Comeback America Page 3

  And that hole is continuing to get deeper. The $56.4 trillion in total liabilities and unfunded promises as of September 30, 2008, is almost three times what it was in 2000. As I write this, the number as of September 30, 2009, is expected to be at least $63 trillion, and it is rising every second of every day—on autopilot. Why? Because of interest costs and the fact that the unfunded obligations for the Social Security and Medicare programs get worse with the passage of time.

  It’s almost impossible to come to terms with an obligation that big. “If you spent a million dollars a day going back to the birth of Christ,” Representative Darrell E. Issa (R) of California suggested in The New York Times (in another context), “that wouldn’t even come close to just one trillion dollars.”

  The unreality of the numbers lends a kind of unreality to the crisis. As the questioners in my audiences ask, whom exactly do we owe this money to? And what happens if we don’t pay it? Nobody is going to lock the president and Congress into a debtors’ prison. The short answer is that these obligations are real. We owe the money to Americans who expect to receive promised social benefits, Americans who work for our government and military, and Americans and foreigners who invest in Treasury bonds. Nobody’s going to end up in a debtors’ prison. But I will try to convince you in this book that unless we come to terms with these obligations, we will pass them on to the next generation, condemning our children to be the first Americans to face a bleaker future than their parents did.

  Why can’t our government cover all these obligations simply by printing more money? The short answer is that it would cheapen the U.S. dollar, weaken America’s standing in the world, and touch off the kind of dramatic inflation we haven’t seen in this country since the oil shocks of the 1970s—issues that I will analyze in later chapters. And don’t forget, inflation is the cruelest tax of all, because you have no control over it and yet it reduces your effective purchasing power. The combined Medicare, Medicaid, and Social Security programs are growing faster than inflation.

  We know what happens to countries that let their fiscal problems get out of control. I began writing this book in December 2008, on a sightseeing trip to Antarctica by way of several South American ports of call. While other passengers were worrying about icebergs, I was chilled by the ghosts of badly handled budgets past.

  We stopped for a day in Buenos Aires. Argentina has been one of the most prosperous nations in Latin America, yet it has never achieved its share of economic power or influence. It has already gone bankrupt once and appeared to be heading toward its second bankruptcy. Argentineans seemed to shrug about this, as if they had no control over their fiscal disaster. I was told of an Argentine saying: “A dollar borrowed is a dollar earned.” You may find yourself shaking your head at this lack of financial discipline, but the fact is that on a national level, at least, we’re just as irresponsible.

  HOW WE GOT HERE

  In important ways, our government’s fiscal policy reflects our own attitudes as citizens. Americans will never fall in love with high taxes, nor should they. The era of the tax revolt gathered steam under President Reagan in the 1980s, when we began to cut taxes and increase spending almost as a matter of political theology. That persistent antigovernment, antitax strain in our national character threatens to keep total revenues from rising high enough to match our spending.

  And our spending habits, beginning in these same years, got out of control. After feasting on easy credit for so long, a culture of debt replaced the traditional American culture of thrift. Our political representatives, rather than moderating our excesses, encouraged them with low taxes and generous government benefits. Political gamesmanship replaced sound policy making. The lack of long-range planning built into our governmental system contributed to the excesses.

  We all know how these excesses came to a head. The 2008–09 financial crisis, which sent our economy plummeting into recession, came after the bursting of a massive housing bubble. In the boom years leading up to that bust, big lenders got fat on profits from issuing mortgages to “subprime” borrowers—that is, to people who couldn’t afford them. When the borrowers predictably defaulted, destroying all the exotic securities based on those mortgages, we received a terrifying lesson on the dangers of excess debt. Did policy makers in Washington learn that lesson?

  It doesn’t seem so far that they have. There are disturbing parallels between the strategies followed by the financial corporations that either crashed or required bailouts in the subprime crisis and the way our government has been behaving in recent years. Let’s look at four of them.

  First, consider the dangerous disconnect between those who benefit from various imprudent practices and those who bear the risk and ultimately pay the price.

  In the subprime mortgage crisis, many of those who sold unsound mortgages and earned the related “origination fees” did not hold either the mortgages or the mortgage-backed securities. Now those who lost their homes and those who held the mortgages or securities are paying the price—and so are taxpayers.

  Is that practice so different from that of the politicians who have increased spending, expanded government social programs, and cut taxes without considering the long-term costs of these actions? After all, today’s taxpayers benefit from low-tax and high-spend policies, and tomorrow’s taxpayers will pay the price for today’s irresponsible behavior.

  Second, remember how impenetrably complicated the sub-prime shenanigans were? They were hard to explain to anybody on the outside—and obviously to many inside players as well.

  Many of the securitized mortgage products and related “insurance” arrangements were very complex, and there was not enough transparency about their size, nature, and related risks. In some cases, banks and other financial institutions created off-the-books entities so that regulators and others would find it hard to trace the risks to the firms’ health. As a result, when things hit the fan, many investors and regulators alike suffered big, bad surprises.

