"Financial Armageddon: Protecting Your Future From Your Impending Catastrophes"
Transcription of Audio Interview, March 03, 2007
JIM: When the stock market bubble burst in 2000, the collapse that followed wiped out nearly two-thirds of the value of the NASDAQ index, and decimated the hopes and dreams of millions of Americans. Now, imagine not one, but four such disasters looming on the horizon – all of them poised to erupt in a massive economic firestorm that will wreak widespread havoc in the months and years to come. Joining me on the program is Michael Panzner. He has written a new book called Financial Armageddon: Protecting Your Future From Four Impending Catastrophes.
Well, let’s get into your book, Michael. In your preface, you highlight how the world is a riskier place today, and certainly – just pick up the headlines; and yet, we’re lacking even the most primitive early-warning system to alert us. What do you mean by that?
MICHAEL PANZNER: Well, we do sort of know about the mainstream-type of disasters: we have monitors for – well, now, for – tsunamis in some parts of the world; we have earthquake monitors; we have information about other kinds of natural disasters. Even the whole sequence of events that took place on the Gulf coast they did have some warnings. But I think the problem when you’re talking about financial issues, particularly dramatic financial issues, is a combination: nobody really has the will or the incentive to play up the risks in too great a way because they’re fearful of actually being accused of starting it – that’s one issue; the other factor that comes to mine with financial issues is that not a lot of people are very literate – especially when it comes to complicated aspects of finance – and as a result, by the time you go through and explain things, sometimes you kind of lose the meaning on most people and they just don’t want to know. So I think it’s this combination of ignorance and fear. And lastly, I think those who are informed and those who are aware of it, in the financial industry, for example, don’t want to kill the golden goose. I mean, they know that it’s working well for them and why do anything to suggest otherwise. [2:38]
JIM: If we take a look, Michael, over the last year, there was silence when the government raised the debt limits to 9 trillion plus; nothing was said when the savings-rate in this country was negative for the second year in a row; you’ve got household debt now that exceeds 150% of disposable income. And also, when the Comptroller of the Currency David Walker said the US today is very similar to Rome before its fall; you had Laurence Kotlikoff who wrote a book The Coming Generational Storm – warning about our unfunded entitlements; you’ve seen Warren Buffet write and speak about derivatives as financial weapons of mass destruction. It seems like nobody is listening. All we want to know about is Anna Nicole Smith, and you know, is Britney in rehab again.
MICHAEL: I think to a certain extent your answers clarified it: people don’t want to know. For example, in terms of the economy, we did have a minor downdraft in 2001; but they’ve been used to – to a certain extent – no penalties for bad behavior, whether it’s borrowing or over-consumption, or malinvestments for at least 15 years. The last time we had a recession was really back in the 90s. You’ve got the Federal Reserve and regulatory agencies across the board that reassure people that they’ve got everything under control; they have cut rates, especially during the Alan Greenspan era at the drop of a hat – suggesting that there’ll be a backstop there no matter what happens. You’ve had rising bubble-driven markets to a considerable extent actually driven by credit – this massive expansion of borrowed money. So you’ve had this combination of factors that says, to a certain extent, “why worry?” And in essence, people have taken that to heart, and said, “why worry? Who cares what these people are warning about. So far, what I see is only good news.” [4:40]
JIM: It reminds me of the old saying: eat, drink and be merry because tomorrow we die.
MICHAEL: Yes, I think that probably sums it up to a certain extent.
JIM: In your book, you identify four looming threats. Let’s begin with the first one – the ticking, debt-time-bomb.
MICHAEL: I think that debt is clearly, arguably, at the root of all evils in terms of the current circumstances we’re in. In essence, one could argue that most of the financial disasters that have occurred throughout history have been linked in one way, or another, to excessive use of debt, excessive use of leverage (people borrowing more than they’ll ever be able to pay back.) And I think just the scale that we’ve seen recently has just been so dramatic because you have technology, you have competition, you have globalization. And all these different forces coming together to essentially facilitate anybody who wants to borrow, and facilitate this growing crop of banks and non-banks willing to satisfy those needs. So, I think it lies at the root of everything from my perspective. Clearly, people who have access to debt can buy more than they otherwise might; it has a sort of narcotic-type influence on many people – if you can buy today and you don’t have to wait and save and scrimp then that has a considerable appeal. And I think it does create a situation where people are inherently hopeful: they borrow, and then they think it’s going to be better because “I’ve borrowed.” And it’s kind of a vicious circle, rather than a virtuous one. [6:13]
JIM: Now, in your chapter on debt you allude to the fact that governments have long looked at debt to finance deficits (deficit spending and shortfalls in the budget.) But Michael, how did our debt dynamic change under the Greenspan Fed?
