Showing posts with label Deficit. Show all posts
Showing posts with label Deficit. Show all posts

Thursday, April 9, 2009

Government Deficits Do Matters

Fun stuff from the Peterson Institute:

http://www.owenandpayne.com/why_you_owe.php

Each American now owes 184,000 dollars because of America's deficits.

Tuesday, September 23, 2008

America's Account Deficit

An oldie but a goodie, from C. Fred Bergsten, Peterson Institute, February 1, 2007:

http://www.iie.com/publications/papers/paper.cfm?ResearchID=705

Our external deficit has risen by an average of $100 billion annually over the past four years. It has climbed by an annual average of $80 billion for the past nine years. The trajectory, as well as the level of the imbalances, is clearly unsustainable.

In the background, you can almost hear Jack Nicholson bellowing, "You can't handle the truth!"

Monday, September 22, 2008

OCM: Other Countries' Money

Despite the failure of several financial institutions, the decline in worldwide stock markets, and unprecedented foreclosure activity, the average American still has no idea how much trouble we're in. America has become beholden to the international community’s willingness to lend us money. I haven’t seen anyone coin “OCM” as a phrase, but whenever you see someone using their credit card, mention OCM—Other Countries’ Money. OCM means realizing our money isn’t ours because of the massive deficits our government has incurred through its spending. Having a deficit means we are borrowing other countries’ money through the form of Treasury and bond sales. By running deficits and spending more than we make/collect, each cent we make no longer belongs to us—it belongs to our international creditors. As a result, we have lost financial control of our own country. If we had a surplus, for example, national healthcare would be a no-brainer. But after Iraq and the bailouts, we are now a nation of beggars. As the old saying goes, “beggars can’t be choosers.”

How did we get to this point? Less than a decade ago, we had a surplus. In 2001, President Bush inherited a 128 billion dollar surplus. Now, we have almost a half a trillion dollar deficit—and that’s just for the year 2009.

http://www.cnn.com/2008/POLITICS/07/28/2009.deficit/index.html

It gets worse. Overall, people agree we have a debt of at least 9 trillion dollars, although some entities, like the Peter G. Peterson Foundation, peg our national debt at an even higher number, 52.7 trillion dollars--see http://www.pgpf.org. The numbers have gotten so large, they seem almost imaginary, like Monopoly money, and that’s the danger—at a certain debt and spending level, the American dollar will lack credibility against the Euro, yen, and Swiss franc, not to mention gold. If the American dollar loses credibility, the entire worldwide financial system will be at risk. If that sounds too “Mad Max” for you, you just need to understand this key concept: we are debtors, and debtors don’t get to make the rules. When I hear people say they want to tie restrictions and regulations on AIG, Merrill Lynch, Fannie Mae, and Freddie Mac in exchange for taxpayer money, I cringe. It’s not “taxpayer” money, any more than the money given to you by your credit card company is “your” money. The money belongs mostly to the Japanese and Chinese, who have lent us trillions of dollars by buying up U.S. debt, bonds, and preferred shares. If we want them to continue financing our lifestyle—which they will do, because few other places contain citizens so willing to spend—they set the terms of the bailouts, not us. Thus, I have no interest whatsoever in what regulations and rules Americans believe should be passed prior to doling out the money to AIG et al. It’s not our money we’re giving to AIG et al—it’s the creditors’ money, and creditors make the rules because they hold the purse.

I am far more interested in what the Japanese and Chinese think about the bailouts. The fact that they are not demanding major restrictions is a pleasant surprise. Singapore and other sovereign wealth funds have lost billions of dollars loaning money to MGM Grand and other American companies. It’s a miracle they are not demanding more concessions or protection for loaning us money. The equivalent of what just happened—especially with Japan's Mitsubishi recently willing to buy up to 20 percent of Morgan Stanley—is like you and me going on a shopping spree, running up 1000 dollars in debt while unemployed, and coming close to declaring bankruptcy—only to have our credit card company reward us with a higher credit line and no punishment.

In large part, international investors are willing to forgive our transgressions because of the bailouts. The bailouts wiped out stockholders (held mainly by Americans and non-Asian investors) and preserved Fannie Mae’s and Freddie Mac’s bonds (held mainly by Asian and international investors). Thus, the bailouts were designed to convince our creditors America was a safe place to invest.

