There Is No Way Out Of This Box

Posted by Karl Denninger

There Is No Way Out Of This Box….

… that does not involve serious pain.

Go ahead folks – tell me how we can simply ignore this.

How we can pretend that the outstanding debt does not have to come back down to reasonable levels.

That these levels are “reasonable” – and that these rates of growth are “reasonable.”

This is the “magic of compounding” writ large – and in a fashion that is going to inflict severe pain on our population – and the longer we wait to deal with it, the worse it will be.

Bernanke, who was at The Fed during Greenspan’s time there, should have used his “education” – his claimed knowledge of economics – to make a lot of noise about this and demand that interest rates NOT be lowered to further encourage more debt-based consumption. 

He did exactly the opposite.

As this decade wore on he should have sounded the alarm on our debt binge in all sectors, especially in the financial and consumer sectors where the growth in indebtedness has been the highest.

He did exactly the opposite.

Since this crisis began, in fact, every single government official who has spoken on the matter has emphasized even more lending, that is, cranking the amount of debt outstanding even higher, and The Federal Government has made good on their intent by, in the last year, spending more than $1.7 trillion dollars they did not have – that is, they borrowed even more.

That “pumping” of credit is why the stock market has “recovered.”  

BUT IT CANNOT AND WILL NOT STAY “recovered”, because the debt that is outstanding is unsustainable – interest costs are crushing innovation and we are now absolutely reliant on near-zero interest rates lest everything collapse.

How bad is it?

During the same time period that we essentially doubled the debt of households, businesses, the federal government and financial institutions (2000-2009) we added just 40.8% to GDP ($10.129tn to $14.266tn)

You might think it wasn’t as bad from 1990-2000 – we went from $5.846tn to $10.129tn in GDP (a 73% increase) while household debt went from 3.58tn to 6.53tn (an 82% increase) and non-financial corporate debt from 3.768tn to 6.195tn (a 64% increase.)  This looks reasonable.  But financial leverage during that decade went from 2.613tn to 7.521tn, a monstrous 187% increase (!) and government debt from 2.613tn to 7.521tn, also a 187% increase (!), both nearly double the GDP growth rate.

The 1980-1990 years?  GDP expanded from $2.915tn to $5.846tn, a clean double.  Pretty good!  Consumer debt, however, went from $860 billion to $3.58 trillion, a 316% increase.  Non-financial corporate leverage went from $1.387tn to $3.768tn, a 172% increase, the Federal Government went from $668 billion to 2.498tn, a 273% increase and financial leverage went from $526 billion to $2.614tn, a 396% increase.

The path we have chosen for the last 30 years in this country is clear, convincing, and impossible to continue upon


We have not created GDP growth through final demand procured as a consequence of production – that is, people like you and I working with our hands or minds to produce something, then spending the fruits of that labor to buy the things we want and need.

Instead, we have used financial leverage to present to ourselves and the world a false belief and “visage” of prosperity that in fact did not and does not exist, with the continuation of this charade absolutely dependent on the unending ability to forever take on more and more debt compared to growth in actual economic output.

Let’s just take ONE example of this: Larry Summers, President Obama’s “chief economic advisor”, thought he could outrun the math at Harvard – where he gave approval to enter into complex derivative trades.  They blew up in the school’s face:

The swaps, which assumed that interest rates would rise, proved so toxic that the 373-year-old institution agreed to pay banks a total of almost $1 billion to terminate them. Most of the wrong-way bets were made in 2004, when Lawrence Summers, now President Barack Obama’s economic adviser, led the university. Cranes were recently removed from the construction site of a $1 billion science center that was to be the expansion’s centerpiece, a reminder of Summers’s ambition. The school suspended work on the building last week.

“For nonprofits, this is going to be written up as a case study of what not to do,” said Mark Williams, a finance professor at Boston University, who specializes in risk management and has studied Harvard’s finances. “Harvard throws itself out as a beacon of what to do in higher learning. Clearly, there have been major missteps.”

MISSTEPS?  This is fifth-grade math!  It is willful and intentional ignorance of fundamental and basic mathematics over the last 30 years that is the proximate cause of the mess we are in today – a mess that to this very day none of these jackasses will come out and talk about or have an honest debate over!

