Tag Archives: Debt

The Cliff That Isn’t

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Washington is abuzz about the Fiscal Cliff, a combination of tax increases and modest cuts in spending growth. Since the Old Media and most of Washington always favor tax increases, the fear must be over spending. But even with the cuts, Washington will remain overfunded. So, what is not to like about the Fiscal Cliff?

The Cliff allows for tax rates to return to those Pres. Clinton approved in the early 1990′s. Most taxpayers will see their rates increase and some people who now pay no income tax will have to begin paying. In a 2007 primary debate, Pres. Obama said it was the country’s moral obligation to repeal all of the Bush tax cuts, and the OM continues to churn the notion that the Clinton tax increases caused the prosperity of the 1990′s. Now that the Democrats are in charge, most of the Clinton tax rates are unacceptable. If, as Obama now claims, the Bush tax cuts are appropriate for 98% of Americans (a fatuous figure since nearly half of Americans pay no income tax at all), does that mean Bush was 98% right in his tax policy? Does that mean Clinton was 98% wrong in his tax policy? The Cliff’s tax rates are a tool by which Obama is dividing the US along phony class lines. If everyone’s tax rates go up, Obama’s us-vs.-them, punish-our-enemies rhetoric becomes powerless.

The argument against the Bush tax cuts has always been that it lead to the budget deficit crisis. However, even Obama admits that his tax increase for 2% of Americans will not significantly reduce the deficit. Instead, the tax increase he seeks is a matter of justice, or as Warren Buffett claims, tax increases would “raise the morale of the middle class.” Obama and Buffett seem to be admitting that overall, the Bush tax cuts are not the problem they and the OM portrayed them to be, but rather the Bush tax rates only need some window dressing for “fairness” and “morale.”

The Cliff also purports to cut spending. In reality, the sequester somewhat reduces the rate of increase in spending. By any measure, all spending will remain uncut. The real-dollar per-capita budgets of all major departments will be higher than under Clinton, including Defense and HHS. In every sense the government will be better funded than under Clinton. Was Clinton an evil plutocrat who hated the poor and minorities? Further, the sequester does not address entitlements such as Medicare and Social Security. Those are the budgets whose out of control growth will destroy the US. Washington’s big spenders know they were elected to increase spending each year, and any slowdown would be against the interests of their donors.

Let the Cliff happen. Why not test the notion that Clinton’s tax rates caused prosperity? Why not see what would happen if the rate of growth in Washington’s spending was cut slightly? Why not make Obama take some responsibility for his spending habits? Why not call the OM’s bluff that the Cliff would be the end of all things? The Cliff and the negotiations surrounding it are a fabrication. The Cliff’s tax rates are Democrat tax rates, voted for by Democrats signed by a Democrat, and more recently endorsed by the Democrat Obama. The Cliff’s spending cuts are a Democrat fabrication as well. By pretending a slightly slower rate of increase in spending is a cut, Democrats built a firewall against real reform. To balance the Federal budget, spending must be cut not by $800bln over ten years, but by $10 trillion. Let the Cliff happen to deprive the Democrats of the lies they and the OM use to protect corruption, waste, and unsustainable entitlement scams.

Eliminate the Mortgage Interest Deduction Now

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Shout Bits has argued that the Mortgage Interest Deduction is not so helpful to regular Americans, but with interest rates at historic lows, now is the time to eliminate this market distortion. Not only does the MID encourage buying unaffordable homes and promote market bubbles, the primary beneficiaries are wealthy individuals and large banks. Eliminating this deduction would actually help most ordinary homeowners.

For 2012, a couple filing jointly can claim an $11,900 standard deduction, even if they have no otherwise deductible expenses like mortgage interest. Therefore, the first $11,900 in mortgage interest paid by such a couple generates no tax savings for them. Today’s national average 30 year fixed mortgage coupon rate is 3.8%, which means that a mortgage smaller than $313k (11900/.038) generates no tax savings for a couple filing jointly. Now, a $300k mortgage is not unheard of, but it is clearly not for the struggling working class.

