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The Fraud Behind the Fed  ( Original )
JAN 27, 2017

ORIGINAL SOURCE: "The Perfect Crime & Paying The Piper" by Daniel R. Amerman, CFA of 1/27/2017

Let's start here; 

 fraud  frôd/  noun noun: fraud; plural noun: frauds

wrongful or criminal deception intended to result in financial or personal gain."he was convicted of fraud"


fraudulence, cheating, swindling, embezzlement, deceit, deception, double-dealing, chicanery, sharp practice

"he was arrested for fraud"

swindle, racket, deception, trick, cheat, hoax; informal scam, con, rip-off, sting, gyp, fiddle, bunco, hustle, grift 

"social insurance frauds"

There has been so much written on this subject and this time Daniel R. Amerman goes deep into the mechanics of this institution to reveal whats really going on behind the curtain in detail and very informative and you can read it right here:

Frauds are the most painful on the back end, not the front end. 

In Part One of this analysis (linked here), we compared two sets of books that the U.S. government keeps, and identified a $5.4 trillion financial "fraud" with regard to the Social Security and other government Trust Funds, including military and civilian federal employee retirement programs. 

While not legally a fraud, because this was the United States government doing it, nonetheless, the savings have all been spent over the previous decades and what is left is the hollow shell of one branch of the government having a financial claim on another branch of the government. A legally binding claim that is not secured by any actual assets, but only by the future borrowing and taxing power of the federal government.

That is outrageous! But, that said, there are a lot of outrageous and unfair things in the world, and there has not been an obvious price to this for most people so far.  Real tax rates have been higher than stated tax rates, and this has reduced standards of living, but most people have no idea that this was the case. So the "fraud" may seem very technical or obscure to the majority of the population.

That will be changing soon, and the consequences will be life changing for many millions of people. Oh, the average person is unlikely to ever understand the reasons why this is happening. But their day to day lives will be different, nonetheless, and not in a good way.

Using the new generation analytical software that I developed for the research report, we are going to explore something that you have likely never seen before: the coming dollar cost to us all of decades of politicians spending our retirement money while claiming that they were saving it.

The Cost In National Deficits

In Part One we explored what the future would look like if the savings in the Trust Funds really existed in the way that the government usually tells us they do, and in the way that most people believe they do.

If this were reality, the government would have $5.4 trillion in actual savings, in actual assets, that it could draw down to make Social Security and other retirement payments to the extent that payroll or other taxes were insufficient.

As shown in Exhibit CB35 above (which is more fully explained in Part One), that extra cash would allow the federal government to make retirement benefit payments in whole, while still keeping budget deficits far below what they would otherwise be. This is what most people understand savings to be - assets which you can sell or otherwise cash out when needed in order to generate money to pay for things.

As seen in Exhibit CB18 above, the red line of retirement benefit expenses steadily climbs upwards with the retirement and aging of the Boomers. With a uniformly increasing blue line of government revenues, the yellow deficit line would ordinarily have to jump up to finance those payments. But the slope of the blue line isn't flat, it jumps upwards with the cash coming in from genuine savings, from redeeming actual Trust Fund assets, and the yellow deficit line is held down until the assets run out. With the depletion of the Trust Fund savings, there is no more money, and the yellow line of annual budget deficits dramatically leaps upwards.

That first set of books, which includes those used by the Social Security Administration, isn't how the Trust Funds actually work, however.

The second set of books, such as those maintained by the Congressional Budget Office (CBO) and the White House Office Of Management and Budget (OMB), take a quite different approach, which is illustrated above in Exhibit CC3. The government already spent the money that supposed to go into the Trust Funds, all that is left is a claim by the Social Security Administration (and others) on the Treasury Department. When the claim is presented, there is no outside source of funds, there are no real assets. So the deficit rises, and the cash to pay the claim is generated by selling additional U.S. Treasury bonds to the public - just as if the Trust Funds didn't exist at all.

