Tag Archives: Debt

What Are The States Smoking?

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People sometimes convert an anticipated payment stream into cash by issuing bonds. Rocker David Bowie pioneered the practice of floating bonds financed by anticipated royalty streams; he received $55 million in exchange for his discography. Accident victims call J.G. Wentworth, the pseudo-opera singers on TV, to convert settlements into liquidity. Now, there are many good reasons to exchange future payments for cash today – uncertainty of the reliability of the payments, fear of surprise inflation surges, unexpected one time bills. A bad reason is to finance a lavish lifestyle. Floating a bond might fund the expenses for a while, but the money will run out, leaving nothing. Such is the case of states borrowing against their tobacco settlements.

In 1998, a group of Attorneys General from 46 states colluded to extract $206 billion from the tobacco industry, ostensibly to fund tobacco related Medicaid costs. A small portion of the settlement was earmarked for an education campaign to reduce tobacco consumption. None of the money went to these purposes. The State money went to fund general budget items unrelated to health, and the education campaign became an annoying series of TV commercials calling tobacco companies liars and murderers – a topic unrelated to the challenges of quitting smoking.

As governments are wont to do, they incorporated the tobacco money into their budgets, spent the payments and more. One by one, the most of the states found themselves in a budget pinch and balanced their budgets with a one-time tobacco bond sale. Last year Minnesota mortgaged its tobacco payments for $700 million. Two years ago, Illinois plugged its budget gap with a $1.5 billion tobacco bond. One time tricks do not solve long run spending problems, though, and Illinois later raised its income tax by over 60%.

Worse still, many of the state’s tobacco bonds are general obligations of their treasuries, so if the tobacco payments fall short, the states are on the hook. Of course that is exactly what is happening. The settlement payments are based on tobacco consumption, which is declining. Kids who want to look tough and women who prefer cancer to obesity still smoke, but many other people are quitting or not even taking up the habit. In several states, the settlement payments are becoming insufficient to fund the bond payments.

Despite the imprudence, Alabama just floated $93 million in new tobacco bonds. The Wall Street Journal reports that Alabama has avoided some of the risks and excesses of other states’ tobacco bonds, however they have mortgaged their future to prop-up irresponsible spending today. Separately, Jefferson County, Alabama (Birmingham) just filed the US’s largest municipal bankruptcy ever. If high finance catastrophes cannot stop politicians from borrowing to spend recklessly, perhaps nothing can.

Like underfunded pensions, tobacco bonds are an example of states’ sneaky borrowing against future revenue to fund wasteful spending today. In most states, running a state budget deficit is illegal, but the politician’s instinct to spend is too strong, so they find a way to borrow.

So, who needs people to smoke? The states that have borrowed against the smokers’ habit would be ruined if everybody quit. Irresponsible, perverse, and probably immoral, yet irresistible to politicians who are paid to spend like there is no tomorrow. The states need spending controls to solve their budget problems, not tobacco bonds to enable them.

David Beers – The Most Powerful Man In The World

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Who has the power to reduce the US to a pile of rubble, crash international markets with a word, and chastise the world’s oldest republic without fear of retribution? S&P’s David Beers, is the world’s puppet master, of course. To listen to the Obama administration, the entire point of Pres. Obama’s insistence on tax increases was to avoid the wrath of Mr. Beers. S&P’s Sodom like rain of fire on the once secure US is just punishment for a failure to compromise (i.e. raise taxes), or so says Obama. Beers is, of course, not a world leader, not an elected official, and not a nation crushing billionaire hedge fund operator. In fact, S&P’s opinion of US sovereign debt is lost in a sea of market opinion.

Apart from cash of all denominations, US Treasuries form the largest, most liquid, and most closely followed market. Thousands of people, each armed with S&P’s knowledge and skill, evaluate US Treasuries each day. S&P’s downgrade was not news; it was just the addition of another opinion to the mix. In March, PIMCO removed US Treasuries from its largest bond fund – a more significant pronouncement on the US’s credit worthiness.

Shamefully, the Obama Administration blamed the messenger, claiming that S&P’s methodology was flawed, but understanding the US Government’s mess does not require an MBA, or even the back of a cocktail napkin. Government revenues are tied to anemic GDP growth, but Government expenditures are tied to an aging population and exploding health care costs. The Government cannot possibly afford to fulfill its obligations of debt service and entitlements given that grim reality. Even if S&P was off by $2 trillion in its calculations, the error is a drop in an ocean of debt.

Either the US will fulfill its obligations or it will disintegrate as a nation, which illustrates the futility of S&P’s analysis. If the US does not reform its insolvent entitlement programs, other spending cuts will only delay a collapse. If the US does restructure its entitlement programs, a AAA credit rating is well deserved. S&P suggests a middle ground, which is the one unlikely outcome. As such, absent meaningful reform, look for more credit downgrades.