From March 2019
Only as a secondary effect might the government intervention, using taxpayer money, help American homeowners by increasing liquidity (“liquidity” being dependent on Japan and China continuing to put us in more debt by giving us more of their money). Government intervention worked—Asian markets recently swung back from double-digit declines, and liquidity is being restored to the worldwide economy. Some Americans have used this increased stability post-government-intervention to believe that deregulation itself was a bust or the cause of our financial collapse. Nothing could be further from the truth.

No rule or law could have saved us from ourselves and our greed. Remember that Warren Buffett himself called financial derivatives “weapons of financial mass destruction” in early 2003—over five years ago. See

http://news.bbc.co.uk/2/hi/business/2817995.stm

If someone with Mr. Buffett’s profile pointed out financial problems using language signifying the severity of a nuclear bomb and was unable to get anyone to take him seriously, what hope would a law have against this kind of indifference?

We had and have numerous laws to prevent financial and mortgage fraud. Laws against fraud exist in every state, and even if no express state statute exists, common law fraud can be pled in any county courthouse. Also, if you live in a company-friendly town, you can bypass your local state court judge and go to federal court under a 1968 federal law, the Truth in Lending Act (TILA). Thus, state and federal laws already exist to prevent financial fraud against consumers and homebuyers. Yet, no law could have prevented a bank from having lax standards for granting loans. Even if such a law existed, it may have forced a working class family to become permanent renters by requiring excessive upfront capital. In other words, laws don’t fix problems—they just arbitrarily create winners and losers. Furthermore, no law could have changed the common practice of mortgage brokers and real estate agents falsifying loan applications. Even if every D.A. in every county had dropped homicide cases in favor of prosecuting mortgage fraud, there would have been plenty of fraud to go around.

The problem wasn’t and isn’t a lack of regulation, but a lack of ethics and honesty. Unfortunately, there is no law that can curb the human appetite for greed when everyone is seemingly making money. Even a casual student of economics has heard of “tulip mania,” which took place in the year 1637. Back then, the price of a tulip contract sold for more than 20 times the annual income of a skilled craftsman; in other words, people were happy to exchange 41,600 hours of hard labor for a flower that you can now get for a buck at Home Depot. Financial bubbles happen, and then they pop. Unless a law can remove humanity’s attraction to getting rich, another bubble will occur, and more people who bought late in the game will be wiped out.

Overall, deregulation has helped the American consumer. Just twenty five years ago, the idea of an average college student being able to fly to Iceland and back was laughable. But the government deregulated airlines, and consumers have received low prices—just check out Southwest Airline’s deals. And that cell phone you have, with the cheap 1000 minutes a month? If the government hadn’t broken up Ma Bell in order to deregulate the telephone industry, you’d be paying twenty cents a minute because of regulations designed to help AT&T maintain a monopoly. The list goes on.

Deregulation is devastating only when unethical people are involved. For example, energy deregulation in California was working initially, until Enron decided to actively steal from Californians and intentionally increase the price of electricity through various shenanigans. The common factor in any bubble’s existence and inevitable collapse isn’t deregulation, but a lack of ethics. Stories from yesteryear indicate that local bankers knew more about their debtors than the local church. Whether apocryphal or not, the very idea that a banker today knows all of his debtors’ financial situations intimately is amusing—and that kind of ignorance should scare all of us.

It wasn’t just leverage that caused this financial collapse—it was the attenuated way in which various people could make money. For example, a mortgage broker could loan hundreds of thousands of dollars over the phone to an applicant or after meeting him for half an hour and filling out some forms. After this initial contact, the broker had no interest whatsoever in the applicant/debtor. The broker received a fee from the bank for giving it the loan, and the bank sold the loan it generated to other investors as part of a larger package. The story is old now, but deserves to be told, because too many people miss its crucial point: attenuation leads to irresponsibility.

