The FreeCapitalist Project is a Pyramid Scheme

Just a few days ago, the FreeCapitalist Project released a new version of their Official Handbook, which you can download here. I have never seen any previous version (or even known about the Handbook before this version), so I don't know how it was changed. The Handbook is for the FreeCapitalist Project, which is a program to get people involved in learning and promoting the things that are part of the FreeCapitalist movement. The FreeCapitalist Project, as far as I can tell, is only about organization of people. There is no financial investment plan or product offered, except for some seminars that are required in order for a person to obtain certain levels in the Project. Other aspects of the FreeCapitalist movement are outside the FreeCapitalist Project, and I am only reviewing the FreeCapitalist Project in this article.

Ponzi Schemes and Pyramid Schemes
Ponzi Schemes and Pyramid Schemes are not the same thing. A Ponzi Scheme involves a scam get people to invest in a person on group that promises at high rate of return, but the return is paid out using other people's investments in the program, rather than the proceeds from a legitimate business. An example would be if I promised you a 10% return on your money next month, and you give me your money, and I indeed give you your money back plus 10%, but I used the money from another person who just recently signed up and gave me their money, to pay you your interest. If I can keep getting new people to sign up, I can keep paying 10% rates of return to people who have already invested in me. Obviously this only works for so long. Mathematically it is impossible for everyone to make money. Let me repeat that: Mathematically it is impossible for everyone to make money. At best there will be a transfer of money from the people who got in last to the people who got in first. This is illegal almost everywhere, but even if it's not, it's obviously unethical. However, Ponzi schemes have been around for a long time and have gotten very sophisticated overtime. People may be able to point out simple and obvious Ponzi schemes, but inevitably there will be new ones that have more complexity and more "products" or "services" that make it difficult to even detect if it is a Ponzi scheme. (see WikiPedia article on Ponzi Scheme)

A Pyramid scheme, on the other hand, does not involve investment like a Ponzi scheme. A Pyramid scheme is business payment model where the participants of the programs are paid based on the activities and referrals of other people they have signed up to be part of the program. An example of this is a business that pays you money if you can get other people to sign up and have them sell the product, and you would receive a commission on their sales. Those people you signed up can do the same thing and sign up further people and so forth, thus building a pyramid structure of a "sales force" where people in the pyramid receive a commission of the sales done by people below them in the pyramid. This is also called "Multi-Level Marketing" since you can be paid commissions from sales done in multiple levels of the company sales force structure. This is and of itself is not illegal, as far as I know, as long as the company can demonstrate that it is satisfying a legitimate market demand for a good or service, and that the primary income of the people in the pyramid is from product sales, not from recruiting people to join. What usually gets companies in trouble is that they require a signup fee for people to participate in the pyramid and\or membership dues and\or the sales are primary from within the pyramid, that is, the revenues generated are coming from the people involved the pyramid itself, not from the outside market. If the revenues are coming from dues, fees, or people in the pyramid, then the company is not actually providing a good or service that is demanded by the marketplace, and is in essence transferring money from the people at the bottom to the people at the top. (see WikiPedia article on Pyramid Scheme)

The Federal Trade Commission has a page on "pyramiding" which says,

"If a plan offers to pay commissions for recruiting new distributors, watch out! Most states outlaw this practice, which is known as "pyramiding." State laws against pyramiding say that a multilevel marketing plan should only pay commissions for retail sales of goods or services, not for recruiting new distributors." (FTC page here).

As in my experience I wrote about in the "What Is Being Sold?" post, a company may actually offer a product or service to the marketplace. However, this by itself is not enough to prove that the revenues of the business are largely from that product or service. And, it also doesn't mean that the revenues from those products or services are largely from outside the pyramid. They could be from the people inside the pyramid. As I wrote in my own experience, most of the water filter sales were actually from people in the company, not out in the market, and the reason people bought the water filters was to support their own promotion efforts in the company, not because they personally wanted to use all those water filters.

If a business at its essence is a Ponzi scheme or Pyramid scheme, no additional complications can change the fact that it is mathematically impossible for everyone to make money, and usually it is mathematically impossible for most people to even make money. And that business can only operate for as long as new participants, or new money from existing participants, enters the scheme. It does not matter what good or service is sold, it does not matter what the details are of the payments, it does not matter who is involved (trustworthy or not), it does not matter what principles the company states it has, the track record doesn't even matter (since it is unsustainable): Ponzi schemes and pyramid schemes have to fail. They are mathematically bound to. Either everyone in the world will join (and the last ones will be the losers), or everyone will run out of new money to put in, and the scheme will collapse. No one can make it work, just like no one can make musical chairs work when there is one less chair than the number of people. The skills of the people involved, or even their intentions, cannot trump mathematics, regardless of different ways to extend or delay the collapse of the scheme. It is just a matter of time.

How the FreeCapitalist Project is a Pyramid Scheme
Now that we have reviewed what a Pyramid scheme is, how it is different from a Ponzi scheme, why it is unethical, we can read through the FreeCapitalist Project Handbook and see why it is a Pyramid scheme and why the rules at the end are written the way they are. I have not seen any information on the financial of the companies involved, and I am only going off of what is publicly available in the Handbook. In my opinion, the payment structure outlined in the Handbook in essence can only be sustained, and the people involved in the program can only make money, while there are new people coming into the program.

There are several levels of the Project, and most of them can only be obtained by progressing from one level to the next:

• Primer Quest
• Community Quest
• New Member Quest
• Silver Quest
• Gold Quest
• Apprentice Quest
• Journeyman Quest
• Free Enterprise Union Quest (elective)
  
• Free Capitalist Radio Affiliate Quest (elective)

For the first level, Primer Quest, no money is required from the participant. All you have to do is download the publicly available Primer, read it, and share it with other people. You can receive cash bonuses if you get other people to do the same. At the next level, Community Quest, you are required to pay a small fee to take an assessment test. This is the first level where any out-of-pocket payment is required, but note that it a fee to take a test, not dues. Also, you can earn more cash bonuses by getting others to do the same.

The third level, New Member Quest, is the first level where you actually become a dues-paying member of the organization and you take the FreeCapitalist Pledge and are required to recruit others into the program in order to progress. There are required classes at this level, but they are free. However, there is a $100 "Quest Fee." There also are cash bonuses offered if the people that you recruit complete certain levels in the program. At this level, your progression up through the levels depends on you bringing new people into the program. Progression at this level, in essence, is defined, at least in part, as you being able to sign new people up. To be at the "New Member Quest" level, means that you have brought other people in (not just that you get an award or bonus if you do). It is a requirement to bring new people in.

At the next level, Silver Quest, and higher, the monthly dues become rather high. At Silver it's $99.97, at Gold it's $149.97, at Apprentice it's $199.97, and at Journeyman it's $249.97. A question I ask is, why so high? What are the dues being used for? And what is the $100 "Quest Fee" used for? There is no "FreeCapitalist Project" building I know of, or facility needed to create a product. There is a FreeCapitalist Project Board and there must be some accounting system to handle all the funds coming in and going out, but that's all I can find. You would expect that at these higher levels that the required monthly dues mind actually go down, or be waived completely, since at all these levels you are required to bring in new people, who will also be paying dues and fees and tuition, and also bringing in more people. But it's not just that you are required to bring in new people, it's also that some of those people must obtain high levels themselves, which indicates that they, too, have recruited new members who have started paying dues, and so on.

