In Part II of this series we briefly explore the difference between real wealth creation and paper wealth creation; that is real or honest profits versus paper or less than honest profits.

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The deployment of capital in risk taking endeavors can create new wealth or profit. We use the word can because though men act, there is no action they can take with 100% certainty of the outcome. There are no guarantees of profit or gain in the real world, only degrees of risk greater than zero and probabilities less than 1. Problems in our human economy occur whenever men conspire to cheat these natural constraints.

 

For those who should have been paying attention, this is not a new revelation. Two thousand years ago, haughty men ignored their fallibility and mortality such that more prudent men were inspired to admonish them,

 

“Come now, you who say, ‘Today or tomorrow we will go to such and such a town and spend a year there, doing business and making money.’ Yet you do not even know what tomorrow will bring. What is your life? For you are a mist that appears for a little while and then vanishes.”

 

Sadly, too many of our friends and countrymen have 401K and brokerage account statements reminding them now that they have put their faith in mists that appear for a little while then vanish. This is the bitter consquence for those who have chosen the comfort of promises and paper profits over the stewardship of money and acceptance of risk that is honest investment. How did it come to this?

 

Historically speaking, real wealth creation becomes possible by putting capital at risk towards catching, growing, digging, making, building, and so on, real tangible assets. Where this capital deployment is fruitful those involved are called producers. Profit is their reward for their contribution to a real increase in the amount of goods and services available to society. 

 

Alongside this real world economy of producers encumbered by all the risks of life, has grown a parallel economy that promises, to varying degrees, relief from the risks inherent to the attempts of these producers to be productive. This parallel economy is the financial community – a community where the stock in trade is an amorphous medium of exchange called money. 

 

The financial community, the money managers, can act either as symbiotic partners with producers or as a parasites. Under free-market conditions symbiotic partnership is the default state of affairs. Where there is no coercion or deception (force or fraud), rational producers tend to avoid parasites. 

 

Unfortunately, a truly free market does not exist, particularly with respect to our medium of exchange itself, money. Parasites that seek to raise their returns on capital beyond levels commensurate with the amount of work and real value they have provided society, have figured out that the agent of force in society, the apparatus of the state (commonly but erroneously referred to as government), can be used to accomplish their less than worthy ends. They create “money” without a concomitant increase in the real wealth of society. This money is paper money, paper profit and paper wealth. The extent to which it can have any real value is based only on how effectively it can be used to swindle others out of their honestly produced wealth.

 

Acting under the sanction of and in collusion with the state (fascism), or as the state itself (communism), these parasites have devised various schemes based on the supposed avoidance of risks and the promise of guarantees. Forcing people to accept Federal Reserve notes (money) as legal tender backed by the full faith and credit of the United States is the most prominent example of such schemes, but it is not the only one.  

Crisis could trigger big public transit payments
Saturday October 25, 5:03 am ET
By Brian Westley, Associated Press Writer

WASHINGTON (AP) -- Transit agencies around the country may have to come up with billions of dollars to repay investors as long-term financing deals disintegrate, a result of the global credit crisis that could eventually affect millions of commuters.

 

The AP writer and editors of this story where quite generous in calling these financial parasites, “investors.”

 

The weak link in the scheme that is now unraveling was identified in the very next sentence of the article (emphasis added): “The problems stem from the collapse of insurance giant American International Group, which had guaranteed financing deals between transit agencies and banks.”

 

Please read the whole article on the transit system carefully. That such a crisis would develop should not be a surprise. People have tried to explain the folly (sinfulness actually) of those who pledged themselves for assurance of another’s debts, that is standing as surety, without having the free and clear capital resources available to pay in the event of default – against all guarantees they pledged. Indeed, there was a time in the economy of the western world when the zeitgeist was "guarantors to the gallows." This was a darker, less enlightened time. While it could be argued that 100% reserves is not workable in our modern economy, it should be clear now that the reserves we have required of insurance companies up to the present time are obviously not enough.

 

To comprehend the confidence game that American International Group (AIG) was running, just think of AIG as the insurance company equivalent to a fractional reserve bank. The inherent structure of an insurance company is that at any point in time it holds only a tiny fraction of the reserves necessary should there be a run on the company for payment of its pledges.*

 

With an insurance company like AIG as the “guarantor” underwriting the whole scam, here are the steps for putting together a typical public transit “investment” scheme.

