid correspondent, Byron King, digs a little deeper to see the implications of sovereign debt and potential future government default that go far beyond the government simply not being able to pay its bills on time. Read on…
NATIONAL BANKRUPTCY, PART I
The word ‘bankruptcy’ is often misused. It is not uncommon to hear someone say, “So-and-So is bankrupt” when what they really mean is that “So-and-So cannot pay his bills.” In this latter situation, if So-and-So cannot pay his bills, then he or she is technically “insolvent.” Insolvency means that you cannot pay your bills as they fall due in the ordinary course of business. Insolvency can also reflect a situation in which someone’s total assets, if made immediately available, would not serve to pay off all of the liabilities. It is an important distinction.
What prompts me to write about bankruptcy is a recent report by economist Laurence J. Kotlikoff, professor of economics at Boston University. Kotliloff wrote of his conclusion that the U.S. government is “bankrupt” insofar as it will be unable to pay its creditors, who, in his use of the term, “are current and future generations to whom [the U.S. government] has explicitly or implicitly promised future net payments of various kinds.” Later, Kotlikoff notes: “Unless the United States moves quickly to fundamentally change and restrain its fiscal behavior, its bankruptcy will become a foregone conclusion:
“The proper way to consider a country’s solvency is to examine the lifetime fiscal burdens facing current and future generations. If these burdens exceed the resources of those generations, get close to doing so, or simply get so high as to preclude their full collection, the country’s policy will be unsustainable and can constitute or lead to national bankruptcy.
“Does the United States fit this bill? No one knows for sure, but there are strong reasons to believe the United States may be going broke.”
Kotlikoff takes note of what he calls a total net “fiscal gap” that looms in the future of the nation. This fiscal gap is the present value of the difference between the federal government’s future income and expenses, as calculated using relatively optimistic assumptions, not including any contingent liabilities such as natural disasters or wars.
The basic numbers in Kotlikoff’s thesis are just a summing up of accounts that are standard in the life of the nation: interest payments, government operations, social security, national defense and other elements of the federal budget that will persist for as long as there is a U.S. government. Kotlikoff adds up the national liabilities to the astounding sum of $65.9 trillion, or about 500% of the nation’s gross domestic product.
I happen to agree with the criticism of U.S. fiscal policy that is embodied in Kotlikoff’s report. By shining a spotlight on the long-term indebtedness of the U.S. government, Kotlikoff is doing a good service. He is highlighting the immense level of federal liability. But I have to take issue with Kotlikoff’s use of the term “bankrupt” in this context. Can the United States government really be financially “bankrupt?” There are implications of sovereign debt and potential future government default that go far beyond the government simply not being able to pay its bills on time. I want to take the opportunity to explore some terms and revisit some history.
The U.S. Constitution specifically requires that Congress enact a bankruptcy law (Article I, Section 8, Clause 4). Thus, in the United States today, bankruptcy is a creature of a federal statute known as the U.S. Bankruptcy Code, with associated rules of procedure. Because bankruptcy in the United States is a legal process governed by law and procedure, no one can be “bankrupt” until a certain set of things happens in a U.S. bankruptcy court.
But what we see today in the U.S. bankruptcy system is the modern evolution of a long and ancient process. Since at least Roman times, and maybe before, a bankruptcy process has been the means by which a society could balance the need to eliminate or moderate a debtor’s debt with the protection of the creditors to whom the debt was owed. In other words, bankruptcy is and always has been a form of legally sanctioned “workout” between debtors and creditors.
There is a common perception that bankruptcy is a means by which debtors can avoid repaying debts to creditors. But bankruptcy is also intended to be a means by which creditors can recover from debtors as much as possible of what they are owed. It is not too much to say that an orderly process of bankruptcy is necessary (and certainly intended) to foster the growth of commerce, despite its association with personal and business financial failure.