When viewed graphically, we can see economic reality, which is that there is no bulge in the blue line as outside assets generate additional cash, and that means there is no depression in the yellow line of annual federal budget deficits. Instead the deficits soar upwards with the increase in retirement benefits right from the very beginning - because there are no real savings.

Using this information, the coming cost of closing the two sets of government books can be seen. This true cost is not gloom & doom, or emotional feelings of depression or anger - but is quantifiable, and therefore actionable.

The true cost of the government taking our savings while claiming it wasn't, is the additional borrowings that are necessary to redeem the Trust Funds. Dollars that would not need to be borrowed if there were actual assets there, as we are assured there are.

The orange area in Exhibit CB38 above is the gap between the yellow deficit lines in the preceding individual graphs. The bottom of the shape is formed by the annual federal government budget deficits (inflation-adjusted) with the first set of books, and the Trust Funds being real assets (Exhibit CB18). The top of the shape is formed by annual deficits with the economic reality of the second set of books (Exhibit CC18). The area in-between is deficits that will occur, but that would not have occurred if the Trust Funds had been invested in real assets.  

Exhibit CB40 above shows the same relationship in a different way. We now see the deficits in nominal terms with no adjustment for inflation - and the amounts are startling. By 2026 the difference in the deficit is up to $900 billion a year (this is different from Part One because of interest expenses, as further explained below). By 2028 the increase in deficits peaks at over $1 trillion per year, in the last full year before the trust funds deplete.

In recent years it has become easy to become a bit "jaded" with the number of a trillion dollars. There are already so many trillions of dollars being thrown around in different areas - are these particular increases really that significant? Will they impact the average person?

Exhibit CB41 places things in perspective. By 1992, the federal debt held by the public - the amount financed by external investors - had reached $3.1 trillion. This represented over 200 years of federal borrowing. However, the dollar was worth substantially more 25 years ago than it is today. When we adjust for inflation (CPI-U), the total publicly held debt in 1992 was equal to about $5.2 trillion in today's dollars.

The amount of the Trust Funds is currently about $5.4 trillion. As they are redeemed and bonds are sold to pay retirement benefits, external investors will have to be found for that entire amount. 

What that means is that even after adjusting for inflation, the government will have to raise more new money to cash out the Trust Funds than the total publicly held federal debt outstanding in 1992 - after over 200 years of previous deficits and borrowing. With all the deficits outside of the Trust Funds occurring on top of that.

That is fantastic sum of new money that needs to be raised - from something or somebody - in what is usually projected by the government to be somewhere within the next 10 -16 years (with the dates varying depending on the agency and the assumptions). 

However, government economic projections tend to be quite optimistic. If a recession were to happen in the next few years, that would depress tax revenues and accelerate the depletion of the Trust Funds, which means the money must be raised much sooner. And if something worse were to occur, such as a trade war or financial crisis, the deficits - and need to raise cash - could leap upwards at any time. 

The Perfect Crime

The real cost of a financial fraud does not occur when we are paying in our savings. But rather it is felt when we try to take them out - and they aren't there. This is just as true for our nation with the Trust Funds as it is with a more conventional private fraud.

None of us have experienced this yet. But we will be, and soon. However, the form will be different with a government "fraud" than it would be with a private fraud. 

With a private fraud, when "the jig is up", the money just isn't there, and it is lost. And some might think that the Trust Funds not being quite real means that they won't be paid out, and there might some major and obvious default, where Social Security and other government retirement programs are unable to make payments in full.

That easily understandable type of loss is highly unlikely, however

With the government, the money isn't there - but it can be borrowed. Indeed, absent some sort of meltdown event, it must be borrowed - and at a pace like we have never seen before - so that every dime from the $5.4 trillion in the Trust Funds can be paid out exactly on time, or there could be severe political consequences.

Something that may not at first glance make sense in Exhibits CB38 and CB 40 above, however, is why the orange and red areas of the graphs keep on going to the right. Once the Trust Funds have been spent - shouldn't they stop?

