Crash Course Chapter 14: Assets & Liabilities

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As we learned in the prior chapter on debt, our nation has an historic, never-before-seen level of debt on the books.

Now some would say that it’s not reasonable to look only at debt, one also has to also consider the assets and total liabilities to assess the situation.

And they’re right.  After all, does it really matter if you have a million dollars of debt if you also have no additional liabilities but assets worth $10 million?

Not really, because your assets exceed your debts and liabilities, you should be $9 million in the clear.

What we’re going to do in this chapter is look at both the assets and the liabilities of the United States so that we can assess whether the current debt loads are worrisome or not.

All right, let’s begin here with assets. So what is an asset?

One definition is: Items of ownership convertible into cash; total resources of a person or business, as cash, notes and accounts receivable, securities, inventories, goodwill, fixtures, machinery, or real estate.

By this definition an asset is something of value that can be converted into cash or provides access to, or enhances a flow of cash.

If we simply say assets are bank deposits, real estate, a stock or a bond, and the physical stuff we own, we’d pretty much cover the vast majority of what we consider to be our assets.

A liability is a likely future expense for which one has an obligation to pay.  Not just the absolute legal requirements to pay – which are the debts – but also any outstanding obligations.

To make this understandable, for a family, their assets would be cash in the bank, home equity and other real estate held, and the things in their home that they owned.

The family’s debts would typically be in the form of a mortgage, an auto loan, credit card debt, and perhaps student loans.

And future other liabilities of this family might include college educations for children that have not yet been fully saved for, or taking care of ageing parents whose own resources are insufficient to cover their future needs.

While “debts” are technically a type of liability, for the purposes of this chapter, when we refer to debt we’re talking about a fixed commitment of a known amount.

When we say  “liability”, we’re referring to a future obligation to pay that is neither fixed nor accurately known.

We know that providing care for an ageing parent will cost a lot of money, but not how much because we don’t know the duration of the expense or how much it will be in any given year.

We’re making this distinction between the terms “debt” and “liability” because the media – and even our government – often treat the two very differently, something Congress reminds us of every time they say that Social Security and Medicare can be modified at any time and therefore don’t count the same as our national debt.

So how does all this stack up in terms of our total net worth as a nation?

To get a handle on the situation we’re going to look at the net worth of households because on the public side of the story, as we saw earlier, the liabilities and assets of the US and State governments really belong to the citizens.

On the private side, the assets and liabilities of companies belong entirely to the bondholders and shareholders of the company, not the company itself.

And who holds bonds and stocks?  Ultimately somebody does, which for the most part means a private citizen does.

Since we can pool citizens into households, we could examine household assets, deduct some relevant liabilities and get a decent view of where things stand.

The Federal Reserve tracks Net Worth at the household level and this data is routinely and widely reported in the media.

According to the Federal Reserve, Household net worth exploded by more than  $20 trillion dollars between 2003 and 2008– an astonishing feat – before collapsing by $17 trillion dollars during 2008 and 2009.

And then again, between 2009 and 2013, the net worth of the country has increased again by nearly $20 trillion.

To put those numbers in context, the entire net worth of the nation did not hit $20 trillion until 1989 so the recent gyrations are akin to amassing and losing as much wealth as was accumulated during the first 300 years of history.

And these are NET assets, meaning debt has already been deducted so the Federal Reserve, and many in the media, take the position that with just over $77 trillion in net worth, Americans are doing just fine and our rapidly-climbing national debt levels are no cause for concern.

But before we get too excited about the astonishing wealth indicated here, there are two key oversights and a fallacy hidden in this report of which you should be aware.

As always, the devil is in the details.  Before I address those I want you to observe this period here spanning from 2000 to 2003.

That dip in the Net Worth of households was due to the stock market collapse that ran from 2000 to 2003 and caused such great panic at the Federal Reserve that Fed Chairman Alan Greenspan lowered interest rates to the emergency level of 1%, thereby igniting the greatest of housing and credit bubbles in all of history.

That led to an even bigger crisis in 2008 that wiped out even more wealth, in response to which interest rates were lowered to 0%. Zero.

As in, as low as mathematics will allow.

Booms and busts. Bubbles and bursts.  That’s how the Fed prefers to operate.

These declines in total net worth lead to this observation: debts are fixed.

When you take on a debt, there it sits, growing larger until and unless you make payments on it.

Debts do not vary with general economic conditions or whether you get a raise or lose your job.  Assets, on the other hand, are variable, sometimes gaining and sometimes losing value.

And so this leads to the next Key Concept of the Crash Course: Debts are fixed, while Assets are variable.

