Article below is a reprint from S&A Digest and was written by Porter Stansberry. I hope this is an eye-opener and educational for you as it was for me.
How to Stop The End of America… A few secrets from Warren Buffett… The Project to Restore America...
Here I go again… By now, almost everyone reading the Digest knows we set aside Friday's for me (Porter) to write personally. And though I've rejected the idea that people can teach anything (there is no teaching, only learning) – I can't seem to help myself. If you're tired of suffering through these lessons, you'll be happy to know my impulse to empower our subscribers by showing them a few of the more unpleasant truths about finance has cost me a lot of money.
As I knew they would, my essays about the importance of cash and the one last week about asset allocation (when you buy what) resulted in a torrent of refund demands – about $1 million worth in the last two weeks. So if you got something out of those essays, do me a favor: Buy something. Anything. Preferably something expensive.
It is a quirk of human nature that most people don't want to learn anything new and react negatively to anyone who challenges their deeply held views (even when they're obviously wrong). You'll know I'm truly a glutton for punishment when you realize the subject of this week's Friday Digest: Our country's severe financial crisis.
Writing about this topic has led to far greater problems than cancellations. I've gotten threatening letters and angry e-mails from folks who seem to believe that pointing out these dangers is tantamount to causing them.
More than two years ago (December 2008), I first warned in my newsletter that America would eventually lose its world reserve currency status and our debt crisis would lead to a massive inflation. I call this complex series of issues the "End of America." Not because I believe it will lead to the end of our political union (though it might), but because I believe we're heading into a crisis that will be far worse than anyone has yet realized. The crisis will result in a significant decline in our standard of living. These are deadly serious issues and I meant every word I wrote.
Even so, two years ago, lots of folks actually laughed at me – including a few in my own office. Not anymore. If you saw the Wall Street Journal headline yesterday (the "Why the Dollar's Reign is Near an End") or if you saw Sam Zell (the most successful real estate investor of all time) yesterday on CNBC, you know many of the smartest folks in our country take my warning seriously. Said Zell:
My single biggest financial concern is the loss of the dollar as the reserve currency. I can't imagine anything more disastrous to our country… you're already seeing things in the markets that are suggesting that confidence in the dollar is waning… I think you could see a 25% reduction in the standard of living in this country if the U.S. dollar was no longer the world's reserve currency. That's how valuable it is.
So today, I want to update some key figures of my End of America report. I want you to know where we stand. This is important enough to risk the inevitable criticisms (and refunds). But I want to take one criticism out of play right now. Don't bother writing to complain about my "politics."
This has absolutely nothing to do with politics. This matter is purely about economics. The facts, as you'll see, are completely clear to anyone who bothers to learn them. We are spending way beyond our means – both publicly and privately. Worse, this spending has warped the incentives in our economy, resulting in not only debts we can't afford, but outcomes we don't seek. At the heart of this crisis, there's a knowledge problem. Most Americans don't understand even the most basic facts about our country's financial position, nor do they take the time to consider the likely outcome of poorly structured government programs.
So please, don't write to me about politics. I don't care about the Democrats, Republicans, or even the Tea Partiers. I don't care whose "fault" it is, because these debts belong to all of us. I care about the people who live in America… people who are going to be wiped out because of feckless leadership and genuine ignorance. I can't do anything about our leadership – that's up to you. I can try to do something about the ignorance.
In our search for facts and solid financial thinking, let's start with Warren Buffett, who is neither feckless nor stupid. Buffett is the world's best investor. He got that way primarily by figuring out how to correctly value equities and allocate assets… and because he learned one of the most valuable financial secrets in modern finance: why insurance companies are so valuable. (Hint: It's the float. But that's a discussion for another day.)
Buffett has become a sort of "rich uncle" to America, giving helpful advice about financial matters. And he recently said something that struck me as profound – something I'd wager almost everyone else ignored. Buffett explained why the buyers of his mobile homes (Clayton Homes) default at rates (1.86%) much lower than the national average for homebuilders (more than 25%). That's true, even though the buyers of his mobile homes typically have low incomes, less job stability, and lower credit scores than the buyers of conventional housing. If you read nothing else in today's Digest, please pay attention to what Buffett says here:
Our borrowers get in trouble when they lose their jobs, have health problems, get divorced, etc. The recession has hit them hard. But they want to stay in their homes, and generally they borrowed sensible amounts in relation to their income.
In addition, we were keeping the originated mortgages for our own account, which means we were not securitizing or otherwise reselling them. If we were stupid in our lending, we were going to pay the price. That concentrates the mind. If homebuyers throughout the country had behaved like our buyers, America would not have had the crisis that it did. Our approach was simply to get a meaningful down payment and gear fixed monthly payments to a sensible percentage of income. This policy kept Clayton solvent and also kept buyers in their homes…
A house can be a nightmare if the buyer's eyes are bigger than his wallet and if a lender – often protected by a government guarantee – facilitates his fantasy. Our country's social goal should not be to put families into the house of their dreams, but rather to put them into a house they can afford.
Pretty simple, eh? Don't sell houses to folks who can't afford them. And make sure both the lender (who kept the note) and the borrower (who made a down payment – equity) have plenty of "skin in the game."
You don't want to create any incentive for the deal to go bad. You want both parties to have a powerful incentive to do what they've promised. After ignorance, almost all our country's core problems come back to these same issues: a lack of equity and poorly designed incentives. Remember these concepts. You'll see them again: skin in the game (equity) and properly designed incentives.
