I recently had the chance to sit down with Pat Gorman from Resource Consultants. He interviewed me for his monthly newsletter. Here is the transcript.

Pat Gorman: Our guest this month is Sinclair Noe. For many years Sinclair was the host of a radio program, “Financial Review”. He has written four books on personal finance and investing. He is the founder and editor of www.Bank-O-Meter.com. Sinclair was also a featured speaker at the Wealth Protection 2009 Conference. Part of that speech focused on how banking, manufacturing, and home ownership are being destroyed and will continue to be destroyed to make way for the future. Sinclair, I think your speech really helped set the tone for the Wealth Protection Conference.

Sinclair Noe: Thanks Pat, and thanks for inviting me to speak at the 2009 Wealth Protection Conference. I think this year’s event was the best ever. I’ve been listening to my audio CDs of the speakers and I’m just blown away by the great advice; even though I heard the speakers at the conference, it’s really good to go back and review and really soak up that information, and there was great interaction with the audience, some great questions from the audience.

PG: I agree, and folks can order those CDs by calling Resource Consultants. OK, you were talking about how different parts of the economy are being destroyed. You’re really talking about the economic theory of creative destruction.

SN: Exactly, that was the theory from Joseph Schumpeter. Innovation overtakes what looks like dominant institutions and the innovators become the new dominant institutions. Cars replaced the horse and buggy, 8 track tapes have been replaced by MP3 players, typewriters replaced by computers. It’s really just part of the business cycle; innovation, growth, maturity, decline. The destructive part of that cycle can be very painful, but the innovative part of the cycle can be very rewarding. I believe we’re seeing evidence of destruction all around us: the housing market, the banking industry, industrial production in the United States, even the dollar is looking pretty shaky.

PG: I guess one good example would be the bankruptcy of GM, Government Motors.

SN: And if you’ve seen some recent ads for GM they’re talking about reinvention. Now if GM can reinvent itself – great, but if they can’t innovate, if they can’t put capital to productive use, then the government could throw tens of billions of dollars at them and it won’t make any difference. GM was a, actually it still is a bloated mess; they built in obsolescence, they made terribly fuel inefficient cars, they got to the point where they didn’t make money building cars; their only profits in recent memory came from financing cars. The housing market was another mess. Builders built energy inefficient homes, out in the boonies; homeowners had to drive miles and miles to get to their jobs. There was nothing practical in their planning, if there was any planning at all.

PG: And it’s probably safe to say that a large part of the profits in the housing industry and the housing bubble came from financing.

SN: Absolutely, we went from a tech bubble in the 90’s to a housing bubble in 2000. Financing helped fuel innovation in tech, but it also exaggerated the profits. After a while the innovation gave way to growth and then we saw maturity and liquidity events, people cashed out and any further innovation was killed. Following 9/11, the Federal Reserve tried to reinflate the economy, and to a certain extent they did. The Fed kept real interest rates negative and negative interest rates are an abomination to the proper pricing of risk; encouraging, almost forcing excessive risk-taking. The Fed essentially created the bubble in housing. For a while there anybody who could fog a mirror could get a mortgage.

PG: And so many people were refinancing that we used to joke that everybody had an ATM in their front door.

SN:  Of course the banks were happy to take advantage; it wasn’t enough that they had negative interest rate – essentially, as much free money as they could borrow from the Fed; the banks figured out a way to turn a 30 year mortgage into a derivative that captured and recognized the cash flow stream. We all know that when you take out a mortgage, over the life of the mortgage you pay mainly interest on your loan. If you have a $500,000 mortgage depending upon rates, you end up paying about three times that amount or one and a half million over the 30 years. The banks securitized that cash flow as a collateralized debt obligation and sold it; they cashed out about 1.5 million cash flow. They created money out of thin air.

PG: That also meant the banks didn’t have skin in the game. We’ve talked about the importance of personal responsibility here for a long time. It’s also important that you have responsibility, not just personal, but in business.

