ERIC SPROTT: THE DETROIT TEMPLATE
Economist and Boston University Professor Laurence Kotlikoff calculates that to fully eliminate the shortfall in Social Security funding, the government would need to either cut all present and future social security benefits by 22%, or increase the Federal Insurance Contributions Act tax (FICA) by 32% (from 12.4% to 16.4%). But this is just to fix Social Security!
For the U.S. Federal Government as a whole, Kotlikoff estimates the fiscal gap to be around $222 trillion! This is many orders of magnitude larger than GDP. In order to wipe out this gap, the Federal Government would need to permanently increase all taxes by 64% or reduce all expenditures (with the exception of debt servicing) by a whopping 40%.
The problem is clear; every level of government has promised too much and is now faced with the politically unappealing prospect of either drastically increasing taxes for the working age population or significantly reducing benefits for the retired (or future retired). As evidenced by the Detroit bankruptcy, the longer we wait, the worse it will get. The greater the delay, the more pain and suffering citizens will face when the benefits and safety nets they have come to expect from the government suddenly disappear.
Given that the Federal government would need to cut all expenses by 40% to balance the books (according to Kotlikoff), it is not hard to imagine that Social Security, Medicare and Medicaid would suffer haircuts in excess of those experienced by the Detroit pensioners.
Over time, politicians from all stripes have proven adept at cognitive dissonance, but these increases in taxes and cuts to benefits will have to happen, one way or another; it is just a matter of time.
The problem is clear; every level of government has promised too much and is now faced with the politically unappealing prospect of either drastically increasing taxes for the working age population or significantly reducing benefits for the retired (or future retired). As evidenced by the Detroit bankruptcy, the longer we wait, the worse it will get. The greater the delay, the more pain and suffering citizens will face when the benefits and safety nets they have come to expect from the government suddenly disappear.
Given that the Federal government would need to cut all expenses by 40% to balance the books (according to Kotlikoff), it is not hard to imagine that Social Security, Medicare and Medicaid would suffer haircuts in excess of those experienced by the Detroit pensioners.
Over time, politicians from all stripes have proven adept at cognitive dissonance, but these increases in taxes and cuts to benefits will have to happen, one way or another; it is just a matter of time.
From Eric Sprott & Etienne Bordeleau, Markets At A Glance:
On July 18 2013, the city of Detroit officially filed for bankruptcy under Chapter 9. At $18 billion, this is the largest municipal bankruptcy in U.S. history.1 According to the current “proposal to creditors”2, the city’s pension plans have been chronically underfunded and the gap between the plan’s assets and liabilities now stands at approximately $3.5 billion. Additionally, the value of unfunded “other post-employment benefits” (OPEB) such as life insurance, health care, etc., now reaches $5.7 billion. There is thus a $9.2 billion gap between the total assets and the liabilities of Detroit’s pension and benefits system (Table 1 below).
According to the restructuring plan, the city intends to write off the entirety of the $3.5 billion pension deficit and give the OPEB liabilities (which are basically not funded at all) the same treatment as bondholders – a 90% haircut. The net result is that pensioners could lose $8.6 billion of future benefits, or 41% of the value of all the benefits (pension plus OPEB) they were entitled to before the city’s bankruptcy filing. Obviously, such a large clawback will have a profound effect on the livelihoods of the pensioners. Doubtless, this will have repercussions that will also affect the economic activity of the communities in which they live. What still puzzles us is how predictable Detroit’s problems were and how little was done to fix them before it was too late.
TABLE 1: DETROIT’S PENSION FUNDING STATUS
Source: City of Detroit – Proposal to Creditors, June 14 2013
Source: City of Detroit – Proposal to Creditors, June 14 2013
Unfortunately, Detroit’s case is far from unique. A recent report by Standard & Poor’s highlights that, for 2012, the total deficit of S&P 500 companies’ pension plans and OPEBs amounted to $452 billion and $235 billion, respectively.3Another report by the Boston College Center for Retirement Research surveyed 126 state and municipal pension plans and found that, for 2011, they were underfunded by approximately $1 trillion.4 Unfortunately, the report does not provide numbers for OPEB liabilities, but another report by the Pew Charitable Trust reports that for the 30 largest American cities, the average funding status for OPEB obligations is 5%.5 This suggests that this is a much bigger problem than what has been publicly reported.
While these numbers appear imposing, in reality, they are just the tip of the iceberg. The promises made by the U.S. Federal Government to its citizens are even more unmanageable. Every year since 2003, the U.S. Treasury reports the net present value of its future obligations for a 75-year horizon (the fiscal gap). This represents (almost) the real debt load of future generations. This metric, by the way, is almost always ignored by the mainstream media.
As of the end of the last fiscal year, the reported total Federal Obligations were approximately $85.4 trillion, an increase of $4.5 trillion from the prior year.6 However, those numbers do not fully reflect the total obligations of the government towards its citizens, since it does not take into account any obligations past the 75-year window.
Economist and Boston University Professor Laurence Kotlikoff has long been recognized as an expert on government finances.7 Based on the 2013 Trustees Report on Social Security’s longrun finances, he finds that the “infinite horizon” fiscal gap for social security alone (the difference between the present value of all future promised benefits and tax revenues) is around $23.1 trillion. To put these numbers into context, the U.S. GDP for this year is forecasted to be a bit more than $16 trillion.
