The Agreement of Thirds

Addison Wiggin – June 14, 2011

  • “The Agreement of Thirds” in Prichard, Ala.: Future model for strapped states, Social Security
  • Bill Gross, John Embry on how the United States is “going Greece”
  • Wholesale price increases slow, retail sales fall… and a glum outlook from the real job creators
  • Busybody bureaucrats in action: Want salt? You’ll have to ask for it
  • Strategic default debate, Day 3… including some helpful tax guidance

   Alfred Arnold is one of the lucky ones.

Once a fire captain in Prichard, Ala., he’s gone back to work at age 66, doing shopping mall security. Since he got the job, he’ll be able to hold onto his home.

One of his colleagues, a fire marshal, died in June. He was too young to collect Social Security, and too proud to accept any help. When his body was found, his home had no electricity or running water.

The city of Prichard is so dead broke. The council elected to stop paying its 150 retired workers in 2009. Eleven have since died.

   By skipping out on its pension obligations, Prichard broke Alabama state law. Never mind that the pension fund was empty, or that Prichard’s tax base is tapped out. The town population has plunged 40% in 40 years.

The retirees sued, conducting an intriguing experiment in the extraction of blood from a turnip.

   Last week, the retirees got their first checks in 20 months, under an agreement to settle the suit. We call it the “agreement of thirds,” given its two main provisions:

  • One-third of all revenue generated by the city must go to pay retirees
  • The retirees will collect about one-third of what they once expected.

“Prichard,” The New York Times reported last winter, “is now attracting the attention of bankruptcy lawyers, labor leaders, municipal credit analysts and local officials from across the country.”

   At worst, Prichard is a harbinger of the crisis to come. At best, it’s a model. Certainly it’s a model for Illinois, where the five state pension systems are $80 billion in the red.

The Illinois state constitution forbids reducing retirement benefits for current employees. That didn’t stop the state House of Representatives from passing a plan last month giving those employees a choice — pay more in to get their existing level of benefits, pay the same and get fewer benefits or switch to a 401(k)-type plan.

The House’s proposal will likely end up in court, too. For now, current retirees are not affected as they are in Prichard, Ala. but we don’t expect that to last. Do you?

   Longer term, Prichard is probably a model for Social Security, too. Social Security, along with Medicare, is a major reason Uncle Sam is in worse financial shape than Greece, according to Pimco chief Bill Gross.

Yesterday, Gross reckoned the real national debt as follows:

  • Take the commonly published figure of $14.3 trillion
  • Add in Social Security and Medicare to reach $50 trillion
  • Throw in the assorted bailout commitments and you get to $100 trillion.

“To think that we can reduce that within the space of a year or two is not a realistic assumption,” Mr. Gross told CNBC. “That’s much more than Greece, that’s much more than almost any other developed country. We’ve got a problem and we have to get after it quickly.”

   The numbers get no better in President Obama’s proposed 2012 budget. “Spending for Social Security, Medicare, Medicaid and the income security programs (mostly welfare),” says to Peter Ferrara of the Heartland Institute who was caught peering under the hood, “will consume 95% of all federal revenue. What is left will not even be enough to pay interest on the national debt, equal to 10% of federal revenues.”

We’ve been forecasting a state of affairs similar to this for six years now. But we’ve made one mistake repeatedly: The Federal balance sheet continues to deteriorate faster than we have expected.

“On our current course,” Ferrara continues, “our national debt as a percent of GDP will soar past the level that triggered bankruptcy for Greece. The European Union tried to end that crisis with a trillion-dollar bailout financed by its taxpayers.”

“But who will bail out America? Who even could?”

   We note here that S&P downgraded Greece yesterday to the lowest rating in the world, CCC. It still considers Uncle Sam AAA.

In the credit default swap market this morning, traders give Greece a 74% probability of default in the next five years.

   “It’s not one iota different than Greece,” Sprott Asset Management’s John Embry says of Uncle Sam’s massive debts. How will they be resolved? “It will either be inflated or defaulted, it will not be paid back under any circumstance,” he tells King World News.

Either way, he says you can be assured of two things: “One is that the standard of living for the average person will be crushed, and two, there will be some form of civil unrest because people confronted with this reality are going to become extraordinarily unhappy.”

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   Stocks are rallying today, for the same reason they tumbled last Friday — that is, for no discernable reason at all. Traders are digesting two economic reports, neither one supporting a “recovery” thesis:

  • Wholesale prices rose 0.2% from April to May. That’s down considerably from the increases seen the previous two months. But the year-over-year increase continues to accelerate, as it has all year. At 7.3%, the latest 12-month increase is the biggest since the fateful month of September 2008
  • Retail sales fell 0.2% from April to May — the first drop in 11 months. Not surprisingly, the amount of money Americans spent on food and gasoline grew, crowding out pretty much everything else.

True, that retail report is “better than expected”… but that alone can’t be good for 125 Dow points, can it?

Anything’s possible.

