Debt Is Not An Asset
by Paul Barrow
All of us should realize right now that this country has some very serious problems. Those problems are the result of greed and the misappropriation of democracy for the pleasure of exercising it. Whether or not the solutions being erected by Congress and the Bush administration will solve them is far from guaranteed, and the most unfortunate part of this gamble is that its your money and mine that's on the table.
Wall Street is supposed to be a stock exchange, not a casino. First and foremost, it's supposed to be a place where individual investors pool capital so that young bright entrepreneurs like Bill Gates can start a small business, hire employees, and create new innovative software products that might possibly even change the world. Wall Street is where individuals provide startup capital for all kinds of research projects in medicine, in biological studies, in the exploration of new forms of energy, and many other things. We need to understand, when we are raging about the evils of capitalism, that Wall Street can be and in fact is a vital place where many good things are happening.
The difficulties of capitalism are found not in these genuinely good purposes but rather in what happens to the title to the investment, whether stocks, bonds or securities, of individual investors and artificial attempts to manipulate its value through the trading of that title. When stock is manipulated, there's some fundamental value underlying it that can be measured by very conventional actuarial standards, that has a strong bearing on that value. Shifts in the value of the company itself, for which a stock underwrites, has a direct ratio to the value of the stock itself.
The problems in the market right now, however, are of a completely different nature, in which the underlying value isn't fixed, isn't material, and cannot be measured by anything more tangible than the predictability of human behavior. The underlying value is a promise to pay a debt, which is detailed in the very fine print of a mortgage contract, and promises are not tangible things at all. Yet promises like this are bought and sold quite regularly, in the context of the mortgage market itself, and those promises themselves become a basis for making further promises called bonds whose value are tied to a whole package of mortgages similar in nature and risk. Although the mortgage itself is tied to a real asset of some tangible value which supports it, its value is not tied to the promise. A property changes value in very slight increments, usually. A promise is either kept or it is not.
The force of moral weight behind a promise to pay a mortgage debt is conditioned by a desire to have something, whether it is the purchase of a new home, a refinance with lower payments, or a new car financed with the equity, or cash value already invested by the owner, in an existing home. There's always an urgency that comes with the promise, a desire that has yet to be fulfilled. The moment it is fulfilled, the moment you have the thing which you needed borrowed money to pay for, the urgency is gone, and a serious obligation now hangs over your head, one that most people would just love to have taken off their hands. Debt is a form of psychological slavery that ties you to a job you may hate, and a whole lifestyle that is propped up by the things for which you are indebted, which you may indeed grow weary of. When problems come up, these are the first things to go.
Slight shifts in the property value of a home can cause a complete failure of the promise to pay the debt on a mortgage, simply because the benefits of paying are no longer the same. If you owe more on the mortgage than your property is worth, an oft-chosen solution is to just walk away from it, especially if it was easy to get into, with no down, with little credit, and nothing but a bad credit report to lose.
A downturn in the real estate market in 2006 began to cause some of these promises to be broken, and when they were broken, the properties involved became empty, vacant houses whose value began to plummet immediately due to a lack of maintenance. This pulled neighboring property values down further, causing a snowball effect on other mortgages, and soon the whole market system began to come crashing down.
The securities market was built, not on the property values themselves, but on the mortgage contracts, and a pyramiding layer of promises on top of the mortgage promise itself that created a bond market -- money loaned back to the banks collateralized upon money loaned by the banks themselves. The banks promised to pay back the sum of the bond in its face value based upon the promise of a homeowner to pay his mortgage. The real value of these bonds was not tied directly to the properties but to the risk inherent in the promises to pay them off.
Diminishing value in real estate was one thing. That might affect the balance sheet of a bank slightly if it holds too many of these bad mortgages. The bank can repossess the property, and there is a loss incurred of income while the property is in bankruptcy proceedings, the cost of cleaning up the property and putting it back on the market, and the cost of brokering a new sale. Banks don't make money doing this, but it's not quite the same as complete default.
Disappearing promises are quite another problem. It's not a matter of incremental loss. It's not profit and loss on the overall book of a bank that is affected. It's the value of the bank's own promise that is tied to a specific fixed number of mortgages very similar in quality that were pooled together. In each pool, called a CDO (Collaterallized Debt Obligation), they were all rated very similar in quality. (See my review of George Soros' book, The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means .) So then in a bad market, when one mortgage fell into default, many of the others in the group did as well, because they were created on similar credit rules. Based on risky mortgages, these bonds paid a high rate of interest, but when the underlying mortgages went bad, there was nothing to repossess. Bond holders held no title in the properties. The only title they had was to the assets, as a creditor, of a failed bank and it's bankrupt promises.
What happened is that a market was created on debt, on promises to pay, rather than on hard assets and the market value of them. I believe that progressives should oppose the use of debt as an asset in secondary financial markets. Debt is not an asset, merely one's promise to deliver an asset. Such promises are routinely broken.
However, democracy may use capitalism in a constructive way if its root function of pooling capital is not permitted to become a free-for-all. When a group of heads toss 50 bucks apiece into a pool to buy a pound of some decent pot, that's capitalism at it's finest. A little more money buys a lot more pot. That initial investment has a good purpose (presuming you believe that smoking pot has benefits).
