The following is excerpted with permission of the publisher John Wiley & Sons, Inc. from Economic Warfare: Secrets of Wealth Creation in the Age of Welfare Politics by Ziad K. Abdelnour with Wesley A. Whittaker. Copyright (c) 2012 by Ziad K. Abdelnour. It's on the border of what I consider acceptable politically (I try to avoid politics on FMF) but I decided to run with it since whether or not you think there actually is a war against the rich, this excerpt should be interesting to us all since we are striving to become wealthy. This is a follow-up to part 1.
Why You Are Not Rich
My intention with this book is to not only shine truth on some of the misconceptions that have been taken as gospel regarding America’s economic legacy, but to also provide some insights into ways you can protect and grow your personal wealth and turn around the current situation to your advantage.
The fastest transfer of wealth in the past 20 years was due to a lack of pertinent regulation, artificially low interest rates, and no risk management. Regulators did not pay sufficient heed to the warnings that were raised more than a decade ago. First Greenspan and then Bernanke kept the interest rates low while a new breed of mathematical whiz kid gamblers lured Wall Street into an “easy money” mentality with their algorithms and super computer arbitrage programs. Add to that shady mortgage originators, politically motivated securities underwriters, and sloppy credit rating practices and you have the perfect conditions for a financial tornado. In the end, they all worked together unknowingly to turn Wall Street into an international casino underwritten by the American taxpayer.
A large and probably unavoidable part of the challenge in today’s technology-driven marketplace is that the velocity of money is fueled by such techniques as high-frequency trading, front running, credit default swaps, and collateralized debt obligations (CDOs). Traditionally, a home mortgage was a loan made by a local banker, and it stayed in the community until it was paid off. The Rule of Threes was the inside joke in the banking fraternity: borrow money at 3 percent, lend it to home buyers at 3 points higher, and be on the golf course by 3.1 That all changed in the 1970s when Salomon Brothers introduced the concept of securitization—purchasing mortgage loans from local banks and bundling them into bonds that were then sold to investors.
The next step was the development of the collateralized mortgage obligation (CMO), which was created in 1983 by the investment banks of Salomon Brothers and First Boston for U.S. mortgage lender Freddie Mac. The CMO is a stand-alone special purpose entity that owns a pool of mortgages. Investors buy bonds representing different classes of risk called tranches. Return of investment
is determined by the structure of the deal, which could be “high risk–first payout” or “first in–first out” or some other arrangement that dictates how money received from the collateral will be distributed.
This led to the development of CDOs, a form of structured asset backed security (ABS) whose value and payments are derived from a portfolio of fixed-income underlying assets, not just mortgages. CDO securities are split into different risk classes, or tranches, where “senior” tranches are considered the safest securities. Interest and principal payments are made in order of seniority, so that junior tranches offer higher semiannual or coupon payments and interest rates or lower prices to compensate for additional default risk.
A CDO is a sophisticated form of an IOU against the cash flow that the CDO collects from the pool of bonds or other assets it owns. If cash collected by the CDO is insufficient to pay all of its investors, the junior tranches suffer losses first.
The financial crisis of 2007 was fueled by the fact that many CDOs were backed by subprime mortgage-backed bonds. When mortgage defaults became a widespread problem, the drawback of
CDO investors contributed to the collapse of certain structured investments held by major investment banks and the bankruptcy of several subprime lenders. It also did not help that global investors began to discover that the AAA-rated bonds in which they thought they were investing were really a bundle of BBB investments with the patina of an AAA rating. In other words, wholesale institutional fraud facilitated in large part by the same ratings agencies who so piously downgraded the nation’s credit rating.