Also as part of the requirements of some of these higher levels, certain expensive courses must be completed.

• Introduction to Self-Reliance for $249.95
• Intro to the 13 Principles of Prosperity for $999.95
• Capitalism & Civic Service for $1,495
• Prosperity Quest Mentoring for $4295

The tuition payments appear to go to American Founders University, not the FreeCapitalist Project directly. So although there are two entities involved with tuition, the effect to the participant is the same: tuition is a fee required for level progression in the Project.

Aside from tuition costs (which could be argued as necessary to offset the costs to offer the courses), why does the FreeCapitalist Project need very much money at all? Since the Project promises bonuses and commissions to participants who complete certain criteria in the Project, the Project needs dues and fees to pay those bonuses and commissions. In fact, since there is no product or service being offered from the Project that brings in revenue to the Project, the promised bonuses and commissions can only come from the dues and fees of other participants. The lower the dues and fees, the more need there will be to bring in new people to pay dues and fees before receiving bonuses and commissions. Similarly, the higher the bonuses and commissions, the more need there will be to bring in new people.

A Review of Equity Milling

I have never been to a seminar on Equity Milling and I have no other information on this besides what I have found on the internet regarding this process. I expect that some will accuse me of not understanding it correctly, and if I did, then my opinions would change. I think that's probably not the case, since only if I misunderstand the fundamentals, rather than just the details, of Equity Milling would I change my opinion. Just knowing to a greater detail how these things are done will not change the fundamentally what is being done. There is not much public information on what Equity Milling is, and apparently to learn more would require me to attend a seminar. I don't know if they are still doing seminars, and but even if they are, I probably wouldn't pay to go anyway. So I give my opinion based on my understanding, which I think is sufficient for an analysis. To be fair, I have tried to separate what Equity Milling is said to be, and what people are doing in practice.

What Is Equity Milling?
Rick Koerber has labeled (and trademarked, apparently) "Equity Milling" which is a method to make money from investment real estate.

There are two basic ways to make money in this approach:

1. Positive cashflow from renting or leasing the property
2. Selling the property for more than you bought it

These are the two ways anyone makes money from real estate: from rental income or capital gains. So how is Equity Milling different? The major difference appears to be that there is a particular program set up to help an investor maximize the gains from a piece of property. The term "milling" apparently comes from the idea that you are trying to maximize the amount of equity you can get, or mill, out of the property. Equity Milling need not be restricted to real estate, either. Any other asset could potentially be Equity Milled. The program of Equity Milling involves the following:

1. Someone to scout out properties to buy
2. Someone to buy the property, preferably for a price below market value
3. Someone (or company) to provide funds for the purchase
   
4. A property management company to manage the property (do maintenance, find renters)
5. Someone who wants to buy the property that is already being maintained with renters in it (with cashflow already in place)

Below is a diagram that Rick Koerber provided as a high level overview of Equity Milling.

(click on the image for a larger version)

A discussion of this by Rick Koerber can be found at http://www.websitetoolbox.com/tool/post/sdcia/show_single_post?pid=18521726&postcount=28

At this level, this is not a bad idea. You would basically be finding properties that you could turn into rentals and sell the property, with renters already in it, to another investor. You would be providing a legitimate service by setting up a rental for an investor that doesn't want to go through the hassle of converting a property to a rental and getting renters in. The investor (person looking to buy from you) would be able to see if the property could actually bring renters in and have the rental income cover the cost of owning and maintaining the property. You (the one converting the property to a rental) would actually be taking some risk because you don't know for sure if converting the property to a rental will work out and produce positive cashflow. So once it already is cashflowing, that's valuable to an investor. At this level, you could probably describe Equity Milling as a business that converts properties into rentals and sells them to investors for a profit.

Criteria for Property to be Profitable
Regardless of what method someone uses to invest in real estate, certain criteria must be met in order for the property to be profitable:

1. The monthly cost of owning and maintaining the property must be less than the rental income. If your have a property that costs you $1000 a month for the mortgage and costs you $200 a month to pay the maintenance company to take care of it all, then you have to be able to rent the property for more than $1200 a month. Seems obvious, but it's crucial that this criteria is met, or else you won't make any money from renting or leasing it. The cost of maintenance probably can't change and rent levels are pretty hard to change because that's determined by the market, so the only thing that you might be able to change for a given property is the monthly payment on the loan (more on this later).
2. You must be able to sell the property for more than you bought it. It's not enough to buy a property, put renters in it, and have positive cashflow if you can't sell the property for more than you bought it for, otherwise you would take a loss. It would do you no good to buy a property and make it cashflow only to sell it at a loss. You'd be better off not selling, and just keeping the monthly cashflow. If you have positive cashflow on the property, then another investor should be able to have positive cashflow from it also, given the same monthly mortgage cost and maintenance cost. However, if that investor won't buy it from you for more than you originally bought it, the cashflow doesn't matter to anyone else but you. You might as well just keep the property. There is a caveat: if you have gotten so much cashflow to more than make up for the capital loss in the sale, you could, in theory, sell the property at a loss, yet net a gain because the cashflow had more than made up for the loss.
3. The property must be able to pay for itself. If the rental property were to require extra outside funds to make the monthly cashflow positive, then it's not a good investment. If, for example, you had Property A cashflowing $500 but $300 of that went every month to pay for Property B, which was then cashflowing $100 with the help from Property A, then get rid of Property B. It really doesn't have positive cashflow. It's leaching off of Property A.
   

Forcing a Property to "Fit" the Criteria is the Beginning of Problems
Perhaps the criteria above look obvious, but I think it's major way people can get themselves into trouble by trying to justify a property being a good investment for them when it really isn't. If the criteria above are not met in an investment opportunity for a piece of real estate, then you won't make money on it, and tinkering with numbers (like assets values or credit) can get people into lots of trouble. And the criteria above only are criteria for making a profit; there may be other issues with the level of risk involved to you that you should be concerned with, like if the loan uses your own credit or a business's (or someone else's credit), if the loan uses another one of your assets as collateral (like your house or other investment property), etc.

You Can't Make Money from Borrowing Against Real Estate
You can either make money from selling real estate for more than you bought it, or from renting it for more than it costs you to own it. If you are not doing one or both of those, then you are probably either consuming it or borrowing money and using the property as collateral. Some people may argue that you can borrow money against a piece of property and invest that money, but you are still just taking out a loan and putting the property up for collateral. You are not making money from the property, in this case, but are just able to take on more debt and using the property as collateral. Like if you took out a loan and used your stock portfolio as collateral. You are not making money from the stocks; you are just using them to be able to borrow.

