Wednesday, April 01, 2009

The Case of the Clock That Doesn’t Tick: Is That All There Is? – Part II

“All too often macro economic episodes, global developments, or ill-advised legislative actions occur that overwhelm financial markets, negating even the wisest, most sophisticated strategic endeavors initiated by investors. Unfortunately, the potential for such an event, one that could have a disruptive, perhaps even a destructive impact on the traditional investment process, becomes more and more likely.” Had I written that a year ago, I could now claim prophetic powers. However, that quote was the first paragraph of an article titled “Budgets of Mass Destruction” that appeared in the September 2004 issue of Viewpointe. If you really think I was smart enough to write that while believing that the recent financial crisis was on the horizon –– fuhgeddaboudit! This was just a statement about a hypothetical possibility, as Alan Greenspan said, a once in a lifetime unlikely event. However, the content of the article was indeed prophetic in that the problem it dealt with then not only continues to exist, but has grown exponentially.

The subject matter had been framed in a speech given in May 2004 that was cited in that same Viewpointe article. The speaker was quoted as follows: “America’s growing annual deficits, exploding long-term debt, and skyrocketing liabilities are converging with demographic trends to form the perfect economic storm. Unless we take steps immediately to end our fiscal insanity, we will face unfathomable, impossible choices –– slashing defense and homeland security spending; depriving our children of quality education; reneging on our commitments on Social Security and Medicare; suffering the impact of higher interest rates; raising taxes sky high; or printing money to inflate our way out of excessive debt.” Now that was prophetic. The noise recently heard throughout the country is the sound of government printing presses banging away. Surprisingly, the speaker was Senator Joseph Lieberman who at the time was still in his statesman-like, rational mode.

The article was true to its title, describing what at the time seemed to be unbearable budget deficits that could lead to economic destruction. But the consequences described, now seem mild when compared to our current debt obligations. (But as you will soon learn, that debt is not truly reflected on the National Debt Clock. In fact it is understated five-fold.)

Also, most relevant were two other personalities mentioned in that same article, about whom I have written several times since. The first was Daniel Walker, who then was Comptroller General of the U.S., and head of the Government Accountability Office. I quoted him as saying, “The simple truth is that due to demographic trends and rising health care costs, we now face decades of mounting deficits. Left unchecked, these deficits will damage our economic [and investment] futures and diminish the opportunities available for our children and grandchildren.” Unfortunately, not only is that 2004 statement still relevant, the situation has actually deteriorated since.

The second individual highlighted in the article was described as follows: “Although there are any number of non-partisan, well known and respected critics of existing fiscal policy (referring to the Bush administration), Peter G. Peterson was one of the first to recognize the problem (described by both Lieberman and Walker) and as a result has been termed the Cassandra of the movement –– prophetic, but ignored.” To those unfamiliar with Mr. Peterson, the article described him as “a lifelong Republican who has had a long, illustrious, and very profitable career with extensive and diversified experience in government and the private sector. He was Chairman and CEO of Lehman Bros., and is the founder and currently (in 2004, but now retired) chairman of the Blackstone Group, a very large investment banking firm; he is a former Secretary of Commerce serving President Nixon; a former Chairman of the Federal Reserve Bank of New York; he is a prolific author, and the founder and chairman of the non-partisan Concord Coalition, an organization dedicated to fiscal responsibility.”

As impressive as is Mr. Peterson’s résumé, even more impressive are his recent actions taken on behalf of his strong belief that the public must be more informed about the true nature of the country’s debt obligations. With a net worth of at least $2 billion, a year ago, Mr. Peterson announced the formation of a foundation dedicated to a long list of goals that now sound somewhat familiar: “The most substantial economic, fiscal, and other sustainability challenges of our current age, including the explosive growth of federal entitlement programs; unaffordable healthcare costs; unprecedented trade and budget deficits along with abysmally low savings rate, and the associated debt; unsustainable and gluttonous energy consumption; an uncompetitive educational system; and the threat to our collective future from the proliferation of nuclear warfare materials.” Although a year old, this all sounds very much like the recent Obama playbook. Be careful President Obama, apparently Mr. Peterson thinks he is you.

Anyone can set up a foundation and espouse a bunch of seemingly admirable causes, but how many are willing to back up the effort with a personal contribution of $1 billion to help assure its success? That is exactly what Mr. Peterson has done. In addition, he convinced Daniel Walker, who had been crisscrossing the country preaching fiscal responsibility, to leave his job as Comptroller General and become President and CEO of his new Peter G. Peterson Foundation (PGPF).

The main thrust of the foundation’s work has been to educate the populous about the enormous debt accumulated by our government. The emphasis is on what might be termed the “real” debt, or the “true” debt, that is totally different from what is generally regarded as the “national” debt reflected by the National Debt Clock. As of March 18 th, the clock registered a debt that had just exceeded the $11 trillion mark. The real debt however (hold onto your hats) is in excess of $54 trillion, possibly by now into the $60 trillion level. (The Government Accountability Office cites the fact that one economist. Lawrence Kotlikoff estimates it at $70 trillion.)

How can that be? Now we come to the unfathomable (to most) issue of accounting abstruseness, and more specifically to the utility of the mysterious acronym, GAAP. However, before we get into the mysterious alphabetic details, I must repeat a story that I wrote herein a number of years ago –– it’s too relevant not to.

The Chief Executive Officer of a large company was interviewing candidates for the position of Chief Financial Officer. Allowing underlings to pre-screen the contenders, three were the final candidates for the job. Not one to waste precious time, the CEO had boiled the interview down to one question that he posed to each candidate. “How much is 2 + 2?” The first prospect replied, “Although I think this is a trick question, the correct accounting answer is four.” The second more shrewdly answered, “I take a somewhat broad view of those numbers and would say it is no less than three and no more than five.” The third worldlier candidate, upon hearing the question, quickly moved to the CEO’s office door and locked it. He quietly dimmed the lights in the room and lowered the shades in the window. He then approached the CEO, bent down and whispered in his ear, “What would you like the number to be?” Guess who got the job.

For years, the government, regardless of party, has indulged in what some might term an accounting scam. Essentially, it keeps two sets of books using two different types of accounting methods; one is termed “cash accounting” and the other is termed GAAP, or Generally Accepted Accounting Practices. While GAAP is the system all businesses are required to use, governments much prefer the former, the one that portrays lower deficit levels. That’s the one the National Debt Clock shows. As mentioned above as of March 18 th, that cash accounting number, for the first time exceeded the $11 trillion level. You will never guess what the “real” GAAP number is –– as publicized by the Peter G. Peterson Foundation –– $54.6 trillion. As an average American family, your portion is just under $500,000. Welcome to the “real” world.

Why the huge difference? Under the cash accounting system, it is not necessary to count what is termed the “unfunded” debt of items such as Social Security, Medicare and Medicaid, and the new prescription drug plan, among other things. Nevertheless, these are obligations that will have to be paid for at some point in the future and thus should be considered as debt as they would be using the GAAP method.

This is the message that Peterson and Walker are trying to get across to the public. In a film and book titled I.O.U.S.A., the Foundation is promoting that message. You can see a 30 minute shortened version at Full page ads have run in The New York Times at $179,000 per page, paid for by the Foundation. Daniel Walker is hammering home the message that unless we face up to the fact that under present spending levels, the debt will increase by $2-3 trillion a year, and by 2050 Social Security, Medicare and Medicaid will consume the entire budget. At that point when our children and grandchildren look to determine how much money is left over to run the government, they will surely repeat Peggy Lee’s sad refrain, “Is that all there is?”