I'd hate to run into Michael Panzner at a cocktail party. Talk about bringing a person down. In his revised and updated book, Financial Armageddon: Protect Your Future From Economic Collapse (Kaplan Publishing), Panzner argues that America — and the world — are facing an all-out financial catastrophe; it's on the horizon — just beyond the “orgy of borrowing and extravagance,” an under-funded retirement system, a scary over-the-counter derivatives market and empty government guarantees.
Registered Rep.: In your book, you say the world is now a riskier place, that the modern financial system has made it riskier — and not less so, as has been advertised.
Michael Panzner: Yes, financial markets are riskier, but it's also part of a broader attitude: People assuming they can [take more risk] and worry about it less.
RR: We've seen it in spades with the credit market debacle.
Panzner: Right. We're clearly seeing the unraveling, the deleveraging process, taking place now. When I was writing the book, investors were in peak euphoria, and people thought there was no limit to the amount of leverage they could have. Clearly that attitude's changed, and I think those attitudes will become even more entrenched as time goes by. But it was at every level of the financial community — you know, investment banks, commercial banks, etc. Everybody was operating under the assumption that they could take on tremendous amounts of borrowed money and capitalize on that without paying the piper in any form.
And you also have the same thing going on at the consumer level. American households are stretched in terms of the size of their outstanding debt. Many will have trouble meeting those obligations going forward. And then you throw in the government side of things. Look at the extent of both the published obligations, such as government debt, and also the government's retirement-related obligations. Some argue that retirement obligations aren't quite the same thing as a Treasury bond, but I'll be anxious to see what happens with all those people who are older and nearing retirement when the government says, “We can't afford your Social Security, and we can't afford your Medicare.”
So, on every level, we've seen that people could take on debt — essentially willy-nilly — and not really be afraid, or not really be wary about the implications. Clearly, however, that's changed in the past several months.
RR: Are you saying the United States is bankrupt — too many future obligations — but no one's willing to admit it yet?
Panzner: I think people are starting to recognize it. I mean, in fact, as I note in the book, there was a very interesting commentary in the Federal Reserve Bank of St. Louis Review, published in the July/August 2006 issue, written by Larry Kotlikoff, an economics professor, saying the United States is bankrupt. At the time the article came out, I think most people would have thought of the article as an abstract hypothesis and not a reality. I think more and more people are coming around to the idea that, yes, we're talking bankruptcy in a literal sense. We may have to worry about that. And I think that's been a dramatic change. I think that sort of hypothetical has moved into the realm of the realistic, and that's scaring people.
RR: Well, why are Treasuries not being sold off then? There are always some doom-and-gloom commentators predicting the worst.
Panzner: Others have written books that predicted hard times ahead, probably in every decade. In many cases they were proved wrong. I think the difference this time around — uh-oh, I'm saying those naughty words, “this time is different” — is that there are so many bearish ducks lined up in a row. You've got enormous leverage in the financial system, in terms of the derivatives market, which, as we've seen in recent months, is turning out to be almost a black hole of losses bleeding Wall Street and Main Street dry. Then you have the fact that the first Baby Boomer signed up for Social Security. That's the demographic tsunami that people have been warned about: the graying of America. In fact, it's a big problem in many countries.
And you also have this issue with the currency: The dollar has lost its place as the world's reserve currency. I think there are clear signs that the United States' role, its long-term role as an empire, is losing steam. Historically, that's what happens: Empires come and go.
So you put that all together, you put all these sort of imbalances and problems and obligations — this whole general idea of living beyond your means — you put that together and I think we're at a moment in time where we are going to see a dramatic change in the outlook for this country.
RR: Well, where's everybody else? Why aren't there more people saying what you're saying? Or are you just way out there?
Panzner: Far, far out there. It's very interesting. A year ago, many people — especially in the mainstream — had the impression that I was ‘out there’; okay, maybe people thought that I wasn't quite as whacked out as those saying the end of the world is near. But now, a year later, my book Financial Armageddon isn't as crazy as it sounded a year ago. All of a sudden you see articles about the stuff I was talking about — derivatives and leverage — in mainstream publications. So, yeah, I was a bit ahead of my time, and I like to think that it's because I put the big picture together.
RR: What were some of the signs that led you to this bearish opinion?
Panzner: The number that really stuck in my mind was total debt, which is really the collection of total public and private debt. Mind you, that statistic doesn't include things like Medicare, Medicaid or Social Security, but outstanding debt — which includes the public and private sector. That number was something on the order of 300 percent of GDP. That was a few years ago. Total debt now is about 350 percent of GDP. The last time we saw those kinds of numbers was during the Great Depression.
And then I started to do some more digging, and I saw debt payments as a percentage of income statistics at record levels. Then I got my mind around the extent of the real estate boom. Clearly, there were a lot of people who were saying there's no bubble there — in the Fed, in the mainstream media, among the economics fraternity. But it had all the hallmarks of a bubble. So what do you get? What causes a bubble? To a great extent it has to do with debt. It has to do with people's willingness to borrow much more than they can afford because they just believe that the price of the asset will keep going up forever. In my mind, the inflation of the housing bubble and this level of debt — which has not been seen for 80 years or so — just struck me as a sort of wakeup call.
RR: What should financial advisors do? What should they be doing for their retail clients?
Panzner: As Will Rogers said: “Don't talk to me about return on capital, talk to me about return of capital.” And I think that's the kind of mindset that you need to focus on. A lot of people are going to be looking and saying, “Well, I can't earn enough yield, or I can't get enough in capital gains,” and, in the end, have real problems getting their money back because they've invested in something or invested with an organization that really had many more risks built in than they thought. It's a time to think defensively.
I think this is where equity investors are making a huge mistake: Everyone still thinks this is a garden-variety environment. But when you had crises in the past, you wanted to buy the dip because there were always buying opportunities. When you have had companies taking big write-downs, you want to buy because that's a signal of the beginning of the end. But few investors are putting the write-downs in the broader context that you have this huge housing bubble collapsing and there's no bottom in sight — literally.
So I can tell you for sure that if the housing market has five years more downside left, there's going to be a lot more write-downs, a lot more pain and a lot more financial institutions going belly-up. Therefore people are not thinking about this in terms of the broader economic fundamentals; they're just doing knee-jerk trades based on what's happened during the Greenspan bubble era.
RR: You talk about derivatives in the book, that the derivatives market is a little like the tail wagging the dog.
Panzner: The classic example here is credit default swaps. The value of outstanding credit default swaps — essentially a form of insurance policy on credit risk — is 10 to 30 times greater than the value of the underlying asset that's being insured. So that creates all sorts of interesting conflicts. There are a number of people arguing, for example, that one reason why JPMorgan Chase may have stepped in — and I don't know this for sure, but it seems plausible — was because of its exposure to the derivatives market, and the implications for its own portfolio if Bear Stearns failed (because it was a very large counterparty in that market). So, it had a vested interest in helping Bear Stearns. Not helping them would've rattled JPMorgan's own structure.
And in that sense you could make the argument of the tail wagging the dog, this whole idea that you now have: When companies are in trouble, you have a lot more people who stand to win if the company goes under. Whereas in the past, the community, the banks, the employees, the management, everyone had a vested interest in trying to help the company survive. Now you have this whole financial community with debts and they would be better off, or would feel happier, if the company went under.
So, it's created a lot of distortions in the traditional working of markets that have made it much, much harder to solve the problems that have come to a head in the past year or so.