A person could continue this pattern of obtaining a piece of property, borrowing against this property to obtain other pieces of property, then borrowing against those to obtain more, ad infinitum. This may be a way to obtain property, but it doesn't necessarily mean you are making money from the property. Only if those properties match the criteria above would you be making money. They must be bringing in rental income that exceeds the cost to you to own and maintain the property, or you must be selling the property for more than what you bought it for. Otherwise, you are just taking on more and more debt, creating a web of properties that you can only hold onto for as long as you can keep borrowing against one to obtain another (or borrow to pay for the ones you already have). You also aren't producing anything, just taking out loans. No matter how complicated, or large, or "diversified" the plan, no matter how long it goes on, no matter how many people are involved, if the plan can be boiled down to just borrowing against one property to obtain (or maintain) another, no one is making money from the property unless the above criteria for profitability are met.

Tinkering with the Mortgage to Make the Property "Fit"
Stll, there are people who will find a property that they want to "invest" in, so they will do everything they can to make the property fit the criteria. One way is to try to lower the monthly cost of the mortgage. For example, lets say you found a property that could bring in $800 a month in rental income, but the monthly maintenance cost was $100 and the cost of paying a mortgage on it would be $1000. You would be spending $1100 a month on it and only bringing in $800. That's a $300 deficit and negative cashflow (you would have to pay $300 a month). This should be "no deal" and you'd be better off not getting the property (ignoring resale for now). But what if you could cut the monthly mortgage cost in half to $500? Then the monthly cost would be $500 (mortgage) + $100 (maintenance) = $600. That's $200 less than the rental income so you'd be cashflowing $200 a month.

But how could you drop that monthly mortgage that much? This is a problem area, one that could really burn people. One way is to get an adjustable rate loan, where the monthly mortgage would be low for awhile, but then go up after some period of time. This would make the numbers work out to get the property in this example, but only for so long, then you have to sell. Hopefully you will be able to sell the property for more than you bought it for. If this sound just like the problem with adjustable-rate mortgage that people have when they got into a home they really couldn't afford - it is the same, except this is dealing with investment property, not a person's primary residence. Your only other hope besides selling when the rate goes up is that rental income would go up by as much. But that's just hoping.

There are several variations that could be done to lowering the monthly mortgage cost besides getting an adjustable rate mortgage. I won't try to list them all, and new ones are devised all the time. But the point remains that a temporary or artificial reduction in the monthly mortgage cost will only work while the temporary reduction is in place, and you must get out of the property before the reduction goes away. It's better to find a property that you can cashflow as a rental using a 30-year fixed mortgage (or similar) rather than one you can't cashflow unless you get some weird "creative" financing with strange changes that kick in after 12 months or whatever.

Decrease the mortgage costs using a big down payment
Another way to reduce the monthly mortgage cost is to simply borrow less, and this could be done be putting down a large down payment. Suppose that I could have positive cashflow on a property as long as I only paid $700 a month on the mortgage, but taking a mortgage on the property would cost me $800. But suppose if I could make a down payment of $20,000, and the monthly mortgage cost would drop to $600 ($100 below the line where I'd make positive cashflow). Should I do it? Should I put the $20K down just to reduce the monthly mortgage cost and so I could have positive cashflow? Probably not. You'd have to see what else you could do with that $20K as an investment and how what rate of return you'd get elsewhere. It would depend on the particular numbers, but you probably should not use a large down payment in order for you to have positive cashflow. If the property can't cashflow without a large down payment, then it's probably not a good investment.

However, there is risk in not putting anything down or getting a 100% or greater mortgage on the property, because in order for the property to be a good investment and be sold for a profit (to be Equity Milled) you have to sell it for more than you bought it for, or more correctly, more than you owe on the mortgage (plus your down payment and anything you spent on improvements, etc). For example,

• if you bought the property for $100K and took out a $100K mortgage on the property (100% loan) then you must sell it for more than $100K, otherwise it will be a loss to you.
  
• If you bought the property for $100K and got an $80K loan with $20K down (80% loan), you still must sell the property for more than $100K, otherwise it will be a loss.
  
• If you bought the property for $100K and got a $125K mortgage (125% loan) you must sell the property for $125K! Otherwise, the property will be a loss to you. That's one problem with taking out a mortgage for more than the purchase price (which should be at the market value): you then must sell the property for more than the loan amount, not the just the original purchase amount. You have basically committed to being able to sell the property for 25% more than what you bought it for, or else it will be a loss to you. I suppose that you could take the $25K from the 125% loan and just hold on to it, but then you'd just have to give it back when you sell (to pay off the 125% loan). Or you could "invest" it, but you'd still have to sell the property for $125K, or come up with the extra $25K when you sell (either by paying cash or liquidating assets). But this "chaining" of assets and liabilities (using the money borrowed against one asset to acquire another asset) can significantly add risk and can cause all your assets to depend on each other. If something happened to one, then all of your assets could be affected (this is actually a special circumstance of the third criteria above, that each investment property needs to be able to pay for itself).

If you get a 100% or greater loan on the property, you must be able to sell it for more than you bought it for. This assumes capital appreciation, that prices will keep going up. If you sell for less than what you owe on the loan, then you have to come up with the cash that makes up the difference between what you owe and what you are selling it for.

The More Middlemen There Are, the Less Profit You Can Capture on the Sale
Refer again to the diagram above. Look at all the people and companies between the Seller and the End Buyer. If you were to engage all those people and companies in a property that you are going to Equity Mill, everyone of those people and companies are going to get a piece of the proceeds. This effectively increases your costs in obtaining and owning the property (because you will have to factor in everyone's fees and commissions before the sale to the End Buyer). This makes finding properties that match your criteria as a good investment harder, because the costs to you will be greater over the course of the transaction.

But there is another side-effect to having all those middlemen: they get paid to do their service, which may or may not match your goals in finding a good investment property. The acquisition guy is going to acquire, the financial institution is going to lend, etc. Whether you make money from you investment is not their concern. They will do their service and take their fee (unless they are "in on the deal" with you, but that gets really sticky. More on that in another post). So you as a person looking to find properties to convert to rentals and sell may experience pressure from these middlemen who just want to do their service and get paid. This is actually a problem in other financial circles. The vast number of mortgage companies that originate a mortgage do not hold onto it. They sell the new mortgage as an investment to some other company. So there are companies who are in the business of making mortgages, not keeping them. This causes them to make more mortgages then they probably should, since they will just hand it off to someone else. The same may be said of other people or companies that offer services for investment properties.

Real Estate Compared to a Gold Mill
Rick Koerber explained that he came up with the idea of Equity Milling when he was involved with a group of people trying to get a gold mill. He drew some parallels between the gold mill and real estate. You don't try to put money into a gold mill, but rather get it out. He concluded that the same could be said for real estate: "Don't put gold in the mountain, get the gold out." He also concluded that you can't always see all the gold in a mountain, so the same could be true of real estate. So the "Equity Mill" process for getting all the money or value out of real estate is akin to getting all the gold, including what you can't see, from a mountain, he reasons.

