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Web Extra: Economy on FIRE and in debt

April 8, 2009, 12:00 am
By Corey Pein
In this week's article on Thornburg Mortgage, I quoted former venture capitalist and author Eric Janszen on whether the housing crash that ultimately claimed one of Santa Fe's largest employers could've been predicted or not.

Our phone interview ranged too far for that article, but we thought Janszen's thoughts on capitalism's boom-bust cycle and the rise of what he calls the "FIRE economy"—for finance, insurance and real estate—were worth sharing at length.

Basically, he thinks the government started selling everybody out to big creditors decades ago, and the massive debt burden that resulted has paralyzed the economy.

Janszen, who lives in Boston, also has some thoughts on the federal recovery plan, with its focus on "green jobs": "How many mortgage brokers does it take to screw in an energy-saving lightbulb?" he asks.

You write the punchline.


I liked your Harper's article on the housing bubble.

Thanks. It seems to be panning out.

That was back in early 2008, when many people hadn't yet grasped the extent of the subprime mortgage crisis. But you went so far as to predict the next bubble—green energy.

I'm actually working on a book on that. So far it does seem likely to focus on infrastructure.

The refrain I keep hearing was that nobody saw the real estate crash coming. You say people could've seen it coming.

Many people did, of course. And many people who did made money on seeing it coming. It wasn't all that hard. There were a few fantasies you had to not buy into. One is that housing prices always go up, and stock prices always go up.

If any other product was sold based on those premises, you'd think people would be somewhat skeptical. It's pretty marvelous to convince so many people of something that can't possibly be true.

Was the bubble contingent on people not understanding what these financial institutions were selling, with mortgage-backed securities and so forth?

They don't even understand that they are products. They think they're a guarantee of something—that if you put money in the stock market, you're saving.

These are financial products. Houses are products. Mortgages are products.

And you say regulations have been written in the finance industry's favor over the years?

Starting with Reagan, under the banner of free markets and low taxes, with the tax relief act of 1981. If you look carefully what it was was the Debtor Creation Act.

The idea was to free up money that used to go to paying taxes to finance public projects—what some economists called the fourth factor of production, the infrastructure, the highways, what all industries need to be efficient, and move people and products.

Now we spend all our money on servicing debt. That's what we do in this country. All this nonsense about trying to cut taxes was really to make room so you could take a good chunk of cash flow out of all these corporations and [give it to banks].

Can you put today's economic situation in a historical perspective? Is there any parallel?

More than one-quarter of all homes have negative equity in the US. That's a bad problem. But there's a worse problem developing.

I refer to the American housing market as "the big slum." A slum is where the market value has fallen below the replacement value. It doesn't make sense to fix anything. You don't fix it, you just let it go to hell. There's no way to get your money back.

So in a tangible sense, the country is falling apart?

Yes. I just got back from a trip to Florida. I've been going down there for 20 years. It's pretty striking. In Miami, South Beach, 20-30 percent of the businesses are out of business. Hotels, restaurants are boarded up with "for lease" signs. You can basically see the area is not doing well.

What's happened is, we had this finance-based economy that was very dependent on continuous debt creation. That's suddenly dried up.

Have we had an economy like this in the past? Yeah, we did in the 1920s.

The "slum" analogy reminds me of Bangkok. I lived there a few years ago, and there were unfinished skeletons of skyscrapers all over town, left over from the 1990s financial crisis.

I've seen that. When I was there—toward the tail end of that, in the late '90s—you saw the buildings going up. I was there with my wife on a business trip. I told her, 'They're never going to finish these things.'

That's happening here in the US. In Miami, there's a lot of half-finished buildings. There's a condo project, in Boston...Nobody's working on it. They ran out of money. That just doesn't happen here. It's not supposed to happen here.

Besides Robert Schiller at Yale, who else predicted the housing crash?

Not to toot my own horn, but we've been making calls on this stuff since 1998. We noted in December of 2007 that we were going to have a debt deflation and bear markets that would take the stock market down 40 percent in 2008. These things are not that hard to call.

But the people who called it were all called Chicken Littles.

It's not that popular to be negative when things appear to be going well. I get interviewed more by the European and Asian press than the US press.

It's part of the culture, that we don't really like people who are skeptical, who ask questions like, "How can you grow an economy that requires $5 of debt growth to create $1 of GDP growth?"

