Markets were briefly in a tizzy last week because of the rumor the Obama Administration was poised to announce an August Surprise, supposedly the forgiveness of at least a portion of millions of mortgages held by Fannie Mae and Freddie Mac for underwater homeowners. The word on the street was that this planned debt forgiveness was a thinly veiled attempt to cull votes for the November elections. Fannie Mae and Freddie Mac hold the mortgages insured by the U.S. government and backstopped by taxpayers, loans the private sector may not have made due to the unacceptable credit risks of the borrowers. These quasi-government behemoths now hold over $5 trillion in mortgages. These mortgages are in pole position for the next leg down of the unfolding housing disaster.
The last time the Obama Administration suggested those who regularly pay their own mortgages also pay the mortgages of those who do not pay or cannot pay their mortgages, the Tea Party movement was born, bursting onto the American political scene like the rabble in Boston a few years back. Rick Santelli's rant against such mortgage policies on the floor of the Chicago Mercantile Exchange inspired the Tea Party movement.
Why all the fuss? It appears that many American's believe their home is their castle, and although most would likely pitch in to defend their neighbor's castle in a natural disaster or emergency, they would rather not pay their neighbor's mortgage. The bankers would love government funded debt forgiveness, so they can keep cashing their bonus checks. I have to believe that President Obama would be slow to double down on this policy error, but his end game is not entirely clear. His policies are starting to make more Americans nervous, even many that voted for him. My advice to President Obama would be to at least fire the knucklehead who floated this latest trail balloon to test the political waters. The fact that those waters are now boiling should have been a clue.
We are in unchartered waters with the Obama Administration, and mortgage debt forgiveness sponsored by the government and paid for by taxpayers is more than most could stomach. Nevertheless, a little history on the subject of debt forgiveness warrants consideration, as it is relevant to the global debt disaster that is bringing the U.S. and global economy to its knees. The idea of the forgiveness of debt on homes to restore economic growth, and for political gain, has a few roots in antiquity.
When too much debt piles up on a civilization, triggering systemic crisis, politicians have historically panicked and opened the Treasury, until regime change or the collapse of the civilization ends such folly. Politicians are uniquely skilled at finding a block of constituents that benefit from zero interest rates and debt cancellation in order to secure votes or power, always at the expense of productive citizens and regular working stiffs. If you think the current global financial crisis is something new, and the temptation to use debt cancellation to secure political good will and boost the economy is a novel idea, a bit of history is helpful to cast some light on this timely matter that sent shutters through the markets and up taxpayers spines last week.
Humanity has been here before, with strikingly similar conditions. It was the overuse of debt funding that led to a Roman crisis at the height of the empire in the year A.D. 33, as told by Lightner (1922), and quoted in Jubilee on Wall Street. Just exchange a few of the bank names, politicians and programs with those of the current global financial crisis and the parallels are disturbing:
When we make a hasty survey of the Roman Empire (read the global economy) to find the symptoms of decay (stagnant and falling GDP) there is brought to light as the outstanding feature industrial stagnation (overproduction) and commercial ruin (excessive debt from loads from subprime, consumer, and corporate debt, triggering bankruptcy, etc.). The year 33 A.D. was full of events in the ancient world. It marked two disturbances as the outgrowth of the mob spirit. The first was in the remote province of Judea where one Christus was tried before Pontius Pilate, was crucified, dead and buried (this was the real deal in debt forgiveness of another sort, but that's another subject). The other event was the great Roman panic which shook the empire from end to end. The consternation accompanying the latter died down and it was soon forgotten (of course the empire later collapsed), but the murmurings of the former swept down the centuries until, bursting into flames, it enveloped the world.
A description of the panic reads like one of our own times: The important firm of Seuthes and Son, of Alexandria (read Bear Stearns), was facing difficulties because of the loss of three richly laden ships in a Red Sea storm, followed by a fall in the value of ostrich feather and ivory (fall in the value of real estate). About the same time the great house of Malchus and Co. of Tyre (Lehman Bros.) with branches at Antioch and Ephesus, suddenly became bankrupt as a result of a strike among their Phoenician workmen (unions) and the embezzlements of a freedman manager (Madoff). These failures affected the Roman banking house, Quintus Maximus and Lucius Vibo (Goldman, Merrill, JP Morgan, etc.). A run commenced on their bank and spread to other banking houses that were said to be involved, particularly the Brothers Pittius (Wells Fargo, etc.). The Via Sacra was the Wall Street of Rome and this thoroughfare was teeming with excited merchants. These two firms looked to other bankers for aid, as is done today. Unfortunately, rebellion had occurred among the semi civilized people of North Gaul (Ireland this time), where a great deal of Roman (European) capital had been invested, and a moratorium (banking holiday) had been declared by the government on account of the disturbed conditions. Other bankers, fearing the suspended conditions, refused to aid the first two houses and this augmented the crises.