MICHAEL: I’m not sure exactly the true motivation. I do believe that over the course of time, Alan Greenspan and company started to believe – to use a colloquialism - their own BS; that they could control the business cycle; that they could fine tune what was going on in the economy; that they could actually tweak the levers like the man behind the curtain in the Wizard of Oz; and keep the whole show rolling. And I think in a sense it went to their head. That was certainly one factor.
I think we were in an era – and I allude to this in the book as well – of consumers as almost a religion, and people felt they had to keep up with the Jones’; they wanted what stores had to sell. And stores – if you like – were more than willing to accommodate those, even those who couldn’t afford it, by offering them credit terms. So in a sense, each pandered to each others’ needs: the needs of the consumer to borrow more (for example, the needs of the consumer to own their own home – which was the mantra of especially the last decade or so); and the need for the US economy to expand in the face of incredible headwinds both domestically and from overseas.
So you take the two together – this idea that you can solve all problems with debt; and this incredible appeal of debt – and you get a pretty dangerous combination in my opinion. [7:54]
JIM: Let’s take a look at especially this new decade – the last 5 years – where lenders and borrowers have basically thrown caution to the wind. We saw the rise of 100% financing on homes – in fact, in many cases, 125%; we saw piggyback loans – you could put money down, and then the bank would quickly turn around, give you a piggyback loan so you could take all your equity out; we saw the rise of no-doc loans. It’s like if we were crazy in the 80s and 90s, and this new century, it’s like I don’t know how else to describe this [except] as absolutely being insane.
MICHAEL: Well, it is – and bankers certainly, if you like, threw their caution to the wind. But it’s very clear, one reason at least why they’ve done that is because in the past they have had to bear the consequences of their bad credit granting decision. With the rise of securitization – and mind you, in my opinion, securitization does have a number of benefits, but – the biggest downside is the introduction of what you might call moral hazard: bankers no longer being as incentivized to produce quality loans, but instead are focused on quantity because they receive a fee upfront, they shunt the loans along to somebody else, and they get repackaged, sliced and diced into securities; and then they can go out and reissue other mortgages, other debts, and repackage them in a kind of virtuous circle. So I think that, again, that was an incentive system that facilitated this kind of behavior.
But it also comes down to the point I made earlier: people are more complacent. It’s inevitable. Minsky alluded to it many times – the idea that essentially stability breeds its own failings to a certain extent: people get more complacent; they are willing to accept less in terms of greater risk. And in essence we also had another issues in that people became very short term oriented. You have a incentive scheme in the hedge funds that I’m sure we’ll go into later, but this whole idea that people get rewarded on a much more frequent, much, much more regular basis – there’s no real link between how people get paid, and long-term performance, long-term interests; and in a sense, their incentive is to do as much as they can in the short run, and let someone else worry about the problem later on. [10:22]
JIM: I want to move on to a second threat that you highlight, and that’s the retirement system. You use a line that when all the numbers are tallied, it’s time to kill all the accountants. Our entitlement system is basically bankrupt, as are many of our company pension plans. In fact, on the day you and I are talking, Mr. Bernanke was on Capitol Hill talking about the entitlements, and I about dropped my jaw when in Fedspeak he basically said the trust fund really didn’t exist and have real assets in the sense of the word, like, corporate bonds, stocks or things of that nature. What it owned, in essence, were IOUs that had to be publicly financed.
MICHAEL: Well, again, it goes back to this sort of ‘don’t worry about it now’ sort of mindset; it goes back to, if you like, unintended consequences of certain kinds of accounting rules. For example, this idea that you can essentially smooth returns. On the face of it, it seems like a good idea – I’m talking about the private sector, right now, in terms of pension accounting – you get ups and downs in markets, you’re really investing for the long term. But people have essentially gamed the system, so they have managed to find themselves in a situation where they have less money available to meet their forward obligations than you would expect under the circumstances. In terms of the government, it is just very easy when you use an accounting system, which if a private company used it, I’m sure the chief financial officer and the chief executive officer would probably be in jail. A cash-based system for a giant as large as the US – I mean, it’s essentially pay-as-you-go. There’s no real accounting for forward obligations. It’s a classic, distorted incentive system. As long as people can paint an image of today’s financial performance – and performance is probably the wrong choice of words when you’re talking about government – of today’s financial picture, then really that’s all that matters when you’re dealing with, for example, I make the point in my book, at all levels of government, with people whose life-cycles are in essence two or four years (depending on how often the elections take place), you don’t have this incentive; you don’t have this real desire for people to focus on the long term consequences of their short term actions. And that combination just creates an ever building deficiency that one day falls apart, and I think we’re very close to it. [12:55]
JIM: What about, also, something that is looming on the horizon. And I don’t think people realize the risk involved here, and that’s the implicit guarantees of our government sponsored entities, such as Fannie, Freddie and Sallie. I mean, if you take a look at the interest rates they receive on the bonds – they’re just slightly above Treasuries because of the implied backing of the US government – the US government doesn’t have the money to back all of these.
