The U.S. Debt Crisis: How it Happened and What Can be Done Updated Nov 2012 Pat Obi 1
OUTLINE 1. 2007 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
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
When the bottom fell out 2007 Mortgage Crisis 2008 Financial Crisis Pat Obi, Purdue University Calumet 4
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: 1990-2008 Data source: U.S. Census. www.census.gov/const/uspricemon.pdf $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
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 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 2007. 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)
What went wrong between 2000 and 2007 1. 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, 2007-2008 Financial crisis from 2008 Pat Obi, Purdue University Calumet 7
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): 400-413. 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): 1-11. 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): 16-28. 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
Government bailouts = National debt LEGISLATION DATE SIGNED BY BAILOUT AMOUNT 1. Econ Stimulus Act, 2008 2/13/2008 Bush $152B 2. Emergency Econ Stabilization Act, 2008 9/28/2008 Bush $700B 3. American Recovery and Reinvestment Act, 2009 2/17/2009 Obama $787B TOTAL $1.6Tr 9
A Look at our Federal Budget Pat Obi, Purdue University Calumet 10
Tax Receipts Fiscal Year 2011 ($Billions) Source: CBO Historical Tables Pat Obi, Purdue University Calumet 11
Spending Fiscal Year 2011 ($Billions) Source: CBO Historical Tables Pat Obi, Purdue University Calumet 12
Budget Deficits and Surpluses (bill of $) Source: CBO and OMB 4000 3000 Carter -$253B Reagan -$1,412B Bush Sr -$1,036B Clinton $63B Bush Jr -$3,537 2000 Spending 1000 0 Revenues Obama -$3,689 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1984 1983 1982 1981 1980 1979 1978 1977 1976-1000 -2000 Deficit (negative) means Federal government spent more money than was received in tax revenues. Surplus is the opposite. Deficit/Surplus
Our National Debt Pat Obi, Purdue University Calumet 14
1790 1795 1800 1805 1810 1815 1820 1825 1830 1835 1840 1845 1850 1855 1860 1865 1870 1875 1880 1885 1890 1895 1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 U.S. National Debt since 1790 Data source: Department of the Treasury 16,000,000,000,000 14,000,000,000,000 12,000,000,000,000 Our national debt rose sharply after 1980, and has continued to rise steadily since then. 10,000,000,000,000 8,000,000,000,000 6,000,000,000,000 4,000,000,000,000 2,000,000,000,000 0 15
U.S. Debt in Recent Years ($ Tr) Source: Department of the Treasury 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 16,000,000,000,000 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
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
Our Money Lenders Source: U.S. Department of Treasury, Ownership of Federal Securities, Table OFS-2: www.fms.treas.gov/bulletin/b2012_3ofs.doc Secondary source: http://www.gao.gov/special.pubs/longterm/debt/debtbasics.html 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
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: www.fms.treas.gov/bulletin/index.html Secondary source: http://www.gao.gov/special.pubs/longterm/debt/debtbasics.html 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
Millions of $ U.S. International Trade Source: US Census Bureau, Foreign Trade Division. www.census.gov/foreign-trade/statistics/historical/index.html 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 1,000,000 500,000 Exports 0-500,000 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010-1,000,000 Current account balance -1,500,000 20
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