These are the so-called “bastions” of higher education – the places where so-called “experts” receive what is claimed to be an “education” in how finance and business work.  If you need an explanation for how our government, regulators and businesses could possibly be so dumb as to make this sort of mistake over the course of three decades you need look no further than the “intelligence” displayed by these institutions. 

That there are actually people – young and old – who pay $40,000 a year or more for this “quality” of education (and they then use that sheepskin to infest business and government alike) simply demonstrates that  PT Barnum was right: There really is a sucker born every minute.

Let me be clear lest anyone misunderstand me: There is no means by which we can return this economy to reasonable forward prosperity except by first deflating the excess debt, even though doing so will cause those who have too much leverage outstanding to fail – that is, go bankrupt – either as consumers or businesses.

We have in fact hit the wall, as I clearly stated had occurred simply from an examination of the math in the middle of 2007.

The facts are in and the math is incontrovertible.

To the politicians of both major political parties: 

You can either deal with reality or have it slap you upside the head in the form of political, economic and civil collapse.

To the people of this nation:

You can either deal with reality and be prepared for the politicians refusing to deal with reality, or you will suffer the consequences of being unprepared when, not if there is political, economic and civil collapse.

Ben Bernanke absolutely must not be reconfirmed.  He has been aware of these figures as a scholar and as a Fed Governor for more than a decade (the tables from which that graph was produced are from The Federal Reserve itself) while absolutely refusing to discuss them in public in an honest and forthright manner. 

What’s worse is that even today Bernanke has refused to take responsibility for his part in intentionally engineering this disaster and allowing it to continue to the point of near-literal insolvency of not only the private sector but government as well!

Our Congress and President absolutely must deal with this reality right now.  Not tomorrow, not next week, not next year or after the elections.  NOW.  “Health Care Reform” is important but this nation will not make it to 2013 when the “new plans” come into effect if actions are not taken NOW to reverse what is going on here.  We can and must address entitlements and health care generally – after we get the immediate situation under control.

It is my belief that our Congress and President WILL NOT deal with this reality, and therefore it is incumbent upon each and every American to be prepared – from this point forward – for the inevitable mathematical consequence of the willful refusal of our Congress and Executive to address the issue of excessive leverage in our business and consumer lending space.

There are many things that Congress and our Executive Branch can do right now to address these issues; among them:

  • The immediate re-instatement of Glass-Steagall and both replacement and enforcement of hard 12:1 leverage limits for both banks and other financial institutions, without exception, loophole or dodge.  Fractional reserve lending is a privilege that must come with strong protections against over-expansion of credit in the system and systemic instability.
  • The immediate withdrawal of excess liquidity from the banking and financial system and the forced marking to the market, recognizing the losses that have occurred already, even though this can (and will) bankrupt many institutions and individuals.  Bankruptcies clear debt and reduce the numbers in the above table.  This must happen, even though those affected will feel economic pain.


  • The re-imposition of usury laws; this will stop debt-pyramiding by corporations and individuals.  I suggest a hard cap of 10 or 15% over “Fed Funds” for all loans; if a bank cannot make money with a gross profit margin on funds of 120% (12:1 leverage @ 10% over cost of funds) they are doing something very, very wrong – like lending to people who can’t pay back the money they are lent.

  • An absolute ban on “naked” credit-default swaps.  These are gambling instruments to the extent they do not represent an actual insurance policy against an actual insurable risk.  To the extent that they, or any other derivative, represents a legitimate hedge against economic risk we must insist that the instrument be traded on a public exchange with a published bid, offer, last and open interest with a neutral middleman counterparty exactly as is done today for listed options and futures.  This will guarantee nightly mark-to-market accounting and margining for all positions and end the thermonuclear threat these instruments pose to the financial system.


  • ALL banking system regulators who oppose any of these positions or who will not swear an oath under criminal sanction to enforce and uphold these operating standards must be relieved of their positions and replaced.  No exceptions.
  • Each and every one of these positions has been brought up by myself in the past in previous Tickers.  We have seen time and time again over the last two and a half years that banking regulators coddle the regulated entities and enable lying, cheating and in many cases outright fraud.

    As our government has fiddled our financial system has burned.  It has not been stabilized by the actions of The Fed and Treasury; rather, it has been made more dangerous and less stable while those who committed evil and knowingly-unsound acts have been allowed to further asset-strip Americans and enrich themselves.

    But irrespective of what people – including Congress, The Administration or even Wall Street want, the math simply can’t be argued with.

    Beware and be prepared America.