Let me take on the toughest problem first: Medicare/Medicaid. Since the government established this program in 1965, it has amassed a $5.6 trillion deficit. This program alone accounts for 40% of our government's total debt. If you could erase these debts, our most recent two foreign wars (Iraq/Afghanistan), and the losses associated with the recent financial crisis, you could eliminate more than half our entire federal debt – a debt threatening to destroy our way of life.
Whether you'd choose to eliminate these debts by eliminating these programs is a political question. I'm not going to discuss politics here. The point I'm trying to make is, regardless of what you'd choose, we have to make a choice. We can't afford to do all of these things.
Like the subprime buyers in the housing bubble, we've bought a government we cannot afford. That's a simple fact. It should be obvious to any thinking person that when government spending makes up 45% of GDP (as it does today) and there's one government employee for every six households, something has gone terribly wrong with America.
When my parents were born, America was still the land of the free. The incentives people faced were different. Before World War II, the federal government made up only 3% of GDP. It didn't provide health care. People had to maintain their health, as best they could. People didn't depend on Ponzi finance (Social Security) for their old age – they had to save. They had to take care of their families and help take care of the unfortunate in their communities.
We didn't spend a lot on the military, either… which gave us an incentive to mind our own business. In fact, back then, our presidents promised to keep us out of foreign wars. Both Wilson and Roosevelt came to power promising to keep us out of the war in Europe. They lied. Almost every other president since has sent our boys to die for others wherever they could. War is good for business… and good for the government.
Lots of people reading this e-mail will say, "I don't want to live in a country like that, where the government doesn't provide a social safety net." Other readers might say, "I don't want America to be 'isolationist.' We need more troops overseas to fight terrorism." OK… So maybe 3% of GDP is not enough for the government we will choose. But 45% of GDP is much too large – again that's not a political choice; we simply cannot afford it.
So how then will we decide? My suggestion: Pay more attention to incentives. And demand much more equity from the voters.
Here are some interesting facts:
In 1965 – when Congress created Medicare/Medicaid and greatly expanded the federal government's role in health care – about 13% of Americans were obese. Today, 32% of Americans are obese.
Before the government enacted Social Security, Americans typically saved between 15% and 20% of their incomes. Today? Almost nothing. In fact, for many years, the savings rate in America was actually negative.
Before the Great Depression, there wasn't any government unemployment insurance. Not surprisingly, there was almost zero long-term unemployment.
One more interesting fact… the U.S. didn't experience a Great Depression until the Federal Reserve was created. The main purpose of the Federal Reserve is to ensure that banks don't fail. Sounds good. But it provides a perverse incentive for banks to act recklessly, which causes bigger booms and busts – just like the one we're experiencing right now.
I'm not arguing government spending is the primary cause of any of these problems. But I am saying you'd have to be a fool to believe incentives don't play a big role in human action. Think about why all politicians try to spend more than they collect in taxes. They have a huge incentive to promise more than they can deliver – and to make up the difference by borrowing against future taxes or printing more money.
The problems created by the perverse incentives of collectivist actions are well known. They are as old as the ideas themselves. They explain why socialism and communism always lead to failure. And yet… we seem eager to pursue these policies in an almost mindless pursuit of bankruptcy. Why? That's not hard to figure out either.
What's the No. 1 reason people make bad decisions? They don't have to suffer the consequences. Which investors made worse decisions during the mortgage bubble? Was it the private hedge-fund managers, whose entire net worth was made up of the assets in their own funds and whose friends and families had invested alongside them? Or was it the senior managers of publicly owned banks, whose creditors were protected by the federal government and who owned little of their own company's equity?
That's easy to answer, even if you knew nothing about the financial crisis. Unless people have a stake in the outcome of an event, they are very likely to choose poorly or recklessly.
The most difficult problem we face today is, far too few Americans have any equity in our government. Less than half of all Americans pay any federal taxes. Don't listen to the nonsense about how almost everyone pays payroll taxes. It's true, but it's irrelevant. Payroll taxes don't come close to covering the costs of the entitlement programs they support.
Cutting government spending will be easy compared to trying to increase the average citizen's equity in government. But we must. People will always demand more from the government until they realize how expensive government solutions really are. And the only way to show them is to share the burdens of government more equally.
Now, I know what you're thinking… I'm making a political argument to reduce the progressive nature of our tax system. I'm not. I'm pointing out a simple fact: When half the voters don't pay for any of the true costs of the government, your society is going to suffer terrible governance.
A democracy that concentrates the overwhelming burden of government on a tiny minority of the population is no different than an investment bank making bad loans and then selling them to someone else. You can't separate the people making the decisions from the costs and the risks of those decisions. And yet, that's what we've done.
We've reached a point where we can longer continue on our current path. America spends 800% more than its nearest rival on its military. We spend 200%-300% more per capita on health care than any other similarly wealthy country. Are we safer? Are we healthier? I honestly don't think so.
And even if you believe we are, can we afford it? Here are the simple numbers. Americans now owe $56 trillion in total debt, much of it held by foreign investors. We must spend $3.5 trillion each year on interest. That is already more than the federal government spends, in total. I do not exaggerate when I tell you we cannot afford these debts. We will never be able to repay these debts – already equal to roughly four times our country's GDP. The largest components of the debts we owe are government debts… and they are growing rapidly and show no signs of stopping.
The only way to stop the debt crisis we face is to reduce the total level of government spending – immediately and permanently. We have to stop giving our citizens improper incentives. We have to increase the "skin" voters have in the game by spreading the burden of government more equally. And most important, we must take away the politicians' ability to debase our currency.
You see… politicians believe, as Dick Cheney famously said, deficits don't matter. They believe these debts can be safely printed away – which is what the Federal Reserve is doing right now.
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