  Is that so different from the way the U.S. government handles its finances? For example, the annual federal budget deficits are understated because they figure in a Social Security surplus that actually exists only on paper. As I will explain in the Social Security chapter, that surplus was credited to so-called trust funds, but the cash actually was spent and replaced with U.S. IOU bonds. They are not readily marketable, but the government is obligated to repay them—with interest. Got that? The financial geniuses who are expert at muddying up corporate finances with complex, off-balance-sheet transactions don’t have much on the budget magicians of our government.

  Third, note that many of the corporations crippled by the sub-prime crisis conducted their mad dash for profits while paying too little attention to the danger signs, including mounting debt, dwindling cash flow, and unrealistic credit ratings.

  It’s pretty obvious that corporations and individuals took on too much debt as they sought the false gains of the housing bubble. It’s also clear that corporations and individuals didn’t focus enough on whether their cash flows were adequate to cover their obligations. Too many investors trusted a Triple-A credit rating—a judgment by one or more of the credit-rating agencies—even when it told them that a major corporation awash in complex mortgage derivatives actually was in great shape. Not surprisingly, when the bubble burst, some of what the agencies had rated as gold immediately turned to junk.

  Is that so different from our federal government’s cavalier attitude toward debt? Washington is adding debt at record rates and becoming increasingly reliant on foreign lenders. To put things in perspective, we took on debt equal to only 40 percent of our economy to win our independence as a nation and to gain agreement on the U.S. Constitution. At the end of World War II, while we had debt equal to 122 percent of our economy, we had virtually no foreign debt.

  Look at where we are today. As of September 30, 2009, we were expected to have total debt equal to approximately 85 percent of our economy, and that was expected to ap
proach 95 percent by the end of fiscal 2010. After that, our debt levels are expected to skyrocket absent dramatic reforms. (See figure 1. If this doesn’t get your attention, I am not sure what will.) And today, about half of our nation’s public debt is held by foreign lenders, up from about 19 percent in 1990 and essentially zero after World War II, and that percentage is on the rise. The major credit rating agencies still are giving the United States a Triple-A rating. But they have noted that this rating is “at risk” if we don’t start putting our financial house in order soon. China and other foreign lenders have also expressed their concern in various public statements and private actions.

  In addition to mounting public debt, the Medicare and Social Security disability programs are already in a negative cash-flow position. The Social Security retirement and survivors income program is now expected to join them in 2010. That is not good news, because cash flow is key.

  Figure 1 U.S. debt as a percentage of GDP: Debt skyrockets in the future.

  Fourth, recall how neither the major corporations nor our government addressed the growing risks of the housing bubble until it had burst into a full-blown crisis.

  Corporate risk managers failed to adequately anticipate the disaster scenario for housing prices. Corporate overseers, including boards of directors, did not do an adequate job of monitoring related risks.

  Is that so different from the government’s lax vigilance? The deregulation in the late 1990s allowed financial service companies to engage in a broader range of activities and take on a greater level of risk. This expansion was not coupled with adequate corporate and federal transparency, accountability, and oversight. Simply put, federal regulators allowed too many players on the field and too few referees. Former Federal Reserve chairman Alan Greenspan has noted in retrospect that he assumed that corporate managers would serve as their own referees, effectively mitigating the related risks. He was wrong, and he has admitted that.

  In the final analysis, greed won out over prudence, and we are still suffering the consequences. Let’s be sure that our federal government’s finances don’t reach that level of crisis. After all, the stakes and risks are much greater for both America and the world.

  THE SCARY BUDGET NUMBERS

  The recession and attendant financial shock appear to be easing as I write this. But in Washington, financial imprudence is part of the fabric of government. You can see that in a single document that gets updated every year: the U.S. budget. In putting together the budget, the president and Congress set our national priorities and allocate resources among them. The results have been pretty consistent. Over the forty years ending in 2008, revenues have averaged about 18.3 percent of our economy and spending has averaged over 20.6 percent, resulting in an average deficit of about 2.4 percent.

  But that gap began to widen under Bush 43, who cut taxes while starting two wars, bolstering homeland security, adding an expensive prescription drug benefit to Medicare, and increasing other spending. In 2007, the federal deficit stood at $161 billion, or 1.2 percent of our economy. In 2008 it was $455 billion, or 3.2 percent. In 2009, figuring in the billions spent to pull our economy out of recession and on various bailout efforts, the deficit rocketed to about $1.42 trillion, 9.9 percent of our economy.

  In Washington, they speak of our “fiscal exposure”—the sum of all the benefits, programs, debt payments, and other expenses that will cost us big bucks in the future whether or not we want to cut spending. The term I’ve used for all of that is our “federal financial hole.” In the first eight years of this century it has grown from $20.4 trillion to $56.4 trillion—a 176 percent increase. Maybe you have a few bills—mortgage payment, auto loan, cable TV, phone—deducted automatically from your checking account. How would you feel if those expenses had risen 176 percent in eight years while your income remained steady?