I think there are two major problems with comparing real estate to a gold mill:

1. Since you can't see the gold in the mountain, you are speculating on how much there is, and how much you can get out. They were called "gold speculators" for a reason. If no one knows how much gold there really is, then it's a gamble of whether you are going to "strike gold" or not. With real estate, the value shouldn't be "unseen" or "unknown" unless there is some short-term market distortion going on, like a "highly-motivated" seller who needs money quickly. There may be people with different estimations of the worth of the property after it is changed or improved some way, but I think that's due more to different estimations of how much work and cost it would take for the improvement and how much the market values the improvement, not if there's some unseen, hidden value no one has discovered yet.
2. Drawing the value out of real estate produces nothing. I suppose that if you were to get gold out of a mountain, then you are actually producing a commodity that people value. But what are you producing by maximizing the equity that you can draw out of a piece of real estate? It seems to me that you are not actually producing a good or service that people value or that didn't exist before, but rather you are just more cleverly drawing value from as many places as possible, to the greatest extend possible. You could argue that this isn't to produce anything but rather obtain funds to then go produce something somewhere. But that would be exactly my point.
   

A mortgage on a mountain that may have gold will probably be for the amount that the bank thinks it can sell the mountain in the market if you were to fail to make your payments. If you get a mortgage on a mountain, then you believe that it contains more gold than everyone else thinks (or everyone thinks they have found better mountains with more gold). The expected value is factored into the market price of the mountain, that is, what everyone else thinks the mountain is worth, assuming free market conditions. Someone will be right about their mountain, and some will be wrong, but the expected value should take that into consideration.

For real estate, there shouldn't be the same type of unknown value. What is it that is unseen in real estate? Everything must be disclosed in a real estate purchase contract. This is why banks want an appraisal on the property before the loan. It is the best estimation of market value. If the appraisal comes in lower than the contact price, then the bank is nervous that they would be lending more money than they will probably be able to get if they have to sell the property in foreclosure. If the appraisal is much above the contract price, the bank is nervous that there is some undisclosed or unknown problem with the property which would otherwise bring down the market price. The bank wants the appraisal to come in right at the contract price to indicate that the bank is lending money that reflects how much the market values the property, so that if they have to foreclose and sell the property in the market, the bank can get their money back.

The only unknown in regards to value in real estate in a free market is potential future value if you change it or work on it somehow. But the same could be said for the mountain: the value may be different based on the value of gold itself, or the changing costs in getting the gold out. But those are all uncertainties about the the cost of producing the gold and the value of the gold, not whether there is any gold. Real estate is no different: the thing that is unseen is the cost of changing the real estate or the value of the real estate after the change. But there should be no "unseen" value in free market conditions. At best it would just be a temporary price distortion (which would be buying property at a discount, which is great if you can find them, but you are basically saying that the seller has the wrong price or the market is slow to notice, but it's more likely that the market is right).

Nothing Wrong with Equity Milling at a High Level
Although I disagree with the metaphor of "milling equity" from property, there's nothing wrong I see with Equity Milling in theory at a high level in order to make a profit. It appears to include the two ways to make money from real estate: from rental income, or from selling it for more than you bought it. The challenge is that you still have to find properties that will be profitable to you, not just be able to be borrowed against. There seem to be a lot of middlemen involved in the process which I would think would make it harder to actually make a profit, but it still could be done. The Equity Milling process itself does not seem state that only properties that will be profitable should be used in the process, and I'll assume that more detailed information on what properties should be used would be include in other discussions. However, there sure seems to be a lot of people that have gotten themselves into trouble with all this. This would indicate that the criteria for profitability were ignored or down-played or perhaps misunderstood. We'll look at that phenomenon next.

People Have Gotten Themselves into All Sorts of Trouble

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Coming Soon...

Going Against Church Counsel

The LDS church has consistently and repeatedly counseled its members to avoid debt.

• "Let us avoid debt as we would avoid a plague; where we are now in debt let us get out of debt; if not today, then tomorrow." -President J. Reuben Clark Jr. (link)

• "With the exception of buying a home, paying for education, or making other vital investments, avoid debt and the resulting finance charges. Buy consumer durables and vacations with cash." -Elder Marvin J. Ashton (link)

• "Investment debt should be fully secured so as not to encumber a family’s security. Don’t invest in speculative ventures. The spirit of speculation can become intoxicating. Many fortunes have been wiped out by the uncontrolled appetite to accumulate more and more. Let us learn from the sorrows of the past and avoid enslaving our time, energy, and general health to a gluttonous appetite to acquire increased material goods." -N. Eldon Tanner (link)

• "Since the early days of the Church, the Lord's prophets have repeatedly warned against the bondage of debt. One of the great dangers of debt is the interest that accompanies it. When it is necessary to incur debt, such as a reasonable amount to purchase a modest home or to complete one's education, the debt should be repaid as quickly as possible." -From an LDS.org article entitled "Debt" (link)

But what does Rick Koerber say about this counsel?

From his radio show on 11/23/2007:

He says that avoiding debt means "to avoid having liabilities that exceed the value of your assets" (listen below)


What does he say it means to save? He says it means to "be active in investing, by managing risk to near zero" and to "put it in a liquid, insured vehicle" (listen below)


Later he declares that if you have any equity in your house, you owe no debt on that house (listen below)

TRANSCRIPT:
“If you have a $400,000 house and a $200,000 mortgage, you have no debt! If that was your only financial situation…you have no debt! You have $200,000 of equity. You have no debt! You are not in debt! You’re not in debt! You’re not in debt! I’m gonna say it ninety times! If you have a $400,000 house and $200,000 mortgage you have no debt to pay off...You have a liability to the mortgage company“ -Rick Koerber ("The Free Capitalist")

Major Misunderstandings
Rick Koerber has two major misunderstandings regarding the counsel to save for a rainy day and to avoid debt.

1. The purpose of savings is to have funds that can be used to cover expenses or other financial obligations when no other means are readily available. This doesn't mean to have assets that can be readily liquified and that are insured. This doesn't mean to have investments that you can quickly convert to cash. This means having cash! Yes, you should put it in a tin can, or a bank. You should not count other investments or assets to be "savings." Savings are not "future consumption" (as he says "consumers" think of it), but it is "saved payments for expenses or debt payments." How many stories are there of people who think their assets are liquid or "insured" only to discover they are not. You cannot "save" investments. You save cash, not assets.
2. Debt is obligation. Having assets does not remove the obligation. If I have $10,000 on my credit card, having a $15,000 car does to not remove my obligation of $10,000 on the credit card. Rick Koerber tries to define "debt" as having assets greater than liablities, but that's having positive net worth, which is not the same as being debt-free. The counsel is to not have debts, which are liabilities. You are not "safe" or "avoiding debt" by adding assets. If you were to sell (liquify) some assets to pay off the debts, then you would have eliminated your debt and would be following counsel. With Koerber's interpretation, if you had $1 million of debt, as long as you had at least $1 million dollars in assets, you were avoiding debt. The counsel teaches to not be encumbered by financial obligation. What happens when asset values come down (like with home values)? Your obligations (debts) don't change, because they are fixed in the contract, but your asset values do. The asset values depend on market supply and demand, whereas your debts are due to a contract you signed and which doesn't change unless the contract says so, regardless of what else is going on in the market. What do you do when your income goes down, or your assets drop in value to such a degree that you can't make the payments on your debts (liabilities)? Eventually, your assets get seized and force-liquidated. However, if you have no debts, you wouldn't lose any of the assets. Rather, the prices would just go down. But you still have them, and there is no interest you have to pay on them. That's the counsel from the church.
   