Professor Kotlikoff calculates that to fully eliminate the shortfall in Social Security funding, the government would need to either cut all present and future social security benefits by 22%, or increase the Federal Insurance Contributions Act tax (FICA) by 32% (from 12.4% to 16.4%). But this is just to fix Social Security!
For the U.S. Federal Government as a whole, Kotlikoff estimates the fiscal gap to be around $222 trillion! This is many orders of magnitude larger than GDP. In order to wipe out this gap, the Federal Government would need to permanently increase all taxes by 64% or reduce all expenditures (with the exception of debt servicing) by a whopping 40%.
The problem is clear; every level of government has promised too much and is now faced with the politically unappealing prospect of either drastically increasing taxes for the working age population or significantly reducing benefits for the retired (or future retired). As evidenced by the Detroit bankruptcy, the longer we wait, the worse it will get. The greater the delay, the more pain and suffering citizens will face when the benefits and safety nets they have come to expect from the government suddenly disappear. Of course, the U.S. Federal Government is very unlikely to default in the same fashion as Detroit, but we should not be surprised if the “Detroit Template” of balancing the books predominantly by cuts to pensions and OPEB benefits is adopted by others. However, given that the Federal government would need to cut all expenses by 40% to balance the books (according to Kotlikoff), it is not hard to imagine that Social Security, Medicare and Medicaid would suffer haircuts in excess of those experienced by the Detroit pensioners.
Over time, politicians from all stripes have proven adept at cognitive dissonance, but these increases in taxes and cuts to benefits will have to happen, one way or another; it is just a matter of time.
Presenting Today's Blatant Bond Market Manipulation (Or BLS Leak)
Today is the second time in three months that someone, or something, either leaked the Non-farm payroll data just ahead of its official release, or if not leaked then a trading algorithm manipulated the bond market ahead of the official data release by launching a "momentum ignition" (see here, here and here for much more on how HFT uses this strategy over and over to set trading bands) launch higher just ahead of the official data release at 8:30:00:0000 am that desperately needed to push 10 Year yields, already on the verge of a 2 year breakout, lower.
The chart below shows how 3 seconds ahead of the official release someone started a buying spree before the actual reported BLS miss. This was followed by a trading halt in the bond complex as the machines reacted to the new "baseline" price in the 10 and 30 Year Treasury future, and proceeded to trade using the newmomentum-ignited reference price as the reference level.
Was this a leak, or was it simply a programmed momentum ignition event designed to provide a higher high in the 10Y futures, and drag the bond complex higher - after all we live in a world in which algos are buying just because other algos are buying - which ahead of the BLS print was threatening to surge above the 2.7535% 2 year high in yield, and finally wake up stocks that soaring yields are here.
As a reminder, this is precisely what happened June 7 when a BLS released resulted in yet another bond market ignition and subsequent halt as described in "Here Is Today's 482 Millisecond NFP Leak, The Subsequent Gold Slam And Trading Halts In Treasurys And ES", although back then it was not nearly as blatant: the "momentum ignition" hit just 482 before the official release back then.
Here Is Today's 482 Millisecond NFP Leak, The Subsequent Gold Slam And Trading Halts In Treasurys And ESWhat was more amusing was the action after the NFP release in both the eMini and the T-Bond futures, all of which had to be halted for a whopping 5 seconds until the algos, selling everything at first, got the memo out that good news today was in fact good news, and promptly ramped risk to the moon. Either that, or someone called in a code Red, made it so all selling was literally prohibited, and with the only path of no resistance up, resulted in today's epic melt up on what was initially a very bearish kneejerk response to the NFP print.First: September 2013 T-Bond Futures trades and quote spread. The deluge of selling hits 482 milliseconds before the NFP release, leading to a 5 second circuit breaker and halting the OTR future contract of the world's largest bond market. Abe would be proud.Meanwhile in equities, all liquidity disappeared. All of it.
Fear not though: the CFTC is on top of it. You see, when bond trading is halted two times in three months alongside of the most important monthly economic release, someone has a fit, and they scream at the CFTC. The Goldman-alumnus headed CFTC. So what does the CFTC do? They "review" it. From Reuters:
CFTC probing Treasury futures trading that led to halt at CMEU.S. futures regulators are reviewing trades that triggered a brief halt in trading at CME Group's markets for Treasury futures just as the U.S. government was poised to release key data on the jobs market."We are aware of it and will be doing a review of the trades, which is standard operating procedure for something like this," Commodity Futures Trading Commission commissioner Bart Chilton said in response to a query from Reuters.CME Group halted trading in some Treasury futures for five seconds, beginning just before the 8:30 am ET (1230 GMT) release of the monthly jobs report.Large trades in 10-year and 30-year Treasury futures were made just prior to the release of the report. Such trades and large market moves can trigger automatic stops in CME markets.
Of course, once the CFTC and CME both discover the ignition originated either at Liberty 33, at its proxy Citadel, or Goldman/JPM, the "review" will promptly fade into obscurity, or at best, the CFTC will "discover" that nothing actually happened contrary to irrefutable evidence to the contrary.
Just like in its investigation of silver manipulation. But at least Bart Chilton will sell more poetry books.
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