OK – Where did the $18 trillion in new wealth since 2009 come from? About 80% of that growth came from a rise in Financial assets and the remaining 20% came from growth in real estate and other ‘tangible’ assets.

When we look closer at the actual amount of household net worth there is today, we see that 83% of the total net worth consists of financial assets totaling about $63 trillion while the tangible assets are the remaining 17% and total around $14 trillion.

If we examine these assets a little more closely we see that the  $63 trillion dollars worth of financial assets consist of things like pension funds, the assets of privately held businesses, deposits, stocks, and bonds, which we can roughly re-compose into these four main classes; stocks, bonds, cash or deposits, and the assets of privately held businesses.

The other bucket of $14 trillion dollars in tangible assets consists primarily of real estate, which is 69% of this bucket, and consumer durables which would be your car, your dryer, and your snow blower, if you have one.

For every single one of these assets, except cash, in order to liberate the wealth from these assets you’d have to sell them first.

One general rule of asset markets goes like this:  Things go UP in price when there are more buyers than sellers AND things go DOWN in price  when there are more sellers than buyers.  Hold onto that thought for when we get to the chapter covering demographics.

Now let me expose two great oversights of this household wealth report.

The first oversight I wish to illuminate is that the data is presented as if it applied to our entire country in a fairly even and therefore useful manner.  It does not.

As of 2010 The Top 1% owned 35% of ALL net household wealth AND looking at stocks only owns 42% of ALL the country’s financial wealth.

If you can’t see it, I apologize; the top 1% is represented by a very thin green smear at the top of the column there.  So it’s great that our stock market keeps powering higher but for every trillion dollars it goes up, $420 billion of that newly-created wealth goes to only one out of a hundred households.

The Top 20% , which includes the top 1%,  owns nearly 89% of ALL  net household wealth and  over 95% of ALL financial wealth in the US.

This means the bottom 80% of the citizens of this country, represented in yellow, holds only 11% of the total wealth of this country – and less than 5% of its financial wealth – and even within the remaining 80%, the distribution of wealth is similarly weighted nearly all at the top.

Oh, but wait a moment. The top 1% isn’t hogging everything.

If we look at debt, we see that the top 1% only holds 6% of the country’s debt. The next 9% own 22% of it; but the bottom 90% – that’s 9 out of every 10 people in the US – holds 73% of America’s debt.

So the rich hold almost all the wealth, but generously, allow the rest of us to hold the debt. Gee, thanks.

Given this tremendous disparity, I’m reminded that Plutarch once cautioned that an imbalance between rich and poor is the oldest and most fatal ailment of all republics.

More immediately, this helps us understand why the great credit crisis of 2008 worse than expected.  Just as was true of the wealth gap in the late 1920s before the onset of the great depression, the severity of a crisis does not depend on average wealth, but the distribution of the wealth.

If a large swath of the population lacks the means to weather the storm, then the storm will be longer, and harsher than otherwise would be the case.

So what does it mean that 80% of our population possesses a meager 11% of the total wealth?  For one thing it means that the recent efforts by the Fed to provide massive amounts of liquidity support to the biggest and wealthiest banks at the inflationary expense of the lower classes were not only misguided, but they were cruel and unusual.

This leads to an easy prediction to make: The wealth gap in the US will hamper our recovery and deepen the downturn.

The second and bigger oversight is that that the fed mysteriously does not offset the net worth of the nation by the general liabilities of the federal and state governments or private corporations.

Wouldn’t it make sense for the Fed to offset these against household wealth?

So let’s look at those under and even unfunded liabilities.

What we’re going to look at here are pension, retirement, and entitlement programs.   At the state and municipal levels we find that pensions are under-funded to the tune of $4 trillion

What this means is that as money was taken in through taxes, states and municipalities actively chose to spend that money elsewhere in preference to putting it into pension funds.

Big promises and insufficient contributions were made at the same time.

What does it mean when we say that the state and municipal pensions are underfunded by 4 trillion dollars?  How is that calculated?

The 4 trillion dollar shortfall is what is called a Net Present Value, or NPV, amount.

This is important so let’s take a quick peek into this idea.

A net present value, calculation adds up all the cash inflows, in this hypothetical example $1000 per year for six years, and offsets, or  “nets”, those inflows against all the future cash outflows.

Since a dollar today is worth more than a dollar in the future, the future cash flows have to be discounted and brought back to the present.  We NET all the cash inflows and costs, discount them back to the PRESENT to determine if the thing we are measuring has a positive or negative VALUE.   NET.  PRESENT.  VALUE.

This is the methodology used to calculate the status of state and municipal pension funds.

Growth in the value of the pension fund assets plus future taxes are offset against cash outlays to pensioners, brought back to the present, to indicate that in order for the pension funds to simply have zero value, $4 trillion dollars would, today, have to be placed in those funds.

