Cram Down the Ultimate $100 Trillion Bailout, U.S. Dollar Value Fast Meltdown Ahead

     

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.

People with 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 Down.

In bankruptcy, 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 union contract.

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.

Governments, 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.

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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.

When debtors 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 Denninger:

Here’s the math.

This fiscal 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%.

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Yes, 1.27%.

Now what happens if we take no more debt at all but rates normalize to 5%?

That would 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 it.

That comes 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.

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October 1, 2010