Koerber's redefinition of "debt" is very problematic. He defines "debt" to mean "not in the red" or "positive net worth." That's not how the Lord uses the term in the following scripture:

"Pay the debt thou hast contracted with the printer. Release thyself from bondage." (D&C 19:35)

You have "a debt" or "debts." You are "in debt" when you have any debt, not when the payments of that debt are more than you can handle. The counsel is to avoid any debt, except for a few things, like a modest house. The counsel is not to "Equity Mill" properties and assets and take out loans and use the money for other investment opportunities. The counsel is not to acquire high levels of debt and many assets to balance out the debts. It's to avoid getting debt in the first place!

Twisting Teachings for Financial Gain
If a person takes true doctrine or correct teachings from the church and twists their meanings so that he leads people astray from the correct doctrine and makes money doing so, what is that called? What is it called when someone takes people's money that goes against counsel but tells them that they are not going against counsel? That's your homework for today. Turn your brain on and figure that out. Let's hope this is not happening in the Free Capitalist movement.

"It's Not About the Money"

An oft-repeated statement on the Free Capitalist radio show is that it's not about the money, but how you live your life. If that's the case, then why do about a third of the photos from the most recent Free Capitalist "community event" focus on luxury vehicles? Got to the front page of FreeCapitalist.com and watch the scrolling photos from the event.


And if you go the website of the central guy of the "Producer Revolution" (which has similar philosophies as the Free Capitalist movement and they reference each other), you can see a family photo album of Garrett Gunderson (you have to go to his homepage, then to "The man" and then the photo album, or just click here: http://garrettbgunderson.com/theman/album.html )


There are many more photos like this. Apparently the sedan is an extremely (I mean more than your house) expensive car.

You may ask, so what? Is there something wrong with nice cars? My answer is no, but if you preach that it's not about the money, yet that's what you reinforce, then that's not quite consistent with your preaching. How many pictures do you have of your family and your car? Maybe one, and it's probably of you waving goodbye on vacation or going off to college, not a glamor shot...or a dozen of them.

It's all about identity and image (see the earlier "What's Being Sold?" post). The message in the Free Capitalist community event photos is "Welcome to the Community of people who have extremely nice cars. Don't you want to join us?" It's like a late-night infomercial where the speaker says, "I've got it all, and you can too, if you follow my 10 step program" except that this is more subtle. They are not showing luxury cars to brag (at least, I don't think so), but rather to get the individual to think, "it sure would be nice to be able to have a car like that." Well you can! Just change your mindset, come to my seminar, buy my product, etc., etc.

To many people in the Free Capitalist, an expensive luxury car is a tool, a tool that you can use to "equity mill" by getting a large loan against it and taking the borrowed funds and investing it in other places (more about this concept later).

What is a Capitalist?

The title of “Capitalist” gets different responses from different people. Why is that? Either people have differing ideas of what the word means, or they have differing opinions on whether it is good or bad. Let’s start with a definition of capital:
Capital is the stock of accumulated goods, or an asset.
An asset is any item of economic value.

So then capitalism is an economic system that enables and fosters individuals and businesses to accumulated goods with economic value, or assets.

Not Always Been the Case in History
Individuals have not always been able to accumulate assets throughout history. Under pharaohs and kings and lords of the manor, individuals could accumulate only small amounts of assets for their own personal use. For example, a man could own a shovel and other hand tools for working the soil, but he couldn’t own the land itself. In many countries, the king was sovereign and was the only one who actually owned anything. Everyone else was granted the use of his possessions, his assets, at his will and pleasure. At one level, the people were able to buy and sell and exchange so they were engaging in a market and even capitalism, but only with meager personal items of little value. At a higher level, the king was the only one with assets and was restricting anyone else from accumulating any meaningful level of assets.

What makes Capitalism Different
Capitalism enables individuals to accumulate assets that can be bought and sold in a market free from control to anyone who wishes to participate. The price does not change depending on who you are. Assets are transferable from one person to another through exchange. Exchange delineates the change in ownership. What can be owned, is at the heart of capitalism, since anything that can be owned and exchanged is an asset.

Under Capitalism, things can be broken down into separate parts for exchange. For example, with many types of bonds, the bond purchaser gives money to an institution and receives back a note promising to repay the money plus interest. The two parts of the bond can be separated into two separate assets: the promise to repay the original amount, and the promise to pay interest. The bond purchaser can actually sell these two parts separately in the market. Why would anyone want to sell a note on the repayment of just the original amount? Maybe they need the money now. Maybe they have a great business plan and could use that money it to make even more. Most likely the price of this note would be for less than what will be paid back ($950 for a note that will pay $1000 in a year, for example). And the note for the interest payment will go for some positive amount, depending on what other interest-paying opportunities exist in the market to choose from. These types of sales happen all the time in the bond market, which is much larger than the stock market. What is different about capitalism is that it allows individuals to separate things of economic value into separate assets (if they wish) and sell those to anyone else in a market without interference

What Can Be Broken Down Into Assets?
What has economic value? The answer is: anything that affects you economically. If you are acting rationally and voluntarily, you only buy something if you value the thing you bought more than retaining the money for it. If you buy a car for $10,000, you valued that car more than your $10,000 (otherwise you wouldn’t have bought it). The reverse is true for the seller. But how much do you value your job? Less than your salary and benefits (otherwise you would quit). Perhaps you don’t like your job, but you like your salary more than not having a job with no salary, so you don’t quit. What about your life? Does your life have a price tag? To you, probably not. You probably do not consider your life as an asset that can be bought, sold, or exchanged for any price. It is outside of the market and should not be included in it. Yet, you probably have life insurance, but you probably have life insurance not as really insurance on the value of your life, but rather insurance on your productivity, or income that you would be making had you not died. Can you turn your future productivity into an asset? Can someone else?

There is a famous example of a company placing a price tag on human life. When Ford made the Pinto, at a certain point they realized that with the current design of the car, that a certain number of people would be killed in collisions. They also knew that they could improve the design of the car so that fewer people would die, but that would cost them more to make the car. They estimated what the financial cost to the company would be for having to pay settlements to the families of those that were killed in collisions. They decided not to improve the design because the increase in the cost for the improved design was greater than the savings they would receive by not having to pay as much in settlements to the families of those killed in collisions. The most profitable route for them was to use the inferior design, even though they knew that this would actually cause more people to die. It can be argued that Ford was a business and its purpose was to make money. It was an economic entity that made decisions based on economic values. They weren’t actually killing anybody. There was no intent to harm people. Yet they would be causing more people to die because of economic considerations. They separated the cost of manufacturing the car from the cost of settlements to families. They could assign a dollar amount to each and compared the two. They actually turned the cost of settlements into an asset (negative in this case, or a liability). It wasn’t human life per se that had the price tag, but how the loss of that life would economically affect the company. So although they made a purely economic decision, it had very real implications of things that most people would consider outside the economic realm.