Historical safeguards like regulatory agencies and credible rating agencies that were created to protect the integrity of the financial system have been compromised by the large Wall Street firms and their drinking buddies in the federal government. The swift prosecution of fiscal malfeasance and political corruption, which used to be the expected response to such bait-and-switch con games, has apparently been sidelined. The federal government and the largest financial institutions seem to have been totally co-opted by a group of elitists running an open larceny ring, seemingly oblivious to the pain and suffering they are wreaking upon the public and ignoring any fiduciary responsibility they had to their investors. It is like the old spaghetti western where the gang of banditos has taken over the village and is laughing while they loot the bank, drink all of the booze, and bully the villagers. What we have now is definitely not free-market capitalism. It is a reign of financial terror.
The Federal Reserve was created to prevent banking panics and wide swings in the economy by holding inflation in check and protecting the value of our currency. It was given autonomy to protect it from political influence; in other words, politicians couldn’t give away economic perks just to get reelected. The Fed has strongly resisted any effort to apply any kind of oversight to its activities by claiming they are attempts to politicize the Fed, but let’s look at the record. Almost every Fed chairman in the past 60 years has manipulated interest rates to brighten the economic outlook for incumbent presidents or newly elected presidents who won by large margins. The purchasing power of the U.S. dollar has fallen 94 percent in the past 100 years. The only way you can create inflation is by creating more money that is backed by the same reserve assets; the Fed is the only entity that can create more money. Ben Bernanke’s quantitative easing (QE) programs have pumped billions of unfunded dollars into the economy, thereby setting us up for massive inflation in the very near future. If this isn’t a form of financial terrorism, it is incompetence of the highest order.
A body cannot function properly nor experience its full potential when it is laboring under the growing infestation of parasites. In the same way, America will never reach the zenith of freedom and prosperity that is the birthright of every one of its citizens as long as we allow ourselves to be governed by those who feel they have a mandate to take what isn’t theirs and to appropriate what they haven’t earned.
When you combine unrepentant bankers, incompetent politicians, and the legion of special-interest moochers who could not operate without a government stipend, you end up with a national economy that has been beaten, abused, and depleted of all vitality.
We are on the edge of economic collapse unless we wake up and forcibly take back control of our government and economy. Over the past 100 years, the game has been rigged, slowly and piecemeal at first, always in the name of serving the greater good, preventing the next bubble or providing greater transparency and security. It is as if the American people are suffering from battered spouse syndrome; the politicians, the greedy bankers, and the Fed all lie to us while they steal our wealth and our liberty. Every time we call them on it, they promise to never do it again if we’ll just give them one more chance. So we let it slide and then act shocked when they do it to us again.
Maybe we should have our collective head examined.
Who Are the Rich and Why Should You Care about Them?
It is an oft-repeated axiom that a person can learn a whole lot about a society by how it treats its poor; but just as much may be learned by looking at how that same society treats its rich. Indeed, the economic future of the poor—and our nation—will be determined in the coming decades by how we treat the people in this country who create great wealth. It will be determined by our understanding of the so-called rich and by our need to foster and protect this minority of true wealth creators.
It is an unpopular thing to say, I know. Rich people need help? Rich people need to be protected? Rich people a minority? “Give me a break,” people say. “They just seem to keep getting richer!”
I am talking here about the entrepreneur who risks all of the capital he can muster from his family and friends to build a company that fills an underserved niche in the market, provides a needed service, or develops a new technology. These are the people the plundering bureaucrats and career politicians have deemed “the rich.” These are the people they have targeted for appropriation to support their unsustainable way of life.
In their narrow view of the world, rich people become “rich” by either inheriting their money or appropriating wealth through manipulation of the system with their cronies, or are self-made entrepreneurs. The first group is so small that they don’t really matter. The second group is easy for the bureaucrats to intimidate and the politicians to plunder with ever-widening regulations and more oppressive oversight; but, again, there are not that many people who fall into the crony-capitalist category. The overwhelming majority of people I refer to as “the rich” are independent-minded, maverick entrepreneurs and business owners who risk their own capital, sweat, and tears to provide a good or service of value to the world around them.