Our Economy Pat Obi, Purdue University Calumet 22
1929 1931 1933 1935 1937 1939 1941 1943 1945 1947 1949 1951 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 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 2007. GDP 8,000 6,000 4,000 2,000 0 23
1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 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) $2Tr 12% 6,000 4,000 2,000 Our GDP fell sharply in 2009 owing to the financial crisis. 0 24
1900 1903 1906 1909 1912 1915 1918 1921 1924 1927 1930 1933 1936 1939 1942 1945 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 GDP ($ Billions) Debt-to-GDP % Looking at our National Debt v. GDP through the years The only time our debt grew to more than 25,000 100% of GDP was right after WWII. But that was due to the Marshall Plan. 140 20,000 Debt as % of GDP 120 100 15,000 80 10,000 60 40 5,000 GDP ($ Billions) 20 0 Pat Obi, Purdue University Calumet 25 0
This shows how much our debt grew as a % of our GDP under each president, since 1981. Year Debt (bill$) GDP(bill$) Debt/GDP President 1981 997.86 3,127 11% 32% Reagan 1982 1,142.03 3,253 4% 35% 1983 1,377.21 3,535 8% 39% 1984 1,572.27 3,931 11% 40% 1985 1,823.10 4,218 7% 43% 1986 2,125.30 4,460 6% 48% 1987 2,350.28 4,736 6% 50% 1988 2,602.34 5,100 7% 51% 19% 1989 2,857.43 5,482 7% 52% Bush, Sr. 1990 3,233.31 5,801 6% 56% 1991 3,665.30 5,992 3% 61% 1992 4,064.62 6,342 6% 64% 12% 1993 4,535.69 6,667 5% 68% Clinton 1994 4,800.15 7,085 6% 68% 1995 4,988.66 7,415 5% 67% 1996 5,323.17 7,839 6% 68% 1997 5,502.39 8,332 6% 66% 1998 5,614.22 8,794 5% 64% 1999 5,776.09 9,354 6% 62% 2000 5,662.22 9,952 6% 57% -11% 2001 5,943.44 10,286 3% 58% Bush, Jr. 2002 6,405.71 10,642 3% 60% 2003 6,997.96 11,142 5% 63% 2004 7,596.14 11,853 6% 64% 2005 8,170.42 12,623 6% 65% 2006 8,680.22 13,377 6% 65% 2007 9,229.17 14,029 5% 66% 2008 10,699.80 14,292 2% 75% 17% 2009 12,311.35 13,939-2% 88% Obama 2010 14,025.22 14,527 4% 97% 2011 15,222.94 15,094 4% 101% 26 2012 15,620.33 15,776 4% 99% as of March 11%
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
The Debt Crisis Pat Obi, Purdue University Calumet 28
Clinton Bush Jr. Obama Federal Government Revenue and Spending (% of GDP) Sources: Congressional Budget Office; Office of Management and Budget Year Revenues Spending 1993 17.5 21.4 www.cbo.gov/publication/21999 1994 18.0 21.0 1995 18.4 20.6 1996 18.8 20.2 1997 19.2 19.5 1998 19.9 19.1 1999 19.8 18.5 2000 20.6 18.2 2001 19.5 18.2 2002 17.6 19.1 2003 16.2 19.7 2004 16.1 19.6 2005 17.3 19.9 2006 18.2 20.1 2007 18.5 19.6 2008 17.5 20.7 2009 14.9 25.0 2010 14.9 23.8 2011 14.8 24.7 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
1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 This gaping hole is our debt crisis!!! Tax Revenue and Government Spending (% of GDP) Sources: Congressional Budget Office; Office of Management and Budget 28 26 24 Carter Reagan Bush Sr Clinton Bush Jr Obama 22 Outlays 20 18 16 14 Revenues 12 www.cbo.gov/publication/21999 30
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
National Embarrassment Friday, August 5, 2011. 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
Debt as % of GDP Around the World Global Finance: www.gfmag.com/tools/global-database/economic-data/10394-public-debt-by-country.html#axzz1nrkii2w5 Many other industrialized economies face mounting debt problems! Country 2006 2007 2008 2009 2010 2011 2012 (est) 2013 (est)) 1 Estonia 8.0 7.3 8.5 12.7 12.5 12.3 13.1 13.0 2 Australia 15.5 14.4 13.7 19.4 23.6 26.8 27.9 27.9 3 Luxembourg 11.5 11.3 18.3 18.0 24.5 28.2 30.9 34.6 4 Korea 28.5 28.7 30.4 33.5 34.6 35.5 36.3 36.8 5 Switzerland 50.2 46.8 43.6 43.7 42.6 42.0 41.2 40.7 6 Sweden 53.9 49.3 49.6 52.0 49.1 46.2 45.3 43.1 7 New Zealand 26.6 25.7 28.9 34.4 37.8 44.1 47.6 50.2 8 Czech Republic 32.6 