“The Bezzle” Defined

I keep getting emails asking me to define "The Bezzle" in a form that "ordinary people" understand, strongly indicating that I’ve failed in that regard thus far.  Let’s try again….

Here’s what John Galbraith said about it:

"In many ways the effect of the crash on embezzlement was more significant than on suicide. To the economist embezzlement is the most interesting of crimes. Alone among the various forms of larceny it has a time parameter. Weeks, months, or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. there is a net increase in psychic wealth.) At any given time there exists an inventory of undiscovered embezzlement in – or more precisely not in – the country’s business and banks. This inventory – it should be called the bezzle. It also varies in size with the business cycle."

That sounds rather arcane, but if you roll it around in your head for a while, it should make sense.

Here are some examples of "The Bezzle":

• Liar loans: The borrower can’t possibly pay off the loan on the original agreed terms and the institution that makes the loan "passes it" to an investor fully aware that the borrower almost certainly lied about credit capacity.
• Overly-rosy projections about growth in property values: The speaker is either incompetent (doesn’t understand exponents – a fundamental mathematical concept) or is intentionally deceiving people.
• Overly-rosy projections about the stock market: "The market always comes back" and "over long periods of time it outperforms other investments."  Both true, but both misleading; if you’re 18 you might be able to wait for it to come back, but the market has remained flat to down from a given level for more than 20 years before.  How long did you say it was before you intended to retire?
• "The Internet is doubling every three months!":  It was – for about six months.  But that got embedded into the business plans of thousands of businesses, long after the growth rate had started to slow down to something more sustainable.  Oh by the way, the fundamental lie of that claim is that in 7 years, the Internet would have gone from its original two people to covering more than the entire population of the planet, including the rice farmer in China and the starving child in Bangladesh.

In short The Bezzle is "the lie" that is always present in business. 

The truth is always some degree of lying in business transactions – always has been, always will be.  And so long as The Bezzle doesn’t become the underlying theme in business, it simply bankrupts the people who try to run it when they get discovered.

But when The Bezzle becomes the underlying premise and basis for business transactions that entire segment of the market is doomed.

Eventually the embezzled discover the fraud, and they get angry that the embezzlers stole their money.  They revolt in whatever way they are able – if there is no law that gives them recourse and no government support for outing the bad actors they either turn to lawless actions or simply withdraw from the marketplace, refusing to continue to be a victim of someone else’s grand scheme of theft.

This point was reached for the US Mortgage Market, and the lending market in general, some time around the middle of 2007, when the two Bear Stearns Hedge Funds blew up.

Realization of The Bezzle always starts slowly, but it is an exponential process, because as the pool of liquidity starts to drain that has allowed the hiding of these crimes more and more dead bodies start to surface, and they all stink.  This results in more and more people starting to question if they have been scammed; a process that, once it begins, becomes exponential in scope and force.

This is where Government comes in, because only government has the lawful power of deadly force.  Only the government has the right to preemptively investigate and arrest people for fraud and embezzlement.

When government fails to discharge its duties in this regard over long periods of time, we wind up where we are now.  The "sea of liquidity" covers the dead bodies for a time, and the government refuses to drain the swamp or arrest those who it knows are committing evil acts.  Witness Madoff and Stanford, both of which were known to the government for more than a decade and yet no enforcement action was taken.  Witness the Fannie and Freddie accounting scandals, which should have led to indictments, prosecutions and a shutdown of these institutions – but didn’t.  Witness the appraisers petition dating back to 2000, bearing more than 10,000 signatures, that was ignored by the government.

Of course those who were part of The Bezzle and profited from it will viciously resist the termination of the cycle, because they will be bankrupted – or worse.  Witness the story in the WSJ this weekend about AIG:

The beneficiaries of the government’s bailout of American International Group Inc. include at least two dozen U.S. and foreign financial institutions that have been paid roughly $50 billion since the Federal Reserve first extended aid to the insurance giant.

Among those institutions are Goldman Sachs Group Inc. and Germany’s Deutsche Bank AG, each of which received roughly $6 billion in payments between mid-September and December 2008, according to a confidential document and people familiar with the matter.

