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The PIC - Connections

Page 5

That apparent wealth shows its true nature when one aggregates the appraised values and calls it the basis of an investment. This is make-a-believe money. If a investment seller shows what appears to be a real asset and goes about actually selling it to people and fund managers who believe the value to be real, it is make-a-believe wealth.

Mortgage lenders used a combination of legitimate accounting practices to make believe that they had an investment that was worth investing in. In make cases they used make-a-believe money that is created by the following approach. They lend $100,000 as a mortgage for 15 years at some interest rate. Typically, that mortgage will be worth $200,000 by the time all payments are made. That is a 100% return on the principle. Divide that by the 15 years and the annual return is 6.6%. The specific numbers vary seasonally and over time, but the concept remains the same.

After lending the $100,000 the lender can wait 15 years to get all his principle back along with his interest. Alternately he can sell shares of the investment to numerous buyers. He takes the original $100,000 and adds the make-a-believe interest total to get a value of $200,000. Now he sells the "assets" as shares for a total of $150,000. He has made an immediate $50,000 gain and the investors will get $50,000 if the mortgagee actually pays off the loan over the 15 years. If he defaults, the share buyer lose. If he pays off early, the share buyer loses. The way to minimize this affect is to bundle 1000 such mortgages so as to average down any specific repayment anomalies. In good times only a few mortgages go into default. But as we have seen in 2007-09 it is possible for the hollow investment schemes to collapse.

Although the share buyers may have lost hundreds of billions of dollars, share sellers walked away with much of the money. The homes of sellers on which mortgages were given, walked away with a lot of the money.

Although it was in 1991, the woman who sold her house to my wife and me made $100,000 gain and move to Florida to play golf until her body would give out and she would be destined to die suddenly or decompose slowly in nursing care. We were willing to pay her price and it was fair. That house peaked out at three times our purchase price in 18 years since. I could have removed all the free equity through a refinance plan while the value was peaking and created a lot of make-a-believe wealth. Fortunately I did not or it would be exceedingly difficult to sell it when I need to sell.

There is no one culprit in the economic collapse of 2008-09. We are all part of the problem and we are all part of the solution. There have been innocent failures and there have been frauds perpetrated over decades by unscrupulous financiers that only have been uncovered by the collapse of the system. There has been government promulgated mortgage lending policies that worked for a while but which eroded the foundation of the system and softened the beams of the building. Each fraud and policy by itself was insignificant to cause system failure, but all as an aggregate, they were. That is what the Principle of Imminent Collapse warns us about.

The true disaster of the global recession economy will impact the larger less industrial nations in particular, China. China was speeding along toward urbanization and an industrial economy. They were building at a frenetic pace to keep up with population growth. The loss of export revenues has all but shut down that building pace. The government still has a surplus of funds to afford that building of urban environments, but there is little commerce to support such a lifestyle. They who were expecting to be urban dwelling employees will now be relegated to the agrarian lifestyle for as long as the recessionary trends persist. The hopes pinned on the younger generation to provide support for elderly parents is being undercut. Funds borrowed from relatives and neighbors to educate the one child of the family was their retirement plan in a country that has little in the way of government provided retirement income.

Many people, such as myself, in the US are hard hit in the retirement accounts. Many of us will recover. We will not starve or freeze in the dark. But worldwide including the US there are millions of people who were already at the margin and will be on the outside of the circle of drawn wagons that protect those on the inside. It is for those populations that bailouts and stimuli are necessary or they will starve and freeze in the coming darkness.

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