THE BLOG
11/11/2011 09:08 pm ET Updated Jan 11, 2012

The Debt Iceberg: What's at Stake?

Much has been said about the role of Congress and the Federal Reserve and Wall Street in largely engineering an unprecedented financial bubble, in the trillions. Two enabled, the other executed. Then, human nature went to work.

The Titanic hit an iceberg when those at the levers pushed it too far. Only in our case, it's a debt iceberg.

How big is the U.S. debt iceberg?

U.S. national debt is right near 15 trillion. Add in unfunded liabilities and we're well over 100 trillion (who can even count after that first 100 trillion... ).

Worldwide government debt is north of 40 trillion. Not to mention hundreds of trillions in derivatives. Worldwide GDP is nearly 60 trillion. Is there enough growth or assets to back this up?

Bailouts, stimulus, borrowing, quantitative easing (in effect, money printing) and the Federal Reserve's buying up bank bad debt, helped form this massive debt iceberg. Debt and falsehood (and there was plenty of it in the making of the housing bubble) have no intrinsic value. Did we think we could create value with that which has none?

Housing prices therefore reached artificial levels. Naturally, artificially created prices deflate to the level of affordability. Affordability is a function of the ability to service debt -- that's why jobs and wage growth are key to putting support beneath housing prices. The debt that supports the assets needs to be re-structured, too, in a way to keep people in homes that could, with a little help, afford them. But that takes time, as each case is different.

It takes two, to work it out, to sit down person-to-person. The way banking and business used to be. Maybe the crisis would not have run so deep had banking not been concentrated in a handful of big banks. Part of the problem of working through this housing crisis is that we've gotten so big to the point of being "out-of control," no matter how much we automate. Maybe there are limits to automation and cost-cutting. Look no further than the robo-signing fiasco and handling of the foreclosure crisis. It appears rather difficult, now, to handle millions of home cases, to even reach a human voice to talk to. Maybe there's something to human interaction and community orientation.

As a nation, we're throwing more debt after bad debt to keep afloat the contraption we built over decades. It appears endless. A free market economy is exactly that -- allowing free market dynamics to work so that prices clear the market, allowing faulty mismanaged businesses to fail before much damage is done.

Bailouts continue. Matter of fact, the American people may just be bailing out the entire U.S. economy after bailing out Wall Street. Taxpayer dollars continue to fund Fannie Mae and Freddie Mac (to the tune of well over 100 billion since the 2008 crisis). So we're, in effect, paying for badly originated mortgages. Yet Fannie Mae and Freddie Mac top executives were awarded, just recently, 13 million in bonuses.

Is this not perplexing, astounding, conflicting, ominous or Orwellian?

For all the strategy and the discipline of implementation that goes into campaigning (with the goal of getting elected) what happened to governing?

As in creating an environment that fosters growth and jobs so all may benefit. Creating jobs means recreating what a free market enterprise system is meant to be -- many competing on a level playing field (rather than a system that's in part morphed into monopolistic capitalism). And that means breaking down the barriers that now keep many from being able to start and operate a small business (and small business is the key, as it provides 65 percent of jobs). If we don't make the necessary structural changes, change may be imposed upon us.

As with Greece. Did Greece anticipate the sudden turn of events? Their bonds are worth, for now, 50 cents on the dollar. The affordability component is missing. How can Greece grow an economy, to pay off debt, under the weight of existing debt and austerity (which leads to contraction)? We come back to the notion that assets backed by falsely created debt (like liar loans) or debt based on overpromising and overspending (like Greece) in time devalue themselves.

Sounds to me, that time-tested responsibility needs a revisit. History shows us that freedom without responsibility naturally leads to anarchy.

Now, if one traces the development of financial instruments over the last few decades, it parallels the cultural shift from one of self-reliance and assuming responsibility to off-loading responsibility. Increasing dependence upon the government to be all things to all people (including bailouts) is simply unsustainable. Look no further than the path of the Euro zone.

Let me further explain.

Seems to me that financial innovation (exotic instruments, derivatives or securitization) became all about finding ways to off-load risk on to someone else. The financial world did just fine before the dawn of derivatives. A bond manager bought a bond after much homework, monitored its credit-worthiness, and sold it if there was a problem.