Most [other] countries have an industrial policy: A combination of government and industry sit around and go, "How do we play our cards here in the global economy?" And it doesn't always work that well. But those decisions are not ceded to the banking industry, like we did here. Our industrial policy has been set by the finance industry for 20 years.

And for the larger, national news organizations, it's more difficult for them to want to be telling a story about how the economy is heavily influenced by financial interests, and it only became socially acceptable to use the word 'financial oligarchs' after that Bill Moyers interview with Simon Johnson from the IMF.

I don't know—Citibank wasn't a life-or-death ad account for, say, The New York Times, was it?

Finance, insurance and real estate: If you put them all together, it's about 80 percent of all their advertising.

The biggest problem with financial news reporting in the US, particularly on television, is that it's hard to tell the difference between the news and the advertising.

I went on CNBC. I said, 'Don't buy any stocks.' I was talking about energy stocks. It's going to be a great investment boom after the Depression, not before it. I used the 'C' word, I talked about cash. They didn't like that very much.

The advertisers are brokerage firms. That's the whole point of the station.

You basically know the game is over when Jon Stewart is beating up on Jim Cramer on national television. Now it's OK. I'm not saying Jon Stewart was told by his producers not to beat up on Cramer [before]. My argument is it wouldn't have occurred to him to look at it at that point, at the peak, when the product is selling.

It's not just looking like a Chicken Little. It's basically explaining that this is how the product is sold.

Who were those people you mentioned who made a lot of money on the crash?

There's some famous guys, hedge fund guys, who shorted the home builders, the credit default swaps. They made some money on it.

Most of the guys who made a lot of money didn't talk to anybody. You don't make money telling people what your expensively developed trades are.

The short sellers have been demonized, almost like they engineered the crisis.

Yeah. There's reasons I did talk about it. I didn't want to be part of the process of making money off what I understood to be a fundamentally corrupt system.

I don't see that as my role. I'd like to see us discard the FIRE economy and move to a healthier economy: Making stuff, and competing on an even footing with other countries.

Playing the downfall of this crummy system is not what I was interested in doing. I wouldn't disparage anybody who did do that. People have to protect themselves. What I would do is tell people what I thought was going to happen. People can start their own trades.

Generally speaking, our guys have done very well. At least, they haven't lost all their money.

Are there any good guys in this story?

Some of the regional banks. There's some banks here in Boston. We have a friend who bought a house-at the top, when we told her not to. She doesn't make a lot of money. The bank said, in order to get a lower interest rate, if you take this class, we'll teach you how to manage money. Basically, they provided her with financial education. That's how it should work.

Most of these guys, it's the opposite.

The largest banks did most of the shenanigans. Below that, smaller banks didn't participate in any of that stuff. In a fair world, what would happen is, with the big banks that were stupid and badly managed, the government would come in, declare them insolvent and sell off their assets to smaller banks-or just banks that are competently run-at market prices.

We're obviously not doing that, for reasons we can speculate on.

I keep seeing people like Treasury Secretary Tim Geithner on TV, stammering to explain the bank bailouts. I think he can't tell the truth, which is that the finance industry has the government over a barrel.

They're not over a barrel.

I get calls from members of Congress asking me what I think she should do. They don't really want to hear the answer. I think the ultimate problem is having to write down trillions of dollars of bad debts for their campaign contributors. There's hardly any other rational explanation.

We lectured the Japanese not to do what we're doing right now. Why can't we do what we did in the savings and loan crisis? If some guys break the law, we put them on trial. Something like 1,000 people went to jail over the savings and loan crisis.

Are you saying Obama is more beholden to the financial sector than Reagan was?

It's hard to say. There's some noises about Wall Street being corrupt. But I don't hear anything along the lines that there are elements of the finance industry itself which are a burden for the economy.

You hear about restructuring mortgages so people can still pay them. Of course what's really needed is to reduce the level of debt in the economy. To continue to pay off the debt on a mortgage that used to be worth $2 million and is now worth $1 million, that's not the objective. The objective should be to reduce the principal.

It's not only mortgages, it's student loans—most students today don't realize that tuition used to be free, or nominal, at many universities not too long ago.