The problem is that trillions of dollars in new external debt will be taken on. And interest payments have to made on that new debt. Which increases the annual level of deficits. Which then further increases the national debt, and so forth. We will be paying the price of the "fraud" every year for the rest of our lives, even long after the Trust Funds have all been redeemed. 

These annual interest payments mean there will be that much less money available for the payment of Social Security and other retirement programs, as well as Medicare, into the indefinite future. Which means there is a good chance that unfortunately (and ironically), the cost of the Trust Funds having been spent instead of invested will ultimately take the form of a reduction in retiree standards of living for decades to come.

Spending what should not have been spent may therefore invert what the public has been told in two distinct ways. One is that borrowing to redeem the Trust Funds will accelerate financial problems for the nation, rather than acting as a buffer against such problems. And over the longer term, retiree standards of living are likely to be decreased rather than increased, with this potentially being true for the rest of our lives.

But the federal government is quite unlikely to ever point that out, and the general public is unlikely to ever understand this. Instead they will see three distinct things presented to them. 

One of them is that the Trust Funds are real, they are fully invested in the safest investments in the world, and these investments will indeed be successfully cashed out in full. There will be no default, the trillions in savings will cover many years of paying benefits to retirees, and it would be ridiculous to suggest otherwise.

Entirely separately, there will be a fantastic surge in new external federal borrowing that comes out of nowhere in the coming years and transforms the markets, while also likely turning many of the assumptions that traditional retirement financial planning is based upon upside down. Who could have known? It will just be the situation.

And also entirely separately, once the Trust Funds have been redeemed, the servicing of that massive new external federal debt will be reducing the amount of money available to pay federal retirement programs for decades into the future. We will be taking the net interest costs paid to outside investors today, and adding on top of that the equivalent of the entire debt costs that the government was paying 25 years ago. That financial squeeze could be painful when it comes to daily standards of living for retirees - but it will just be reality, and who could have known?

If this were a crime, it would not only be the largest financial crime in history, but it would also be the perfect crime - because few of the victims will ever realize that there was a crime at all. 

Paying The Piper

The Trust Funds "fraud" is one of several reasons why the future within a five to ten year horizon must behave in a way that is quite different from the past. (There are powerful investment implications for the next several years as well.) 

The 2010s to date may have seemed strange compared to previous decades - but we are still just getting started. The quantitative easing and creating trillions of dollars out of thin air, the lowest interest rates in history, and the resulting run-up in stock and real estate prices - those were all unprecedented and even bizarre, but they were also just the warm-up.

Many people are anticipating that normality will be returning to the markets as the financial crisis of 2008 continues to recede into the past. And if it weren't for the increase in the national debt, the coming surge in retirement benefit payments - and the unwinding of the Trust Funds "fraud" - they would hopefully be correct.

Just one piece of the puzzle is what we have reviewed in this analysis and the preceding analysis. The real meaning of the Trust Funds - which is the direct opposite of what the federal government assures the public - is that the Treasury Department will be developing a voracious appetite for new cash over the coming years, to an extent that none of us have seen in the past. They have to get that money from somewhere. Or somebody.

Simultaneously, the rapidly increasing total national debt held by the public will make the financial viability of the United States ever more dependent on keeping interest rates very low. 

So, the government will have a record need for new cash - which usually involves paying higher interest rates - even as its ability to pay existing interest rates is going the other direction. 

This toxic relationship has been "baked" into the Trust Funds ever since the decision was made to use them to finance the national debt instead of making genuine investments, but we have not yet seen the price. Because until recently, the eventual high cost for the nation seemed far in the distance.

That is no longer the case, and the time is now approaching rapidly when "the piper must be paid".

Paying the piper for the Trust Funds by itself - as the need for new funding surges while the ability to make interest payments to investors in exchange for that funding declines -  will transform the bond markets. It has to. This will likely dramatically change stock market prices and returns. Even as powerful incentives are created for the government to increase the rate of inflation. 