Distortions Can Occur
I you look at everything as an asset, distortions in values can occur. If you look at a business, you can identify goods and trademarks and intellectually property, all of which is ownable and transferable. But what if you look at, say, your church congregation, or your neighborhood organization, or even your family? What assets do you see? Should you see any assets? What about a school, or a city? What assets does a country have? I would argue that there are limits to what should even be considered an asset. I consider it exploitation when one tries to extract assets from people or places that should not be considered assets in the first place. For example, human life (or more correctly, the economic impact from the loss of human life), should not be considered an asset (no one can own it, it can’t be transferred, etc). Other things like “town character” and genetic code should not be considered assets that can be owned or transferred. But when everything that has economic impact (which is just about everything) is “assetized” and owned and sold and government upholds the sale, then we have Capitalism taken to the extreme.

Capitalism can cause people to have a distorted view of what should be an asset, and what should not. Capitalism can cause things to be divided into separate parts things that should not be divided. If you look at everything as being composed of separate assets that can be sold in the market, you will have a distorted view of things. Your "perspective" changes (and according to Principle #4 determines action). The notion of “value” of things actually changes and takes on an economic representation. Look over the 13 Principles of Prosperity and note how everything takes on an economic slant, even those things that should be outside of the economic realm.

“God Is a Capitalist”
Rick Koerber says he made the subtitle of one of his books, “If God is A Capitalist, Why are Most Christians Socialists?” (see video http://www.youtube.com/watch?v=b1oyZazXZxY). Koerber defines a capitalist in a way he claims is the “classical” definition: that capitalists are “people who value freedom and liberty, who recognize the principles in the Constitution of the United States, and the revolution begun, but not yet finished, as the ideal the prototype for living lives worth living. It’s more than just investing. Capitalists live much differently to the chagrin of many in society. As the backbone in society, as the least appreciated. Capitalists are the world’s producers.” I find no basis in this definition of a capitalist. Capitalism says nothing about the Constitution or how one should live his life.

At another time on his radio show (Dec 24, 2007) he says, “A capitalist is someone who refuses to allow the idea in their mind that force or deception is ever appropriate in human relations.” Koerber misses a crucial point: Capitalism can cause distortions in values without using any force. Capitalism is only about a system that allows things of economic value to be turned into assets and be accumulated. It has no comment on how that should be done or whether that should be done. So, no, I don’t think God is a capitalist, unless we ascribe some extra meanings to the term. But I think this is an attempt to ascribe a morality to an economic system that is amoral by definition. Capitalism itself cannot be good or bad, only what people do with it. And if there is a confusion of terms (“capitalist” mean something morally good to me but neither good or bad to you), then I can says that acts done under “capitalism” are good. Then what Ford did with the Pinto was good (because they were being capitalists). Then considering most everything as assets that can be separated and sold, is good. Even God becomes a capitalist Himself.

What is Being Sold?

I have purchased many self-help, self-improvement, and personal financial success programs, and I have been to many investment seminars, some of which really have changed my life for the good in major ways (thank you Tony Robbins). I am not opposed to people selling strategies or education on how to improve you life. However, there is an entire industry that only makes money by selling the hope of a lifestyle improvement, and pretend to have a good or service that the market wants, but in fact have nothing to offer to the market. This happens with a lot of legal (and illegal) referral programs and pyramid payment structures.

For example, years ago I got involved in a company that sold water filters. The filters were sold to the public, but people that were in the company could buy them at a discount and make a profit by selling them to the public. There was nothing inferior about the product I know of, and the higher-up people in the company would have demonstrations about how good the product was. But what do you think they actually did to get us to be involved in selling this product? They showed us how much money we could make by building a “sales force” under us. We would make a percentage off of the products that people below us sold. In fact we would make a small percentage from what the people sold who signed up below the people that we signed up, down to four levels. So the way to really make money in the company was not to sell water filters. It was to get other people below you to join and sell water filters. But get this: you didn’t get the percentage from the water filter sale when the person below sold that filter to the public, but when that person below bought that filter from the company. So in essence, you wouldn’t care whether the person below you actually sold any filters to the public, only that the person below you bought the filter from the company with the intention to sell it to the public (regardless of whether they did or not).

So what was being sold here? Not water filters. In fact, almost all the water filters sold in this company were bought by people in the company, but not ever sold to the public. It didn’t matter to the people higher up in the chain. The filter was bought and they got their commission. What was being sold was the hope of wealth that came from participation in this company. What was being sold was a better lifestyle through getting people below you, and them getting people below them (there was a signup fee), and then have them buy water filters with the intent of selling to the public.

I remember one lady basically bearing her testimony about how the company had improved her life and she cried as she told us about how now she could spend more time with her family. Another guy told about how now he was financially free and not stuck in the corporate world where everyone just stabs you in the back (whereas in this company everyone helps each other succeed). The top guy made videos of him on his yacht telling the rest of us that we could have this, too, if we worked hard enough. Another top person should us her new house on the beach where dolphins could swim in right into her living room, and only a few months earlier she didn’t even have enough money to pay to fix her furnace. What was being sold? Not water filters, but a new lifestyle. And we were all in the company signing people up and buying water filters for that lifestyle. Nearly all the revenue generated in this company was from the hope that people could improve their situations. There was little market demand for the water filters, but huge demand for a better lifestyle.

That company of course is long gone. Once the supply of people who wanted to buy-in to the company dried up, it all fell apart. Some people made money, but mostly from the people who got in at the bottom. I haven't checked, but for the people that made it big, they might as well do the same thing again. It worked for them, and it's not illegal. They just need a different sham good or service to sell, and they can repeat the process, because the demand for that lifestyle is still there.

I don't know enough about the Free Capitalist movement to say whether they are selling a good or a hope for a better lifestyle, but it would be on my list of things to check out. If any company requires the payment of large sums of money to the company in order for you to make money, that's a red flag. That would indicate that the company cannot actually make money from selling just information or education or training, but that the company relies on a constant influx of people "buying-in" with the hope of improving their situations.

Check on what is being sold.

“Democracy is evil”

Rick Koerber says this often on his radio show. He argues that democracy is evil because it is mob rule and the majority tyrannizes the minority. He also argues that a republican government protects the rights of the people. This is a confusion and misunderstanding of the form of a government, and the restrictions on that government. It is the Bill of Rights that enumerates rights that individuals have and the restrictions of government in relation to those rights. But the Bill of Rights says nothing about the form of government. We could have a pure democracy with the Bill of Rights and, as long as people and government adhered to the restrictions, we would not have our rights infringed. Rome was a republic, yet not everyone was treated the same under the law, and the acknowledged rights of individuals was not as free as our Bill of Rights. Also, the United States had slaves denied of almost all rights, yet still was a republic, or more correctly a democratic republic.

The framers of the Constitution devised a government that would most likely be controlled and restrained in protecting the rights of individuals. In fact, we often have pure democracy used in our government. We use pure democracy to decide on City Council elections and on ballot measures. Are those pure evil? Or does the evil only apply at the national level? There are even times in the Book of Mormon where matters of governance are determined “by the voice of the people.” I can’t say for certain but that sure sounds like they counted up the yeas and neas and acted according to whichever got the most votes. Imagine our republic with no Bill of Rights. Imagine a pure democracy with the Bill of Rights. Which would you rather have? It’s not the form of government that protects our rights. It’s the codified and widespread adoptions by the people and government officers that protect our rights. People choose the form of government that they feel will be the most likely to control in adhering to those protections of rights that the people declare.