Ideally, by means of bankruptcy proceedings, debtors can be made to stop piling up debt for unproductive purposes, and creditors can be made to stop extending credit to bad risks. The nation’s (if not the world’s) economic resources can go elsewhere besides into more bad debt, and in a rational economic system, the resource inputs will be put to higher and better uses.
The bankruptcy process is also often referred to as providing a means for debtors to obtain a “fresh start.” This is because, in many instances, bankruptcy proceedings can eliminate most, if not all, of the debt that a debtor owes. But credits and debits must balance, and the debtor’s gain is a creditor’s loss. It is not always pretty, but this is the idea that we have to work with.
The concept of bankruptcy is quite old. The word itself comes from two Latin words, bancus and ruptus. In ancient Rome, the bancus was a tradesman’s counter, across which almost all transactions were conducted and money was exchanged, not unlike the merchant’s counter today (except without the cash register). You can see old banci in, for example, the ruins of Pompeii, preserved for almost two millennia beneath the ash of the Vesuvius eruption of A.D. 79. And the word ruptus means “broken.” So literally, bancus ruptus translates as the breaking of a tradesman’s counter.
Under the debt-payment laws of ancient Rome, when a merchant was in financial distress, his creditors could go to the local authorities and swear that they were owed unpaid debts. After an investigation, the judicial authority would make a determination as to whether or not a merchant’s business was able to pay the debts. If the determination was that a merchant could not pay, then a third party was appointed by the creditors, or by a Roman magistrate if creditors could not agree on whom to appoint. This third party acted similar to the role of a trustee, and was called the curator bonorum, meaning “protector” or “caretaker.”
The trustee had the legal power to take over the day-to-day running of the merchant’s business. If there was no hope of returning the business to solvency, the trustee could literally smash a merchant’s marketplace bench or openly carry off the bancus as a declaration to the public of a merchant’s financial distress. Thus the merchant’s place of business was broken or gone, hence the term bancus ruptus.
After smashing or carrying off the merchant’s bancus, the trustee then was charged with holding and disposing of the merchant’s property for the benefit of the creditors. The trustee auctioned off the property of the bankrupt merchant to the bidder who would pay the most to creditors. The merchant was usually left with nothing and could find himself and his family sold off into slavery.
The ancient roots of both the concept and the term for bankruptcy deal exclusively with personal and commercial financial failures. There are no real historical roots for sovereign financial failure. When Alaric and successive groups sacked Rome, for example, they did more than just smash the banci of the merchants; they tore the nation to ribbons. Thus, the use of the word “bankruptcy” in connection with unpayable U.S. federal financial obligations may be inapt. It would probably be better to label the U.S. situation as one of “insolvency,” but let’s look at some more history.
Rome conquered the British island as far north as Scotland, and Roman law governed parts of Britain even after the Roman Empire fell. The historical records are sketchy, but point to the existence of some form of bankruptcy procedure in medieval Britain. We do know that for over 450 years there have been codified bankruptcy laws in Anglo-Saxon jurisprudence. However, what we assume to be bankruptcy today, the elimination of debts, is not what bankruptcy started out as in English law, or what it became.
In England in 1542, creditors passed the first modern statute that one could view as bankruptcy related. The law had to do with the concept of perjury, or lying to the authorities. This statute was designed to prevent fraud by debtors upon creditors. Under the 1542 statute, the debtor was summoned to appear before a chancellor upon the demand of the creditors. The debtor was examined under oath. If the chancellor determined that the debtor owed a valid debt and the debtor failed to surrender his possessions to pay his debt, the debtor was sent off to prison.