Real estate prices and asset/liability management strategy returns may go to a place that we have never seen before. And there is a very good chance that retirement account regulations will change as well, in ways that may lead to increased funding for the government.

Now, some people will approach this from the perspective that as the pressures grow, then systemic fragility grows, and the chances of a hard reset increase dramatically. A reset that could be limited to major and life changing reductions in retirement benefits - or it could be far larger. 

This perspective could easily be correct. The financial issues of the coming five to ten years (and beyond) dwarf what caused the financial crisis of 2008. The pressures will be enormous, the decision-makers involved are far from perfect or all-knowing, there are many other problems in the world that could act as triggers, and this could indeed create a much larger and more enduring economic and financial crisis.

For those who wish to be prepared, a clear understanding of the sources of pressure, how they interrelate and feed off of each other, and the applicable numbers and years - could be essential information.

That said, the 2010s have been a time of acute economic and financial stresses - but we haven't seen the meltdown that some have continuously said would be inevitable. Instead we are seeing record stock market prices (and profits), record bond prices (and profits), and near record real estate prices (and profits).

It is counterintuitive for most people, but as my long-time readers know (particularly those who have reviewed the previous educational resources) - containing problems and crisis can be lucratively profitable. This happens in ways that may not initially make sense to most people - but the evidence can be seen every day on the financial pages.

We likely have unprecedented attempts to contain problems on the way. Which, counterintuitive though it may sound, has the potential to create a new round of major profits in some investment categories. This may be particularly true over the transition period, the early stages of dealing with a rapidly growing set of problems. 

(For those who own my "Profiting From Government-Dominated Markets" set which was originally published in 2014, it is worth pulling out the DVDs or manual and watching or reviewing the entire Stock Implications Chapter 6 (DVD #4), particularly the "The Potential For Dow 20,000 and Dow 24,000" section starting on page 241. Consider the "banding" concept which is explained, and the how the Fed raising rates as the Dow reaches 20,000 is consistent and rational from this perspective.)

Mysteries Versus Quantifiable Knowledge

For most people, the reconciliation of the two sets of books is likely to lead to a long series of surprises over the coming decade and beyond.

The unfortunate part is that this is not some dark and unknowable mystery. Rather, the redemption of the Trust Funds is a quantifiableprocess. Using the tools of financial analysis, numbers and graphics can be used to fully identify what is happening, how the process works and what the relationships are.

Yes, this is complicated. Just trying to reason it out is very difficult to do, particularly for someone who is not a professional analyst. This is particularly the case because one could say that the whole purpose behind using two sets of books, each of which are highly complex, is to make it impossible for the public to understand what is happening.

But, starting with the analysis as a base - this can be entirely understandable. The $5.4 trillion redemption of the Trust Funds can be explained. It can be intuitively understood by people who have never taken a finance or economics course, as well as by financial professionals.

Whether the word fraud should be applied to the $5.4 trillion in purported savings that have already all been spent by the government is an individual decision, with strong emotional and political aspects. But the approaching reconciliation of the two sets of books is not about emotions or politics. 

Reality just is what it is. And reality is that the nation will be going through a quantifiable and understandable $5.4 trillion financial process that because of its sheer size is likely to influence and change investment markets and results in almost all categories. Most people will be "flying blind" as this happens when it comes to their investment and retirement choices - and are unfortunately, likely to end up paying the price for that.

Most importantly, the reconciliation of the two sets of books will not be happening in isolation. Yes, the future path for the national debt cannot be understood without understanding the role of the Trust Funds. But there will be many more factors influencing the national debt other than just the Trust Funds, and some of these factors are even more important.

Yes, the future path for Social Security and Medicare cannot be understood without understanding the real meaning of the Trust Funds being entirely invested in financing the national debt. But the Trust Funds are only one of many elements that that will be determining actual payouts, and some of the other elements are more important.

Everything is intertwined, the relationships are quantifiable, and nothing will be happening in isolation.