MICHAEL: I suppose if they create credit money they’ll have it, but it will basically destroy the US in other ways – I mean there will be negative consequences. But the point here is that they’ve boxed themselves in. And again, it’s kind of a short term mentality, live for today kind of phenomenon at the government level. But they’ve not dissuaded the market from believing that Fannie Mae, Freddie Mac and other similar types of government-sponsored entities won’t, at the end of the day, be supported, bailed out – you know, whatever the choice of terms you want to use. There’s been a lot of dialogue lately, but the market so far is ignoring it. And I think where you’re going to get a real crunch is you’re going to get a combination of a housing market imploding that severely damages the financial condition of – let’s use the two biggest entities – Freddie and Fannie; and then the government stands back and say, “you know what, we really meant it, we’re not guaranteeing these guys,” and they’re going to end up with the exact situation they don’t want, which is a complete crisis where they’ll be forced to step in at the absolute wrong time; and they’ll spend a lot more money on it. So, in typical government fashion, the way I see things playing out is that by not dealing with it initially, and addressing the problem, they’ll have to address a much larger, a far more systematic problem in the future. [14:45]
JIM: You know the one area of the market which appears more frightening than anything else you’ve written in your book is derivatives. Warren Buffet, as I mentioned, talked about them as financial instruments of mass destruction. But we’re looking at double-digit growth in what is the most highly levered end of the financial market in the history of the world. And there’s absolutely, just complete complacency on Wall Street, which is making a fortune on it, as well as the hedge funds that are involved in it.
MICHAEL: There are two issues here – really the crux of the problem. The first is as you noted, people are making a lot of money with increasingly complicated investments and instruments. And in a sense, a lack of transparency, a lack of an ability to actually understand these instruments without high-powered models, high-powered computers, and all the accoutrements of today’s modern rocket science type of finance world, means you can bury a lot of profit in those numbers. So on Wall Street, I would argue it’s not just complacency in a sense, it’s also not wanting to kill the golden goose – as I referred to earlier. It’s a money machine for Wall Street. Some of the analysts, I guess, if you like, who observed the amount of money that is flowing through are talking on the order of billions – that investment banks have realized (and commercial banks for that matter, although there’s more of a crossover between the two nowadays) billions of dollars through the sale of these investments. So you have this one issue. You have people who really don’t have any incentive to talk about the risks of what they do.
And on the other side of the coin, and probably I took the challenge on, knowing full well that I might fail at it, is the idea that they can be quite complicated if you really digress into the nitty-gritty of what people are doing. However, if you strip away the complicated aspects, the academic terminology, all the other peripheral aspects that tend to obfuscate the picture, you can see in essence that they are essentially leveraged bets for the most part; they are instruments that are ethereal in nature – they depend on other things for their value. And once you get to the heart or the root of what drives derivatives – why they exist, what they do in terms of risk shifting, for example, which is the big reason for their growth – then it’s not such a challenge to deal with the fact of what the sort of unintended consequences of this dramatic expansion is. But the problem is that people who talk about derivatives – oftentimes, people who are steeped in the nomenclature – they are unwilling to explain it in layman’s terms; and I took that challenge in the book. And I believe that people had to know about these things because they are the financial weapons of mass destruction. And in my opinion, that will play a strong role in the unraveling that lies ahead. [17:52]
JIM: I wonder if you’d address for the moment the issue of hybrids, where you describe them as toxic monstrosities; you have a situation where you can go from a highly rated obligation to junk bond status overnight with prices falling off a cliff in a twenty-four hour period.
MICHAEL: Yeah, I mean people use this terminology – it’s actually got a name – cliff risk. And when I first heard it I said who would invest in anything that would have those kinds of parameters? I mean that’s the kind of investing environment you alluded to earlier – people are just buying all sorts of ridiculous things at all sorts of fairly tight prices in this reach for some kind of return over and above what they might get in sort of plain vanilla investments. The way they essentially work is – to break them down into simple terms – that there can be an accumulation of bad news, an accumulation of defaults in an instrument which is essentially dependent on other derivatives which are obviously dependent on something else. So it’s a kind of – I think they refer to one variation as CDO-squared, okay. So you know you’re off in cloud-cuckoo land when you’re talking about instruments like that. But the idea is that there is a sudden exponential effect once you get past a certain threshold of credit events, which is the terminology they use for credit derivatives, meaning bankruptcies, defaults, that sort of thing; so all of a sudden, one day, you hit this threshold and, bam, those securities have essentially lost their value. They’ve gone from having value to having lost a substantial portion of their value overnight. And you know, it just creates a situation now of potentially very unpredictable outcomes. And you put that all together with the other multiple layers of risk I describe in the book, and you just get a situation that no one can get their heads around. The most likely outcome is probably going to be the worst case outcome. [19:54]
JIM: you have a chapter in your book called Economic Malaise where you discuss these various issues that we’ve been talking about so far. But as you point out, it doesn’t matter how serious they are, there appears to be, I call it a ‘don’t worry be happy’ attitude; nobody seems to see the danger in our economic model which is based on debt and consumption. The fact that our current account and trade deficit last year was nearly 900 billion; the fact that foreigners own the majority of our debt; the fact that just about everything you buy in the store isn’t made here; we’ve outsourced manufacturing; we are outsourcing services; and we’re outsourcing our energy system – and nobody seems to find anything wrong with that.