   Small business owners, who fuel most of the job growth in the United States, are feeling glum. The latest small business optimism index from the National Federation of Independent Business turned in a “recession-level reading,” to quote from its report.

At 90.9, the reading is the lowest it’s been since last September. It was in the high 90s during 2006-07.

   Steady as she goes for the precious metals. Gold is at $1,522, silver at $35.16.

   Because the Argentine government has solved all of the nation’s other problems, it is now turning its attention to the citizens’ salt consumption.

The health department in Buenos Aries province has reached what CNN describes as “an agreement” — purely voluntary, you understand — with the hotel and restaurant federation to remove salt shakers from the tables.

“On average, each Argentinian consumes 13 grams of salt daily,” says the health minister, “while according to the World Health Organization, you should consume less than five.”

You can still ask for salt, according to this account… but only after the food’s been delivered to your table… and you’ve tasted it.

And perhaps after your name’s been entered into a health department database of salt scarfers, but that part isn’t being publicized right now:

The expected crowd size once the new rules take effect…

Ahh, what the hell. Argentines have to deal with rising poverty, falling literacy and inflation in 20%-per-year range. At least they’ll be doing so with lower blood pressure now.

Although even that “benefit” could be bunkum as well. A recent European study discounted the tie between salt and hypertension altogether.

   “What the hell has happened to this country?” asks a reader rhetorically about the United States while following up on our debate over the doubling “strategic default” rate…

“Is it now OK to quit paying your bills because the bank screwed you first? This is the mentality of children, people! Contract law be damned! What about your integrity? An individual with character honors a contract… period!

“No wonder our country has gone to crap. Quit trying to turn wrongdoing into something ‘financially sound.’ Nobody likes to be underwater with their mortgage, but if you can afford to pay and don’t, then you are a bum!

“I hope every landlord you deadbeats try to rent from charges as much rent as your mortgage is worth. I’d like to see a law that prohibits all the ’strategic defaulters’ from ever being able to own a home again.”

“Did you keep all your toys? The ones you bought while you were raping your underwater house for the invisible equity in it? Or did you ‘strategically default’ on those too? The love of money, immaturity and selfishness only begin to describe what we’ve become as a nation.”

“Oh, well, as long as you’ve all kept a clear conscience — or did you ‘strategically default’ on that too?”

The 5: Sheesh.

   “The moral dilemma in walking away from a mortgage,” writes another with a little more restraint, “is that other common folk are left holding the financial bag through bank fees, bank bailouts, ad nauseam…”

“If we could made the banks suffer the consequences of their mistakes, supporters of strategic default make a good point. However, I’ll see a bankster own up to his own bad decision about the same time I see him in dining on Chik-fil-A, not lobster.”

   “Strategic defaulters are forgetting or oblivious to the fact,” writes a fourth, “that it is ‘forgiveness of debt’ and considered income by the IRS.”

“I share an office building with the IRS and they tell me they will be going after strategic defaulters. I think I would rather owe the bank money than the IRS.”

The 5: Indeed, “Federal and state tax laws have long viewed canceled debt as income, says a Wall Street Journal piece from May 2010, “because consumers who borrow money to buy a house — or who pull money out of their house to buy cars and such — and then don’t pay it back ‘wind up ahead of where they were,’ says an IRS spokesman.”

The exception is money borrowed to build or buy a primary residence. But home equity loans, HELOCs, and cash-out refis? Investment properties? IRS agents see dollar signs with all of those. And with a $1.65 trillion deficit staring Uncle Sam in the face, we daresay they see more dollar signs than usual.

   “We don’t need violence,” a reader writes in reply to the reader who suggested a modern-day storming of the Bastille, “when we have the vote.

“Just vote the bums out after one term, and don’t vote by party — they’re both the same. I’m 60 years old and there are politicians in Congress who were voted in when I was a kid. They have too many leeches attached to them after one term — imagine after 20.”

The 5: Yes, because that’s worked so well over your lifetime…

We’re already anticipating the mail in response to this: “If you don’t favor violent revolution and you think electoral politics are useless, what’s the solution?”

The solution is another time-honored French tradition: Sauve qui peut.

Cheers,

Addison Wiggin
The 5 Min. Forecast

P.S. The question of how you execute “sauve qui peut” is more important now than at any time most of us have been alive.

It’s what we’ve asked every speaker to address this year at the Agora Financial Investment Symposium in Vancouver: Is it time to fight for the values that made the United States so prosperous or time for your capital to flee for more-hospitable climes.

Registration for this year’s conference is now closed… but you can get the next-best thing. You can now sign up to get CDs and/or MP3s of every conference session, with a written summary of every investment recommendation. Sign up now to lock in the best-available price.

Also, as you know, registration for Vancouver is free for all Agora Financial Reserve members. If you’re not currently a member, we’ve opened the doors for a limited time, ending this Thursday, June 16, 2011. Review your excellent benefit package and enroll here. Don’t miss out: It’s the best deal in the industry. And it’s going fast.

rspertzel

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