In 1570, England passed its first full bankruptcy law, during the reign of Henry VIII. This law is the foundation of the early American bankruptcy laws. The practical reason for passing the law was because the debtors’ prisons were at capacity and the incarceration of large numbers of people was creating a national problem in England. While debtors’ prisons remained, under the law of 1570, creditors gained additional remedies to enforce the collection of debts. As the law was implemented, early bankruptcy procedures and remedies had some provisions that would be considered unusual under today’s law. For example:
Bankruptcy was not a legal proceeding that a debtor initiated as a matter of self-protection (as is often the case today), but rather something that was commenced against a debtor. Thus, individuals could not file for bankruptcy, and only creditors could commence a bankruptcy case against the debtor. The usual situation came about when the debtor was avoiding repayment to the creditor. People were commonly imprisoned for unpaid debts. Simply the act of filing a bankruptcy action brought a severe stigma upon the debtor and the debtor’s family.
Bankruptcy commissioners (eventually called trustees) could break into a debtor’s home and seize assets, which could then be sold to satisfy the debt. But even the sale of all of a debtor’s assets did not stop the collection of remaining debts owed. That is, there was no discharge of obligation for the remaining unpaid debts
Collection efforts could continue even after the sale of all of the debtor’s property. It was not uncommon that a highly indebted individual could have his ear cut off or have his ear nailed (while still attached to his head) to a pillory in a public place. Ouch!
Under the English Statute of Anne, a revision to the earlier bankruptcy act passed in 1705, uncooperative debtors could be executed. According to historical records, five people were executed under this law.
Byron W. King
for The Daily Reckoning
August 1, 2006
Editor’s Note: Byron King currently serves as an attorney in Pittsburgh, Pennsylvania. He received his Juris Doctor from the University of Pittsburgh School of Law in 1981 and is a cum laude graduate of Harvard University. He is a regular contributor to the free e-letter, Whiskey and Gunpowder, which covers resources, oil, geopolitics, military history, geology and personal freedom.
“I sing of ARMs and the Man…”
– Virgil’s Aeneid
We don’t really have that much more to sing about ARMs, dear readers, but we just couldn’t resist the headline.
Still, now that we think about it, our cautionary tale is likely to end just as bloodily as any epic poem we’ve read. Imagine what would happen if mortgages were adjusted upwards to rates anywhere near 10% – or anywhere near where they were 25 years ago?
That is why the Bernanke Fed cannot really fight inflation or stagflation the way Paul Volcker once did. Too many homeowners wouldn’t be able to afford it. ARMS were meant to give marginal borrowers flexibility. Instead, they have locked both the borrowers and the Fed itself into…well, leg-irons. The borrowers have no margin. Most cannot afford even the slightest boost in their payments. And with such boosts now automatic, the Fed can only react to inflation threats by prevaricating.
According to David Rosenberg at Merrill, discretionary items are now rising at a 5% annual rate – far beyond Ben Bernanke’s target. But what can he do?
ARMs were supposed to be a way to realize the American dream of home ownership. But, like much else in American life, that dream too has been hollowed out.
For two reasons. The first is “declining marginal utility.” The more you have of something, the less each additional unit is worth to you. A little defense is precious. But add more soldiers, weapons…more office workers, consultants, crony contractors and pension programs, the less real defense you get for your dime. And eventually, if you spend enough, you get a negative return…as we have in the Middle East today. There, once, only a few extremists hated us. Now, a couple of hundred thousand soldiers and two wars later, whole countries and civilizations hate us. And, we are less secure than ever. The marginal utility of defense spending has fallen below zero.
The second reason for the hollowing of America is that the horde of parasites aging institutions, picks up managers, hangers-on, hustlers, opportunists – who pursue their own agendas, and subvert their clients’ goals.
And so it is with the American home. People fantasize about the peace of mind, the security, and the independence they will get from owning their own piece of earth. Even if things go against them, they tell themselves wistfully, at least they will have a place to rest their heads…a castle of their own where they will be king, emperor, tyrant, and elected chief-of-state all at once. Home sweet home.
But look what they actually get. Peace of mind? Security? Independence? Only if they are comatose enough not to notice the incessant barrage of property taxes, zoning laws, building codes, and mortgage payments that rains down on them from the first day they become owners. In fact, with today’s mortgages, they never actually own their house – it owns them!