Since the first $313k of a mortgage balance is not deductible, the tax incentive is to borrow as much as possible. After all, Uncle Sam is kicking in about a third of the interest expense above $11,900. Further, the tax code discourages paying down mortgage balances, since as interest payments fall, so does that tax benefit. This perverse incentive leads to speculative bubbles which burst when incomes fall below the point where an income tax deduction is available. The MID certainly contributed to the real estate crash of 2008.

Worse still, a recent study by Andrew Hanson at Georgia State University concludes that the tax code’s reach into the mortgage market increases mortgage rates for modest homeowners. Mortgage lenders siphon off 9 to 17% of the government’s subsidy intended for homeowners (as much as $1.7bln per year) in the form of higher rates. Not only does the MID not benefit smaller borrowers at all, according to Prof. Hanson’s study, it costs them hundreds of dollars extra, even if they cannot take an interest deduction.

It is always wrong, corrupt, and perverting for the government to manipulate markets as it does with the MID, but now is the perfect storm of minimal benefits and maximum harm. Mortgage rates cannot fall much further due to structural cost limits, so the interest deduction benefit is nearly as small as it ever can be. Likewise, with tighter lending criteria, only the well-off can qualify for loans big enough to earn an interest deduction above $11,900.

With the Federal Government looking for ways to raise taxes, the very worst choice would be raise marginal rates. Instead, a flatter and broader based tax code is the answer that is more just and stable. Eliminating a deduction that only benefits the well-off, while harming modest borrowers and enriching big banks, is an obvious choice. The time is now.

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.

Bogus Deficit Solutions

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As the federal debt climbs toward an ill-defined event horizon where the dollar crashes and basic services are shut down, voters face a cacophony of conflicting and scary predictions. Pres. Obama has threatened to withhold Social Security checks, as if Social Security is the lowest priority for the $4.1 trillion in revenues Washington hopes to receive this year. Washington is expected to burn through $1.4 trillion more than it collects this year, which is clearly a disaster. Still, should Obama take the entire blame?

To state the obvious, the deficit is the difference between federal revenues and outlays. Contrary to Pres. Obama’s carping about millionaire jet setters, the revenue side of this equation has resolved itself. Tax revenues peaked under Pres. Bush at $4.2 trillion ($450 bln deficit that year), but they have already recovered to $4.1 trillion. Falling revenues caused close to half of the deficit in 2009 and 2010, but they are no longer a problem.

What about Obama’s wasteful stimulus programs? Between the recovery stimulus, the housing stimuli, the auto bailouts, and the Fannie / Freddy bailouts, Obama has wasted well over $1 trillion. Still, that money is spread out over at least three years, and is mostly behind us. It cannot account for this year’s $1.4 trillion deficit.

Federal spending has been on autopilot for some time, and Obama’s spending increases are nothing extraordinary.

Federal Spending 2000 – 2011


source: Wolfram Alpha

The chart shows the impact of Obama’s stimulus, but spending has since returned to its historical growth rate. Likewise, the promised spending cuts negotiated the last time Obama and Congress butted heads are nowhere to be found.

The reality of the US’s budget problem is that the Federal Government is a beast with no master. Obama and Congress are only servants to an economic and political force that wants to grow. Most Congressmen owe their careers to some part of the federal beast, and no majority can form to pass even the smallest reforms. While Rep. Pelosi’s recent call for no cuts whatsoever sounds radical, that is basically the sentiment of every Congress for the past 90 years.

Obama’s calls for millionaires (read those who earn $150K) to pay their fair share are of course bogus, but so are Herman Cain’s calls to ‘cut the fat.’ Reforming obvious government waste cannot close a $1.4 trillion gap. Eliminating the Departments of Education, Commerce, Interior, Labor, NSF, Community Service, SBA, and Energy would only save $90 bln.

