The U.S. Debt Crisis: How it Happened and What Can be Done

Transcription

1 The U.S. Debt Crisis: How it Happened and What Can be Done Updated Nov 2012 Pat Obi 1

2 OUTLINE Mortgage crisis 2. Federal budget 3. Debt buildup 4. The debt crisis 5. Failed attempts by Congress 6. Suggested path to debt elimination Pat Obi, Purdue University Calumet 2

3 Perspective Our total debt as of June 2002 = $6.13Tr [as % of GDP: 60%] June 2012 = $15.86Tr GDP = Gross Domestic Product, measure of the size of our economy. A Debt/GDP ratio of 100% means we owe as much as we produce. [as % of GDP: 103%] Pat Obi, Purdue University Calumet 3

4 When the bottom fell out 2007 Mortgage Crisis 2008 Financial Crisis Pat Obi, Purdue University Calumet 4

5 Jan-90 Jul-90 Jan-91 Jul-91 Jan-92 Jul-92 Jan-93 Jul-93 Jan-94 Jul-94 Jan-95 Jul-95 Jan-96 Jul-96 Jan-97 Jul-97 Jan-98 Jul-98 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Median Home Price: Data source: U.S. Census. $280,000 $260,000 $240,000 g = 60% $220,000 $200,000 g = 17% $180,000 $160,000 $140,000 g = 9% Focus Point $120,000 $100,000 Pat Obi, Purdue University Calumet 5

6 Household Debt v. Disposable Income (in billions of $) 16,000 14,000 12,000 10,000 The level and rate of growth of household debt exceeded how much American households earned in income during the 6-year period before the housing market collapse in Household Debt g = 11% 8,000 6,000 4,000 Disp. Income g = 5% 2,000 0 Sources: Bureau of Economic Analysis (income); Federal Reserve Flow of Funds (household debt)

7 What went wrong between 2000 and Steep jump in household debt to $14Tr 2. Decline in mortgage underwriting standards 3. Rising default risk in the mortgage market 4. Complex Wall Street financial derivatives 5. Unsustainable home and stock price levels 2008 Stock market plunge = -40% Household wealth loss of > $13Tr, Financial crisis from 2008 Pat Obi, Purdue University Calumet 7

8 My scholarly contributions with respect to the 2008 Financial Crisis Obi, Pat, Jeong-gil Choi, and Shomir Sil (2010). A Look Back at the 2008 Financial Crisis: The Disconnect between Credit and Market Risks, Czech Journal of Economics and Finance. 60(5): Obi, Pat, Saul Lerner, and Shomir Sil (2010). The 2008 Global Financial Crisis: A Discussion of Causes, Consequences, and Remedies, Journal of Global Commerce Research, 2(4): Obi, Pat, Paolo Miranda, and Shomir Sil (2011). An Inquiry into the Time Series Dynamics of Short-Term Interest Rates and Stock Returns, Journal of Business and Economic Studies, 17(1): Obi, Pat, Job Dhubihlela, and Jeong-Gil Choi (forthcoming 2012). Equity Market Valuation, Systematic Risk, and Monetary Policy, Applied Economics. Pat Obi, Purdue University Calumet 8

9 Government bailouts = National debt LEGISLATION DATE SIGNED BY BAILOUT AMOUNT 1. Econ Stimulus Act, /13/2008 Bush $152B 2. Emergency Econ Stabilization Act, /28/2008 Bush $700B 3. American Recovery and Reinvestment Act, /17/2009 Obama $787B TOTAL $1.6Tr 9

10 A Look at our Federal Budget Pat Obi, Purdue University Calumet 10

11 Tax Receipts Fiscal Year 2011 ($Billions) Source: CBO Historical Tables Pat Obi, Purdue University Calumet 11

12 Spending Fiscal Year 2011 ($Billions) Source: CBO Historical Tables Pat Obi, Purdue University Calumet 12

13 Budget Deficits and Surpluses (bill of $) Source: CBO and OMB Carter -$253B Reagan -$1,412B Bush Sr -$1,036B Clinton $63B Bush Jr -$3, Spending Revenues Obama -$3, Deficit (negative) means Federal government spent more money than was received in tax revenues. Surplus is the opposite. Deficit/Surplus