Regrettably, too many Americans, and far too many of the intellectuals and politicians, understand neither these people we call “the rich” nor the methods they have used to become rich in the first place. Did hedge fund managers and investment bankers game the system and walk off with a lot of money? Yes. But, again, having a lot of money no more makes you rich than growing up next door to the Greenwich Country Club gives you class. The rich are people like Bill Gates, Warren Buffett, Larry Page and Sergey Brin, and Michael Dell. They have provided value to the world and been rewarded for their efforts. They also know, better than the federal government, how they should best utilize that wealth.
Most people don’t think they actually know anyone who is truly rich. Not really. They experience them in the abstract, through magazine articles, newspaper stories, or Lifestyles of the Rich and Famous clips. They catch a glimpse into their psyches through statements they make in the media or interpretations of their latest business maneuver. They try to quantify their importance in their own lives by studying policy statements and annual reports or poring over ratings and statistics that rank their net worth and their influence; but the study and the analysis is always through the prism of someone else’s ideological lens. In that respect, our opinions about the rich are a sort of societal inkblot test, revealing more about ourselves than anything else. Our analysis of the raw data confirms our deeply held notions about the rich and, in the end, has more to do with our views on capitalism itself.
Those who are vested in the philosophy of the Left, believing capitalism creates unfair outcomes, have statistics to confirm their outlook. It seems absurd on its face that the top 1 percent of American families control 90 percent of the nation’s wealth. Wouldn’t it be possible, they ask, to contrive an economy that is just as prosperous but with a fairer distribution of wealth? Couldn’t we cap the earnings of the rich at $50 million? Or even $100 million? The defenders of capitalism and free markets on the Right say “no.” They contend that the bizarre inequalities we see are an indispensable part of the processes that create wealth. They imply that capitalism doesn’t make sense, morally or rationally, but it does make wealth. So don’t knock it, they say.
What nonsense! It has very little to do with the reality of the rich. It is really quite sad that defenders of the rich or even the rich themselves can’t come up with a better economic or moral case! Quoting Adam Smith and supply side economists just doesn’t cut it. American novelist and homespun philosopher Mark Twain reportedly noted that a person can lie with the numbers but the numbers don’t lie. The rich have most of the money. That’s why they are called “the rich.”
So who are the rich? Having spent a lifetime working with some of these people to create and preserve their wealth, I believe I am qualified to explain who they are, where they come from, and why you should care about preserving their wealth and protecting their desire to hold on to it.
Come back tomorrow to read part 3 of this series.
"Couldn’t we cap the earnings of the rich at $50 million? Or even $100 million?"
Who is suggesting that? That seems like a straw man argument.
Posted by: jim | March 13, 2012 at 04:46 PM
The congress is currently trying to push versions of a bill that would limit t he spread between CEO salary and those at entry level. It's definitely not a cap. What do you all think?
Posted by: Luis | March 13, 2012 at 06:45 PM
As shown in the statement "But, again, having a lot of money no more makes you rich than growing up next door to the Greenwich Country Club gives you class", the author seems to be trying to re-define the word rich from its commonly accepted definition of "having alot of money" into "creates great wealth". I think this attempted re-definition is disingenuous because looking at Forbes list of the 10 richest Americans three of them Jim Walton, Alice Walton and Christy Walton largely inherited their wealth as opposed to creating it. Two David Koch and Charles Koch inherited part of it (though they did increase it significantly). Finally Sheldon Adelson got his fortune almost entirely through building and running casinos and though it's debatable gambling is more of a transfer of wealth than the creation of wealth. So if we follow the authors definition of "rich", then almost half of the top ten wealthiest people in the U.S. are not "rich", they just have alot of money.
Posted by: Arthur | March 13, 2012 at 08:10 PM
This article presents a very well written and succinct summary of the corruption in the financial sector that I have read about many times in some of the market letters that I receive. This is why I refer to the period where I was very fortunate, 1960-2000, as the good old days. The playing field used to be fairly level in those days but sadly, lack of regulation and government oversight allowed some of the most powerful institutions to get away with gross dishonesty. Of course these institutions were too big to fail so naturally the government bailed them out.