One last point: Koerber says that a government cannot have a will because it is not a living thing but rather the summation of the wills of the people. If that’s the case, can a government, or a form of government, be evil? Or just people

The 13 Principles of Prosperity and a Critique

Principle 1: God is the author of prosperity (i.e. Principles Govern). No argument with this one, although a discussion of “principles” is detailed below.
Principle 2: Faith begins with self-interest. This is a stretch of ideas. This is taking faith, which is a belief or hope that something is true even though you have not directly experienced it, and saying that in order for you to have faith, you must first be interested in yourself. Does someone rush into a burning building with the hope that they can rescue someone because of self-interest? Does someone pray for the recovery of someone else because self-interest? It is true that a person may have concern for the well-being of their soul which starts them to exercise faith in a religious sense, but that’s a application of faith to his own self, not a principle that that is where faith starts.
Principle 3: Agency implies stewardship. I heartily agree. Although I believe you can have agency with no stewardship. For example, a slave still has agency over his own behavior, although he actually owns nothing, is responsible for nothing, except his own behavior. So I agree that agency implies (but does not necessitate) stewardship.
Principle 4: Perspective determines action. Perspective is a factor in one determining his action. Why someone does something has many facets and is the basis for all sorts of schools of thought and explanations. I think it would be more correct to say that perspective affects actions. Otherwise, it must be the case that no one would ever act differently unless their perspective changed, and everyone would always act differently if their perspective changed.
Principle 5: People are assets. This is an economic description, and only makes sense in an economic sense. You wouldn’t say, “my mother is an asset” or “my baby is an asset.” But since these are “principles of prosperity” we’ll consider that this is only in the economic sense, where people are acting in an economic role (as in a business), but it does not go beyond that.
Principle 6: Human life value is the source and creator of all property value. This almost made sense, but got confused along the way. Why does property (things that can be owned) have any value? Why does your house, your patent, or your money have value? Is it because of the value of human life? Does the value of a person create the value of your car? A person created your car that has value, but did the value of that person do it? I think this is trying to say that value comes from people creating it, and the fact that people can create things is one of the things that creates value of human life. But I would still argue, if I find a lump of gold in a creek, who was the source and creator of the value of that gold?
Principle 7: Dollars follow value. I agree in this statement, but I don’t think it is a principle. I agree that in general, things of value have a higher price than things of lesser value. But price and value are not the same thing. How many dollars follow how much you value you cat, or time with your kids? How many dollars (or other currency) followed the Apollo missions to the moon? Does anyone ever create something of value yet not receive any compensation for it? If so, then dollars sometimes follow value.
Principle 8: Exchange creates wealth. This is half correct, especially given principles 6 and 7 above. Here, I think wealth is meant to mean the accumulation of things of value. If people create value, then exchange cannot. What exchange does is facilitate the distribution of wealth. Furthermore, if people can specialize, then they can be more effective in producing one type of a thing of value, which they can exchange with other people doing the same thing, which increases the total amount of things of value that people have. So exchange frees up people to specialize in producing a particular type of value, causing more of that particular thing of value to be produced, and if people produce different things of value to a greater degree than before, and the exchange those items, there is more total wealth. But exchange without specialization and greater production wouldn’t create more wealth. For example, how much wealth is created if my neighbors and I continually trade the same DVD’s and furniture with each other, over and over. Also, specialization doesn’t always mean production of things of value will increase. Exchange + specialization + increased production of things that are valued = greater total wealth.
Principle 9: Profit is the tool of validation. This is another statement, not a principle. If you produce something of value, making a profit on that would indicate that you are producing something that has value for less than the cost of producing that thing (hence the profit).
Principle 10: Productivity is the standard. Another statement. What standard? Whose standard?
Principle 11: Force destroys freedom and prosperity. Agreed, except “force” would need to be defined. Most people would agree that physically taking someone’s car is force, but what about misrepresenting an investment plan? What about using a person’s weakness to get them to do something they wouldn’t otherwise do? Is that force? Also, force is justified in some scenarios, just like protecting yourself from being robbed. Does that destroy freedom and prosperity? So perhaps it’s the unjustified or unethical use of force that destroys freedom and prosperity. This them forces (laugh) us to determine the proper use of force, and what make force proper versus improper.
Principle 12: Collective action has no unique moral authority. I think the idea here is that doing something collectively does not change whether something is right or wrong, just because it is done collectively instead of individually. This idea comes from Bastiat where he says that a group of people does not have the moral authority to do something that an individual does not have the authority to do. This is often used as a rebuttal to socialism as being without moral authority, since an individual can’t take property from another person, neither can a group of people. I don’t think this is quite right, or at least it doesn’t apply in all situations. What right do I have in arresting someone? What right do I have controlling access to protected airspace? What right do I have determining if someone committed a crime? No person has any of these rights, yet I think most people would accept that these are legitimate functions of government. If they are legitimate functions of government that no individual has, where does government get the moral authority for them? (I’ll leave it at that point)
Principle 13: Personal liberty requires private property. This I totally agree with, although few people would disagree. The disagreement seems to revolve around the use of that private property. Owning something without being able to use it would negate owning it. But to what extent can you use your property? Can you do anything you want with your house and yard (no, there is zoning and building codes)? Can you do anything you want to your car (no, there are safety and emission standards)? Can an airline do whatever it wants with the maintenance of its airplanes (no, there are regulations)? This isn’t so much a disagreement with this principle, but rather that the principle is not very meaningful because it doesn’t really get at the nature of the debates that go on today about the use of private property.

Are These All the Principles?
So is that all? Are there only 13 principles for prosperity? If there were other principles, then if someone were to adhere to these 13 principles, they still might not obtain prosperity. That would be a good thing to know. Perhaps these are 13 “of the principles” of prosperity. If that were so, then that means there are other principles yet to be discovered. But if whoever wrote these principles did obtain prosperity, and he listed these 13 principles as how he obtained that prosperity, then that would really mean that these 13 principles are what enabled him to obtain his prosperity, but not necessarily someone else, since someone else may need to engage other unlisted principles to obtain their prosperity. Perhaps a better description would be “13 Ideas that helped lead to my prosperity (may not be complete or apply to you).” If that were the description, how differently would students and followers adopt and enact these principles? Maybe they would be less likely to make certain mistakes (because they wouldn’t fear violating a principle) and they might find other unknown principles.

The Mistake of Taking Experiences and Converting Them to General Rules
It would be a mistake for someone to take the steps that they felt led them to a particular outcome and declare that those steps are universal for everyone or even unbreakable principles. This is taking the specific, and declaring it to be the general. What are the principles of getting into college? I could tell you what worked for me and even what I think other people should do, but I wouldn’t declare them “principles” to get into college. What are the principles of a good marriage? Of winning the 100-meter dash? Of overcoming depression? Lots of things can work, and maybe there are common threads, but it’s quite a claim to declare the “principles” of winning the 100-meter dash, etc.