Money was tight for another reason: agriculture had been on a decline for some years (the Internet bubble and then the real estate bubble) and Tiberius (Bush/Obama) had proclaimed that one-third of every senator's fortune must be invested in lands within the province of Italy in order to recoup their agricultural production (why don't we try this one, and let the senators eat some of their own cooking).
Publius Spintler, a wealthy nobleman (Rangel), was at that time obliged to raise money to comply (pay his taxes) with the order and had called upon his bank, Balbus Ollius, for 30 million sesterces, which he had deposited with them (OK the analogy isn't perfect). This firm immediately closed their doors and entered bankruptcy before the praetor. The panic was fast spreading throughout all the province of Rome and the civilized world (still pretty accurate). News came of the failure of the great Corinthian bank, Leucippus Sons (pick a bank name), followed within a few days by a strong banking house in Carthage (pick a city). By this time all the surviving banks on the Via Sacra had suspended payment to the depositors (it almost happened, but round II of the banking crisis is dead ahead). Two banks in Lyons next were obliged to suspend; likewise, another in Byzantium. From all provincial towns creditors ran to bankers and debtors with cries of keen distress only to meet with an answer of failure or bankruptcy (money funds broke the buck).
The legal rate of interest in Rome was then 12 percent and this rose beyond bounds (these were real market interest rates before central banking). The praetor's court was filled with creditors demanding the auctioning of the debtor's property and slaves; valuable villas were sold for trifles (a real estate crash) and many men who were reputed to be rich and of large fortune were reduced to pauperism (rumored billionaire Allen Stanford, along with jumbo mortgages down the tubes). This condition existed not only in Rome, but throughout the empire (from New York to Greece).
Gracchus (pick Paulson or Bernanke), the praetor, who saw the calamity threatening the very foundation of all the commerce and industry of the empire, dispatched a message to the emperor, Tiberius (Bush/Obama), in his villa at Capri (Texas/Hawaii). The merchants waited breathlessly for four days until the courier returned. The Senate assembled quickly while a vast throng, slaves and millionaires, elbow to elbow, waited in the forum outside for tidings of the emperor's action. The letter (TARP, but probably not an August Surprise) was read to the Senate then to the forum as a breath of relief swept over the waiting multitude.
Tiberius was a wise ruler and solved the problem with his usual good sense (the analogy breaks down a little right here). He suspended temporarily the processes of debt (debt forgiveness and Fed mortgage purchases) and distributed 100 million sesterces from the imperial treasury (TARP) to the solvent bankers to be loaned to needy debtors (AIG, U.S. Banks, GM and European banks) without interest for three years (Fed funds rate at zero). Following this action, the panic in Alexandria, Carthage and Corinth quieted (the quiet before the double-dip storm, as the debt problem is actually far worse today).
This ancient Roman panic quieted, but marked the beginning of the end of the Roman empire. It was downhill for the empire after this panic. Nero was clearly under added stress. The current debt crisis of the global economy has not yet quieted. In fact, it is growing louder daily as the reality of the coming double dip is now sinking in. The debt crisis during the height of the Roman Empire is interesting, but where government policy involvement and debt cancellation gets particularly relevant to the rumored August Surprise is even further back in human history than Roman ruins.
The Jubilee passage found in the Levitical law in the Bible is highly relevant to the global debt crisis. This text was written well over a thousand years before the Romans got into the debt-cancelling act. Read it carefully. The Jubilee law was actually crafted astutely to prevent the buildup of excessive debt levels in the economy, and not primarily to justify its cancellation. Debts were only forgiven if banks violated the Jubilee law that prevented the buildup of excessive debt. The Jubilee was not a bank bailout or stick taxpayers with others bad debts. Consider the passage from Leviticus 25: 8-19. This ancient text provides remarkable insight into the current global financial crisis, which is at its heart a global debt crisis.
Every fiftieth year, on the Day of Atonement, let the trumpets blow loud and long throughout the land. For the fiftieth year shall be holy, a time to proclaim liberty throughout the land to all enslaved debtors, and a time for the canceling of all public and private debts. It shall be a year when all the family estates sold to others shall be returned to the original owners or their heirs.
What a happy year it will be! In it you shall not sow, nor gather crops nor grapes; for it is a holy Year of Jubilee for you. That year your food shall be the volunteer crops that grow wild in the fields. Yes, during the Year of Jubilee everyone shall return home to his original family possession; if he has sold it, it shall be his again!
Because of this, if the land is sold or bought during the preceding forty-nine years, a fair price shall be arrived at by counting the number of years until the Jubilee. If the Jubilee is many years away, the price will be high; if few years, the price will be low; for what you are really doing is selling the number of crops the new owner will get from the land before it is returned to you.
You must fear your God and not overcharge! For I am Jehovah. Obey my laws if you want to live safely in the land. When you obey, the land will yield bumper crops and you can eat your fill in safety.