Bottom line - The rich are getting richer and the poor are getting poorer, but of course everyone knows that now.
Posted by: Old Limey | March 13, 2012 at 08:37 PM
The problem that we have is that the so call "rich" in our society are lumped in together and become vilified. It seems that if someone falls into a category of earning a certain amount (often described as making over $250,000 a year) means that these people somehow are part of problem and should be punished with higher taxes.
Posted by: JimL | March 13, 2012 at 09:12 PM
JimL
I have a substantial investment income but I am nowhere remotely close to being rich. I consider the rich to be those people that wield a lot of power and have annual incomes in the several million dollar range as well as receiving high bonuses. Usually these would be people very high up in financial companies such as Goldman Sachs, AIG, Fannie Mae, Freddy Mac, Countrywide Mortgage, BofA, CITI, Lehman Brothers, Bear Stearns etc. In other words, the top executives in the companies that played a major role in creating the great recession.
Posted by: Old Limey | March 13, 2012 at 09:44 PM
Old Limey,
Then why use the word "rich" to describe those people? Rich has a simple standard definition - possessing great wealth. Obviously the level of wealth required to constitute "rich" will vary with your perspective, but by pretty much anyone's definition, you are very rich. Why say only people working high up in the financial sector (who you earlier vilified as dishonest) are rich? Instead, why not come up with a different word for people who make a lot of money in a way you perceive as dishonest? The word that comes to mind is "crook." Your comment, with the new word, makes more sense:
"I have a substantial investment income but I am nowhere remotely close to being a crook. I consider crooks to be those people that wield a lot of power and have annual incomes in the several million dollar range as well as receiving high bonuses. Usually these would be people very high up in financial companies such as Goldman Sachs, AIG, Fannie Mae, Freddy Mac, Countrywide Mortgage, BofA, CITI, Lehman Brothers, Bear Stearns etc. In other words, the top executives in the companies that played a major role in creating the great recession."
Posted by: Jonathan | March 14, 2012 at 01:16 AM
JimL , The reason it "feels" as though people who make 250k or more are part of the problem is because of the current lacking of the justice system to prosecute and convict the defrauders (i.e. crooks). I truly believe it is the rich and powerful who pad the right people's pockets to get away with murder. Is this all done on the backs of the hard working rich? Yes, because the defrauders need honest businesses to hold up the economy to make their stolen money worth something.
Going back to what I was saying, people making over 250k are not part of the problem, they not only help our GDP but they pay more income taxes too. Those multimillionaires who do not work and pay less than 15% taxes on "carried" interest are, in my opinion, part of the problem for the economic sludge we are in. The difference is that if they were honest financially, then they are not the cause for all our problems today.
Posted by: Luis | March 14, 2012 at 07:48 AM
@Jonathan
The following article released this morning substantiated my statement.
By CHRISTINA REXRODE | Associated Press – 1 hr 27 mins ago.
NEW YORK (AP) — An executive resigning from Goldman Sachs, the powerful investment bank, said in a blistering essay that the company had lost its "moral fiber" and said managing directors there referred to clients as "muppets."
Greg Smith, an executive director at Goldman, said the company needs to "weed out the morally bankrupt people" and suggested the erosion of Goldman's culture threatened its survival after 143 years.
Posted by: Old Limey | March 14, 2012 at 10:53 AM
@Luis
Correct me if I'm wrong but it is my understanding that the only income taxed at a flat rate of 15% is income from longterm capital gains. This is why Warren Buffet's tax bill is so low and why some famous hedge fund managers have been able to make over a billion dollars in one year and pay such little tax.
I have had zero capital gains since I switched to income producing investments in 2007. I was in the 28% bracket for 2011. The largest taxable income I had in 2011 was the mandatory required distribution from our IRAs, there's no getting around that once you go over 70.