14 Our National Debt Pat Obi, Purdue University Calumet 14

15 U.S. National Debt since 1790 Data source: Department of the Treasury 16,000,000,000,000 14,000,000,000,000 12,000,000,000,000 Our national debt rose sharply after 1980, and has continued to rise steadily since then. 10,000,000,000,000 8,000,000,000,000 6,000,000,000,000 4,000,000,000,000 2,000,000,000,

16 U.S. Debt in Recent Years ($ Tr) Source: Department of the Treasury ,000,000,000,000 14,000,000,000,000 12,000,000,000,000 Carter (D) $206B 33% Reagan (R) $1.44Tr 159% Bush Sr (R) $1.06Tr 41% Clinton (D) $1.71Tr 42% Bush Jr (R) $3.57Tr 63% 10,000,000,000,000 8,000,000,000,000 6,000,000,000,000 4,000,000,000,000 2,000,000,000,000 - Cruise and Pershing missiles - Star wars - Reduced tax rates but eliminated many personal tax deductions Dessert Storm (Iraq) $500B stimulus in 1993 to fight recession - Two separate tax rebates - War on Terror (Iraq) - TARP ($700B) Obama (D) $4.92Tr 46% - $800B stimulus - War on Terror (Iraq + Afghan.) 0 16

17 The National Debt Components 1. Intragovernmental debt: Money borrowed from other government agencies, e.g. Social Security Trust Fund (SSTF) and Medicare Trust Fund (MTF) 2. Federal Reserve. Money borrowed from the Fed. 3. Debt held by the public: Money borrowed from U.S. citizens, foreigners, corporations, state and local governments, and others. Pat Obi, Purdue University Calumet 17

18 Our Money Lenders Source: U.S. Department of Treasury, Ownership of Federal Securities, Table OFS-2: Secondary source: Total Federal Debt = $15.6Tr [March 2012] Foreigners = $5.14Tr [33%] Intra-govt + Fed = $6.4Tr [41%] U.S. investors = $4.05Tr [26%] Pat Obi, Purdue University Calumet 18

19 Mar-01 Jul-01 Nov-01 Mar-02 Jul-02 Nov-02 Mar-03 Jul-03 Nov-03 Mar-04 Jul-04 Nov-04 Mar-05 Jul-05 Nov-05 Mar-06 Jul-06 Nov-06 Mar-07 Jul-07 Nov-07 Mar-08 Jul-08 Nov-08 Mar-09 Jul-09 Nov-09 Mar-10 Jul-10 Nov-10 Mar-11 Debt Ownership (in billions of $) Our Money Lenders? Source: U.S. Department of Treasury, Ownership of Federal Securities, Table OFS-2: Secondary source: 7,000 6,000 Intra-gov + Fed Res 5,000 4,000 Foreign investors 3,000 U.S. Investors 2,000 1,000 Foreigners now lend more to the U.S. government than Americans 0 Pat Obi, Purdue University Calumet 19

20 Millions of $ U.S. International Trade Source: US Census Bureau, Foreign Trade Division. Source file: US Intl Trade in Research folder 3,500,000 3,000,000 2,500,000 2,000,000 1,500,000 We buy more from other countries (mostly China) than they buy from us. That creates a current account deficit. Foreigners then use their surplus $$$ to buy U.S. Treasury bonds (meaning they lend the $$$ right back to our government so as to earn interest on their surplus funds) Imports 1,000, ,000 Exports 0-500, ,000,000 Current account balance -1,500,000 20

21 The Big Question Has our debt reached a crisis point? One way to consider this question is to line up our debt against our nation's ability to pay The ability to pay is tied to the size of our economy measured by GDP Pat Obi, Purdue University Calumet 21

22 Our Economy Pat Obi, Purdue University Calumet 22

23 U.S. Economy since Market Crash of 1929 (bill of $) Source: Department of Commerce 18,000 16,000 14,000 12,000 10,000 Our economy has grown steadily over the years on average, about 6% per year since after WWII - until the housing market collapse in GDP 8,000 6,000 4,000 2,

