Treasury Secretary Henry Paulson's $700 billion proposal to stabilize the banking system may push the national debt to the highest level since 1954, threatening an erosion of foreign appetite for U.S. bonds.
The plan, which asks Congress for funds to buy devalued securities from financial institutions, would drive the debt above 70 percent of gross domestic product and the annual budget gap to an all-time high, possibly exceeding $1 trillion next year, economists estimated.
``This is sobering, absolutely sobering, even to someone who doesn't drink,'' said Stan Collender, a former analyst for the House and Senate budget committees, now at Qorvis Communications in Washington.
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``The market is very, very negative because of the consequences of raising the debt ceiling and the increase in debt in general,'' Manfred Wolf, head of currency sales in New York for HVB America Inc., a unit of Germany's second-largest bank. ``Foreigners may not be that attracted anymore to U.S. assets.''
Gross U.S. debt, which includes debt held by the public and by government agencies, this year reached about $9.6 trillion, or about 68 percent of gross domestic product.
The Treasury is already borrowing to fund Federal Reserve efforts to inject liquidity into credit markets. Last week it announced sales of $200 billion in short-term debt.
``We've all used the phrase `uncharted waters' so often, yet we keep finding new uncharted waters,'' said Louis Crandall, chief economist of Wrightson ICAP, a research firm Jersey City, New Jersey. ``The fact that the Treasury's borrowing operations are now being affected on such an unprecedented scale adds new uncertainties'' to bond markets.
Bad-Debt Purchases
The Treasury's potential use of all $700 billion to purchase impaired assets would raise the country's debt to more than 70 percent of GDP. The last time American taxpayers owed as much was in 1954, when the nation was still paying down costs incurred during World War II.
``It's an alarming level of debt given that we're not fighting something like World War II,'' said Robert Bixby, executive director of the Concord Coalition, a non-partisan budget watchdog group.
The government reaching the requested debt limit would entail every man, woman and child in the U.S. owing more than $37,000 each. The median U.S. income last year was $50,233.
``We're putting a lot of debt on the books and people are going to be spending a lot of money paying that off for a long time,'' Bixby said.
Why is all of this so scary? Here is why:
Above is a chart of the current account. All this means is the following: the US buys more stuff from abroad then we sell abroad. The problem is we don't have the money to pay for all of this. Why? Because the US savings rate is terrible:
Notice how the US is saving less and less. That means we have to borrow money to buy all of this great stuff.
Above is a chart of foreign ownership of US government debt. Notice how it has doubled over the last 8 years. In other words -- we're in debt to foreign central banks up to our eyeballs
So let's review:
-- The US is living beyond it's means; we buy more stuff than we make.
-- As a result, foreigners lend us money. This is the equivalent of vendor financing. Think of it like the global GMAC account.
-- Now the US really needs to increase it's debt level. The problem is we've been doing that during the good times. So now we're near the point where a massive issuance of debt could spike interest rates, sending the rate ever higher on the mammoth amount of debt we already have. Great news, huh?
5 comments:
With WWII debt we at least has some decent infrastructure built... what about now?
This plan is insane since it's asking people with some of the dirtiest hands to solve the problem.
I haven't seen anyone suggest that we finance at least part of this bailout with massive tax increases on the wealthiest 1%. Presumably, this group includes those who most profited from creating this mess, and those who will profit from the bailout. Additionally, why not raise capital gains taxes to pre-Bush levels? This is another area that has become a bit obscene, and created incentive for investors to throw caution to the wind.
In short, what I'm saying is why not pay the cost of the bailout from the purses of those who both created the need for it, and profited most from it?
Bonddad, I’m screaming into the wind here, and have said this in other forums. You have a bigger megaphone. Consider the following:
You can't take on the bad assets without other consequences as you describe above.
You have to solve the problem by thinking of the US not as lender of last resort - the flipside is we are the world largest borrower – but rather Managing Director of the world’s largest Venture Capital Fund.
The problem here is trying to define the price paid for these assets, and whether we the USG will take a bath on them while letting the perps get off scot free and continue to do what they’ve been doing.
The way to solve the problem is to use the techniques that any M&A lawyer, Venture Capitalist and appraiser would know.
Defining value – particularly in a start up or work out is almost entirely speculative despite our best efforts to provide a quantitative framework, so therefore don’t sweat the valuation and demand a rate of return threshold. With this requirement comes all sorts of indices of negative as opposed to positive control.
First any market participant which wishes to avail themselves of Government funding or participate in Reverse Auctions, and if the Government ends up buying their toxic waste, would agree that the Government would ULTIMATELY receive – oh say a 15% Internal Rate of Return on the purchase assets. If the sale of those assets or final workout does not reach that level, then the USG would receive a preference on dividends or any other distribution of free cash flow of the Seller until such time as the IRR is achieved. This would require that other preferred and bondholders agree to the USG stepping in front, but what choice do they have? Again, as a lender of last resort these types of deals are done everyday in venture, mezzanine and work-out financing.
Furthermore, VCs often demand limits on compensation. VCs will demand that the Company immediately suspend all restricted stock grants, option grants or any other form of equity compensation. They often limit total compensation. So in this situation, the USG could demand that maximum compensation (salaries, wages, benefits and bonuses) for employees including executive management and the Board is forthwith limited to no more than the Senior Executive Service of the US Government (around 150-200K) which is still around 4x median household income for the taxpayers who have to pay the tab). Given the number of unemployed already on the Street, I don't think too many people will be jumping ship.
The key here is not to punish the equity – or the debt – or otherwise forcibly disrupt debt covenants or dilute existing equity but rather align equity and debt, employees and management into (1) paying the USG as quickly as possible and (b) more prudent conservatorship of the cash flows they do generate.
Now of course these are rather onerous conditions, but certainly no worse than any Venture Capitalist or any workout.
The companies would understand it perfectly, scream like stuck pigs, and comply.
You'd clean up the problem, make a profit, and do so faster than anyone can possibly imagine.
Let’s not twist their arm, give them a choice. If they can do better in the market, let them do so.
I know from experience that the old-time VCs would insist that founders pledge a substantial part of their assets to the enterprise, such as taking out a second mortgage on the family home. In other words, they wanted you to put something on the line.
I know of a couple of people who lost their homes that way when the enterprise went blooey.
So a prime step is for the beneficiaries of the Fed's largesse to sign over a large portion of their assets of worth to accompany the junk.
Let the banks go into bankruptcy. Let the FDIC take them over. Spend the money on reimbursing the depositors instead of the CEO's and fat cat investors. Airlines run in bankruptcy all the time. People still can fly.
Am I wrong, Bonddad? Am I missing something numerically?
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