The financial debacle had nothing to do with regulations, or lack thereof. It had to do with our society itself, and how year after year, cities get larger, neighbors rarely see each other, and no one can reasonably promulgate a set of core principles each and every American believes in. We have become so reliant on laws rather than personal trust that we've had to pass laws to protect people when they help others. Many states have passed laws protecting Good Samaritans from being sued for helping others if their assistance unintentionally results in further injury. In other words, in some states, if you help a woman on the street replace a tire, and her tire happens to blow up in the middle of the street through no fault of your own, you can be sued for negligence and lose your life’s savings as a result. When a law has to be passed to counteract other laws that discourage others from lending a helping hand, something is deeply wrong, and the absence of laws is clearly not the problem.

I wish I knew the solution to our modern economic problems. I am too pessimistic to decree an amorphous form of morality as the solution—morality is so vague and subjective, it can masquerade as homophobia, Jim Crow, anti-Mormonism, or anti-whatever-the-minority-is. But capitalism, we too often forget, relies on mutual trust. I trust that when I make a loan, it will be paid back. I trust that when I give you a dollar, the paper will be honored by the next establishment when I want to buy something. I trust that a mechanic won’t rip me off if I go to get my car fixed—and if I don’t trust any mechanics, that means I have to do it myself and not spend any money, which restricts the economy. As another writer once pointed out, currency has value because it flows, like a current. Value is created when money moves from person to person and is worth nothing standing still.

If I had to venture a guess about to increase trust and ethics, I’d try to fix two problems: one, a non-stop treadmill of working hours that takes people away from their loved ones and their friends, creating higher living expenses and less time for parents to teach their children anything; and two, a lack of corporate responsibility to long-term shareholders and customers. As more people change residences and products more often, corporations become disinclined to foster long-term relationships and instead chase the bottom line, knowing they might never see a particular customer or resident again.

How do we fix these problems in an era of increasing competition? That’s the trillion dollar question. Unfortunately, we won’t get an answer if we wrongly frame the debate in terms of what laws to pass and how to increase regulation. The debate should be about OCM and realizing we are debtors who have made our children beggars because of our fiscal irresponsibility. It’s a painful truth to admit, but admit it we must—the first step to overcoming addiction to OCM is admitting we have a problem.

© Matthew Mehdi Rafat

Update on 2/28/2009: more on local bankers, from Warren Brussee's The Great Depression of Debt:

In the past, local banks gave mortgages to area home buyers, and the banks kept those mortgages. That was a big source of the bank's income, so they were careful about who got those mortgages. Banks verified income, employment, and past payment history. And they did their best to make sure that people did not get over their heads on the amount of their mortgages because they realized the high costs of foreclosures even if homes could be sold at their current market prices. There even seemed to be a morality involved, and bankers were looked up to in their communities as conservative protectors of wealth. [page 40]


Update on 8/13/2010, from Niall Ferguson's The Ascent of Money, page 262, Penguin, 2008-9:

"Once there had been meaningful social ties between mortgage lenders and borrowers. Jimmy Stewart [in It's a Wonderful Life] knew both the depositors and the debtors. By contrast, in a securitized market (just like in space) no one can hear you scream--because the interest you pay on your mortgage is ultimately going to someone who has no idea you exist."

Update: if you want to make the above issues very simple, focus on leverage. Leverage continues to be the major catalyst of financial collapse, along with a lack of diversification. In 2004, the SEC exempted investment firms with a market capitalization of over $5 billion from the net capital rule. Thus, Goldman Sachs, Lehman, Bear Stearns, and Morgan Stanley were no longer governed by the 12 to 1 leverage limit. These investment firms promptly increased leverage dramatically, sometimes up to a 40 to 1 ratio. The stock market soon became a casino instead of an efficient place to start up or evaluate companies. Not surprisingly, several firms collapsed or had to change their corporate structure. The exact same thing happened before, in 1998, with the most famous hedge fund at the time, LTCM:

"At the end of August 1997 [prior to the its collapse in August 1998] the [LTCM] fund's capital was $6.7 billion, but the debt-financed assets on its balance sheet amounted to $126.4 billion, a ratio of assets to capital of 19 to 1...On Friday 21 August 1998, it lost 550 million--15 per cent of its entire capital, driving its leverage up to 42:1." (Niall Ferguson's The Ascent of Money, pages 324, 327, Penguin, 2008-9)

