Fantasy Wealth vs True Wealth

The experiences of my youth have molded me into a fiscal conservative. Though no man is an island, there had been a number of times in life where the only thing that could be counted on was my own entrepreneurship, ingenuity, and effort. Thank God I live in a country that gave me the freedom to venture out. I have seen debt affect good judgement in family and professional life. Early in my career, I saw family members, employers, managers, and fellow workers feel coerced into decisions they would not otherwise make, due to financial pressures. All decisions involve a moral component. I found myself often at odds with management and those around me. Painfully and shamefully, I found out “going along to get along” was not the answer. Those failures to speak up still haunt my memories. Years of confusion and a number of job changes ensued. Terrible injustices occurred, and eventually tension and confrontation reared its head. Still in demand, but battered and wounded, — at 31 —, I walked away from the corporate world. I now had my diploma from the University of Hard Knocks along with my BA in Business and Economics. I value them equally, as I paid dearly for both.

After selling my interest in one business, retiring another, and an extended illness, — 2003 began as a sprint to financial independence into our retirement years. Despite my early incompetence, my wife and I had raised a family, helped graduate both of our children from college (debt free), and had said the final farewell to our parents. Left with no debt ourselves, and some inheritance, my wife and I purchased a 5000 s.f. commercial building. It was my desire to get out of contracting, — yet remain in the floor covering industry with which I was familiar and had success. At 50 years old, I was beginning to feel the wear and tear on my body. Building equity, longevity, and a nest egg for old age was the goal. Neither of us wish to burden our children or society.

The business promptly took off. I found myself in the midst of the housing boom. Credit was easy, and housing was going up double digits annually. In an effort to be prudent, profits were reinvested into the building, inventory, and the business. The days were very long and hard, but it was a joyful labor. Debt to equity ratios were always on my mind and kept well in line. I thought we had built the business to survive any down turn. I was aware of potential problems in subprime mortgages, mortgage backed securities (MBSs), and — relatively new financial innovations — credit default swaps & collateralized debt obligations (CDSs & CDOs). In doing a financial statement one year, I discovered we had a net worth greater than we previously thought. I certainly did not feel rich. Much of it was in the business, inventory, and real estate. I would later find out that my initial instincts were correct.

We all know what followed. The housing crisis began in 2007, but really did not arrive full force in the Northwest until 2008. Financial markets broke down, liquidity dried up, and anything related to housing stopped. My education in economics had warned me about the crisis, but I was ill prepared for its severity. There was virtually no customer traffic. Fourteen investors, contractors, builders, and developers either lost their businesses or got out of housing. Remarkable to me was that, while having to wait to be paid, eventually everyone paid us for all purchases. One even came in with cash from what he called the “Oven Mitten Bank.” He paid me out of some cash he was using to live on. The strength of my customer’s character shall forever stick in my mind.

My business had become a victim of the economic ‘feedback loop.’ Lose money policy on the part of the Federal Reserve, very easy lending standards, government regulators turning their collective back, rating agencies more concerned about fees than honest credit risk, and the creation of new financial instruments (CDSs & CDOs) had destroyed ‘price discovery’ in housing. The free market did not fail, it had been usurped for years! It was the free market now trying to correct the abuses, in contrast to what George Bush was telling us. Housing prices had climbed to unsustainable levels and any business related to it (like my own) had geared up to service the ‘hyper stimulated’ demand. The industry was at ‘over capacity!’ I, like others, were left with assets who’s prices were now collapsing, — and no cash flow to support it. That is the hazard of economic bubbles. When the air comes out, asset prices crash. They go “no bid,” demand ceases, and the market literally disappears.

Asset prices did what they normally do in crashes, they were driven below the long-term mean (average) for the market. Along with that, our net worth reverted to reflect the revised value of assets. You see, the “wealth effect” we experience in 2006 — 2007 was fantasy. When I reflect on that time period, I tell people, “You cannot lose what you never had!” I also tell people that, “If you were not in the midst of it, you do not understand it.”

Why do I tell this story? Most friends I talk to, I tell them the Great Recession of 2008 is not over. Much of the crisis was mitigated by a transfer of wealth: banks were bailed out; investment banks (ex. Goldman Sachs) were declared commercial banks in order to have access to TARP and other funding; AIG was bailed out to enable it to pay off banks on CDSs and the like; even European banks were bailed out; and various special interests were given ’emergency funding.’

The Federal Reserve initiated QE l, QE ll, Operation Twist, QE lll, and we had seven years of ZIRP (Zero Interest Rate Policy). Future tax payers have been left with the bill. This ‘non-solution’ to the crisis is going to boomerang back, and may already be happening. Below are a few quotes by Richard Fisher, former Dallas Federal Reserve President. His comments were made a few days ago on CNBC. Both Mr. Fisher’s written remarks, and video, are available here. The context of his remarks are addressed to those that wish to blame the current economic turmoil on China. No, we did it to ourselves, again!

Fisher explains “It is not China, it is The Fed that is at fault. What The Fed did, and I was part of it, was front-loaded an enormous market rally in order to create a wealth effect… and an uncomfortable digestive period is likely now.” Simply put he concludes, “There can’t be much more accommodation, the Fed is a giant weapon that has no ammunition left.”

A Must Watch that is unforgettable, is when a shocked Simon Hobbs (at 5:10 on the video) says: “Will The Fed come on and say ‘we’re sorry, we over-inflated the market’ when it crashes?” We doubt it.

What an admission! We go farther into debt as a nation and as a people for what, — a wealth effect? Get ready folks, here we go again. Market Intervention and Fantasy Wealth are the games being played on the American people. Only this time, ‘The Fed is a giant weapon that has no ammunition left.’ I didn’t say it, a former Dallas Federal Reserve President said it. That means this time, everyone gets to come to the party! No bail outs, just bail-ins. As Mr. Fisher puts it, “An uncomfortable digestive period is likely now.”

Hang on to those things that are true wealth, — your Faith, your family, your character, and family and friends that surround you. I cannot help but think that we will need to be strong spiritually, emotionally, and physically in order to deal with the challenges ahead. “Denial can be a nice place to visit, but you cannot live there.” (Reference: unknown)