Sunday, September 20, 2009

The Maelstrom and the Matador

I took a few days to make sure you all downloaded the Federal Reserve Flow of Funds report for September 17 and waited to see if any of you would take up the baton to explain what’s happening to the rest of us. If you were one of the lucky ones, you read the Reuters report that gushed that U.S. household wealth grew by $2 trillion. “Household” ownership of U.S. Treasuries grew to a level 65% greater than similar holdings one year ago. On the surface of the superficial reporting one could have concluded that the September 17 report was, well…uneventful. But that’s if you don’t look at the report.

A dear friend of mine read last week’s post and asked if I could explain the “maelstrom” metaphor I used. And, I realized that several weeks ago I promised an expansion on the Matador analogy so, here goes.

Popularized in the English language by the University of Virgina’s favorite (drug addict) son Edgar Allen Poe in 1841 , the term maelstrom has Nordic and Dutch etymology likely from the Dutch for “crushing (or grinding) current”. In Poe’s terrible short story, we see a remarkable metaphor for the past, present and future of the U.S. financial situation. The narrator in Poe’s story, during the descent, reports the following.

“I made, also, three important observations. The first was, that, as a general rule, the larger the bodies were, the more rapid their descent — the second, that, between two masses of equal extent, the one spherical, and the other of any other shape, the superiority in speed of descent was with the sphere — the third, that, between two masses of equal size, the one cylindrical, and the other of any other shape, the cylinder was absorbed the more slowly.”

Let us consider my use of the metaphor informing the Federal Funds Flow data. We’ve all been inundated with the “too big to fail” moniker since the great unraveling last year. Ironically, what we’ve done is actually responded by making a few things bigger. In a review of the Flow of Funds, a simple realization comes into sharp focus. First, consumer and business access to, and use of, credit is moribund. Second, the Federal Reserve has done a wonderful job of consolidating it’s sphere of influence (yes, read the double Poe meaning) in both conventional debt instruments and those linked to GSEs or Government Sponsored Enterprises. Calculating the loss of future-income based personal and corporate access to and use of credit combined with a measurement of the excessive, off-setting utility of unsecured credit by the Federal government, one realizes that we are left with a rapidly GROWING insolvency. There is greater debt in the system and it is further removed from revenue-related enterprise. Remember that tax is the revenue that services the debt in a simplified sense and, with profits, income, and employment depressed on a >35% devalued dollar, you have a going-concern problem.

And, I can’t help but add my signature warning. In the September 17 release, we found out that pension reserves are MORE desperately under-funded and leveraged than previously estimated. So, in a time when personal “savings” growth is almost entirely attributed to three “assets” – namely, functionally uninsured deposits in FDIC formerly insured banks; U.S. Treasuries (which are the ultimate Ponzi as the individual buyer will one day have to pay - in tax - for the insolvency of the maturity of the instruments); and Mutual Funds (overloaded with, you guessed it, Treasuries, municipal bonds and equities in Government Sponsored Enterprises) – and the population is aging, we’ve placed fewer, larger bets at the high-roller table. Are you ready for this? Reserves for pensions and insurance defined benefits now stands at about 1/3 of the value the same liabilities had 4 years ago. That's right, with LESS financial confidence in the system, we have 2/3 less backing our annuity obligations. And, yes, the PBGC is still in a free-fall.

Which begs a number of questions that I’ll touch on later. However, let’s settle into the precipitous descent. The anniversary of the Matador’s slaying of the bull – death by a thousand lances – has been marked by a recognition of the identity of the Matador. Many readers thought I meant Bank of America when I used the metaphor. But, alas, I didn’t. The identity is the Fed, Treasury, NY Banking trinity which used the cataclysm of Merrill Lynch and the collapse of Lehman Brothers to create the most amazing hostile takeover of a national financial infrastructure since – well, the 1840’s when Henry, Emanuel, and Mayer Lehman read a short-story by Edgar Allan Poe. Isn’t symmetry wonderful? We are all under the waves on this one in the U.S. And, worst of all, September 17, 2009 really was what I had reported – the conclusive evidence that we’ve got challenging days ahead. And, foreshadowing a future posting, you’ll note that insurance and reinsurance firms will be reporting revenue growth from increasing fees assessed to policy-holders as they are rapidly unwinding their balance sheets before the next circuit of the maelstrom.

(1) Edgar Allan Poe. “A Descent into the Maelstrom”. Graham’s Magazine, May 1841, 18:235-241.


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Thank you for your comment. I look forward to considering this in the expanding dialogue. Dave