SN: And in the past few years the financial sector has done nothing but slough off its responsibility. The next step was to pass off even more risk by writing credit default swaps, which were sold as a form of insurance against default of these portfolios of CDOs and other derivatives. The only problem was that unlike regular insurance they didn’t set aside reserves in the event of a default. And AIG was one of the biggest players in the CDS market. They thought they were writing insurance policies against default of portfolios but they were really writing policies against a bear market. The CDS, and that’s about a 60 trillion dollar market, created an incentive for default. Now if a bank has purchased a CDS on a portfolio of mortgage backed securities they make money when that portfolio goes into default. And it’s not compensation for losses; it’s more like a bonus for defaulting. There is no incentive to stop foreclosures; there is incentive to see more foreclosures. Now that AIG has been nationalized we’re seeing taxpayer money used to pay off hedge funds and banks for foreclosing on our neighbors. The banks figured out a way to make money when the bubble was inflating and they figured out a way to make money by bursting the bubble.

PG: Where do you stand on the idea of more regulation for the financial sector?

SN: Nobody likes regulation; it hasn’t done anything to stop the bubble economy, just the opposite. It makes the bubbles and the subsequent popping of the bubbles more frequent and more harmful. At the same time you’ve got to have some rules to conduct business. I don’t think regulation will have much impact.

PG: Why?

SN: The truth is that the finance industry has taken over our government. We have a financial oligarchy that is blocking reform. We are a debtor nation and that means the creditors are the slave masters and the debtors are the slaves. Most people still think that what’s good for Wall Street is good for the country, and that’s what the banks want you to believe. They don’t want you to read the fine print, they don’t want you to notice the fees, and they certainly don’t want you to realize you’re enslaved by debt. They want you to think usury is an acceptable business model. They’re not looking out for “us” they’re looking out for “them”. You know that; most of the people that will read this interview know that, but not everybody knows that. The banks have immense political power. There are probably just a handful of politicians that are not in the hip pocket of the financial lobby. Look, the financial sector represents 41% of GDP in this country and that is a much bigger portion of GDP than the government. A lot of the people in government came from Wall Street and when they leave government they’ll probably go back to Wall Street. I don’t think regulatory reform will have much impact because the reform is essentially written by the financial lobbies.

PG: Our elected officials may want the banking lobbies money but they also want voters even more.

SN: And the money from the financial oligarchs pays for the campaigns that bring in the voters. Government and the financial sector are like conjoined twins that share the same heart. Inevitably the financial sector will implode under the weight of what Richard Maybury calls malinvestment. Basically the banks made poor use of capital. The banking system is broken. We have always known that heedless self-interest was bad morals; we know now that it is bad economics. Dulled conscience, irresponsibility, corruption, and ruthless self-interest cannot be the business model for an essential segment of our society. Regulation is just going to prolong the pain. Nothing really changes until we have creative destruction, until the old system falls apart and is replaced by new, innovative ideas. I don’t think anything happens until we see some outrage and some new ideas.

PG: We’ve seen some outrage, like when the news came out that AIG was taking taxpayer money and paying out big bonuses. That was pretty outrageous.

SN: That wasn’t outrage, it was frustration and indignation. Wall Street has been operating with a casino mentality, they’ve been gambling with people’s deposits and their retirement money, they’ve been gambling with derivatives, which are nothing but instruments of mass destruction. And right now, we’re just too complacent. We are the complacent slaves.

PG: What about the recent Stress Test for Banks? I think I know what you’ll say because I read an article on your site about the Stress Tests being a lie.

SN: A total sham. The Stress Tests for banks was based on a scenario that unemployment is going to level out. Unemployment exceeded the “baseline scenario” before they completed the Stress Tests. The “more adverse scenario” calls for 10.3% unemployment by the end of next year. I think we could hit 10.3% by September or October.