Posted by: Old Limey | March 14, 2012 at 11:05 AM
Old Limey,
That article lent credence to your statement that top executives played a major role in creating the recession, but has nothing to do with your attempt to redefine the word "rich."
Posted by: Jonathan | March 14, 2012 at 11:09 AM
@Jonathan
There are many uses of the word "rich" in Webster's dictionary, for example "Rich foods", or "A rich fuel mixture". However the following one comes close to my defintion of wealth.
"Rich is the general word for one who has more money or income producing property than is necessary to satisfy his normal needs."
Just visit any US shopping mall (including the parking lot) and watch the people for a while, I think anyone from countries other than Europe might well conclude that all of the Americans they see are rich. Even an American on unemployment and foodstamps is richer than most of the people we see from other countries on our nightly news stories.
Posted by: Old Limey | March 14, 2012 at 11:59 AM
@Old Limey - Help me understand what changed in 2000 to make the playing field not level? I'm not a banker but it seems that those on the "in" always had the upper hand and that there was corruption even before 2000.
For example, the S&L scandal of the 80's comes to mind and most of the Enron crimes occurred in the late 90s. Also all the dot com IPOs pre-2000 are a big one. Most of those failed to pass any business model yet were allowed to go public. The only folks who made out on that were your Goldman Sachs of the world.
I just think there will always be the rich and always the poor. One's behaviour is the biggest impact on their socio-economic status. And yes health, birth family, luck, fortune, and circumstance also play a huge part.
Posted by: texashaze | March 14, 2012 at 12:05 PM
What the author of these posts doesn't seem to understand is that the transfer of wealth over the last 20 years was DELIBERATE and caluclated. That's and indictment of not only both political parties, but the small cabal of globalists who are imposing this massive transfer of weal not only on Americans but the world as a whole.
Posted by: Mark | March 14, 2012 at 01:15 PM
a
Posted by: Old Limey | March 14, 2012 at 01:34 PM
@texashaze
Why 2000 was a pivotal year in my memory was that after retiring in 1992 just as the Internet was starting to make its presence known to the majority I lived through the dot.com bubble.
The Nasdaq 100 index experienced a 596% increase between 4/11/97 and 3/27/2000 and then dropped precipitously, giving it all completely back by 10/7/2002. What followed was the "Lost Decade" where the Nasdaq 100 index lost another half of its value. Fortunately I was using fund selection and market timing throughout that period and there's nothing better than huge market swings when you are timing the market.
To get back to your question, before I retired, back in the 60's, 70's, and 80's I used a stockbroker. He would call me at work and tell me what to buy or sell. Sometimes at lunch my friends and I would visit his office to watch the market. They had a huge blackboard with people on ladders using chalk to change the quotes on popular issues while we watched. In those days the typical volume on the NYSE was 3-5 million shares. After I retired and the Internet revolutionized the market and every Tom, Dick, and Harry was in it, the volume of shares traded daily soon rose into the billions. Program trading appeared and the little guy lost his edge to the big firms with the big computers. These days the best of the computer whizzes graduating from schools like MIT go to work for companies like Goldman Sachs and with real time information on all market orders and trades available to them are able to program supercomputers to make thousands of trades/day following every small move the market makes.
Posted by: Old Limey | March 14, 2012 at 01:38 PM
@ Old Limey I now know for certain how those in position of wealth to avoid taxes to the tune of 13.9% per annum. Romney's 2010 taxes is posted online for anyone to see. All of his income was capital gains and factoring other deductions he came out well below 15%. I don't have any beef personally with 15% capital gains rate as that is a risk account, but to get deductions beyond that it is absurd. I want to learn a little more about Romneys trust accounts and overseas account to see how taxes are handled. Now if he would only release his previous years taxes for us to find out....
