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Kotlikoff: financial system is a Ponzi scheme that could collapse at any time

Fiscal reform | Kotlikoff: financial system is a Ponzi scheme that could collapse at any time Ian Fraser

A leading professor of economics has warned that the global economy is a giant Ponzi scheme that could collapse at any time.

Speaking at a pensions summit in the Netherlands, Professor Laurence Kotlikoff of Boston University told delegates that the global financial system – which remains largely unreconstructed despite near implosion following the collapse of Lehman Brothers two years ago – is a massive con trick, characterised by lack of transparency, and largely made up of fraudulent guarantees and financial promises that cannot be kept.

Kotlikoff, also known as Larry, is the author of Jimmy Stewart Is Dead: Ending the World's Ongoing Financial Plague with Limited Purpose Banking, a book endorsed by Mervyn King, governor of the Bank of England. He served as senior economist with president Ronald Reagan's council of economic advisers in 1981-82 and has advised the IMF, World Bank, OECD and scores of national governments around the world.

Kotlikoff believes that government bailouts of financial institutions did little to address underlying problems of our financial system and that, in fact, they made things worse. He said:

"AIG insured the uninsurable, and now the US government has taken over that role. But managing the crisis by taking on promises you can't deliver is not a fix to systemic risk. It is itself systemic risk."

He added that, if the United States didn't use "bogus" accounting to keep unfunded liabilities off its balance sheet, it would be in worse shape than Greece: "To cover all those liabilities, federal taxes would have to be raised by 64%, or expenses would have to be cut by 40% – and that is an optimistic estimate."

He said that if the US doesn't take steps to reduce its deficits, its fiscal problems could trigger a second financial crisis worse than we've seen seen so far.

"Once people figure out the government can't actually deliver what it has promised, other than by printing huge amounts of money, this may trigger a bank run. Pimco has already said it will buy no more US Treasuries, which is not a good sign."

Since Kotlikoff spoke in the Netherlands, Standard & Poor’s has lowered its outlook on the long-term rating of US sovereign debt to negative, citing a "material risk" that policymakers may fail to reach an agreement on proposals to trim its massive budget deficit. This, coupled with renewed fears about the eurozone, triggered an immediate fall in US share prices on Monday.

In Kotlikoff's view the financial system is inherently fraudulent because financial institutions insure the uninsurable and take on liabilities they cannot honor, while these institutions and their managers take on only limited liability and pass the buck to the taxpayer when things go pear-shaped. In short, it's what Jeffrey Sachs, in a review of Jimmy Stewart is Dead, has described as "a system in which bankers make promises they can't keep in order to collect outsized earnings unrelated to real productivity."

Kotlikoff believes the only way to fix this is to introduce the "limited purpose banking", the old-fashioned know-your-customer type banking practised by the Bailey Building and Loan Association in Frank Capra's 1947 movie It's a Wonderful Life. Kotlikoff said this

"takes the multifaceted fraud out of our financial system by turning all banks, insurance companies, hedge funds, etc. into fully transparent mutual fund companies. Limited purpose banking also abolishes over 115 federal and state regulatory authorities and replaces them with the Federal Financial Authority, which verifies, fully and immediately discloses, and independently rates and appraises all securities held by the mutual funds. In a nutshell, limited purpose banking makes Wall Street safe for Main Street."

He also believes the pensions system must be reformed so that employers are removed from the picture since "companies have their own interest at heart", and those interests rarely coincide with providing their employees with a good income after retirement. Instead Kotlikoff believes the government should introduce mandatory savings of about 8% of salaries, to be invested collectively in a globally diversified index fund at virtually zero cost, he said.

He told delegates at the conference that he hoped his views would resonate in the Netherlands and inspire measures to overhaul a broken financial system that is living on borrowed time. "Don't expect the US to take the lead in this," he said. "We are the ones who created this mess in the first place."

I am grateful to Mariska van der Wes, who attended and reported the summit on behalf of Investment & Pensions Europe, for her report of Kotlikoff's talk).

Further reading on economic and fiscal reform post crash:



Tags: fraud , liability , Pensions , stocks and shares , transparency
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