[http://metaphoricalweb.ning.com/profiles/blogs/where-has-all-the-money-gone]
I entered into an interesting twitter exchange recently, to whit:

BrendanWenzel: A lot of people have "lost" money, but who is gaining it
all? Wealth is never destroyed, but transfered. Who is it being
transfered to?
kurt_cagle:Actually, in this case, "wealth" is just being destroyed,
because assets are being repriced downward.
kurt_cagle:Most real wealth was made 2004-2006 by people in top 1%;
we're just now discovering the fact that we've been robbed.
BrendanWenzel: So you are saying that these worthless assets never had
value and were just a tool to steal wealth?
kurt_cagle: ... a tool to steal wealth? Um ... yup, pretty much. Did
any investment banker really produce $30 million worth of value? No.


The numbers vary - from $2 trillion dollars to more than $40 trillion
dollars depending upon how measure it, but in any case, a lot
of "wealth" has seemingly gone up in smoke in the last year.
Retirement, pension and college funds have been cut by 50% or more,
municipal bonds have turned to dust, treasuries at the local, state and
national level are bare. The world has, seemingly overnight, gone from
being hyperfrenetic with activity to being, well broke ... and broken.

The question that Brendan brought up is a sensible one - where did all
that money go? Is there someone out there who's now sitting on a pile
of everyone else's money? No ... and yes.

People, including bankers who should know better, tend to look upon
money as being, well, solid. You work every day, you get a paycheck for
your efforts that represents a contract with your employer. That
contract is usually slanted toward the employer - you provide the
labor, and at the end of two weeks or one month or some other
milestone, the employer gives you a piece of paper transferring a
certain amount of value from the companies earnings to you. You take
this to the bank, the bank deposits it, and from there you can "spend"
this value.

Suppose, however, that the company has not made this money in earnings
yet. Instead, they went to a bank and said "give us a line of credit,
here is our plan to make value in the future". The bank evaluates the
plan and the individuals involved, and if it feels like the plan will
return a reasonable amount of earnings within a reasonable time, it
will give the company that line of credit - a form of a loan, along
with a fee to be added in order to compensate the bank for the risk
that the company won't in fact make these earnings over the stated time.

This means that the money that you are making is not based upon
existing value, but upon future value production. In essence, the
company is in turn taking a risk that you will produce, though it is
usually a pretty safe one. If you don't, then you will no longer
receive that compensation, and someone else will be hired.

Yet, say after a couple of years, the company is not making enough
money - the guess that was made concerning the profitability of the
venture was off. The company's already sunk money into infrastructure,
into salaries for the people, into energy costs, and into intangibles -
marketing efforts. The company can go back to the bank and ask for an
additional loan, but the bank at some point needs to determine whether
the ongoing effort will ever prove profitable - otherwise, it is simply
throwing bad money after good. The bank decides that "no, we're not
going to give you the loan" and assuming the company doesn't find other
investors (typically with more stringent requirements because of
increased risk) it will close its doors, and everyone will be out of a
job.

Now in this particular venture, you may have made money - though much
of that money went into paying off necessities - housing,
transportation, energy, food, information access and so forth - so you
may have actually just broken even or even fallen behind. However, when
the company fails, it can't turn around and ask for that money back.
It's been spent. The money that the bank has also loaned has been lost
- the loan becomes non-performing, because it no longer generates
revenue, and the bank also took a loss.

If the bank charges fees on the establishment of the loan, these fees
are things that can be assessed early - at the time the loan is made.
At some point, the bank manager might realize that taking the fees are
less risky than waiting for the loan to mature. They sell the loan as
a "security". Now, this security is still potentially valuable, because
it represents a steady stream of income in interest, and an investor
can buy the security as a long term performing vehicle - so long as the
person or company who took out the loan can continue to make payments.

Now the bank, at this point, has been lobbying the government to let
them sell these securities, and a particularly business friendly
administration gives the go-ahead. All of a sudden, a bank can make a
loan, pocket the fees for that origination, then sell the loan as a
security taking additional fees. What this means is that the bank no
longer has any real incentive to insure that the person or company
taking the loan can actually pay it back, because by the time it
becomes an issue, it will be someone else's problem. The bank has
essentially siphoned off a fairly significant amount of money in the
transaction without actually creating significant value.