Bonus: "In 2007, the United States needed to borrow around $800 billion from the rest of the world; more than $4 billion every working day. China, by contrast, ran a current account surplus of $262 billion, equivalent to more than a quarter of the U.S. deficit." (Niall Ferguson's The Ascent of Money, page 355,
Penguin, 2008-9)

Update and counterargument on 5/25/12, from The Atlantic Monthly (June 2012), by William Cohan ("How We Got the Crash Wrong"): 

"[T]he truth is that in recent decades, Wall Street firms have almost always been highly leveraged. For instance, according to a 1992 study by the U.S. General Accounting Office (now the Government Accountability Office), the average leverage ratio for the top 13 investment banks was 27-to-1 midway through 1991 (up from 18-to-1 in 1990). A subsequent GAO report, in 2009, noted that the big Wall Street investment banks had higher leverage in 1998 than in 2006. According to SEC filings, in 1998, the year before it went public, Goldman Sachs was leveraged at nearly 32-to-1, while in 2006 it was leveraged at 22-to-1. In 1998, Bear Stearns’s leverage was 35-to-1; in 2006, its leverage was 28-to-1. Similar patterns applied at Merrill Lynch and Lehman Brothers. To be sure, leverage has fluctuated over time: In the early 1970s, for instance, it was generally below 8-to-1. But in the 1950s, it sometimes exceeded 35-to-1. Of course, even a dollar of debt is too much if you are clueless about how to manage risk..." 

"The problem on Wall Street has never been about the absolute amount of leverage, but rather about whether financiers have the right incentives to properly manage the risks they are taking. During Wall Street’s heyday, when these firms were private partnerships and each partner’s entire net worth was on the line every day, shared risk ensured a modicum of prudence even though leverage was often higher than 30-to-1. Not surprisingly, that prudence gave way to pure greed when, starting in 1970 and continuing through 2006, one Wall Street partnership after another became a public corporation--and the partnership culture gave way to a bonus culture, in which employees felt free to take huge risks with other people’s money in order to generate revenue and big bonuses.  People are pretty simple: they do what they are rewarded for doing." More here

From Nader A, on 5/26/12: "Leverage is not new--applying it to complex derivatives is over the last 15 years is. The LTCM group used to arbitrage penny differences on equity and fixed income markets, but with leverage, they could profit in the millions, until everything turned (mostly because short term liquidity changed). Someone once said of LTCM, "You guys are picking up nickels in front of steamrollers," meaning they were scooping up small differences but with large amounts of leverage.The real changes in Wall Street are "Off the balance sheet obligations." Balance sheets, income statements and cash flows do a poor job showing what a company potentially owes, which could change drastically over time.  For example, Enron used Special Purposes Vehicles to stash debt from their balance sheets, but did not show their financial obligations when the SPVs soured. Lehman used repos to transfer debts before quarter ends. CDSes sold by banks started to increase in balance sheet obligations as debts widened. The problem in Wall Street today is that the current financial reporting does not reflect future obligations when "things change"; instead, it reflects current, optimistic, and biased asset values, which is okay until you have a "black swan" event.  The other thing about [complex] derivatives is that it obfuscates the problem. The recent JP Morgan trade that went bad was a derivative based on a derivative based on a derivative. Once you apply leverage to complex, multi-level derivatives, then the problems become systemic. So with respect to the sovereign debt problems in Europe, it's not as much the problem of Greece defaulting, as it is the banks holding the debt falling into insolvency and triggering a cascade of derivative swaps." 

Update on 6/3/12: from Sebastian Mallaby's 2010 book, More Money than God: "Capitalism works only when institutions are forced to absorb the consequences of the risks that they take on.  When banks can pocket the upside while spreading the cost of their failures, failure is almost certain." (pp 13, hardcover, Penguin Press)

Re: the difficulties regulating leverage: "In the wake of LTCM's failure, Greenspan and his fellow regulators could see that the real challenge was the leverage in the financial system writ large.  Ironically, this was what Soros had tried to explain to Congress in his testimony four years earlier. Sure enough, the culprits in the crisis of 2007– 2009 were leveraged off-balance-sheet vehicles owned by banks (known as conduits or structured investment vehicles, SIVs), leveraged broker-dealers, and a leveraged insurer. Hedge funds were not the villains.

