If you’ve never
heard of a "Cram Down," you are about to get a first hand
lesson on the receiving end of the biggest one in history. The words
"Cram Down" used to be reserved for companies in bankruptcy
or smaller venture backed companies that run out of cash and are
recapitalized by "cramming down" the equity held by existing
shareholders. The only other alternative to closing the doors is
to reorganize the ownership structure to attract new capital and
keep it in business. Those who don’t have the money to play in the
next round – i.e. don’t have a money printing press –
will get wiped out. Having personally experienced a number of these
unpleasant affairs in various businesses, you are definitely better
off giving than receiving a Cram Down.
Let’s say you
bought 100 shares of XYZ Company and paid $10 per share. The company
runs into trouble and is either going to raise new money or shut
down. After a recapitalization or Cram Down, those shares might
be worth $.01 per share – the value of the old shares are set by
the new money – and your investment of $1000 ($10 x 100 shares)
would now be worth $1. The new money gets to buy shares for 1/1000th
the price you paid for yours, so they invest $1000 of their own
money and if you don’t, you will own 1/1000th of the percentage
in the company that you used to own. These situations are always
governed by the Golden Rule, those with the gold make the rules
– the party putting in the new money names the terms.
a lot of this get to boss around those who don’t have a lot of this.
You might be
able to buy some of the new shares at the new price, but the new
money investors usually try to scoop up control of the entity, to
enrich themselves even further and prevent future meddling by uppity
shareholders, whose old shares are usually converted to "Common"
shares – for this reason, people who get crammed down usually aren’t
a happy bunch. Common shares are called common for a reason; they
don’t carry the protections and rights of the preferred shares and
common shares fall at the end of the pecking order when a payout
happens. Common shareholders are usually lucky to collect a penny
when there are lots of preferred shares ahead of them. You’re always
better to be in the preferred nobility than a commoner in a Cram
whomever ponies up the "new money" or is favored by the
judge receives the lion’s share of the equity in the restructured
company and everyone else is virtually wiped out or "crammed
down." In a bankruptcy, the judge has wide latitude to "cram
down" various classes of debt and equity and involuntarily
impose this over the objections of various classes. A recent example
is the General Motors bankruptcy, where the bondholders were crammed
down for the benefit of the unions, which went against 200 years
of established bankruptcy law (normally the company’s lenders get
the majority of the equity, unions get a much more modest share
for concessions). The golden rule applied here, too. The U.S. government
put up the gold and ruled that the United Auto Workers should get
the equity, not the widow and orphan GM bondholders. The bondholders
investment of $27 billion of their cash wasn’t worth as much in
that Cram Down as the future votes of the United Auto Workers, who
put in no cash and offered a modest discount to their company busting
GM filed for
bankruptcy protection June 1, 2009. Bondholders got 10% for their
$27 billion, the U.S. government got 50% for their $50 billion invested
and the United Auto Workers union got 40% for political connections.
Elderly retirees lost a large part of their retirement savings in
this Cram Down.
companies and individuals around the world all have a mountain of
debt they will never be able to repay; they are INSOLVENT. In the
old days – debt would be extinguished by repayment in gold or the
loan would default and the lender would take over the collateral.
What’s special about gold? For 5,000 years, gold has been considered
money without counter-party – it’s just you and a lump of gold
– you are not reliant on the good credit of another party. It’s
where the buck stopped, literally.
Today, in the
era of unlimited money printing, there is no gold repayment. We
replaced gold repayment with money printing by the privately owned
central banks. When a central bank issues money in excess, existing
holders of that currency are "crammed down" by the new
money coming into the system. Since 1913 when the Federal Reserve
was created, over 95% of the value of a dollar has been crammed
out of the pockets of savers and into the hands of bankers, politicians
and the recipients of the new money. This slow motion Cram Down
is called Inflation and it is the mortal enemy of the saver. As
you are about to see, the motion is about to get a lot faster because
there is a new, efficient tool being used to strip value away from
savers known as the Bailout.
The first dollar
Cram Down took about 100 years to strip 95% of the value from savers.
The next 95% devaluation will take just a handful of years.
A number of
commentators have estimated we are already into the bailouts to
the tune of at least $14 trillion. This is in addition to last week’s
report in the UK Telegraph (covered in my column HERE)
that a well connected banker estimated the next round of "Quantitative
Easing" (or QE2 as they now call this round of bailouts) could
reach $30 trillion, or about 50% of the world’s GDP. Given that
this money is, like all fiat currency, issued in the form of debt,
how would that extra $30 trillion ever be paid back? When money
is issued as debt, there is no end to the need for money to pay
the interest on the existing debt (e.g.: if $100 is issued at 5%
interest, another $5 of money must be created just to pay the interest,
but there is interest on the interest, ad infinitum). As we explored
last week, we’re now beyond the point of ever paying back the CURRENT
debt with anything resembling the value it had upon issuance.
go deadbeat, they can’t even pay the interest, let alone the principal
and the U.S. Government might be approaching that point soon, according
to B4IN contributor Karl
year (2010) we have approximately $13 trillion outstanding in debt
(including "intergovernmental borrowing," that is, Social
Security and Medicare.)
Our total debt
service is projected (it’s not quite over!) to be 4.63% of the budget,
or about $165 billion. That’s approximately 7% of revenues, incidentally.
That’s an effective
interest rate of about 1.27%.
Now what happens
if we take no more debt at all but rates normalize to 5%?
be $672 billion, or about $500 billion more than it is today. Incidentally,
that’s fifty-two percent of all (personal and corporate) income
taxes, up from today’s thirteen percent.
Of course the
CBO says we will run about $1 trillion in deficits for the next
ten years. Let’s presume it’s five years, and we’ll give it the
$1 trillion, although I think that’s low – maybe by 25% or more.
So let’s add
$5 trillion to the total, for $18.5 trillion, and apply a 5% rate
to $925 billion, or dangerously close to all personal income taxes,
which are $1.061 trillion.
Got it folks?
All personal income taxes, or if you prefer all FICA and Medicare
taxes, will go only to pay interest.
We won’t get
there. Before that day comes the world, which buys our debt as a
"safe haven," will discern this math and cut us off. It
is a certainty. Look at what happened with Greece, where literally
within days short-term interest rates went to 10% – a rate that,
were it to happen here, would cause The United States to blow up
monetarily and politically right here and now.