Saturday, December 11, 2010

Debtor in Possession… well, at least Possessed

Article One, Section 10. Constitution of the United States of America

No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; Coin Money; emit Bills of Credit; make any Thing but gold and silver a Tender in Payment of Debts; Pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligations of Contracts, or grant any Title of Nobility.

To call it a Constitutional Crisis would be wrong in two ways. First, our national constitutional illiteracy is so great that we wouldn’t know most of it if it bit us in the face. Second, for the past few Presidential and Congressional cycles, the breach of the “protect and defend” oath has been more common than the actual enforcement of the Constitution and, as such, it’s melodramatic to imply that Americans actually still care about the Constitution, much less are animated to the level befitting the animation of Crisis. That said, I thought I would humor you with an interesting puzzle which, like other inconveniences where things like the Constitution get in the way, will be surreptitiously cloaked in some hyperbolic rhetoric and ignored by the governed. Bear with me because each of the ingredients below back a cake but they appear to be uncorrelated when you see them on the counter….

As a nation, we’re bankrupt. The St. Louis Federal Reserve Review (July/August 2006) published a wonderful article by Laurence J. Kotlikoff entitled, “Is the United States Bankrupt?” in which he argued, before the 2008 melt-down, that the question is not entirely answerable because for countries, many of the rules that apply to people or corporations don’t apply. Countries can go broke – as many have – but, with creative currency manipulation and foreign complicity, they can enjoy a non-dead zombie status for a dreadfully long time. In his conclusions, he suggested three steps to solve the problem that was looming in 2006: 1) impose a retail sales tax of up to 30%; 2) establish a personalized Social Security scheme; and, 3) establish a universal health care system. Without these radical steps – and with the economy still reportedly healthy when written – we were going to be in tough shape.

We’re in worse shape than we were in 2006 and Kotlikoff’s critique reads like an epitaph on an already mouldering marble stone in a forgotten graveyard. However, take heart! This President and Congress have demonstrated an equal unwillingness to confront the politically undesirables and are once again wrangling over how to demonstrate the fiscal irresponsibility which serves as the mainstay to satiate the lunatic electorate and special interests which seem to forget that an illiquid dollar, regardless of how many you horde in the current madness is worthless.

Before I wander too far into this farce, it’s worth pointing out a rather interesting and largely unreported piece of data (unless you live in Detroit where the data affects the regional GDP). The Pension Benefit Guaranty Corporation (“PBGC”) – ah, yes, that venerable institution that Inverted Alchemists have known more about than any other segment of society – reported its deepening deficit in which its known liabilities outstrip its capacity to meet its obligations (and that’s before the municipal pensions crater at year’s end). However, in the fine print of the PBGC report on their illiquidity, there was an alarming – albeit, innocuously presented – piece of data. You see, insurance of any kind has two ways of making money: premiums and investment income. And the PBGC contracts “institutional investors” to manage its investments. Well, premiums were insufficient to meet obligations and investment income in 2010 was down. More fascinating still is the fact that the U.S. Government’s investment strategy is underweight in equities (almost 1/3 equities and 2/3 in currency and monetary instruments). In the face of recommendations like the one made by Kotlikoff for Private Social Security, one must puzzle over the fact that the government’s own money managers don’t believe in the equity markets despite the public statements lauding the recovery of Wall Street. For all of our wishful thinking about being on the road to recovery and with over 2 million more Americans with expired unemployment benefits, we’ve got an interesting puzzle on the horizon.

It looks like this. When municipalities simultaneously face growing demands for services based on the growing unemployed masses at the same time that they themselves are underwater with respect to, or have leveraged their own pension liabilities, they will be unable to respond with adequate revenue. As a result, as is already happening across the country, municipalities are teetering on bankruptcy (which, by the way, they can declare). This will have a double negative impact. Obviously the liability will seek to be absorbed in PBGC or related instruments thereby increasing the notional benefits guaranteed. However, at the very moment these new obligations hit pension insurers, the bond, currency and fixed income defaulted assets will be what is supposed to backstop the benefit. Oops, the cupboard is bare! States, most of whom are in abysmal fiscal condition themselves, will be asked to step in but have no capacity to do so. And then….