24 GDP Contribution by Recent U.S. Presidents (bill of $) Source: Department of Commerce 16,000 14,000 12,000 10,000 8,000 Carter (D) $0.76Tr 27% Reagan (R) $1.97Tr 39% Bush Sr (R) $0.86Tr 14% Clinton (D) $3.3Tr 33% Bush Jr (R) $4Tr 28% Obama (D) $2Tr 12% 6,000 4,000 2,000 Our GDP fell sharply in 2009 owing to the financial crisis. 0 24

25 GDP ($ Billions) Debt-to-GDP % Looking at our National Debt v. GDP through the years The only time our debt grew to more than 25, % of GDP was right after WWII. But that was due to the Marshall Plan ,000 Debt as % of GDP , , ,000 GDP ($ Billions) 20 0 Pat Obi, Purdue University Calumet 25 0

26 This shows how much our debt grew as a % of our GDP under each president, since Year Debt (bill$) GDP(bill$) Debt/GDP President ,127 11% 32% Reagan , ,253 4% 35% , ,535 8% 39% , ,931 11% 40% , ,218 7% 43% , ,460 6% 48% , ,736 6% 50% , ,100 7% 51% 19% , ,482 7% 52% Bush, Sr , ,801 6% 56% , ,992 3% 61% , ,342 6% 64% 12% , ,667 5% 68% Clinton , ,085 6% 68% , ,415 5% 67% , ,839 6% 68% , ,332 6% 66% , ,794 5% 64% , ,354 6% 62% , ,952 6% 57% -11% , ,286 3% 58% Bush, Jr , ,642 3% 60% , ,142 5% 63% , ,853 6% 64% , ,623 6% 65% , ,377 6% 65% , ,029 5% 66% , ,292 2% 75% 17% , ,939-2% 88% Obama , ,527 4% 97% , ,094 4% 101% , ,776 4% 99% as of March 11%

27 Debt as % of GDP since after WWII Between 1953 and 2012, Rep administrations added 30 percentage points to the national debt/gdp ratio. Dem administrations subtracted 17 percentage points from that ratio. Pat Obi, Purdue University Calumet 27

28 The Debt Crisis Pat Obi, Purdue University Calumet 28

29 Clinton Bush Jr. Obama Federal Government Revenue and Spending (% of GDP) Sources: Congressional Budget Office; Office of Management and Budget Year Revenues Spending How much we collect in tax revenue has fallen as % of GDP. Correspondingly, government spending has risen sharply as % of GDP. The combination of these two facts has led to widening budget deficits (next slide) and therefore, growing national debt. 29

30 This gaping hole is our debt crisis!!! Tax Revenue and Government Spending (% of GDP) Sources: Congressional Budget Office; Office of Management and Budget Carter Reagan Bush Sr Clinton Bush Jr Obama 22 Outlays Revenues

31 Failed Attempts to Resolve the Debt Crisis 1. Bowles-Simpson Commission (empanelled 2/18/10) $4T in savings over 10 years Failed to pass committee stage (required supermajority of 14/18 votes ; 11 were in favor) 2. Obama-Boehner grand bargain (summer 2011) Spending cut $3.5T + $1T in revenue increase (total of $4.5Tr) over 10 years On 7/22/11, Boehner pulled out; did not want tax increase 3. Budget Control Act of 2011 (passed 8/2/11) Only $1Tr in cuts; no revenue increase Additional automatic $1.2Tr, if no budget agreement by Jan 2013 (this is the so-called fiscal cliff ) Pat Obi, Purdue University Calumet 31

32 National Embarrassment Friday, August 5, S&P downgraded U.S. credit rating from AAA to AA+ Stock market plunges 7% next day! Financial markets were unhappy with the failed attempts Pat Obi, Purdue University Calumet 32

33 Debt as % of GDP Around the World Global Finance: Many other industrialized economies face mounting debt problems! Country (est) 2013 (est)) 1 Estonia Australia Luxembourg Korea Switzerland Sweden New Zealand Czech Republic Norway Slovak Republic Denmark Slovenia Poland Finland Israel* Netherlands Spain Austria Germany Hungary Canada United Kingdom Belgium France United States OECD-Total Ireland Portugal Iceland Italy Greece Japan