The kings of today’s castles are not independent; they’re chained to the grindstone of work to meet mortgage payments. And they’re not secure: miss a payment, and their houses are snatched from them. They have no peace of mind; the dream of free and clear ownership swings perpetually just beyond their grasp, like Tantalus’s grapes. Our kings switch from one mortgage to another like galley slaves trying out oars.
And well they know it. People may be slow to think, but they are fast enough to feel. In surveys of American attitudes, pollsters have discovered that people already have a vague feeling that they are not as well off as their parents, and that they expect to be even less well off in the future. Of course, social scientists and economists dismiss these sentiments in favor of the numbers. Per capita consumption, they claim, is way up over the last half century. People have two and a half times as many cars and watch a lot more television. They earn more money. They have about three times as much house per person and graduate from college more often. They can now go into supermarkets and select from as many as 200 different kinds of breakfast cereal. How’s that for a great country?
Thus the number crunchers prevaricate. But behind the dissembling numbers are the sentiments that tell the truth. People feel worse off because their real quality of life is falling. Real earnings – after inflation and taxes – have been falling for the working stiff for the last 30 years. Highway traffic moves more slowly. It’s harder to find a parking place. People spend more on education and health care – with less to show for it. They work more hours than before, only to have more shopping malls than high schools. They use vastly more energy than the rest of the denizens of the planet and make more per hour, but they live in a way scarcely better…and perhaps much worse.
All institutions age, decay, and collapse, we observe. Even the American dream…
More news from our currency counselor…
Chuck Butler, reporting from the EverBank world-currency trading desk in St. Louis:
“A ‘pause’ is not an ‘end.’ At least not for a couple of months anyway. There’s always a chance the Fed Heads come back to hike one more time. However, currency traders are champing at the bit, and quite restlessly waiting for this Fed announcement.”
For the rest of this story, and for more insights into the world currency markets, see The Daily Pfennig
And back to Ouzilly…
*** We were accused recently of being tight. We hasten to defend ourselves.
We do not deny our tightness. Indeed, we are mildly proud of it.
There is something vulgar about throwing money around, when a more modest expenditure will do the same work. For example, we always travel in second class on the Eurostar, because we feel first class is just not worth the money. And between a $10 bottle of wine and a $50 bottle, there’s not enough difference to make us want to spend the money either.
On the other hand, we’ll pay more (or less) to get the piece of property we want, because there is typically a lot of difference between an ordinary place and an extraordinary one. And we don’t mind paying extra for business class on a long-haul flight, because otherwise we couldn’t sleep. And if we couldn’t sleep, dear reader, we couldn’t bring you these daily reckonings. Of course, in that case, perhaps, some of you might prefer we flew coach.
In any case, tightness is, we believe, a capitalist virtue that has simply got itself a bad name in the current intellectual climate. In other words, tightness, like exploitation (that other capitalist sin) may lie ultimately in the eye of the beholder. We offer this from the spy classic, Ninotchka:
PORTER: May I have your bags, Madame?
KOPALSKI: He is a porter. He wants to carry them.
NINOTCHKA (to Porter): Why? Why should you carry other people’s bags?
PORTER: Well, that’s my business, Madame.
NINOTCHKA: That’s no business…that’s a social injustice.
PORTER: That depends on the tip.
*** We received this note from Dan Denning…seems that things are a bit lonely in the land down unda:
“Single, small, but growing Australian publishing firm seeks slightly off-beat, free-thinking, intelligent, hard-working, curious, and creative editorial assistant to write, edit, analyze, think, feel, and engineer stupendous success in publishing world-class material for Australian investors. Must enjoy challenges, controversy, and the crushing pressure of deadlines. No financial experience necessary, but it wouldn’t hurt. Ideal candidate has profound distrust of conventional media, suspects the world in reality is different than what appears on TV, and seeks the real story.