Sounds like we're at a crossroad.

There's a scene in Alice In Wonderland where Alice meets the Cheshire Cat at a crossroad.

Alice asks, "Would you tell me, please, which way I ought to go from here?"

"That depends a good deal on where you want to get to," said the Cheshire Cat.

So where's the developed world headed?

Depends on where we want to go. Do we seek truth and reality, or fiction?

Note the following:

"Sovereign debt has lost its apparent risk-free status," Hervé Hannoun, deputy director general of the Bank for International Settlements, said in a recent speech in which he called for an end to "the fiction." To restore confidence, he concluded, the world needs to move "from denial to recognition."

For all the talk about transparency (maybe the 21st century word for honesty) it's been anything but that in the last decade. There was a looking away when some warned Congress of pending subprime lending dangers. There was a push back when some warned about derivatives.There was a looking away when a whistleblower warned of Bernie Madoff's ponzi scheme. There was a push back when some warned that Euro zone sovereign debt may lead to the next subprime crisis.

What's disturbing is that the beat goes on. There was a push back when regulators tried to restrain MF Global's risk-taking, concentrated bet on Euro zone sovereign debt. MF Global was not just the first casualty of the Euro zone sovereign debt crisis. It shows up naked truth, what's still wrong with the system (after 2300 pages of Dodd-Frank) -- use of high leverage, concentrated excessive risk-taking, the alleged $600 million missing customer funds, political influence.

Now back to the Euro zone.

Is Greece like Bear Stearns (the weakest link, first to break back in 2008), then Italy, then... maybe it's only the beginning of all over again. In 2008, private-sector bad debts were absorbed by governments. Who will absorb government debts? Will the only outlet be expansionary monetary policy?

The pain, then, will be felt by the people through extraction of wealth, be it taxation, austerity, devaluation of currencies. The much written and talked about wealth schism will only widen. Will
history then remember the beginning of the 21st century as the great wealth extraction, or dream extraction, or a developed world in moral hazard?

Like a multiple choice question -- A, B, C or D (all of the above). As I read ongoing headlines, thoughts like this swirl in my head.

Read about a young individual who did everything by the book. You know, go to college, get good grades. A fast food chain won't even call back upon a job submission. No job, no dreams. No dreams, then what?

Youth unemployment in the U.S. remains troubling. Spain's stands at 40 percent. Within the Euro zone, some have been in a temporary employment waiting room at one place for over a decade -- waiting for the promise of permanent employment to be filled.

Talk to young folks here in the U.S. lucky enough to have a job, the same refrain. I feel like "I'm in a waiting room" or "I feel like I'm swooshing about laterally."

Are we moving forwards, backwards, or standing still in circular motion, with technological advances, financial engineering?

In 1952, Albert Einstein prophetically wrote, "overburdening necessarily leads to superficiality." In his poignant piece "Education For Indepenedent Thought," he goes on to note, "It is essential that the student acquire an understanding of and a lively feeling for values. He {or she} must acquire a vivid sense of the beautiful and of the morally good." Otherwise, (Einstein goes on to elaborate), one becomes rather robotic with specialized knowledge only.

Note the "hubristic emails of the Goldman Sachs trader Fabrice Tourre:"

"More and more leverage in the system," wrote "Fab" to a girlfriend. "The entire edifice threatens to collapse at any moment. Only potential survivor, the fabulous Fab... standing in the middle of all these complex, highly levered, exotic trades he created without necessarily understanding all the implications of those monstrosities."

Then this:

"Anyway," he went on, "not feeling too guilty about this, the real purpose of my job is to make capital markets more efficient and ultimately provide the U.S. consumer with more efficient ways to leverage... himself, so there is a humble, noble and ethical reason for my job ;) amazing how good I am in convincing myself !!!"

"Implications of those monstrosities?"

Shattering of dreams, impoverishment of millions through debt. Freedom and democracy are at stake.

Ask the Greek people. Did indebtedness take away their ability to live freely, to have choices?

Frightening.