MICHAEL: Well, some do – you do. And certainly, some people who are paying attention, who do realize more often than not because they have a few grey hairs on their head, history is a bit of a pendulum – things do ebb and flow, you do go from good times to bad times, just like you go from the seasons. So there are people, but it’s a very, very small group. Once again, it comes back to the ‘well, nothing’s happened so far, so things are okay.’ And again, one of the analogies I likened to in an article I wrote once before about the derivatives market was how relaxed people were about the situation down in the Gulf coast before Katrina hit. People had taken the logic to a certain extent that nothing bad had happened before, they thought they had seen it all – we were prepared; or at least, they had been reassured that they were prepared; there were supposedly backstops in place. And to boot, they had various forms of incentives, including insurance to build in flood-prone areas. So you have these perverse incentives, and you have this human behavioral failing where people tend to focus on what happened in the recent past, and they say, “well, there’s no reason to worry because nothing’s happened.” It’s really mind-boggling, especially in light of the fact that at least at the government level I think Homeland Security listed it as one of their three top risks. I don’t remember the time span, but I think it was somewhere about a year before, and this is a government agency which obviously didn’t really establish itself as being very credible when the event hit. It had been pointed out that this was a genuine threat, and people just didn’t want to know. And I think you can draw some parallels to what happened there to the way people are viewing current circumstances in the US. And in essence, we’ve had 200 plus years of relative success in the US, even when we’ve had civil war; we’ve had the Depression, we’ve had other events we’ve managed to sort of struggle through; and not only that, but in the very near term, past two decades or so, whatever down sides we’ve seen – whether it was Long Term Capital Management blowing up, whether it was the Asian Crisis, whether it was the dotcom meltdown – things seemed to go okay. So people are reassured by their recent past, and fail to see that history is a series of ups and down, and they’re just not looking back far enough. [23:10]
JIM: As we look at the bigger picture here, the odds of what we have before us is a large systemic crisis which is increasing by the day. You relate this issue to the gas crisis in the summer of 1979, when most people thought there was a fuel shortage when in reality it was a panic response. Certainly, we got a little wake-up call to that event on Tuesday of this week, when at one point the Dow was down over 500 points before a miracle started to occur in the futures pit.
MICHAEL: I think to a certain extent what you see there is a combination of events coming together along with the complacency that you’ve alluded to previously. You’re seeing it in investment markets. I think, for example, there are a number of investment professionals – investors, hedge funds, et cetera – who were essentially standing back, saying that at the moment the bell rang, they were going to be able to exit. Essentially, a herd of elephants were going to be able to go through the revolving door all at once. And I think the reality of what we saw on Tuesday – and personally, I think that’s just the beginning of it; it’s not a one-day wonder as some would have us believe – but you’ve seen an early taste of this idea that people have been complacent. They know they’ve essentially got an out because markets are liquid; or they’ve got insurance; or they’ve got the Fed backstopping them; or interest rates are relatively low; or somebody somewhere is going to bail them out; and if they need to hit the bid – to sort of use the market terminology – they’ll have no problem. And I think we’ve seen, if you like, a taste of how that might not quite work out according to plan.
The other thing I noted in my first book is this heavy reliance on technology; this heavy reliance on models and technical-type trading methods. I think there are a lot of stop losses built up under the market. I think people are saying, “well, when the game is over I’ve got my protection to get me out. I’ll be out automatically. I’ll just push a button, or my order will be executed. Or something will happen automatically for me and the markets will accommodate it.” And I think you’re back to this same sort of logic that we saw back in 87 with portfolio insurance. No one ever asked the question, until after the fact, really, is when everybody is out there, say, looking to sell using their dynamic hedging methods – who’s going to be doing all the buying? And I think that kind of phenomenon – that second question of ‘who’s going to be doing the buying?’ – is not being addressed yet again. [25:56]
JIM: As you were talking about communication, this to me is the ideal set up for this systemic risk and crisis to unfold because today we live in instant communication market globally, and that to me sets the stage for this systemic crisis to unfold. And as you point out in the book, when it does – and I think it’s just a question of when, now – the Fed will not have a clear strategy at the time. And they are more likely I would say to panic; it’s every bit as likely to unfold where we see the markets actually lock up, as you pointed out, with all this dynamic hedging. One assumes you have to have a buyer on the other side; and as we saw in 1997 and 1998 and in certain parts of this new decade, when you’re unloading positions – especially if you are a high-risk, leveraged player – you’re getting out of your risky positions first, and you may find there are no buyers.