An important realization about NPV calculations is that the future has already been largely taken into account so waiting and hoping for a different future result to emerge pretty much never works.

If we have to place $4 trillion in the funds today, but don’t do this, next year the shortfall number will be even larger.

The only way it could be smaller is if fewer people are collecting benefits or the fund’s assets outperform the assumed rate of growth that fed the NPV calculation.

Moving right along. Corporations are coming off the highest levels of profitability in decades but they too opted to underfund their pensions, to the tune of  $4 trillion Net Present Value dollars, in preference for, uh, other uses for that cash.

Because pensions typically invest in bonds and stocks in a roughly 60/40 split any recessions or market declines will only add to the shortfall.

In part, the pension shortfalls are a direct function of the extremely low interest rates currently available – thank you Greenspan and Bernanke! – and also because the main stock market index – even though it is making new highs here  at the end of 2013 – …is still languishing by historical standards if we inflation-adjust the returns over the past 15 years.

Since most pension funds assume a seven to ten percent yearly compounded return, and since stocks and bonds are not yielding anywhere close to that amount over time – even including the market run-up from 2011-2013 – the pension shortfalls are understandable.

But when we get to the Federal Government, that’s when scary numbers emerge.   David Walker, the recently retired Comptroller of the US, and a personal hero of mine for valiantly and tirelessly working to raise awareness of the looming US government shortfalls, said of the US Government:

  1. It’s financial position is worse than advertised
  2. It has a broker business model
  3. It faces “deficits in its budget, its balance of payments, its savings — and its leadership.”

In my assessment he’s absolutely right. And here’s some data to support that.  This is a table taken right from the US government annual report found on the treasury department website.

Again we are going to be looking at NPV numbers.  The first is a nearly $16 trillion dollar shortfall representing the total US government Net position without including social security and Medicare.

Again, this means that ALL US government cash inflows PLUS   the value of all government assets have been offset against   known outlays to determine that, today, the US government would have to somehow obtain $16.1 trillion dollars to balance its liabilities and assets.

But that’s just 1/4th of it.  Once we add in social security and Medicare, the shortfall suddenly balloons to $55 trillion dollars by the Treasury Department’s own calculations.

Whoa!  Stop right there!  That’s over 3 times GDP!!  This means the US government is insolvent.  Full stop.

Why is this not topic #1 on the President’s agenda?  A country this far in hock has some real future issues and is potentially on its way to bankruptcy.

In case you are harboring the notion that there’s some money socked away in a special US government account, like a “lock box”, this picture shows George Bush standing next to the entire Social Security “trust Fund”.

There it is… the entire trust fund is a three ring binder with slips of paper in it saying that the US government has spent all the money and replaced it with … special treasury bonds.

Hold on there. Aren’t Treasury bonds an obligation of the US government?  How can the government owe itself money?  It can’t.

All government revenue either comes from taxpayers or borrowing so when the time comes to pay off those special bonds that money will either come from taxpayers in the form of higher taxes, or additional borrowing.

If it were possible to owe money to yourself and pay interest to boot, then we could all become fabulously wealthy by writing ourselves checks.  But of course, this is a foolish, easily dispelled, notion,

At any rate, depending on which government agency’s numbers you use, the Federal shortfall is anywhere from $53trillion dollars to $85 trillion dollars.

This number is so large that it even scares small monkeys.  And proving the point that you cannot grow your way out of an NPV shortfall, this number has grown by nearly $40 trillion dollars over the past 10 years, advancing during both strong and weak economic times.

After all, who else besides taxpayers living in households are going to pay off those liabilities?  Nobody, that’s who.  If the fed did perform this offset, because the federal government alone has a negative net worth that far exceeds total household net worth, the reported net worth would plunge below zero.

I consider it a blatantly silly practice to tally up the assets of the country while neglecting its liabilities, let alone its debts.

This is the same as someone with ageing parents and looming college bills claiming they are in good financial condition because they have a slightly positive balance in their bank account.

In summary, US households have a positive net worth if and only if we neglect to include liabilities into the mix.  When we include those, then the picture turns quite negative.

Japan and Europe are in similar situations, driven by a poor combination of bad planning, failing to save, promising too much, again demographics, and low economic growth ever since the year 2000.

Because the liabilities are so silly, so large, you can count on them never being honored.  But just because we write a liability off it does not mean it goes away.  By giving retirees less, they or their families have to shoulder the burden of living within their means – something our government still refuses to do.

To really understand why future the future liabilities of so many developed countries are massive and growing larger, we need to quickly explore the topic of Demographics.

Thank you for listening.

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