What this means is that they will be encouraged to make many more
loans, because there is no moral hazard if a loan goes bad. If the loan
is a mortgage or a lease, the bank may also encourage the ones acting
as brokers in the sales of these properties to try to get top dollar,
because it increases the fees that they can take off the transaction.
The mortgage broker sees no problems in that - he too gets a percentage
off the top, so the more valuable the property, the more he makes. The
county assessors that determine the baseline price will try to increase
the property price as well, because that increases revenues in the tax
coffer, and if tax revenues go up, well, its good for the city or
county.

Now, normally, this breaks down if interest rates are high - because
the person who actually commits to the purchase has to pay the interest
on top of the agreed upon price and fees. However, if interest rates
are kept generationally low, then even though the house may cost more,
the individual payments may be smaller, especially if they can be
spread out over a longer period of time. Then of course, you also have
speculators who buy up properties with no intention of paying the long
term price - they simply become brokers themselves, selling to someone
else at a higher price in three or six month, because real estate
prices always go up. The buyer may also simply not have the financial
resources to purchase the property in the first place under normal
circumstances, but with a bit of "creative accounting" they are
encouraged to buy.

Now this chain goes all the way up and down - ratings agencies are
encouraged to rate securities higher than they should be, corporate
raiders use risky securities (junk bonds) to effectively purchase
companies, replacing actual earnings with debits against future
earnings. Stock brokers use this debt to leverage purchase of stock
with very little actual money committed, and so forth.

All of this activity involves replacing existing earnings - real work -
with promised earnings - credit, and because there is comparatively
little oversite, the actual obligation on the part of the wage earners
and company earnings climbs and climbs and climbs, until you get a
situation where a person would have to work continuously, 24 hours a
day, for century or more to produce the real work that's been obligated
on her, usually without her direct consent. That's clearly unfeasible,
and the system ultimately collapses as each company or person fails.

Debts that the banks and shadow banks hold have to be written off,
rather than being treated like assets. This reduces the amount of money
that the banks can commit to writing loans, and also instills a sense
of hyperconservatism in extending new loans, because they can no longer
service the old ones. This causes credit availability to collapse,
which means that companies can no longer pay their workers (as the
paychecks were paid from the loan which was to be repaid by earnings).

As workers lose their jobs, they cut back on their spending, which
causes other companies to go out of business, which only exacerbates
the situation. Companies are forced to lower their prices in order to
move any product, and a deflationary spiral sets in. Everything loses
value as the availability of money dries up and markets plummet.

Eventually, demand for goods reasserts itself, as things wear out, as
population grows, or as people become less fearful about the future.
However, the damage has been done - the negotatiated value of things
have dropped dramatically, whether that's the cost of a new car or the
cost of a stock, and people who purchased the stocks thinking that it
was a safe investment now discover that they're holding worthless paper
- the company has either gone out of business or, if it survived, now
has a much smaller cash position and it will take time for it to get
back to its earning potential, significantly reducing the long term
return on investment.

So, given that, chances are pretty good that there's not one person out
there who is now sitting on everyone else's money. The money never
really existed, save in potentia. What disappeared was the expected
potential of that future labor.

However, that doesn't mean there aren't scoundrels. Companies who buy
and sell these securities have profited immensely by the transaction
fees and bonuses, which also came from future earnings. It would be
much like you being paid for the next thirty years of your wage earning
time up front. If the business fails, it makes no difference to you -
you've already been paid handsomely, and can turn around and spend that
money any way you choose.

Yet that money has to come from earnings at some point, and it does. It
comes from pension funds that fail, leaving people who have invested
with nothing. It comes from reduced pay elsewhere in the industry, as
credit has been compromised. It comes from tax revenues, which decline
dramatically in a recession because people don't have the wherewithall
to pay. In other words, the thirty million dollar "bonus" that the
hedge fund manager or bank CEO takes home comes directly or indirectly
from the earnings of others, who now have to work longer just to get
back to where they are.

So, yes, it was a ponzi scheme, a bubble with a skim, caused by the
greed of "financial professionals" and political officials, aided by
tax cuts that were highly favorable to these same people, and a war
that made it possible to hide similar fraud elsewhere. It is still
going on, and it has bankrupted this country for years to come.Where
has all the money gone

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Posted By Kurt Cagle to Metaphorical Web at 5/07/2009 10:03:00 AM

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