MICHAEL: That’s the thing. And people talk about how hedge funds have become a growing force in the business – that’s certainly not anything new. But one interesting observation, and I think even regulators have started to point it out, is that for all the talk of starting to use rocket science, and the smart money looking at sort of unique opportunities and inefficiencies in the market, there does seem to be a lot of herding; there does seem to be a lot of position taking in the same kinds of instruments. There does seem to be a great deal of the same kind of risky strategies – selling credit-default swaps, for example, which is a form of derivative. But in essence, it’s the equivalent of a short put in the equity market, for example, where you essentially get a little bit of premium income up front at the risk you get wiped out if it all goes wrong. And I think you’ve got a number of people in the investment business…And I don’t want to just blame hedge funds: there’s a lot of smart money in hedge funds; there’s a lot of people who are worried about current circumstances as I am. But it’s certainly been the trigger for a lot of less enlightened individuals to be attempting to do the same thing. So you’ve got this situation here where people are essentially lulled into complacency thinking, “Well, if it all goes wrong, I’ll just push the button and I’ll be out.” – Not thinking through that question of well, if everybody is doing it, then I may not have anyone to sell it to.
The other issue as well is that many of them have similar risk management models, which to a great extent depend on market volatility. So if market volatility goes up, they’re all going to be trying to sell stock which is going to create more volatility which could become a kind of self-feeding phenomenon, which will essentially lead to wider spreads, illiquid markets, leading to more volatility, leading to more potential selling interest. You do have this combination of events, and no one just asks that basic question: who’s going to buy all this stuff? I think that’s at the heart of it. [29:10]
JIM: Let’s talk about where we’re heading, and that is your chapter on a depression. Because once the system implodes – as we saw in the Great Depression – and also when serious events occur in the economy or the geopolitical realm, the psychological damage I would equate to trauma; it can be so devastating that what happens next is it leads us into a depression whereby all of the malinvestments, the economic distortions and they all begin to unwind; and as they are unwound, the day of reckoning finally arrives.
MICHAEL: And in fact, that’s how they lay out the order of the book is that I start with malaise because I think it’s conceivable you could have a period of economic malaise where we perhaps go into recession (which I think we’re headed to this year) where you really get a contractionary environment but nothing so dramatic. But I think with all of these imbalances that have built up in the system, and with all of this debt that has been accumulated – and most of which will never be paid back – what you’ll likely get at that point, in my opinion, is some sort of external shock; a systemic crisis stemming from developments I’m guessing most likely in the derivatives market. But somehow, it’ll be related to this era of new age finance – however you want to describe it – which really shocks people into a reality that things are nowhere near what they thought. I mean, I think, it’s common in psychology for people to have a dramatic response to dramatic events; and I think that’s what you alluded to in your introduction here – is that I think that’s the kind of phenomenon that we will see on an economic level which will permeate the social environment, permeate politics, permeate geopolitics; and really have a radiating influence on the whole big picture. [31:14]
JIM: I want to talk about the response to the depression because you and I are thinking alike here. You have a chapter after the depression called Hyperinflation, which means the government will respond and just print paper endlessly. The currency will become almost worthless as they do that. Michael, I don’t see any politician that we have in Washington in either party, or in the White House, if faced with the consequences as we head into this depression (which I see as being inevitable) would sit there today before it happens, and say, “Guys, we’ve messed up, we’ve taken on two much debt, the government is spending too much money; we’ve got too much leverage in the system. Let’s take our medicine now. Vote for me because if you do I’m going to raise your taxes, I’m going to cut back on spending, I’m going to curtail benefits.” I just don’t see any politician of that caliber that could do that.
MICHAEL: Well, I don’t either. But it’s interesting that you make reference to my sequence because there are a number of people who look at the world in a slightly different light than I do: they see hyperinflation as the end game of the current circumstances. I think it boils down to a lack of understanding about this idea of printing money. I think what you have to realize is that up to this point is they’ve been printing credit money. In essence, money that will have to be paid back, or if it doesn’t get paid back that will create a deflationary-depressionary downward force on the economy at large. And I think that the difference is that at the point where essentially people feel they have nothing to lose once circumstances get as bad as I think they are likely to become, you’ll have this situation where people will say: “Well, forget this idea of loaning people money. Let’s just give them money.” And essentially, print it in the context of what has happened in past hyperinflations – what’s going on in Zimbabwe now, what happened in Weimar, Germany; what happened in many Latin American countries. So I think you have this situation where people will hit rock bottom, and the result will be politicians, regulators, central bankers – if the central banks still exist at that point, and I’m not so sure – the response will be, “well, we need to save ourselves, or else the game is over.” And I think that will be the likely response at some point. But there is, in the way I’ve laid it out, a clear progression: this malaise, this systemic crisis, this depression – and ultimately hyperinflation comes last. And I guess, unlike the gold bugs, they need to wait for that initial stage first before we see ultimately the kinds of gains that people are expecting. [34:14]
JIM: Let’s talk first of all about the fall out that comes afterwards as the result of this systemic crisis and the depression that the country moves into. You talk about, for example, maybe politicians suspending or reducing the COLA caps on pensions; you talk about something we saw happen in Argentina – the corralito – where people were restricted from having access to their cash in the bank because the banking system will be bankrupt; you talk about crime which will run rampant. Address some of the social issues because this goes beyond economics.
