STUMP » Articles » Living Beyond Your Means Kills: Debt is Just the Killing Weapon » 16 February 2016, 06:35

It’s true whether you’re a Dickens character, an aristocratic Austen family, a modern celeb, a city, a state, or a nation.

I have referred to the Micawber principle before:

“Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness.

Annual income twenty pounds, annual expenditure twenty pounds nought and six, result misery.”

From Mr. Micawber of David Copperfield fame. The only way Mr. Micawber finally gets free from his overspending ways is he’s shipped to Australia with a few other inconvenient characters. Without the ability to rack up any debt, he becomes a prosperous sheep farmer in Australia (or some such).

My favorite Austen novel, Persuasion, has an aristocratic version of Micawber in Sir Walter Elliot.

An excerpt (with my edits for readability):

But now, another occupation and solicitude of mind was beginning to be added to these. Her father [Sir Walter Elliot] was growing distressed for money. She [Eldest daughter Elizabeth Elliot] knew, that when he now took up the Baronetage, it was to drive the heavy bills of his tradespeople, and the unwelcome hints of Mr Shepherd, his agent, from his thoughts.

The Kellynch property was good, but not equal to Sir Walter’s apprehension of the state required in its possessor.

While Lady Elliot lived, there had been method, moderation, and economy, which had just kept him within his income; but with her had died all such right-mindedness, and from that period he had been constantly exceeding it. It had not been possible for him to spend less; he had done nothing but what Sir Walter Elliot was imperiously called on to do; but blameless as he was, he was not only growing dreadfully in debt, but was hearing of it so often, that it became vain to attempt concealing it longer, even partially, from his daughter.

He had given her some hints of it the last spring in town; he had gone so far even as to say, “Can we retrench? Does it occur to you that there is any one article in which we can retrench?” and Elizabeth, to do her justice, had, in the first ardour of female alarm, set seriously to think what could be done, and had finally proposed these two branches of economy, to cut off some unnecessary charities, and to refrain from new furnishing the drawing-room; to which expedients she afterwards added the happy thought of their taking no present down to Anne, as had been the usual yearly custom.

But these measures, however good in themselves, were insufficient for the real extent of the evil, the whole of which Sir Walter found himself obliged to confess to her soon afterwards. Elizabeth had nothing to propose of deeper efficacy. She felt herself ill-used and unfortunate, as did her father; and they were neither of them able to devise any means of lessening their expenses without compromising their dignity, or relinquishing their comforts in a way not to be borne.

There was only a small part of his estate that Sir Walter could dispose of; but had every acre been alienable, it would have made no difference. He had condescended to mortgage as far as he had the power, but he would never condescend to sell. No; he would never disgrace his name so far. The Kellynch estate should be transmitted whole and entire, as he had received it.

Ultimately, they decided to rent out the big estate to an admiral (who had been made rich by the Napoleonic wars), and live in a smaller space in the seaside resort of Bath, where other similar spendthrift landed gentry went to try to be fashionable on the cheap.

While yes, it really was Puerto Rico, Chicago, and Greece that set of these thoughts, this recent tweet also spurred this thinking:

I write this to you my brothers while still 53 million dollars in personal debt… Please pray we overcome… This is my true heart…

— KANYE WEST (@kanyewest) February 14, 2016

Okay, then.

One needs to have a really big income to rack up so much debt. But worry not, Kanye. You’ve got nothing on Chicago.

DEBT IS JUST THE INSTRUMENT

Recently, munilass Kristi Culpepper went off on those people buying the recent Chicago Board of Education bond offerings. An excerpt:

The sole purpose of this bond issue was to provide CPS with a few months of budget relief, not unlike the general obligation bonds Puerto Rico issued immediately before being cut off from the capital markets in 2014. And in exchange for the ability to cash flow until this June, CPS will be making payments on this new debt until 2044 at an interest cost of 8.5% — roughly triple what a top-rated borrower would be paying.