S&P’s downgrade offers no new insight into the US’s deep troubles, but because of its iconic quality, the lay-public may have received a wake-up call. Naturally, the far left is livid, and it blames the Tea Party. The Left knows that its mission of establishing a socialist-light regime depends on continued deficit spending, and the S&P decision naturally tends to support the Tea Party’s call for spending restraint.

Dems’ vitriol against the Tea Party (“Terrorists”) and S&P (“Stunning lack of knowledge”) exposes their true motives. No rational observer can now claim that the US is not in deep trouble. No rational observer can now claim that Social Security and Medicare can continue without significant reforms. If the Dems truly wanted to save their welfare-state crown jewels, they would be seriously negotiating how to restructure entitlements so that they do not collapse and take the US with them. Instead, the Dems launched a myopic and desperate power play to counter S&P’s plain truth.

Dems, especially their far left fringe lead by Obama are trying to turn the S&P downgrade into class warfare – firing up their base for the 2012 election. This is sad, because Obama used the rhetoric of unity (as hollow as it was) to win in 2008. Also, this is pathetic, because independent voters are unlikely to buy Obama’s new angry pitch, and indeed his ratings among independents continue to fall. Mr. Beers and S&P are hardly power brokers, but they have just become pawns in an ugly game of electoral chess.

How Much Does Washington Really Need To Cut?

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As of this article’s publication, Washington pols are completing a debt ceiling deal. The fluid negotiations suggest that Pres. Obama will get a debt ceiling extension that will last beyond his reelection bid, Sen. Reid and Rep. Boehner will abdicate their budgetary responsibilities to a faceless committee, and the Tea Party will not have to swallow very many tax increases. Everyone wins, except there are no real spending cuts or plans to keep the US Government solvent for more than perhaps a decade. The US is racking up a frightening debt load, but how much spending must really be cut to prevent the collapse of the US Government?

As Shout Bits mentioned, Federal revenue has returned to nearly its pre-recession levels, only about $100bln short of its all-time high. The $1.5 trillion deficit problem is caused by the fact that Federal spending kept climbing at its normal pace while tax revenues took a three year break. There is no solution to the US Government’s crisis that does not rely on increased economic growth, and that must involve the rich.

Contrary to  Obama’s demagoguery, the US tax system is highly progressive, meaning that the fate of the rich is the fate of the Federal Government. The poor’s income taxes have never been lower in modern times. Tax receipts as a percent of the economy rise and fall with economic growth, but the government’s take has fallen to a level not seen since the 1950′s. Considering the myriad services such as Medicare that have been added since then, tax revenues must return to their historic highs to fund taxpayer expectations. Because the top earners pay most of the taxes, the US needs a resurgence of the rich. The rich need to invest and employ so they can become richer and pay more taxes.

Of course there is no guarantee of such a windfall given oppressive new laws such as Obamacare that are stifling the economy. Still, if tax receipts returned to about 18% of GDP, the Bush era peak, tax revenues would increase by $450bln. Considering that is more than twice the illusory savings from the latest debt talks, Washington’s top priority should be a restoration of the US economy. If tax revenues returned and the economy grew at a rate of 3.5% for a decade, tax revenues would further grow by an average of $460bln per year. The US’s history suggests that when government oppression is relaxed, such prosperity is possible, and often exceeded. Still, that leaves $590bln annually to be cut to balance the budget over a decade, less than half of the current plan.

The US spends $159bln per year on the Iraq and Afghanistan wars, so assuming they end soon, the magic number could fall to $431bln, about the deficit Pres. Bush was running as he left office. It is not curious that bad economic policy amounts to the bulk of Obama’s woes.

As Shout Bits mentioned, wasteful spending and Washington corruption account for a small part of the required cuts – perhaps $90bln. With Sen. Reid defending cowboy poetry, and Rep. Pelosi disallowing any cuts whatsoever, eliminating entire departments such as the DOE and DOC seems impractical. Even assuming the elimination of entire wasteful departments and general bureaucratic belt tightening, the budget must be cut by $330bln per year while capping Social Security and Medicare.

There is no way past substantial military cuts. There is no way past increasing the eligibility ages of Medicare and Social Security. There is no way past cutting welfare entitlements. As every libertarian and realistic conservative has been harping for years, the US must redefine the Federal Government’s role to be a much smaller part of everyday life. The US Government cannot solve every problem, and everyone cannot have everything – a tide change in the Washington paradigm.

The prescription of $330bln in annual cuts to basic government services is more than enough to bring Greek style riots to the streets. Such tough cuts could dissolve the union separating states with economic growth from those that have been declining. Still, these cuts will happen; the only question is whether the US will choose them or they will be imposed when the wolf is at the door. Tea Party voters know this, even if intuitively, and they are unlikely to back down.