If hedge funds were only part of the challenge, why didn't regulators clamp down on the wider universe of leveraged investors? Again, the answer echoes 1994: The regulators believed they lacked a good way of doing so. They could not simply announce a cap on leverage: The ratio of borrowing to capital was an almost meaningless number, since it failed to capture whether a portfolio was hedged and whether it was exposed to risks via derivatives positions. Regulators could not simply cap hedge funds’ value at risk, either: LTCM’s collapse had shown that this measure could be misleading. The frustrating truth was that the risks in a portfolio depended on constantly changing conditions: whether other players were mimicking its trades, how liquid markets were, whether banks and brokerages were suffering from compromised immune systems. The Fed’s Peter Fisher, who was at the center of the regulatory brainstorming following LTCM, could see the theoretical case for government controls on hedge funds and other leveraged players. But it seemed so unlikely that the government would get the details right that he never pushed for action." (pp. 245-246)

Update on 6/24/13: Michael Lewis warned about collateralized mortgage obligations back in November 1989: "The CMO stands for collateralized mortgage obligations, but bond salesmen call it 'toxic waste.'"  (originally published in November 1989 in Manhattan, Inc.; re-published in Michael Lewis' The Money Culture, paperback, W.W. Norton and Company, pp. 105 (1991))

Update on 11/0/14:"Although they are established to protect both the security of ownership and that of transactions, it is obvious that Western systems emphasize the latter.  Security is principally focused on producing trust in transactions so that people can more easily make their assets lead a parallel life as capital." -- Hernando de Soto, The Mystery of Capital (2000), paperback, pp. 62. 

Update on July 2017: "As a man who did business with other people's money, the banker had to be intensely respectable... 'The function of bankers is to be trusted, not to be liked.' 'Adventure is the life of commerce,' wrote Walter Bagehot, first editor of The Economist, 'but caution, I had almost said timidity, is the life of banking.'" -- from The Bankers: the Next Generation (1997), by Martin Mayer, hardcover, pp. 5.

"[A]s Charles Rice of Florida's Barnett Banks puts it, 'The Harvard Business School never graduated an MBA that can't be hornswoggled by the businessmen of the Florida panhandle.'" -- Id. at pp. 10. 

Saturday, August 9, 2008

Deficits Come Home to Roost

I was talking to a friend of mine today, and she, a life-long Democrat, was showing me that she paid 35% in taxes. She said she did not mind paying 35% to the government and favors maintaining existing welfare programs as well as entitlement programs. I suddenly realized how dire our spending habits are--just maintaining existing programs would cost future generations trillions of dollars more than we can afford and would bring our nation closer to defaulting on government issued debt (bonds, Treasuries) or requiring foreign capital injections (e.g., Citigroup, Merrill Lynch and MGM Grand).

I then realized something unsavory--the money would be coming from my friend and I to cover the existing entitlement/spending programs, and the only way the government could get it was by taking more money from us and our children. I told my friend her 35% rate was an inaccurate indicator of how much government spending programs cost. In reality, unless the government wants to default on our debt, her tax rate should be 50%, and sales taxes would have to increase every year to cover government spending. I tried to tell my friend her support for existing spending programs means that my children and her children would eventually be subject to an income tax rate of around 50% and a California sales tax rate of around 10% to maintain the programs she likes. That's when I realized if you're an American, and you care about this country's future, you must support cutting government spending. The only question should be where the cuts come from, not whether they should be made. Even supporting the maintenance of current spending programs is wrongheaded.

I gave my friend a link to Richard Fisher's recent speech, which I've posted elsewhere on this blog:

http://www.dallasfed.org/news/speeches/fisher/2008/fs080528.cfm

I asked her to read it, because if she, a very smart law school graduate, could not understand that even maintaining existing spending programs required higher sales taxes and her children to pay 50% in income taxes or risk Zimbabwe-type inflation, we had little hope as a country of exiting our financial morass.

I facetiously pretended to be Uncle Sam with a spending problem. I told her I had been using my credit card and spending trillions of dollars of her money and now I needed more, or I'd go bankrupt. I said I had taken loans from the Chinese, Japanese, and British, and I had to pay them interest every single month. The 35% I was taking from her wasn't enough. I couldn't take too much from the poor--it would not be enough, even if I raised their taxes to 50%. The top 25% already pay 85% of taxes (see http://willworkforjustice.blogspot.com/2008/07/top-25-of-earners-paid-85-of-all-taxes.html) to support my spending habits, and it isn't enough. My friend and her children had to pay more.