MICHAEL: They’re all related, and most people who write these kinds of books tend to focus strictly on the investment implications, or in a slightly broader sense the financial implications. But I think they are all related. Social conditions – I think Robert Prechter certainly tied developments in terms of what goes on in the social arena with what goes on in the economic arena. I think in his view the social drives the financial. But leaving that aside, they are all relevant to the equation in my opinion. And here’s an example: I feel that crime will be on the increase. I mean there has actually been studies suggesting that you get an environment where a weaker economy does tend to lead to more crime. But I think the way that I lay it out, and the logic as I see it, is that you’re going to have budget pressures at every level of government – particularly state government. They’re going to have pension obligations that are essentially going to destroy many municipal authorities or bring them into bankruptcy; and they’re just not going to be able to afford cops. So you’re going to find a situation where people are more desperate, and [there will be fewer] available resources from state and local government – even, as well as the federal government – to police certain areas. So you could find no-go zones to a certain extent. So I think the social aspect is very closely linked, and I think it’s important for people to understand that economics doesn’t happen in a vacuum – there’s a spillover effect; there’ll be [a] few political effects. Once the US is no longer the consumer of last resort in the global economy, our relationship with the rest of the world is going to change dramatically. If we have nothing to offer them in terms of shipping their foreign goods here, or essentially using their outsourced labor, then we become marginalized; and you’re already seen it, at least in some of the hot spots – so Venezuela calling the US, “the devil;” Russia and China almost going there own way to a certain extent, (and more so over time), where they say, “well, what do we need the US for?” And again, I think that this has a link to economics that people don’t typically address in a business and finance book. And in my view, it’s as relevant to what you think about the world and how you should go about planning for the future as strictly as the investment implications. [37:17]
JIM: Another thing that you point out – which we certainly saw when the NASDAQ bubble burst – which is the financial engineering, the accounting correction that was taking place in Corporate America was exposed; and I think you’ll see this exposure come out in the open again – but not just the private sector but also in the public sector. We have a situation here in San Diego where we have a pension scam that government was running; understating their pension liabilities and making promises where you had the city that’s almost bankrupt.
MICHAEL: Oh yes, and I believe that. In fact, I read an article recently – and frankly, I can’t remember the source, it was on one of the blogs I believe – suggesting that San Diego also had exposure to certain elements of the hedge fund investing universe. But in essence, they had exposure to risk in the same way that people who are selling credit-default swaps, or selling insurance: they were realizing relatively small returns up front with the risk that it all goes horribly wrong if things move against them. But I think you’re going to see all kinds of chicanery revealed once the tide of liquidity, the tide of good times, moves out – both at the public level and at the private level. And more so, I think corruption is an interesting point because if you get into an environment where governments start to break down, I think particularly at the state and local level, where people are getting laid off, or people are not getting the sort of rises or pension benefits that they used to, they become more incentivized – probably – to accept money in exchange for doing something fast, or doing something that they shouldn’t be doing. So I think, in essence, what you’ll see will only get worse over time. [39:13]
JIM: One of the things – and this relates once again to the social implications of all this – a couple of years ago because accounting was becoming more devious our companies were getting even more creative which was surprising after the exposure of all of the Enrons, the Worldcoms and Global Crossings of the world. I hired the head of the accounting department of the Graduate School here – one of the major universities – and she was telling us something that alarmed her. She was teaching her students to look into the footnotes of financial statements to find what was really going on, and they were sort of complaining, “well, this is like a lot of work. Why do we have to do this?” And she made a comment to her students, “you have to do that if you want to find out if the numbers are real or not.” And one of the students responded, “Who cares, if the stock is going up.”