The debt limit impasse presents two stark and unpleasant choices: 1. The US can become a European socialist state with its current level of government services, but with high taxes, low growth, and a permanent underclass of the unemployed; or 2. The US must seriously rethink its big ticket programs: Welfare ($571 bln) , Social Security ($695 bln), Medicare ($453 bln), and Medicaid ($290 bln), and the military ($695 bln). To listen to Washington, simply freezing these budget items would bring about the apocalypse. Even if the budget were held to inflation it would take 21 years at the current GDP growth rate of 1.5% to balance the budget.

Is Obama to blame for this mess? No, but like all Washington insiders, he is opposed to any real solution. False compromises of tax increases and fantastical far off budget cuts cannot solve the US’s serious troubles. Real solutions like a balanced budget amendment, or simply letting the US hit its debt ceiling sound radical, but every moderate method has already failed. Beltway thinking is the road to disaster, which is something to remember when a GOP moderate asks for your vote.

The US As Greece

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Today, S&P placed US debt under a “negative” outlook, which means that US government bonds are at risk of a downgrade in the next few years. Basically, S&P does not think that the US Government will find a way to borrow less as a portion of its economy than it has during the past two years – borrowing as a portion of GDP has more than doubled since 2009. US Treasuries fell to a three year low on the news. Bad news indeed, but is this a Glenn Beck moment? Not really – the decline of the US’s borrowing power will be gradual and its victims surprising.

US government debt is sold at an open auction, making its effective rate variable depending on bidder interest. Because of the US’s ‘AAA’ rating, its debt had been considered free of default risk (i.e. the risk that principal and interest will not be paid on time), but today’s bond trading ended that assumption. Unless, after its review, S&P reaffirms the US’s AAA rating, US bonds will no longer be assumed to have no default risk.

If the US slides to a mid to low investment grade rating, what happens? Will the US economy shudder to a halt? Probably not, but things will be different.

First off, the US Dollar’s place as a world currency will be diminished. When people own US currency, they rarely own Dollars. Instead, they most often buy US treasuries because unlike raw Dollars, T-bills earn interest. T-bills are nearly as liquid as raw Dollars, so there is currently little risk for buying and selling them even if the holding period is as little as one day. Now that default risk is included in US treasury prices, that liquidity is reduced because holders are now concerned they can lose value at any time should their T-bills be devalued.

Other obligations of the US Government are now suspect. FDIC insurance on bank deposits is backed by the same ability to borrow that S&P downgraded. True, the FDIC sometimes holds a reserve, but that is also invested in US Treasuries. Everything the US Government does – Social Security, Medicare, defense – has become more expensive and more uncertain.

Even if the US someday becomes Greece and cannot borrow any more money, is that the end of prosperity? Not at all because money is only a prism through which real wealth is measured. Farmers will still grow their crops, and people will still heat their houses. The main effect will be a reduction in foreign trade, especially imports. As China is today, the US economy will shift to an export economy because foreign holders of US debt will spend their Dollars rather than using them to buy more US debt. US manufacturing employment will increase. The inflow of Dollars will drive down its value and drive up inflation. US imports will fall because foreign goods will become uncompetitive. Trading partners like China will suffer more than the US itself because they depended on exports to the US.

A US society that can no longer borrow will look different in many ways. Any activity that depends on borrowing will be curtailed because interest rates will climb relative to US Treasuries. The average house size will be smaller because real mortgage rates will be higher. Bloated universities will collapse as students will no longer borrow several times their salaries to finance questionable degrees. People will still work, but employment will shift toward manufacturing in response to foreign demand for US goods. Indeed, with foreign held Dollars chasing a finite number of skilled workers, the lives of tradespeople will likely improve. The US of the mid-21st Century might resemble the 1950′s in terms of living standards, income distribution, foreign trade, and government spending.

People will look back on the late 20th Century and early 21st Century as a time of wild excesses of debt, socialism, and unwarranted entitlement. While future people might wonder what it was like to live in a country where entry level office workers could qualify for six figure mortgages, they will likely not respect the lives or values of the ‘me’ generation that lead to the US Government maxing out its line of credit.