The financial crisis? Everyone saw it coming. Many people wrote about it and some even outlined how it would play out with a fair degree of accuracy. You are not alone if you were one of the ones screaming from the rooftop that our economy is in trouble, and our debt is killing us – even if you were saying it before the real estate bubble burst and housing prices were climbing ever higher.
The question is: what did you really do about it? What can you say that you did to protect yourself – or better yet, what did we do as a country to avoid it?
It’s like we’ve been standing on a train track staring at an oncoming freight train – and we’re too paralyzed with fear to jump off the track!
There’s really only one reason why we are in the middle of this current financial crisis we’re in: Debt. Personal debt, from credit cards to large mortgages that we can’t handle; corporate debt, which made the banks over extended so they can’t handle the mortgage defaults; and government debt which is siphoning hundreds of billions of dollars off our tax revenue every year just to pay the interest.
Sure, there have been other contributing factors – corporate greed, lax government oversight, trade imbalance, natural disasters, terrorist threats, war in Iraq – but we would be able to manage this crisis if we didn’t have the massive debts we are currently carrying. In reality, the crisis might not have even happened.
Debt has been a major factor in almost every major financial upheaval in history. For example, a primary factor that lead to the great depression was that you could buy stocks on margin with only 10% equity. This was great during the roaring 20’s, when everyone was making money. Many economist/historian accounts agree that the stock market crash of ‘29 would NOT have led to the great depression if it were not for the 90% margin rules. Too many investors were suddenly underwater, and brokerage houses could not cover the margin requirements of bankrupt clients, which bankrupted THEM in turn – and the cascade effect brought everything down.
The trigger of the current crisis was mortgages instead of stock margins, but otherwise there are many similarities. When a homeowner has a 90% or higher loan to value mortgage, there is no room for error. When we had an inevitable downturn in real estate values last year, which happens on a fairly cyclical basis, too many people suddenly owed more than their home was worth.
Banks are only working on a few points spread between their cost of money and the mortgage rates, so it doesn’t take very many under water properties to wipe out the gains from THOUSANDS of other profitable mortgages.
The challenge of the bailout is to keep the economy from going into the downward spiral that leads to an all-out depression. This starts when consumers cuts back on spending, then companies don’t make as much profit and lay people off, which reduces spending even further. And the cycle feeds on itself until everything crashes.
Here’s another popular prediction: even if this near trillion dollar bail-out of the financial markets succeeds in shoring up the economy for a few years, our national debt will continue to stifle the economy, devaluate the dollar, and eventually bankrupt the U.S. Government.
Our current government debt is now over TEN TRILLION dollars – and that’s not counting unfunded obligations to Medicare, Medicaid, Social Security, and other social programs, which bring the total to around $60 Trillion dollars by most estimates. So the bailout plan adds another trillion dollars to the pile. What’s the big deal?
Official projections for the last twenty years have shown that we cannot keep up with the interest payments, much less actually pay down the principal on the national debt – and it’s gotten predictably worse every year. In 2007, the U.S. Government spent over $400 Billion of our tax dollars just on interest payments. There WILL come a time, at some point in the future, when interest payments alone will surpass the tax revenue that the government collects. Everyone knows this. We had an opportunity, some fifteen years ago, to make a major shift in government policy and drastically reduce our debt – it would have been somewhat painful, but it would have been manageable at the time. Unfortunately, no one wanted to hear it. To raise taxes AND decrease social programs goes against both the Democratic and Republican sensibilities. Spending money we didn’t have and lowering taxes seemed to be the only things that made people happy, and the national debt has more than tripled because of this.
Ever since it has gotten out of control, no major party candidate has seriously tried to fix the debt problem. Even up until a few weeks ago when the financial markets came to the brink of disaster, neither Barack Obama nor John McCain had taken a public stance on the national debt. To do so is political suicide. Why? Because there is no solution to the problem that does not entail admitting that the U.S. Government is heading for bankruptcy. Any fix will mean DRASTIC changes to our tax and spending policy – changes so distasteful that there would be no chance of getting support from voters or consensus on Capital Hill.
We would rather stare at the freight train barreling down on us, and deal with it when there’s blood on the tracks.
The crux of the matter – at this point in time – is that if the bailout is not successful and we have a repeat of the great depression, tax revenue will fall dramatically because of the high unemployment and reduced corporate earnings. This will make it impossible for the United States government to operate within budget, and the national debt will soar beyond all imagination.
What are the options – or what WILL the options be – when we get to the point where we can’t even pay the interest on our national debt? There are many, but none are pleasant. Here are some examples:
Print more money – if new money is released slowly to pay down the debt, it creates inflation and devalues the dollar over time. Any personal assets (especially cash and cash based investments) are then worth less – effectively creating a "progressive tax" on assets because the more you have the less it is worth. If done quickly, this inevitably will lead to hyper-inflation and extreme devaluation of the dollar. Look at the Latin American crisis in the 80’s as an example. We’ve always been very critical of countries that take this route, as the outcome is very predictable.
Default on the payments – while it’s unlikely that other countries would declare war on the U.S. to force us to pay up, our economy would still suffer major damage from a default. Also, over half of what we owe is internal debt. Think of it this way – Social Security has a lot of cash which has been “invested” in U.S. Treasury Bills, a form of national debt. A default would mean that Social Security payments would immediately stop, and our elderly population would be thrown into poverty. Welfare payments would most likely cease as well and the economy would go further into a tailspin.
Pay off the loans right now – This would cause a very large, but relatively short term, period of pain. After that, things would be great! But is everyone in a position to, and willing to, contribute their share? The current national debt is roughly $30,000 per person – so my family of four would owe $120,000. No problem – break out your checkbooks, everyone! Even if this was applied on a sliding scale, with wealthier people paying more, we could not cover it. We are too late for this to be feasible.
Make a payment plan – if an individual is in debt, they can go to a credit counselor who helps them negotiate a payment plan with their creditors. But if they owe too much, and can’t even handle reduced interest payments, their only choice is to declare bankruptcy. Even if we negotiated a zero interest rate and payments for 30 years, that would still require $1,000 per year from every citizen – on top of current taxes to keep the government operating. Remember that we just gave everyone $600 as an “economic stimulus” payment – adding an additional tax just for debt payment would depress the economy, and no one wants this to go on for 30 years!
Ask for forgiveness – we’ve forgiven debt to other countries before, on a much smaller scale, usually with a promise for some favors in the future. Would our lenders allow us to walk away without any consequences after spending well beyond our means for so many years? Not likely.
Liquidate Assets – when a corporation that is short on cash gets into trouble they usually start selling assets to stay afloat. We owe almost $600 Billion to Japan – maybe they’d take Hawaii in exchange? Canada can have Alaska. England has wanted Massachusetts for 200 years – to give payback for their little tea party. What do we give to China and Brazil – parts of California and Florida, maybe?
Granted, the last suggestion, actually breaking up the U.S. is crazy. Absolutely unthinkably crazy – but if we let the situation go till we can't make our payments, it’s the type of “out of the box” thinking that we will need to consider. There are no easy answers. There are no solutions that will be an easy sell to congress and voters – but we need a leader that will at least admit we have a severe problem and offer some solutions.
Our debt is like a freight train. It’s coming closer and closer – and the recent crisis on Wall Street just made it accelerate a little bit.
The worst thing we can do is stand on the tracks, continue to stare at the train, and just hope that it will come to a stop. It won’t.