Just under $40 million of the bond proceeds will be treated as capitalized interest, meaning that CPS borrowed money to pay the investors who are buying their bonds so they can use the money that would otherwise be used to service the debt for other purposes. Approximately $208 million of the offering was a “scoop and toss” refunding. This means CPS is extending the maturities on debt that is currently coming due so the district does not have to pay that either.

So Chicago taxpayers incurred a lot of new debt that they have nothing of tangible value to show for. It’s just a simple transfer of their wealth to the capital markets, on top of the quarter of a billion dollars they recently paid their interest rate swap counterparties. This has become a routine occurrence not only for CPS, but for the City of Chicago, which shares the same tax base.

……
It would appear that most of this issue was picked up by traditional municipal investors (per the Bond Buyer), which would be high yield mutual funds and the like. If you are a mom-and-pop investor, the most significant piece of information for you to take away from this post is that it is worth the ten minutes it takes for you to monitor the holdings of the funds you’ve invested in. A lot of toxic waste lurks out there, and more than a few funds were willing to take their clients’ hard earned money and put it into the CPS Ponzi scheme.
…..
Instead of blowing Rauner’s remarks way out of proportion, market participants should look in the mirror. This bond deal was not a traditional bond issue or an example of the socially responsible partnership with taxpayers that has defined the municipal bond market for over a century. Chicago officials, market professionals, and money managers are engaging in a giant gang rape of taxpayers in this instance. And they are shocked, shocked that they are the only ones who care about whether or not they get repaid? Rauner’s not saying anything different than a bankruptcy judge or a Chicago parent or taxpayer would say. No one is holding a gun to your head and forcing you to buy this paper.

Instead of clutching your pearls like a delicate and inexperienced debutante who thinks she is entitled to universal approval, consider this: perhaps it matters to other people what kind of deals you are participating in and what the money will be used for. And perhaps that has real consequences. Engage in antisocial lending and you will find yourself politically indefensible and alienated on both sides of the spectrum.

While Culpepper is making this a moral issue, I don’t see the need to call this antisocial, etc. I would rather emphasize her points elsewhere in the piece that the people holding these bonds are likely going to get defaulted on in some manner. It’s just a matter of when it would happen.

It would be nice to assume that the people involved in this deal are making a calculated risk, but I am going to guess most of them are not. Most of them assume they’re going to get paid in full, and they are here for that super-high yield. Yippee!

Wait, waddya mean the principal is gone?

And I assume a bunch of lawyers are keeping their eyes on this for the lawsuits when Chicago does go bankrupt fully, whether de jure or de facto. It’s definitely insolvent, but not yet hit the cash flow wall.

OVERSPENDING IS THE CAUSE

The point is the problem doesn’t come from the debt per se, but from the overspending all these years. One can overspend a little bit, take on a little bit of debt… but if that debt is never paid off, if one just keeps accruing more debt, and some of that new debt is just rolling over the old debt… there is trouble.

There is appropriate use of debt: 30-year bonds to cover the construction of a building that will last 30 years. A 1-year note to cover liquidity needs, due to lumpiness of tax receipts.

Not appropriate use of debt: 30-year bonds to pay for that 1-year note.

But if you keep overspending your income, that’s where you end up.

What fixed it for Micawber and the Elliots was pushing them far away from their over-spending lifestyles, and allowing no further debt racked up.

Heck if I know if that’s what’s on tap for Kanye. He threw a Hail Mary, asking for $1B from Zuckerberg. Uh, yeah. Zuckerberg didn’t get rich by throwing money at people who outspend their income. He doesn’t seem the junk bond type to me.

While debtors prison no longer exists, there will be no debt forgiveness, no bailout — just bankruptcies and defaults. Those who overspent, and those who lent money to the spendthrifts will both get hurt.

But at least the spendthrifts got a few good parties and cars out of the money first.