There are several authors who are talking about the bankruptcy of States like Illinois, California and others. The American Catholic (November 30, 2010) published an article entitled “Bankruptcy Coming Soon to a State Near You,” in which they discussed the systemic fiscal challenges looming on the horizon for many jurisdictions. In the discussion of State bankruptcy, I find an interesting Constitutional question… ah, yes, I promised I would come back! What is the Constitutional capacity of Representatives and Senators from a State which bankrupts? Precisely what role does such a State’s impairment play on the Constitutional duties of Congressional members from that State? How do you objectively steward national assets (or in our case, liabilities and debt) and still defend your home turf? On the one hand, faux federalists of the Tea Party ilk would love to see “less big government intervention” and would love to jump on Fox News to advocate for callous neglect (provided it wasn’t THEIR State). Interventionalists would advocate for fresh national debt to come to the aid of the failing States (Can anyone say “stimulus for shovel ready projects”?). This acrimonious banter will ignore the Constitutional question. Can a Representative or Senator be the de facto Bankruptcy Trustee – advocating for the interests of the creditors – while at the same time fulfilling their elected role as advocate for the State that sent them to Congress? The answer, in case you’re wondering, is NO!

Remember how quickly diehard Conservos decided that taking stimulus was justified – over their boisterous rhetoric of the specter of socialism – because “everybody else was doing it.” You see, the euphoric hypoxia induced by the cult of elected power when positions are purchased – not earned – makes fiscal accountability an endangered species and directly starves the moral center in the cerebral cortex of much needed fortitude. Principles are, regrettably, viewed as “best efforts” ideals, not as binding calibrators of accountability. And we really didn’t have a Constitution framed in which the fiscal collapse of the State would be contemplated. We should have. Silly me, I wax nostalgic when I read that our Constitutional fathers wrote that appropriations for War should not exceed two years (Article One, Section 8). And of course, the part about the enumeration of our population in which certain classes of humans were to be counted as 3/5 human.

However, I think that our bigoted forefathers might have buried a clue in the 3/5 human National Treasure that, with a little lemon juice on the disappearing Masonic ink on parchment, some magical spectacles from Ben Franklin’s top left desk drawer, and a black light, might just form the germ of a good idea. When States become insolvent (as the law is iffy at best on whether they can actually be bankrupt), how about we reduce the Congressional voting participation by the proportion of the State fiscal burden places on the national government? How about making 3/5 Representatives and Senators – including having the proportion be reflected in party majority status? After all, 3/5 was structured for indentured sub-humanity and a member of Congress from a dead-beat State is representationally indentured (at least morally indistinguishable from a pithed toad). When a State craters, let’s have some real teeth in it. Why? Am I just some heartless, ill-tempered patriot? Absolutely not. I think that if Congress knew that fiscal irresponsibility at the National level and State level had DIRECT consequence on the wielding of power, we could turn the tables on making some of the hard decisions.

Having a Congress and White House which both refuse to act with or model accountability requires a Constitutional response. The reference at the beginning of this blog reminds us that the State cannot impair Contracts and, with their conflicted fiscal role in our nation, bankruptcy would do that. As the Constitution is silent on State bankruptcies, the least we can do is extrapolate in the pursuit of Happiness (or at least, amusement).

In the coming months, the PBGC will be a canary in the coal mine. The bird’s already got emphysema, is taped to the perch and has a molting wing. However, it will become a Monty Python stage prop pretty soon. Watch how quickly Michigan, California, New Jersey, New York and Illinois members line up to appropriate money into the PBGC crater. Watch to see how they respond in January to the new wave of pension liabilities that are forthcoming. Watch how they finesse the municipal pensions which are collapsing cloaking their advocacy in sweeping generalizations rather than broadcasting their self-interest. Carefully examine the asset allocation for the PBGC (and FDIC for that matter) investment management and watch how they dance around the need to do the right thing while falling in line with the lemming-like insanity that dupes a gullible public into believing that the markets are surging. What you’re observing is a fate of our nation that our founders never imagined. And in this case, the best you can say when you’re sitting in your cave having bludgeoned dinner with a club fashioned from the bumper of your minivan, was that, courtesy of this blog, you saw it coming!

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