It gets better.  You see, Ben Bernanke said he had no authority to regulate AIG in his testimony before Congress.  True.  But he did have authority to regulate commercial and investment banks in this country, and if he and Greenspan had done their job we would not be here because those firms could not have bought or sold CDS with AIG – a company that had essentially no capital behind its bets.

Bank of America is trying to avoid disclosing the employees who got bonuses from taxpayer funds on a "time-shifted basis" just before it acquired Merrill Lynch; they are claiming imminent "irreparable harm".  One has to wonder if the "grave and irreparable harm" being discussed is violation of certain people’s rear ends in prison should they be sent up the river post-disclosure?

The FHA has been mightily trying to paper over the truth as well but it’s not working out so well:

With the surge in new loans, however, comes a new threat. Many borrowers are defaulting as quickly as they take out the loans. In the past year alone, the number of borrowers who failed to make more than a single payment before defaulting on FHA-backed mortgages has nearly tripled, far outpacing the agency’s overall growth in new loans, according to a Washington Post analysis of federal data.

Many industry experts attribute the jump in these instant defaults to factors that include the weak economy, lax scrutiny of prospective borrowers and most notably, foul play among unscrupulous lenders looking to make a quick buck.

This is yet another government attempt to hide The Bezzle instead of force it out into the open, deal with it, and imprison those responsible for it.

Nor does it stop there – the Democrats’ most recent housing bill, passed just this last week, drew this criticism from Republicans:

“Congress shouldn’t force them to pay the mortgages of deceitful borrowers who committed fraud or borrowers who made bad decisions,” said House Minority Whip Eric Cantor, R-Va.

“It is nothing short of absurd to punish those who acted responsibly while rewarding the reckless and sometimes illegal actions of others.”

Ah, but where were you when the EESA/TARP was being debated, or when AIG was being bailed out, both of which are the same thing, writ large?

We have our share of apologists for The Bezzle and its continuation too, including Barry Ritholtz:

The latest idiocy coming out of the usual collection of misfits, dolts and cheerleaders is that the last 20% leg down in the market is pretty much all President Obama’s fault. Now before I explain — yet again — why this is so foolish, I have to point out that just about everyone who is saying this has been pretty much wrong about, well, pretty much everything.

Oh really?

I’m one of the people saying this, and have I been wrong about "pretty much everything"?  Go back and read some of my earliest Tickers, including my 2008 Prediction Ticker and those in 2007 in which I said that we’d take $2.5-3 trillion in mortgage losses for residential real estate.

The fact of the matter Mr. Ritholz is that President Obama has ratified The Bezzle instead of working to put a stop to it, and as such he both owns and is responsible for the continuation of the slide in the markets since the election.

If 2000-03 taught us anything, it is that The Market is bigger than any man or any office.  It will not suffer The Bezzle once it becomes uncovered as a systemic component until it is flushed out to the point of becoming undetectable.

During the 00-03 Bear Market The Bezzle was mostly in The Internet Space, and so the tech names were where the damage was focused.  This time, however, it has infested literally every area of commerce that has a tie to finance, which of course is nearly everything.  Homebuilders, big industrial companies, banks and insurance companies are all intertwined by finance – along with many other sectors of our economy.  All are being taken to the outhouse one at a time, shot, and then dumped down the hole.

The damage will stop only when one of two things happens:

1. All of the identifiable Bezzle is flushed from the financial system OR
2. Government comes out and makes clear that it will clamp down, enforce the law, and that the bad actors both forward and back will be prosecuted, the ill-gotten gains recovered to the extent possible, and the truth demanded from all firms going forward.

Those are the only choices folks. 

Government is not responsible for the fraud, but it is responsible for turning its head and refusing to look, investigate and prosecute.

Government profited from the increased tax revenue and "fake wealth" that was "created" as a consequence of The Bezzle, and the campaign bribes, er, contributions that flowed from it. 

Now government must choose – either put a stop to The Bezzle, here and now, or watch the market dismantle it piece by piece, firm by firm, and deal with the collateral damage – another 10-20 million unemployed (at minimum) and a Depression worse than the 1930s.