PG: And we all know the shadow stats peg unemployment at closer to 18% right now. The government just stops counting people after a while. A lot of people don’t have jobs but they’re not considered unemployed.

SN: If the economy doesn’t get better real quick, and I don’t think it will, the 19 banks will need to raise almost $600 billion more, but 10 of those banks are paying back their TARP funds; they’re betting they won’t need that money; they’re betting that the instruments of mass destruction won’t blow up in their face. When we see these banks go back for more and more taxpayer money our indignation will grow. When we get really outraged, we’ll make some changes.

PG: So you don’t really know if there will be a meltdown?

SN: No, I don’t know. That’s like predicting what day we’ll have a wildfire. I might tell you the forest is dry, we’ve had drought conditions, the wind is picking up and it’s hot, but that doesn’t mean we’ll have a wildfire today. This economic climate could go on for ten years or the whole thing could implode in ten days.

PG: Are you looking at anything in particular that could cause that implosion?

SN: A bunch of things; state governments are running budget deficits of more than $280 billion and that could be problematic. California represents the eighth largest economy in the world and they’re about to crumble into the ocean. We could see something similar to the failure of Lehman or Bear Stearns and you remember that Paulson said that almost caused a global systemic failure. We could see a good old fashioned run on a bank – remember IndyMac and Northern Rock? How about if the Treasury held a bond auction and nobody showed up? Eventually, with all this debt, you’ve got to think the dollar will be devalued. I told you I’ve been listening to the CDs from the Wealth Protection Conference. I was listening to the CD with Richard Maybury’s speech. That is powerful stuff. Everybody should listen to that. There is certainly the possibility of some geopolitical event; maybe a disruption in the oil supply.

PG: Earlier you said the dollar looks a little weak.

SN: We’ve been hanging out right around 80 on the dollar index for about the past month and 80 is long term level of support. We actually saw a breakdown below 79, so that is the new level of support – break down below 79 and speculators will smell blood.

PG: Doesn’t that really get back to the debt problem? The government has been pouring money down a black hole. I think the budget deficit is projected at around $1.8 trillion this year and total marketable US debt is something like $6.5 trillion. The United States is the largest debtor in the world.

SN: The largest debtor in the history of the world. Meanwhile GDP has been negative, which is another way of saying debt is growing infinitely faster than GDP and I don’t see how that’s positive for the dollar. The deficit keeps growing and the response is to spend even more money on completely unproductive segments of the economy. It’s like trying to save a suicidal alcoholic by giving them whiskey and razor blades. Last month Geithner went to China and some university students asked him if China’s huge holdings of dollar assets were safe. Geithner said they were very safe. The students broke out in laughter. That’s really pathetic. There’s just not much global confidence in the dollar right now. So, who’s going to buy dollars? A few years ago I asked our friend Arch Crawford how high he thought the price of gold might go. He said the better question was “how low can the dollar go?”

PG: How low can the dollar go?

SN: I’ll just say that the easiest way to pay off massive debt is with inflated currency or with a devalued dollar. And that makes gold very attractive, and I think silver looks even better.

PG: Tell us a little about your website, bank-o-meter.com?

SN: I try to keep people up to date on the banking industry. We’ve got a list of failed banks and soon to fail banks. The sooner the banks fail, the closer we are to a real recovery – that would be the greenest shoot you could see. I try to have some fun and I try to remember that great fortunes can be made and great opportunities exist, even in a Depression. It’s a free website, so I encourage everyone to check it out. www.bank-o-meter.com or www.eaththebankers.com.

PG: Thank you for joining us today.

SN: Always a pleasure. Thank you.  

Pat Gorman is the owner of Resource Consultants in Tempe, AZ. Pat is also the author of “The Value of Honest Money”. He is the long time host of the radio program “Hard Money Watch”. Pat is also a great resource for all your gold and silver needs. To contact: www.buysilvernow.com 

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