MICHAEL: You’re back to the same mindset, you know, the number mindset: what’s the number, did they beat the number, what’s today’s economic data point did it beat, or miss the data point. You know, this kind of narrow, simplistic focus on the present. I mean I think it’s something I pointed out in my last book – you know, people have short attention spans; and I’m not sure if it’s physical or psychological or social but people are not that interested in delving below the surface; they’re not that interested in knowing the detail behind the headline; they are not that interested in knowing the headline number really represents an average with a fairly wide diffusion of the various constituents. So I mean it seems like the environment we’re in is that people think life should be like TV – it should be simple, it should be easy to understand, and nothing to worry too much about. And unfortunately, that’s not the reality; and it’s going to come home to roost in the years ahead. [41:08]
JIM: Let’s move on to some of the social implications because one of the things I like about what you’ve done in this book is you’re thinking in what I call three-dimensional ways, and showing how to all these things there’s a sequence, there’s a linkage. And you talked about the social implications; some of this is just going to be quite horrendous: the increase in homelessness; crime will be running rampant; the criminal justice system will cease to function, it will be overwhelmed; cities won’t be able to afford the police force; and also, the established order will be challenged. We could go to blackouts - heck we have those in California now. Food, water, fuel, medical shortages. I mean, look what happened in New Orleans, and also when the pipelines were taken out as a result of the hurricanes of 2005, and you have a good look at what could be coming.
MICHAEL: You know, I don’t want to sit here and say people are bad, and I don’t inherently believe that, so I don’t want to give the wrong impression. But, on the other hand, I think there is a reality if people have to survive, or circumstances are such that people will have to prioritize critical elements of their life, then a lot of things are going to fall by the wayside; and a lot of behavior may become somewhat primal. People, if they are worried about, for example, their family and feeding their family, they may have a different mindset than they would have had in an environment that we’ve had up until recently. And I think that’s very likely. And no one can fault that kind of perspective, but you have to think it through and think if this is what’s going to happen then the logical sequence, however horrible it sounds, is likely to be this. And that’s the way I’ve thought it through. I haven’t pulled any punches here. And it’s not because I think Americans are bad or people are bad, but I think that circumstances do make the man – in parentheses – to a certain extent, and that if you get an environment that becomes much more difficult, much more of a struggle, much more competitive in a kind of simplistic, basic, primal sense the people have to respond or perish. And I believe that we will see that kind of a progression. Clearly, I’m not looking for literal fighting in the streets, but it wouldn’t surprise me that you get those kinds of activities in certain hot spots around the country. [43:42]
JIM: I want to contrast where we are today compared to the Depression in the 30s. And you bring up, when you address the issue of geopolitics, when the US is no longer a superpower and we have no interest to the rest of the world. As you pointed out, Russia and China are pursuing their own direction; Europe is also going in that direction. When we lose this loss of influence, and you’re seeing it unfold today, in the last couple of decades we have outsourced our manufacturing; where in the 1930s, the US was pretty much a manufacturing power house; we no longer save, or have any savings, so we are dependent on foreign capital. We’ve outsourced manufacturing, we’ve outsourced our services in many ways now; and we’ve outsourced energy. How are we going to be equipped to handle this?
MICHAEL: Well, look, you know as well as I do that people have managed to survive one way or another. But whether they handle it in the way that Americans are accustomed to, I think that is a whole other question. In my view, it’s going to be very unfamiliar ground for most people – extremely unfamiliar ground for the majority of Americans. And I think that’s the critical issue. Perhaps those who have lived in places like Zimbabwe, or lived in places like Latin America, or Argentina, who have been through circumstances of sheer degradation and bad times, can appreciate the sort of environment I’m [describing], but not in the US. I mean people are still living in this kind of dream that America is the one and only superpower and will forever remain that way. Well, anyone who has done any reading of history knows that superpowers come and go; it may take longer than I think – personally I think we’re at some sort of inflection point. And I think it’s the combination of the financial circumstances that we’ve gotten ourselves into, and the social state and the mindset we’ve gotten ourselves into. We’ve kind of got an entitlement mindset, which at least in my reading of history, it coincides with sort of the decline of the empire. And you’ve got all the little signs, which suggest that America, which can throw its weight around – well, they can’t. And you’ve got this other aspect which you’re seeing more and more of, lately, with this Administration – and believe me, I really don’t consider myself Republican or Democrat – but there are moves afoot to introduce the kinds of things that Americans would never have stood for ten years ago: this whole talk of suspending Habeas Corpus; and really chipping away at the Bill of Rights. These are the kinds of things you see when an empire is in decline; these are not the kinds of things you see when an empire is on the ascendant. And in my view, you put all those pieces together, and you have to say, “how does that translate to every day life?” – and it’s not a pretty picture. [46:44]
JIM: How does one prepare for this? Because what your book is – almost one analogy – is a radar of the storm that is gathering tremendous force out there. And right now, nobody sees it. All people do is they go out and they see the sun is shining, the wind is calm, and they don’t see this. But on your radar screen – your book, you highlight all this. How does one prepare for this? How do you get defensive in its preparation?