“Port Phillip Publishing Seeks Contributors to Blossoming Anti-Social Financial Network
“Could you run the above recruitment ad for me in your version of the DR? We are getting lonely here in Australia, which is why I refer to myself as ‘we.’ There is really only me when I say ‘us.’ Yet I’m sure there is an Australian Mogambo out there somewhere…an eager ‘Short Fuse’ in Sydney…or a future Steve Sjuggerud in Melbourne. Perhaps even an Adrian Ash in Adelaide, although as we all know, there is only one Adrian Ash (that I know of.)
“We just can’t seem to find the local writing, researching, and muckraking talent in the traditional channels. And I have tried so many bars that my liver is in revolt. It appears, the contrarians have been driven so far underground in this market that even Agora, with the vast reach of its many publishing tentacles, has not succeeded in sussing out where the off-beat free-thinking investors congregate.
“But I know they’re out there. Contrarians are like aliens that way, not readily visible, but lurking among us everyday like a small army, silently biding its time. Statistical probability suggests there have to be some brokers, analysts, and recent college graduates who recognize that the one true path to financial independence and spiritual fulfillment lies in taken the career road less traveled. None of them are wearing the mark of Cain on their foreheads though, so I haven’t found them yet.
“We are looking, of course, for the person who does not like being told what to think or what stocks to recommend to his or her clients. Instead, he likes to think for himself and values the independence that comes from not having investment banking clients. He finds something honest and direct about having his interests directly aligned with his readers. And he realizes that the most investing money is usually made going in the opposite direction of conventional wisdom (although even this bit of conventional wisdom bothers him…so many people say that the conventional wisdom is wrong, our ideal candidate becomes suspicious and wonders what it means when EVERYONE says that the conventional wisdom is wrong…it’s a recursive paradox.)
“Anyhow, can you run the above plea for a comrade in arms for me (us, we)?
“I called it ‘anti-social networking’ because I’m fascinated with the growth of social networks like MySpace and am convinced we are unconsciously building a formidable network of creative, eccentric, and slightly unstable thinkers, analysts and writers. I’m trying to consciously build it now, which means hiring someone full-time.
“Upon returning from the huge success of the Vancouver conference, it occurred to me that the various outposts of the DR (London, Baltimore, New York, South Africa, Paris) are social networks themselves…made up of readers, writers, analysts, and outcasts who have come together to form their own better-than-Oprah support and discussion groups about financial markets and the world.
“I know the DR has been critical, and justly so, of the so-called Internet economy. But even you have to admit there might be some truth to Metcalfe’s law, namely that the value of the network is a function of the square of the number of users. In layman’s terms, the more contrarians we unite globally, the more valuable the network is to each and everyone one of us slightly socially unacceptable nodes.
“That doesn’t mean you have to think of yourself as a node. You are both quite charming and deserve more than to be thought of as nodes. If it improves my chances of having my request honored, think of yourself as a transmitter and powerful amplifier from a humble node at the far ends of the DR network: I seek more connections, and am sending my binary plea back to the mother ship in hopes of a favorable response from other isolated, antipodean nodes.
“Thanks in advance for enriching the social and work life of your editor in Australia and all of our future readers. We are changing the world, overturning one stupid piece of conventional wisdom at a time, and reducing the world to its essential components or tragedy and comedy. There is still a lot of work be done.
“P.S. Prospective editorial contributors, free-lancers, and revolutionaries can reach me at firstname.lastname@example.org.
“P.P.S. The speaker roster in Vancouver was filled with editors and analysts who were former readers…Chris Mayer, Jeff Clark, Justice Litle, and Dan Amoss to name a few. These guys made their way to career freedom by leaving slightly more institutional careers for the chance to write what they really thought, recommend what they really liked, and publish work that can change people’s minds as well as fatten their wallets. All of these guys happened to be readers of Strategic Investment at one point too…so there’s a good chance they probably figured they could do at least as good a job as I was doing…and probably better. And it turns out they may be right! Which means there’s a good chance Australian readers in a similar spot can do better than me today. In which case, what are you waiting for?”