That would be comparable to an IPO. When stock is issued the very first time, that's an IPO, or an initial public offering. However, after this initial market, there is an aftermarket in which an investor wants to buy a stock that has already been issued, that has been placed back on the market for sale. His purchase creates a secondary market, where trading in the highs and lows of these stocks is the primary activity of the stock exchange. As long as that stock is backed by real assets a company has acquired or developed in terms of product, physical plants, fixtures and equipment, which exist as the direct result of the original investment, then there's a direct ratio of capital investments to assets. When it is a bond based upon a debt, such as a pool of mortgages providing a stream of income that will pay interest, the asset isn't real, and the only ratio you have is to probabilities rather than real assets. It's merely a promise whose value is entirely subject to the slightest change in fortune for the underlying debtor/mortgagor. Outright prohibition of this kind of trading needs to be enacted into law.
Companies ought also to be barred from purchasing debt from other companies or institutions, because it permits the purchase of that debt at a discount, thereby leveraging small amounts of capital into disproportionate degrees of power. From an investor's point of view, that's ideal. But from the standpoint of democracy, that's capitalism at its worst.
The U.S. government was stolen from the people by our Most Holy Founders who had the wealth and capital to buy up all the debt we accumulated to pay for the Revolutionary War. When matters of how we construct a government came up, just as creditors do in a bankruptcy proceeding, they had the power to make the rules, and they had one very focused thing in mind: to collect payment of that debt any way that they could. This story is detailed very extensively in a book recently published called Unruly Americans and the Origins of the Constitution, authored by Wood Holton.
The Founding Fathers' original purpose in creating a Constitution was to establish a legal framework to legally tax everyone else and require them to pay face value upon bonds they acquired for as little as 1/8 the original price, and to insulate themselves from the victims of this scam and from democracy itself through the use of a Senate and the power of presidential veto.
The original bond holders sold this debt the government owed them for a price less than the face value on each bond to finance the construction of new homes, plant crops, and create a livelihood after the war. It was a genuine need, but it should never have been financed with the national debt. That should never have been permitted. Giving debt itself a market price made it possible for just a few men with a very small amount of money to control the wealth and strength of an entire nation.
The inevitable outcome is a structure that reflects that original purpose: a government that expresses the will of a narrow group of people who hoard wealth and power, who may dictate who shall be our candidates for office, what information we are allowed to have through the media, and what laws are passed that regulate our lives. Those individuals have erected a corporate structure that ostensibly provides jobs and income but in fact also minimizes the wealth we can accumulate, makes obsolete everything we consume in order to keep the corporate structure on top and capitalized to continue providing us with more of the same useless garbage over and over again. The system is designed so that they hold on to their assets, acquire more, and distribute less. The rich become richer, the poor poorer. That's called "growth." Corporations are growing. People are shrinking.
These represent some of the evils of capitalism, but my suspicion is that communal concepts based upon the power of community have essentially similar origins. We organize to unite individuals who have limited power as individuals but who may dramatically increase our power when uniting with others of like mind. Most states, unions and organizations are based upon that same idea. That's United Progressives.
Capitalism also represents a community of people who have united in order that small amounts of capital can do large things. However, the fundamental difference is that capitalists, i.e., those who provide capital, share risk in proportion to their investment. It represents an accurate reflection of life itself. Some of us go skydiving and some of us, like me, work in the garden. The degree of risk determines the size of both failure and reward. If the garden fails, you can plant a new one. If skydiving fails, there usually isn't a second chance. I think that those are fair considerations to make in constructing a society. There should be some reward for risk.
However, because risk stratifies people as well, these stratifications become impenetrable class and power barriers when misused. More risk does not mean more equal and less risk less equal, and yet risk is distributed in shares or specific percentages of over-all value, and they are counted like individual votes, like real people in a democracy The more you own, the more votes you have. When you have 51%, you have a controlling interest.
That's the defining point at which capitalism completely breaks down. It is no longer a fair distribution of risk, but a disproportionate amount of risk that is acquired by a single player whose own prejudices as well as wisdom or the lack of it becomes a part of the risk, who may also completely upend the original purposes of pooling capital. The original purpose of pooling capital during the Revolutionary War was to gain independence from British tax collectors. After the war, taxes imposed by the states were six times higher than they had been before and resulted in widespread rebellion.
There should never be a market for national debt or for debt of any kind beyond the original function. No one purchasing bonds for war debt or any other debt created by our government should be allowed to transfer that debt to anyone else, except in the case of death, or perhaps a physical or mental impairment, and there ought to be strict limits on the percentage of over-all debt either a company or a country or any one individual may acquire that represents power over the health, welfare and incomes of other people.
No foreign country should be allowed to acquire our national debt or the debt of private corporations upon whom our economy depends to any percentage significant enough to affect our markets if a demand for payment in full would be made to satisfy that debt.
What is happening right now is the inevitable consequence of allowing debt to be the basis of our market and greed to be the underpinnings of democracy. Debt is not an asset. The last thing we should ever have done was to hinge the future of this country on the promises of our worst credit risks.