MICHAEL: Well, there’s something to bear in mind – people who do write books that question the conventional wisdom, oftentimes they offer alternative screeds as to how it can be different. People who write business and finance books that address a particular danger or concern tend to focus on the investment side; or tend to put it in terms of “how can I profit from this opportunity?” I’ve taken the view that it’s going to be a struggle, and that the best way to deal with the coming storm is to prepare for it in the same way that you would any other kind of potential disaster in the making. It comes down to planning, it comes down to lifestyle choices, it comes down to how you evaluate relationships; and it comes down to how you manage essentially your personal finances – whether it’s investments, whether it’s you’re borrowing, the make up of your assets; really looking at it from the perspective that it’s going to happen so you better be prepared. And forget the idea that somehow it’s not going to happen (or forget the idea that you can stop it from happening.) And that’s the perspective I took, and it’s a cold, hard view, but I think it’s a reasonable one.
Look, at the end of the day, if you live your life by planning for – and obviously I’m generalizing here, there’s a lot more detail in the book – but if you plan more, and you think more about your future, it’s going to help you no matter what happens, okay. But in an environment where there’s going to be a great up tick and uncertainty – where there’s going to be shortages, where there’s going to be wild fluctuations in prices, where there’s going to be tremendous unemployment – then you really have to think much longer and much harder, and with a much more aggressive and disciplined mindset than you would under different circumstances. And I address that perspective: you need to think like a guerrilla in a sense. How are you going to tackle this problem that’s coming, and get through it? [49:10]
JIM: And finally, you talk about lifestyle, and the kind of lifestyle one should be living in preparing for this, and the kind of lifestyle the country will be going through. Address that for a moment.
MICHAEL: Well, I think you can safely say that the age of consumerism is over. I think people will revert back to a time when simplicity, family, interests in what you can do creatively, how you can live more healthily. For example, I believe one casualty of the coming disaster will be the healthcare system; and there will be a lot of people who don’t have access to healthcare. So one solution is going to be to live a healthier life. Now, I don’t want to sound here like a nanny-state individual - I mean this is a personal choice; for certain people, it’s going to be one choice versus another; but the idea is if you are going to be looking after yourself in old age because the health care system is in shambles, the Social Security system is basically gone away, and you have no pension and you still have to keep working until the day you drop, then it’s going to steel your mind to adjust your behavior. And I guess I’m just laying it out in fairly straight forward terms; I mean this is not a rant this book – people who do write them write them as a kind of rant, or something off the deep end – a man standing on the corner saying, “the end is near.” No way. This is a logical, thought-out book on what is likely to happen, in my opinion, based on all these circumstances; and what can you do to prepare for it when it does. [50:50]
JIM: You know, Michael, when I read your book – and you were kind enough to send me a copy, I guess it goes on sale this week – after I finished reading it, and I only had this happen the last couple of years with one other book, which was James Kunstler’s book, I literally wanted to get my favorite bottle of wine and cigar and get on my sail boat and head off into the sunset. But yet, I read, I see the very same things that you’re talking about in the book; and I read this stuff every single night. So what you have put together here, and pieced together beautifully are the different aspects of it all – not just the financial system because there are some books out there that talk about this financial doom, but you relate it cohesively and sequentially how it unfolds. And I tell you, it’s got to be any eye-opener for people.
MICHAEL: Well, look, I took the perspective that it’s better to be straightforward, brutally honest, look at things that there is no real upside here in focusing on the best-case scenario because if the best-case scenario happens then you have nothing to worry about. The problem is if the worst-case scenario happens what are you going to do about it? And I think that’s sort of the mindset issue that you’ve addressed a couple of times in this conversation, which is this idea that people seem to think: why worry about something bad because so far things are okay. And essentially, I took the perspective that that’s not going to help anybody. What’s going to help people is knowing how bad it can get and what they can do in response. [52:31]
JIM: It’s amazing because that’s the conclusion that I have come to. In other words, it’s too late to avoid what is coming; we’ve gone well beyond that. I thought we might have had an opportunity in the 90s to correct this and it did appear there for a couple of years in the early 90s that we were thinking of going in that direction. But we’ve moved so far afield from that, that at this point it’s just a question of when.
MICHAEL: I do want to qualify it in one respect, me, anyone else, no one knows for sure what will happen. I mean absolutely, categorically no one can predict the future tomorrow. However, based upon the weight of evidence that I’ve seen, and the perspective of history, I think it is very likely to happen in the way that I’ve laid out. And it scares me. When I was writing the book, frankly, it scared me; and I wrote it because I looked and I said it makes a lot of sense, but when you actually stand back and read it it’s very frightening. And from that perspective, I think that’s the kind of wake-up call that people really need nowadays. [53:44]
JIM: I want to compliment you – I think you did a very good job, and I would urge our listeners if you want a sobering view of what may be lying out there, somewhere in the future, it’s a great book. Michael, I want to thank you, once again, for joining us on the Financial Sense Newshour. The name of the book is called Financial Armageddon: Protecting Your Future From Four Impending Catastrophes, once again by Michael Panzner. Michael, all the best to you, Sir.
Thanks very much.
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