There is also a danger in declaring something to be a principle when it’s not. I was recently reading about the early Christians and the sects that formed early on. A central belief of one the sects was that physical matter was evil, but spiritual things were good. This doesn’t sound too bad, until you read how they took this principle to them to its logical conclusions. If matter was evil, then God must not have created it. That means someone or something else created it. That means that God did not created the world. And if Jesus was God, then He would not enter a body made of evil matter, therefore he only took on the appearance of a body, but it wasn’t actually physical matter. This might sound silly to us, but it was the doctrine of some major sects 1900 years ago. I am not trying to make a comparison between the 13 Principles of Prosperity and early Christianity as if they were of the same severity, I’m just using another example of when a faulty principle can yield very wrong ideas, even if sound logic is applied.

What the 13 Principles Refer to
What do the “13 Principles of Prosperity” refer to? Do they refer to principles of human behavior, or principles about how the universe just “is?” They are not statements of personal behavior, which I think is the biggest shortcoming. These are not principles about what you should do, but rather the way things are.

What Would You Say the Principles of Prosperity Are?
If you were to come up with “Principles of Prosperity” what would you list? I would have to first define prosperity (I am only considering this in the financial sense here). I would define “prosperity” as being financially able to do the things I want to do. What do I want to do? Well, that changes and means different things at different time, and so what I consider “prosperity” would change also. But some things would probably remain consistent throughout my life. For example, I would rather be a poor freeman instead of a rich slave. Having a $800,000 house with a $4000 a month mortgage making $300,000 year sounds good….in some scenarios. Here’s when it doesn’t sound good: when I need to work 80 hours a week to make that much money, or when I depend on one job from a single employer and the next best job only pays $60,000 a year, or when I just an adjustable rate mortgage whose interest rate and payment are going to double in the next few months, or if my job and my assets values depend on an continual increase in price levels. What this drives at is the element of security as being integral to prosperity.

What is Prosperity?
Under some definitions of prosperity, a person could be prosperous during an economic boom, but be devastated during a downturn. This can especially happen if the value of assets and the flow of income are heavily dependent on there not being a downturn. Anybody can make money when all stocks are going up, but who goes bankrupt, and who doesn’t, when stocks just go flat, let alone decrease? How unwise it would be to lose your assets just because their values didn’t go up enough. For example, if I own my home debt-free, but take out a new mortgage on the total value (say $200,000), and invest it in the stock market because I see it going up and up, what am I going to do if the stock market goes down? What if I am paying my mortgage and living expenses on the gains from the stocks going up and up? When the stocks stop going up and up, I have no gains, I have no funds to pay for my mortgage and living expense. Then my mortgage may get behind or default and I could lose my house. I may also have to borrow money to pay my living expenses. I would have been better off, more prosperous, had I left the house debt-free and gotten some other job. I might have appeared to have been prosperous for a time, but what I was really doing was taking on massive risk that would cause me serious hardship if things didn’t go my way. Maybe things would work out, maybe not. That’s what risk is: uncertainty.

One Lost Principle: Managing Uncertainty to a Level You Can Handle
A principle I would add is: manage uncertainty to a level you can handle. Would you rather have the boat, the big house, the month-long vacations for 2 years, only to lose everything the next year? What about a choice between having the boat for two years, and possibly losing the boat next year, but keep the house. That’s not nearly as bad. The point is that people at different times in their lives can taken on more and different types of risk, and that they should only take on risk that does not jeopardize their financial well-being. Some may argue that you have to take risks to make money and that you may have to sacrifice in order to make it big. Some people have made it big by betting the farm. Some people have made it big at the casino, too. You do not want to bet the retirement savings on a big return right before you retire. You do not want to risk your house when you have 4 kids at home. If you have $100,000 extra that you do not need for your current living expenses and could stand to lose it, then you can take the riskiest investment you can find, because if you lose it, you haven’t put yourself in financial jeopardy. If you had only $5000 in savings but $100,000 in equity, then investing that $100,000 of equity in the same risky investment would be unwise.

Another Lost Principle: Credit Only Facilitates the Creation of Wealth, but It Doesn't Create It
Every economic boom seems to bring out books and seminars and plans for people to “grow their money” or invest it in places that give a high rate of return. When a person takes $1000 and gets $1200 back, this seems like a pretty good thing to keep doing. There’s nothing wrong with getting a positive high rate of return by lending money to someone or some company. But, that person or company must be increasing productivity greater than what they are paying you in order for there to actually be wealth creation. Otherwise, it is just shifting money around.

For example, if I lend Bob $1000 to start a lawn care business with the agreement that he will pay me back $1200 at the end of the year, unless Bob actually provides $1200 of service that didn’t exist before, no wealth was created. In fact, if Bob doesn’t create $1200 of new service, I am actually going to take money from Bob, even if he pays the $1200. Bob would be worse off, although I would be better off.

This is a conundrum with asset bubbles and the boom-bust cycle. If productivity is not increasing, and only asset prices are, then there is no increase in wealth. At best there is a transfer, most likely an unbalanced one so that some gain while others lose. It doesn’t matter how creative or “non-traditional” the financing or how the money gets moved around. If there is no corresponding increase in productivity, there is no increase in wealth. Increasing assets prices are not an increase in wealth. For one person they may get more of the wealth, but the pie has not changed. Otherwise, we could just double the prices of all homes and stocks and we’d all be rich.

So for any use of credit, the lender is lending money to the borrower to facilitate the use of something else (like a house or a business plan), but only if those funds facilitate an increase in productivity will there be an increase in wealth. It is true that you may only be concerned about your own wealth, but not the total pie, which I don’t have much problem with. Just remember that unless productivity increases, your taking wealth from someone else. This is why ponzi schemes are illegal: it is impossible for them to create any wealth. They can only transfer it, from the people at the bottom to the people at the top. And a lot of sub-prime borrowers have discovered that getting a house they couldn’t afford otherwise did not create any wealth anywhere. No one was more productive by them taking out the loan. They just hoped the transfer of wealth would go in their favor, or that they’re future productivity would be able to fulfill the obligation of the mortgage (note that the mortgage did nothing to increase their future productivity). Just remember that financing assets with no increase in productivity does not create any wealth.

Other Lost Principles
I’m sure there are other lost principles. Readers will come up with many I imagine, but this is all I will list now.

A Note on My Critique

Some people may find my critique nitpicky or reading too much into what is stated. And some might say that I just don’t really understand what is stated because I haven’t investigated it enough, or read the literature from them enough. All I am doing is contributing to the conversation about these things. Perhaps some of these things look simple, but when challenged appear more complex or difficult than originally thought. Maybe some things in fact aren’t really principles. When the Constitution and the Bill of Rights were being written, it took months of vigorous debate. The principles in those documents did not readily appear, and no one person agreed with all that was written. Also, thoroughly discussing and challenging what is written in the Constitution and Bill of Rights can yield a greater understanding and appreciation for them, and perhaps reveal shortcomings. Maybe the same can be said for the statements of Free Capitalist.

I am not affiliated with Free Capitalist or have any involvement with any company that does any business with them, to my knowledge.