It's absurd how high tuitions have gotten. If you've got credit chasing after everything, it'll raise prices. It was the same with housing...you had these crazy products like CDOs and so forth.

Right: Textbooks wouldn't cost $150 if they weren't purchased on credit, through student loans.

It's stupid.

That's how these credit bubbles work. Everybody's happy on the way up, because everybody seems to be making more money.

Are there more crimes there?

I haven't checked. Anecdotally, there's an increase in youth violence. Property crimes, I'm not sure.

In Florida, I happened to sit next to a Miami Herald reporter talking real loud on a cell phone, telling whoever he was talking to that since the economy turned down-particularly since last year-there's been an incredible crime wave.

There's a serious discussion going on in Michigan about shutting down parts of Flint. They're saying, "There'll be no police, no fire protection; If I were you I'd be moving out."

If you think about it, what they ought to be having a conversation about is doing homesteading: If you move in, there'll be no property taxes for 10 years. It would have the opposite effect. Generally people will move in and try to rebuild communities.

You always hear about how the government in Afghanistan doesn't control much territory beyond Kabul. I wonder sometimes how much territory the US government has essentially ceded in a similar way. I mean, it's not just cities like Flint, it's rural America, too.

When people talk about slums, they think about urban slums. There's huge areas of exurbs, just outside the suburbs, where the economic activity has really died. The people there don't have much to do. Their economy died. Nobody cares about them.

I'm not sure what you do about that. I think some form of homesteading is the solution.

But don't people migrate to the city, where the jobs are?

That hasn't been happening. The Census released a report—migration in the US is off like 87 percent. It's not like there's some booming state someplace. Which is what's unusual about this downturn compared to every other since World War II.

Also, this is the only downturn where there are fewer cars on the road. There's all sorts of other obvious indicators that this is not just a recession.

Another thing you'll see reported all the time is that this is the highest rise in new jobless claims since 1982. The implication is this is like the early 80s recession, except in some ways worse.

What's not reported is every recession was induced on purpose by the Fed, in order to cool down the economy. This recession was not created by the Fed. The implications of that are lost of a lot of people: They are absolutely not in control.

It's going to come down to fiscal stimulus. They're doing some pretty stupid things, like you're seeing there, which is building roads.

Even though most people aren't employed in construction...Is that because the Democrats are beholden to labor unions?

No, they're just not very creative. They just spend a lot of money and hope the money goes into the hands of people through some jobs that get created.

Everybody seems to repeat these numbers the Obama people put out, about how many jobs the stimulus will create, and if you look closely, they're based on these ridiculous formulas—X amount of money creates Y amount of jobs, however you spend it.

That's the myth of the multiplier. That's the idea you spend this money and it produces more stimulus than it would appear to directly-that it's going to generate more output than it would if you just bought the stuff. It's a fallacy.

Japan started out where we were, in terms of public debt, back in 1992. They were at about 60 percent of gross debt to GDP. Now they're at 159 percent—a notch above Zimbabwe, just below Jamaica. None of that spending improved their sustainability as an economy. All they did was move the debt from private to public accounts over 20 years through the stimulus programs.

This is what our rocket scientists are planning for us. There can't be enough output to pay the principal and the interest on all this debt.

Well, what if Americans' productivity keeps going up?

Productivity helps.

Indentured servitude, maybe?

There you go.

It's siphoning off the cash flows from households and businesses that could be going to savings or investments-instead it's going to pay off inflated debts from the FIRE economy era. It's a political decision. And not a very good one.

I propose that we restructure the economy to do stuff that we would've been doing, like building a First World transportation system and communications system.

Hey, that would be nice. Another thing I remember from Asia—cellphones are super cheap and you don't have to sign your life away on a contract.

And they actually work everywhere! And they have four-megapixel cameras and video, because the bandwith is there. Some of that has do do with the fact that population densities are very high. That makes it more economical to build wireless networks. We're a big country—that makes it harder.

Fundamentally—and I've got to run—the real boon is in reducing the energy intensity of our economy, so it takes less energy to produce $1 of GDP. That's going to work like a tax cut. We need a debt cut and a tax cut.

When's the book out?

Hopefully within a few months. It's Portfolio / Penguin. The book's title is The Post-Catastrophe Economy. It's going to be about how we're going to reconstruct this thing.


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