The Market Ticker
Commentary on The Capital Markets- Category [States]

I've had people in the so-called financial industry, and their captive media, scoff at me when I explain exactly how the so-called "economic growth" we've posted up over the last 30 or so years has been a scam -- and more-importantly, why it cannot continue.

To recap the reason for all of this (and the ramp in the markets over the same 30 year period) is this:

Rates are at 10%.  You can borrow $1 million as long as you can come up with $100,000 in interest every year.  Note that the expectation is that you would pay off said bond when it matures, so if you're going to do that in five years (a 5-year bond, not an amortized loan) you'd need to come up with $1,500,000 -- $1 million in principal for the bond 5 years hence and and $500,000 for the five years of interest payments (the latter typically being paid out quarterly.)

But if rates are generally declining on a secular (long-term) basis you can cheat, and this cheating is both very seductive in the short term and extraordinarily destructive over the longer term.

In the short term if the rate of interest declines on a secular basis in five years it looks awfully attractive to roll over that bond instead of pay it off, as the interest rate has gone down.  Much more-dangerously, however, it also looks attractive to keep the interest payment the same and borrow however much more you can by writing an even bigger bond!

So let's assume that in five years the rate of interest is 5% instead of 10%.  You have had $500,000 over that five years in sunk interest cost.  But now you roll over the debt instead of paying it off, and since you do so at 5% you borrow another million dollars by writing a second bond, both of them five years in duration.

Note what happened here -- your original expectation was that you'd have to lay out $1 million to retire the bond.  Instead you kept it and added another million to it.  This is a net $2 million you can spend that you otherwise would not be able to; an utterly enormous "windfall" that appears to literally come from the sky.

So long as this trend continues so does the scheme.  When the $2 million is due if rates have fallen to 2.5% you can now borrow not 2 million but $4 million, and so you do.  The swing in your municipal budget is not $2 million (since you otherwise would have had to lay out the $2 million, but rather $4 million dollars, and all you have to do is keep coming up with that $100,000 a year to keep the scheme going.

That is exactly what has happened in the municipal finance game, in the Federal Government finance game and in the corporate and personal finance game.  It has continued through all of the last 30 years including the 2008 crash!

What happens, however, when rates stop going down?  You suddenly have a problem.  If they don't rise but simply flat-line then while you may be able to roll over that bond you can't borrow more.  So if you had $4 million out you still do and the net "gain" that was magically appearing in your municipal budget stops showing up.

This is what has happened here:

One reason for the lack of borrowing: officials at local governments that were stung by budget shortfalls after the recession have been leery of taking on new debt. Instead, they’ve been seizing on low interest rates to refinance higher-cost bonds. About two-thirds of the $312.5 billion issued through Sept. 30 has been for that purpose, Bank of America Merrill Lynch data show.

Got it?  The state, county and local governments have been refinancing -- but they cannot keep borrowing more, they instead must keep refinancing in order to keep the interest payments manageable.  Note that nowhere is ever mentioned paying off the principal on any of these bonds because that almost-literally never happens.

We have backed ourselves into a corner with ponzi finance and scam in the government sector across the board.  This problem is not limited to the Federal Government; it also exists at the state and local level and in fact in many ways its far worse there than on the federal side, since the exposures there are often not subject to simple legislative action.  Many of the baked-in-the-cake expenditures have managed to grab state constitutional protection which, absent an amendment to same, is virtually impossible to slough off.

This is going to blow up in our faces folks, and I've been warning about it for a long time.  It is an irrefutable mathematical fact that these leverage levels are unsustainable -- and there is nothing that can be done about it now other than living with the relative privation that will and must come in this regard.  The people responsible, including especially the folks at the big banks and other financial outfits that did the book-running for these deals, should be prosecuted for running a ponzi scheme and tossed in prison with the assets of their firms sold off and used to plug the holes to the extent possible, but you know that won't happen any time soon either.

There is no such thing as a free lunch and if you believe you've found one what actually just happened is that you got scammed.

View this entry with comments (registration required to post)

2015-09-09 10:41 by Karl Denninger
in States , 243 references

A baby on the label of a beer bottle encourages underage drinkingsays the State of Michigan -- and forces Founders to remove it.

Michigan has followed New Hampshire by banning the sale of Founders Brewery’s Oatmeal Breakfast Stout because a baby appears on the label

The Grand Rapids-based brewery announced last week it was changing the label after the image was said to promote underage drinking.


Those of you who live in Michigan -- you allow this sort of crap to go on in your state?

And don't start with it being "no big deal" either; liberty is always and everywhere a big deal and when you enable and promote laws that punish acts which have no relationship to the alleged harm you are enabling a group of people to act as bullies and thugs.

If you're going to do that and allow it to go on why should anyone else not respond to you in kind?

Update 2015-09-09 15:00 CT: The MLCC has responded to my telephone inquiry on this matter -- here is their written response:

“We in no way, shape or form ordered them to change the label. The U.S. Constitution's First Amendment and the U.S. Alcohol and Tobacco Trade and Tax Bureau (TTB) govern and regulate label issues, not the state.”

Founder's entry on the matter is found on their web site.

The two appear to be in direct conflict at first blush......unless, of course, the MLCC's response is full of weasel words (e.g. they didn't force a label change, they just banned the sale of said labelled beer!)  I will spend some more time on this and if I am able to get anything definitive I will update this entry further.

View this entry with comments (registration required to post)

Main Navigation
MUST-READ Selection:

Full-Text Search & Archives
Archive Access

Legal Disclaimer

The content on this site is provided without any warranty, express or implied. All opinions expressed on this site are those of the author and may contain errors or omissions.


The author may have a position in any company or security mentioned herein. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Market charts, when present, used with permission of TD Ameritrade/ThinkOrSwim Inc. Neither TD Ameritrade or ThinkOrSwim have reviewed, approved or disapproved any content herein.

The Market Ticker content may be reproduced or excerpted online for non-commercial purposes provided full attribution is given and the original article source is linked to. Please contact Karl Denninger for reprint permission in other media or for commercial use.

Submissions or tips on matters of economic or political interest may be sent "over the transom" to The Editor at any time. To be considered for publication your submission must include full and correct contact information and be related to an economic or political matter of the day. All submissions become the property of The Market Ticker.