34 The Path to Debt Elimination [my contribution] This part of the presentation is slightly technical. You may find it more helpful to watch the following YouTube video to fully understand the argument: Pat Obi, Purdue University Calumet 34

35 Step 1. Set max debt/gdp goal (based on historical GDP growth rate) Avg annual GDP growth rate ( ) 6% Avg annual Debt/GDP ratio ( ) 60% Using this approach: Based on 2011 GDP of $15T Max debt level should be $9T (i.e. 0.6 x $15) But 2011 debt level was $15.22T Giving us excess debt of $6.22T (i.e. $ $9) Step 2. Set spending and revenue levels to fit within the debt ceiling Pat Obi, Purdue University Calumet 35

36 Focus: Bowles-Simpson 2010 debt reduction plan Spending cut = $3T Revenue increase = $1T Combined savings of $4 trillion spread over 10 years Min spending cut = $300B / year Min revenue increase = $100B / year Approach is also consistent with recommendation of the Debt Reduction Task Force set up by the Bipartisan Policy Center (which Called for a national debt reduction sales tax ) Pat Obi, Purdue University Calumet 36

37 Using our 2012 budget components as a starting point Revenues Amount % of Total Individual income taxes $1,128 44% Corporate income taxes % Social insurance taxes % Other revenues 205 8% Total revenues $2, % Outlays Mandatory spending $2,038 56% Discretionary spending 1,352 37% Net interest 264 7% Total outlays $3, % Deficit (-) or Surplus -$1,100 Source: Congressional Budget Office (CBO s Baseline Budget Projections) 37

38 Begin with total outlay of $3.655Tr Then reduce spending by $300B per year Adjust each budget item based on its % contribution to budget Correct for inflation and place selected limits, e.g. mil and Medicare Year Unadjusted Spending Deficit Reduction Adjusted Spending 2012 $3,655 $3, ,655 $300 3, , , , , , , , , , , , , , , ,

39 Ten-Year Spending Projections ($ billions) Mandatory Spending Items Year Social Medicare/ Other Net Defense Discretionary Security Medicaid Mandatory Interest 19% 19% 20% 23% 12% 7% , , , , , , , , Base year is 2012 Pat Obi, Purdue University Calumet 39

40 Ten-Year Revised Budget, Debt, and GDP Projections ($ billions) Year Net New Interest Total Adjusted Spending Projected Revenue (3% growth +$100B/yr) Deficit/ Surplus Total Debt Projected GDP (growth rate = 3%) Debtto-GDP $2,555 -$1,100 $15,223 $15,693 97% 1 - $3,507 2, ,998 16,164 99% 2 $21 3,385 2, ,470 16,649 99% ,247 3, ,616 17,148 97% ,114 3, ,435 17,663 93% ,987 3, ,929 18,192 88% ,167 3, ,398 18,738 82% ,262 3, ,752 19,300 76% ,365 4, ,992 19,879 70% ,475 4, ,117 20,476 64% ,593 4, ,130 21,090 58% 40

41 Takeaways 1. Uncontrolled debt buildup began in early 1980s 2. National debt reached a crisis point in 2010 due to: Huge spending increases (from 19% to 25% of GDP) Drastic tax revenue reductions (from 20% to < 15% of GDP) 3. My proposed solution: Peg debt to GDP E.g. set long-term debt target no more than 60% of GDP Then set budget limits: spending (ceiling) and revenue (floor) 4. There should be a national conversation on Social Security - cuts Medicare - cuts Comprehensive tax reform to get rid of loopholes and simplify tax code Corporate taxation (Focus on a corporate tax system that stimulates growth) Pat Obi, Purdue University Calumet 41

42 DISCLAIMER The material in this presentation is based on information that I considered reliable at the time of my data collection. I do not warrant that it is accurate or complete. It should therefore not be relied upon as such. Pat Obi, Purdue University Calumet 42

43 The U.S. Debt Crisis Thank you! Questions? Please me at Pat Obi, Purdue University Calumet 43