Posted by: Luis | March 14, 2012 at 01:42 PM
@texashaze
"And yes health, birth family, luck, fortune, and circumstance also play a huge part."
I couldn't agree more with your statement.
Health - still excellent at 77.
Birth family - Poor but hard working, frugal, and were good role models.
Luck - That's my big winner, looking back I couldn't have been luckier.
Circumstances - I seemed to always be in the right place at the right time.
Posted by: Old Limey | March 14, 2012 at 01:48 PM
OK then why not say that anyone making over $500K/year is rich and should pay more taxes?
The $250K/year cutoff is a low straw-man argument, that was designed precisely in order to generate dissent for the proposed taxes on the wealthy.
But most of the wealthy make far more than that--just set the bar a bit higher at $500K/year. It's pretty hard to argue that making over $500K/year is just middle class.
Posted by: MC | March 14, 2012 at 01:49 PM
What is interesting to me is that the government defines wealth based on income -- which we all know does not necessarily lead to a high net worth (which determines true wealth IMO.)
Posted by: FMF | March 14, 2012 at 02:05 PM
@Old Limey - I see what you mean. It seems that computers leveled the playing field by allowing everyone access to the trading but now the only one's with an advantage are the brokerage houses...
BTW, your timing is great!! I love your story - riding the CA housing boom from cheap to expensive and riding the stock market as well. Now that the world is globalized I doubt that will ever happen again.
Posted by: texashaze | March 14, 2012 at 02:38 PM
@Mark - I don't understand what you mean by the "transfer of wealth over the last 20 years was DELIBERATE and calculated". That's a pretty bold statement. Who is getting the wealth and who is receiving? Please provide evidence of this.
Posted by: texashaze | March 14, 2012 at 02:48 PM
Old Limey you said : "I am nowhere remotely close to being rich."
Aren't you a mult-millionaire?
Posted by: jim | March 14, 2012 at 02:57 PM
@Texashaze
Unlike "Reader profile DV", I also actually have my own chef, it's my wife who loves to cook, last night she prepared Alaskan king crab legs with a Ceasar salad. Of course, she would tell you that she has a live-in gardener that keeps everything beautiful as well as managing her investments and seeing that her bills get paid. She also has a chauffeur - how about that? She gave up her license recently because of eyesight issues. I guess you could say we are both rich.
Posted by: Old Limey | March 14, 2012 at 03:00 PM
MC, the $250k figure would put a household in the top 2%. Hard to argue the top 2% is the 'middle' of anything. I'd call that 'high income'.
Posted by: jim | March 14, 2012 at 03:05 PM
Jim:
The short answer is "Yes", but I don't live like one nor do our children. I never planned on it but I used my engineering talent to teach myself how to become a very good investor after retiring and the market cooperated so it happened in 1999, 7 years after I retired, and has continued on to this day without ever a losing year.
I drive a 21 year old car, our house chardonnay wine costs me $23.88/case, I buy my shirts and sweaters on eBay, our entertainment is provided by NETFLIX, and I also wash & clean my car, grow lots of our own fruits and vegetables, do the more strenuous house cleaning, and do my own plumbing & electrical work when needed.
My youngest daughter (51), divorced 4 years ago, has a $2.7M investment portfolio and supplements her huge alimony and keeps busy by selling used books on Amazon.
Her twice divorced sister (53) has a $1.9M investment portfolio, recently moved to Maui and telecommunicates to San Jose, CA to do the billing for her attorney boss as well as taking care of her two adopted baby girls (2 & 3). They bought an ocean front fixer upper, her third husband (a builder) is almost finished renovating it.
Posted by: Old Limey | March 14, 2012 at 08:48 PM
Limey, I'm sorry but if you're a mult-millionaire then I don't think you can really claim you aren't "rich". Just because you don't act or 'feel' rich doesn't mean you aren't in the category based on your very high net worth.
The age of your car and the cost of your wine is not relevant.
Posted by: jim | March 15, 2012 at 03:00 PM