If the Jubilee law was followed, there would be little debt to forgive. The current global debt crisis has created overproduction, inflation and a global economy now caught in the midst of a long wave winter season. The crisis would not have been nearly as bad without all the government sponsored, taxpayer-backstopped debt at Fannie and Freddie and elsewhere that is now going bust. The Jubilee debt forgiveness law would likely not work in our complex modern economy, but its message and warning is clear, limit debt leverage. The point here is not to recommend the institution of a Jubilee law; it is to point out the insight provided by the law into any debt forgiveness policy.
The Jubilee is very different from a government edict cancelling the mortgage debts of one group of unproductive debtors and transferring those debt obligations to productive citizen and taxpayers that have played by the rules and are paying their mortgages. That would be unconstitutional legalized theft and would cripple contract law. It would only increase the debt in the system because government would have to get a piece of the action to manage a program that shifts the debt onto others. In addition, real estate prices would still crash.
The year of Jubilee was not a law for wealth redistribution; it was a law of debt collapse prevention. Only lenders with weak underwriting standards and that lent money to borrows that could not repay their loans before the Jubilee year would be penalized by having debts owed to them forgiven. Poorly managed banks would not survive past one Jubilee cycle. The government policy in this crisis has been to reward them for their banks for bad behavior.
What is particularly interesting about the Jubilee, are the parallels with the Kondratieff long wave theory. The Jubilee would have limited excessive debt, production and prices, the three key drivers of the long wave cycles. The long wave is a 48-64 year boom and bust cycle that in many ways acts as a modern day Jubilee. The current one began in 1949. Modern free market international capitalism does not have the Jubilee, but has the economic long wave, where debt, prices and production rise and fall in a long wave boom and bust cycle.
If you don't see the connection between the Jubilee and the long wave, then current collapsing global long wave debt bust deflationary winter season replete with global overproduction probably took you by surprise. Long wave theory, with remarkable parallels to the Jubilee, has been validated by research in System Dynamics research at MIT. It appears as if the author of Leviticus was onto something about human nature and our tendency to repeat stupid behavior in long wave cycles.
If the Jubilee law were actually in place, the amount of debt leverage in the system would constantly be falling a few years after the Jubilee until the next Jubilee. Consider that if you had approached a bank to borrow $100 million on a 10-year note for a real estate project in 2006, you may have secured funding. That is if Wall Street assured your originating bank they would take the loan off their hands, bundle, securitize it, and sell it to a nun's retirement fund as AAA paper.
However, if the bankers and Wall Street knew that 2012 was the Year of Jubilee and all debts would be cancelled in one great debt collapse of Biblical proportions, then loans would not be made that had not been thoroughly reviewed in underwriting; and no loan would be made to anyone that came due after 2012. Debt levels would constantly be falling under a Jubilee law, not rising. This law has now been turned upside down. Bad debtors and bad bankers are rewarded, and prudent savers are punished by being forced to pay for bailouts and earn artificially low rates on their savings.
Yes, I intentionally picked 2012 for a year of Jubilee in my illustration because my long wave cycle research and smaller business cycle research suggests it will mark the transition from the long wave winter season into a new long wave spring season, driven by emerging markets. The smaller cycles are the key to understanding where we are in the larger cycles. The global debt collapse that is now accelerating into 2012 is effectively a modern day Jubilee, manifested in the global long wave cycle bust years.
Taking the unpaid debts of one group and loading them onto another is not a rational policy. Unfortunately, those at the switch appear to be incapable of looking beyond the next election cycle, so they float trial balloons of debt cancellations to test the political waters that now rise to a tempest in the teapot.
Government needs to get out of the way. Unfortunately, most politicians appear foolish enough to believe that more debt can fix a debt problem. They are wrong. The only way to address a debt problem is to reduce the amount of outstanding debt and create conditions for a booming economy and new long wave spring season that will grow the global economy out of the legitimate debt that does not fail in the crisis. The first step is radically changing the tax code, which will deliver the growth required. We need to abolish the income tax for a flat sales tax. The economy would boom. If you would like to learn more about the real causes and the only policy solutions to the mess we are in, read Jubilee on Wall Street; An Optimistic Look at the Global Financial Crash.
The only thing worse than bankers being bailed out by hard working citizens around the world would be an August Surprise that takes the debts of those that can't pay their mortgages and force others to pay them. Punishing good behavior and rewarding bad behavior appears to be the new political strategy. Give me a break. If a mortgage can't be repaid, stick it to the banker that made the loan, not the next door neighbor. If the bank fails, it fails. The days of any politician that cannot get these basic concepts straight are numbered.
It's August, but a November surprise is coming. However, the real change is likely not coming until 2012. The long wave debt collapse and the natural beginning of a new long wave spring season will change everything in 2012. The year 2012 will effectively be a modern day Jubilee on Wall Street and globally. A new age of international free market capitalism will emerge from the burning wreckage of crony state capitalism around the world. Adam Smith called it The Great Republic in The Wealth of Nations. The Great Republic will make the Roman Empire at the height of its glory look like child's play.