I racked up a list of expenses I had--the war in Iraq, Fannie Mae, Freddie Mac, welfare, military, payroll, Social Security, Medicare, and Medicaid. I told her I had overused my credit card for the past ten years and was spending money I didn't have, while paying only the minimum balance each month. To make matters worse, I had little actual savings--I was living paycheck to paycheck, surviving on my friend's 35% injections. Thus, any spending was going to have to come from more loans and more debt. I said I was now having a hard time meeting interest payments on my loans, and she had to pay me more money so I could take it outside of our country to pay my foreign creditors. I explained if there was any other way of getting the money, I'd avoid raising taxes. Please, I begged her, show me a way to get the money without taking it from you and your children but also maintaining my spending habits. (And no, massive inflation is not an option--as Zimbabwe shows, if everyone's rich, no one is.)

That's when it hit me. There's no other way for Uncle Sam to get the money without cutting spending, except by raising taxes. For example, California will probably raise sales taxes to balance its budget, which will hurt the poor. (The sales tax is a "regressive" tax, a fancy way of saying it falls disproportionately on the poor.) California's spending, if it results in a higher sales tax, will cause the poor to save less money, because now they have to pay higher taxes when buying food, drinks, clothing, and cars. Thus, to maintain government programs that help the poor, California is going to raise a tax that will hurt them, so the government can make the poor more reliant on their programs. Confused? You should be. Like you, I didn't study Infinite Loop Economics.

And that's the harshest lesson of all--in part because we have tried to help the poor by spending money we don't have, we've destroyed our ability to help them. The poor don't have a lot of political power, so most likely, we will have a higher sales tax before a higher income tax (which falls disproportionately on the aspiring middle class and affluent).

So here's the sad, twisted result: we've spent money we don't have, causing us to take more money from the poor so we can give it to the government. The best way to help the poor is to take some short-term suffering--like cutting government programs, foreign spending (e.g., Iraq war), and general benefits (e.g. government employee pensions), so we actually have money in the bank to help the poor in the future. We had a surplus only a few years ago. See chart, below.


For the Republicans gloating right now, our surplus occurred under Democratic President Bill Clinton, a fact that helps Sen. Obama, not Sen. McCain. For the Democrats gloating now, the surplus occurred under a Republican Congress. As we can see, the issue of out-of-control deficit spending is non-partisan. We need to go back to having a surplus before we think about helping others. Anyone who talks about maintaining spending programs or worse, increasing entitlement programs, is doing our country a disservice.

Patriotic Americans must take away Uncle Sam's credit card, cut it up, and not return it until he reforms his profligate spending. That means cutting programs that help senior citizens, the poor, teachers, the military, and other government employees. There's no way around this harsh scenario--being on a budget isn't easy for anyone. But unless you want Uncle Sam to default on his debt, rampant inflation, or 50% taxes on your children, you will support a balanced budget. If you're still not convinced we have to cut spending, all you have to do is go out there and find that money-growing tree. It's out there somewhere, probably nearby the Tree of Wishful Thinking. Hopefully you'll find it before we all go off a cliff.

http://www.youtube.com/watch?v=VYnZL0BOXDc

Signed,

Not the King of Wishful Thinking

Wednesday, August 6, 2008

Charles Wheelan and the Fed Budget Deficit


Charles Wheelan, a Yahoo Finance columnist, is the author of Naked Economics, one of my favorite and most accessible economics books. Here's what he had to say recently:

If you want to know how bad this [debt] problem is likely to get, check out this alarming graph [above] from the Heritage Foundation based on data from the Congressional Budget Office. (Warning to parents: The graph is inappropriate for children -- not because it's pornographic, but because they'll realize how much your generation is totally shafting them.)

See http://finance.yahoo.com/expert/article/economist/98587?count=30&start=6#dtk-cmtscnt for more.

Bottom line: we're borrowing from many future generations to pay for obvious mistakes now. The U.S. dollar and our world image are suffering as a result.