  The hole is getting deeper because we are doing little to bring our income into line with our spending. And until now I haven’t even talked about the interest payments on our federal debt. Suppose our government fails to increase federal revenues above the current rate. Based on the GAO’s latest long-range alternative budget simulation, within about twelve years, our interest payments will become the largest single expenditure in the federal budget. By 2040, all of our federal tax revenues will add up to enough to cover only our two biggest expenses: interest on our debt and Medicare and Medicaid. Everything else—Social Security, defense, education, road building, you name it—will fail to be funded.

  As you know, benefits payments are the biggest chunk of the government’s massive obligation. Since the 1960s, the growth of these mandatory payments has overtaken what we spend on defense as a share of our national output—and what we spend on everything else in our federal budget, from law enforcement to border protection, children’s programs to national parks, highways to foreign aid.

  Although defense has declined dramatically as a percentage of the overall federal budget over the past forty years, we have actually increased total defense spending. In recent years, we have added resources to fight terrorism abroad. That means that other discretionary programs are much more susceptible to cutting. These include education, research, transportation, infrastructure, and other programs that, if properly designed and effectively executed, can promote economic growth and development. How will squeezing those areas serve to keep America great?

  All of this puts us in a major-league quandary. Our nation has to bring what we earn into line with what we spend at a time when our spending literally is out of control. One option—cutting investments in America’s future in order to finance our large and growing mandatory spending programs—is another way of cheating the next generation. Unfortunately, today we are both cutting our investments in the future and handing our descendants a mountain of debt. That is a double whammy for young people and the unborn. It’s not just irresponsible, it’s immoral and downright un-American. More on that later.

  Two

  AMERICA 2030: WHY WE

  MUST ACT—NOW

  Those of you who are parents (and I’m a parent) may want to reject out of hand the idea that we are in effect stealing from our children’s future and bequeathing to them a far less prosperous life. But if we don’t begin to address our fiscal challenges soon, it’s only a matter of time before the consequences begin to show up, most likely starting with higher interest rates. As things get worse, our children will slowly see their living standards decline. We can still prevent these things from happening. The ultimate goal of cleaning up our fiscal policy is not to avoid a recession or even to balance the budget per se—it’s to pass on the kind of healthy, vibrant nation that we inherited.

  It’s easy to fall back on generalities—that America is a great country, and that we always rise to great challenges and will do so again. True, but we can only succeed by taking action, and we have a lot of action to take. Let’s say we do take only small steps to address our fiscal crisis. Let’s say we stop cutting taxes, but we don’t increase them radically either. Let’s say our government continues to take in about the same level of historical revenues, but we hold discretionary spending to 2008 levels as a percentage of the economy, and we don’t expand health care or other entitlements any further. That sounds pretty benign, but it’s actually a disaster scenario for our children.

  Let’s take the example of kids born in early 2000, when our national budget was in balance and the technology-powered future seemed bright.

  During the first eight years of their lives, we have learned, the nation’s financial hole grew by 176 percent to $56.4 trillion. And the number is not standing still. That was its size as of September 30, 2008—before the official declaration of a recession, before the significant market declines of October 2008, and before the big stimulus and bailout bills designed to jump-start the economy and address our immediate financial crisis. In fiscal 2007, recall, our budget deficit was $161 billion, or 1.2 percent of the economy. By 2009, the deficit soared to $1.42 trillion, wh
ich is about 9.9 percent of the economy. Just think about that for a second. Our federal deficit grew by almost nine times in the past two fiscal years!

  Given our scenario—no benefit cuts, no tax hikes—the government would have to finance this gaping hole mainly by borrowing money from domestic and foreign investors, with interest. Don’t forget, according to the GAO’s latest long-range budget simulation, even without an increase in overall interest rates, our interest payments would become the largest single expenditure in the federal budget in about twelve years. And what do we get for that interest? Nothing!

  Of course, something will have to give before we get to that point. However, the government has overpromised and under-delivered for far too long. How can we fix things? Will we cut benefits, those mandatory payments that are chiseled into law? Or will we raise taxes to onerous levels? We will probably have to do some combination of both. That is, we will have to renegotiate the social contract with our fellow citizens and raise taxes. However we do that, our kids will pay the price. And the bigger the bill we pass on to them, the bleaker the future we will bequeath to them.

  Let’s assume that Washington policy makers continue to punt on making tough spending choices and ultimately raise taxes to address the growing deficits. Nobody will reach in our kids’ pockets and take their money because the government will take it before it even reaches their pockets. What will that mean for their after-tax income? Right now, on average, Americans pay about 21 percent of their income in federal taxes and another 10 percent to state and local governments. By 2030, to pay our rising bills, that amount could be at least 45 percent—higher even than the average 42 percent that most Europeans pay. By 2040, it would be at least 53 percent and climbing. In reality, total taxes in 2030 and 2040 would be even higher than these estimates because of the fiscal challenges facing state and local governments—such as Medicaid costs, unfunded retiree health care promises, underfunded pension plans, deferred maintenance and other critical infrastructure needs, and higher education funding.