 

1)      City officials call for expansion of public transportation. Bond placed on the ballot to fund projects.

 

2)      Believing that something for nothing, or almost nothing, can be obtained, a majority of voters are sold on benefits of passing bond.

 

3)      Municipal Bond sold at auction to investors (insurance companies, mutual funds, pension plans, banks, wealthy individuals – around the world.) Interest bearing debt obligation placed on taxpayers of community.

 

4)      Proceeds from bond sale used to buy buses, subway cars, transfer stations, terminals, and other capital infrastructure.

 

5)      Public transportation continues to loose money draining city budget. Unpopular fare increases for system voted down by city council members seeking re-election.

 

6)      AIG offers city solution for money losing (wealth decreasing) operation: capital purchases made from first bond sale sold off to second-generation investors then leased back from said same investors. (Notes: First municipal bond investors secured by taxing authority of city – not capital items purchased with bond money then subsequently sold-off. Second investors use depreciation of former city capital assets as bonus tax write-off.)

 

7)      City allowed to apply 10-20% of capital asset sale proceeds to their general operating budget masking for a time full impact of money losing transit system. Balance of proceeds held by AIG who guarantees deal and, acting as agent for city, makes lease payments to lease holders/investors.

 

Let’s review what has gone on here. Even the minority of voters who understood they were taking on debt to create public infrastructure have been defrauded. They are still on the hook for the interest bearing debt they acquired, but now, they are additionally on the hook for long-term, profit-bearing, lease contract payments to parties who ended up owning what was supposed to be “public” infrastructure. Worse, as the news article points out, city taxpayers are on the hook to make additional payments to the lease holders if the credit rating of lease payment guarantor AIG is degraded. Why is this? Because, AIG did not put its majority share of the proceeds from the sale of the city infrastructure in some lock-box trust fund with the city’s name on it. No, not a chance. 

 

As we mentioned earlier, AIG is an insurance version of fractional reserve banking. Most of the money from the sale of city infrastructure is long gone. It has been transferred on to AIG shareholders and highly compensated executives or invested in shopping malls, apartment complexes and other investment vehicles that provide a stream of money to offset all the pledges AIG itself has contracted to make on a regular basis. Perhaps you hold one of these as an annuity?  

 

The public transit scam AIG was running was just the tip of the iceberg (or Greenberg as it were). Rather than being an honest and fruitful contributor to the wealth of our economy, in reality the AIG business model is only one step removed from being a Ponzi scheme. This is why it was inevitable that it would default and require federal protection in an attempt to shield the criminals running the operation from prosecution.

 

Let’s move one step back in the public transit crisis. Are the entities that bought the initial bonds to provide for public transit infrastructure honest investors? No. A true investor, who is a good steward of his or another person’s money, would not risk capital in an operation that is not, has never been, and will not likely ever be, a profitable endeavor. He would be knowingly throwing his money away.

 

The investors who bought the city bonds are parasites in the community that the bonds were issued in. Yes, they nominally competed with other parasite investors as to how little of interest rate on the bonds they would be willing to accept. But, they purchased these bonds with the knowledge and expectation that the full coercive force of government would be used to guarantee they receive their payments with interest. They knew that the payments on these bonds could not be made through the profitable operation of the transit system they were issued for. They knew that the only way they could be afforded a gain on their money was through the confiscation of wealth via taxes on truly profitable endeavors operating within the city’s tax base. Note: This is why in many cases primary bond buyers and their agents (banks and insurance companies) are the biggest financial supporters of “say yes to the bond.” Along with city contractors and developers they are the primary entities that gain profit from the system.

 

This is admittedly an unpleasant view of municipal bond purchasers. But, the financial use of the word "bond" was derived from an equally unpleasant concept – bondage. Unlike family bonds or bonds of friendship, a municipal bond is something to be offered with great discretion and avoided if at all possible. 

 

The guarantee or promise of a rate of return in the case of an interest payment on a debt, coupled with the power of the state to tax and fund ongoing expenses through the issuance of public debt, creates a moral hazard equal to or greater than any of the other moral hazards introduced by governments intervening in the free market. All investment not only does involve risk, it must involve risk. Investment without risk is not investment. It is criminal activity.

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