31.0 34.4 41.1 44.5 47.1 48.7 49.7 9 Norway 59.4 57.4 55.0 49.1 49.7 56.5 51.3 48.6 10 Slovak Republic 34.1 32.9 31.8 40.0 44.8 49.8 53.4 55.3 11 Denmark 41.2 34.3 42.6 52.4 55.6 56.1 58.0 58.2 12 Slovenia 33.8 30.7 30.4 44.3 48.4 53.7 58.1 61.0 13 Poland 55.2 51.7 54.4 58.5 62.4 64.9 65.4 64.7 14 Finland 45.6 41.4 40.4 51.6 57.6 61.2 65.5 68.5 15 Israel* 84.7 78.1 77.0 79.4 76.0 74.6 73.8 72.4 16 Netherlands 54.5 51.5 64.8 67.4 70.6 72.5 75.3 76.9 17 Spain 46.2 42.3 47.7 62.9 67.1 74.1 77.2 79.0 18 Austria 66.4 63.4 68.4 74.4 78.2 79.9 81.9 83.2 19 Germany 69.8 65.6 69.7 77.4 87.1 86.9 87.3 86.4 20 Hungary 72.4 73.4 77.0 86.7 86.9 89.8 90.8 91.5 21 Canada 70.3 66.5 71.1 83.4 85.1 87.8 92.8 96.6 22 United Kingdom 46.0 47.2 57.4 72.4 82.2 90.0 97.2 102.3 23 Belgium 91.6 88.0 93.0 100.0 100.2 100.3 101.5 101.0 24 France 71.2 73.0 79.3 90.8 95.2 98.6 102.4 104.1 25 United States 60.9 62.1 71.4 85.0 94.2 97.6 103.6 108.5 26 OECD-Total 74.6 73.3 79.7 91.4 97.9 101.6 105.7 108.4 27 Ireland 29.2 28.7 49.6 71.1 98.5 112.6 118.8 122.4 28 Portugal 77.6 75.4 80.7 93.3 103.6 111.9 121.9 123.7 29 Iceland 57.4 53.3 102.1 119.8 125.0 127.3 127.4 126.2 30 Italy 116.9 112.1 114.7 127.1 126.1 127.7 128.1 126.6 31 Greece 116.9 115.0 118.1 133.5 149.1 165.1 181.2 183.9 33 32 Japan 172.1 167.0 174.1 194.1 200.0 211.7 219.1 226.8
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: www.youtube.com/watch?v=1ndejsqwj7w Pat Obi, Purdue University Calumet 34
Step 1. Set max debt/gdp goal (based on historical GDP growth rate) Avg annual GDP growth rate (1980-2006) 6% Avg annual Debt/GDP ratio (1980-2006) 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. $15.22 - $9) Step 2. Set spending and revenue levels to fit within the debt ceiling Pat Obi, Purdue University Calumet 35
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
Using our 2012 budget components as a starting point Revenues Amount % of Total Individual income taxes $1,128 44% Corporate income taxes 279 11% Social insurance taxes 943 37% Other revenues 205 8% Total revenues $2,555 100% Outlays Mandatory spending $2,038 56% Discretionary spending 1,352 37% Net interest 264 7% Total outlays $3,655 100% Deficit (-) or Surplus -$1,100 Source: Congressional Budget Office (CBO s Baseline Budget Projections) 37
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 1 3,655 $300 3,355 2 3,355 300 3,055 3 3,055 300 2,755 4 2,755 300 2,455 5 2,455 300 2,155 6 2,155 300 1,855 7 1,855 300 1,555 8 1,555 300 1,255 9 1,255 300 955 10 955 300 655 38
Ten-Year Spending Projections ($ billions) Mandatory Spending Items Year Social Medicare/ Other Net Defense Discretionary Security Medicaid Mandatory Interest 19% 19% 20% 23% 12% 7% 2012 + 694 694 731 841 439 256 1 637 637 671 903 403 256 2 580 580 611 970 367 256 3 523 523 551 1,041 331 256 4 466 466 491 1,118 295 256 5 409 409 431 1,201 259 256 6 400 400 500 1,290 300 256 7 400 400 500 1,386 300 256 8 400 400 500 1,488 300 256 9 400 400 500 1,598 300 256 10 400 400 500 1,717 300 256 + Base year is 2012 Pat Obi, Purdue University Calumet 39
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 2012 - - $2,555 -$1,100 $15,223 $15,693 97% 1 - $3,507 2,732-776 15,998 16,164 99% 2 $21 3,385 2,914-471 16,470 16,649 99% 3 21 3,247 3,101-146 16,616 17,148 97% 4 21 3,114 3,294 180 16,435 17,663 93% 5 21 2,987 3,493 506 15,929 18,192 88% 6 21 3,167 3,698 531 15,398 18,738 82% 7 21 3,262 3,909 646 14,752 19,300 76% 8 21 3,365 4,126 761 13,992 19,879 70% 9 21 3,475 4,350 874 13,117 20,476 64% 10 21 3,593 4,580 987 12,130 21,090 58% 40
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
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
The U.S. Debt Crisis Thank you! Questions? Please email me at cpobi@purdue.edu Pat Obi, Purdue University Calumet 43