43
1 The U.S. Debt Crisis: How it Happened and What Can be Done Updated Nov 2012 Pat Obi
1
The U.S. Debt Crisis: How it Happened and What Can be Done Updated Nov 2012
Pat Obi
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
Pat Obi, Purdue University Calumet 3
Our total debt as of … June 2002 = $6.13Tr [as % of GDP: 60%] June 2012 = $15.86Tr [as % of GDP: 103%]
Perspective…
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.
When the bottom fell out…
2007 Mortgage Crisis
2008 Financial Crisis
Pat Obi, Purdue University Calumet 4
Median Home Price: 1990-2008 Data source: U.S. Census. www.census.gov/const/uspricemon.pdf
$100,000
$120,000
$140,000
$160,000
$180,000
$200,000
$220,000
$240,000
$260,000
$280,000
Jan
-90
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Jul-
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g = 60%
g = 17%
g = 9%
5 Pat Obi, Purdue University Calumet
Focus Point
Household Debt v. Disposable Income (in billions of $)
Sources: Bureau of Economic Analysis (income); Federal Reserve Flow of Funds (household debt)
0
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Household Debt
g = 11%
Disp. Income
g = 5%
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.
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
What went wrong between 2000 and 2007
• 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
My scholarly contributions with respect to the 2008 Financial Crisis
9
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 $1.6Tr
Government bailouts = National debt
A Look at our
Federal Budget
Pat Obi, Purdue University Calumet 10
Pat Obi, Purdue University Calumet 11
Tax Receipts – Fiscal Year 2011 ($Billions)
Source: CBO Historical Tables
Pat Obi, Purdue University Calumet 12
Spending – Fiscal Year 2011 ($Billions)
Source: CBO Historical Tables
Budget Deficits and Surpluses (bill of $) Source: CBO and OMB
-2000
-1000
0
1000
2000
3000
4000
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Spending
Revenues
Carter -$253B
Reagan -$1,412B
Bush Sr -$1,036B
Clinton $63B
Bush Jr -$3,537
Obama -$3,689
Deficit/Surplus Deficit (negative) means Federal government
spent more money than was received in tax
revenues. Surplus is the opposite.
Our National Debt
14 Pat Obi, Purdue University Calumet
U.S. National Debt since 1790 Data source: Department of the Treasury
15
0
2,000,000,000,000
4,000,000,000,000
6,000,000,000,000
8,000,000,000,000
10,000,000,000,000
12,000,000,000,000
14,000,000,000,000
16,000,000,000,000
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Our national debt rose sharply after
1980, and has continued to rise
steadily since then.
16
0
2,000,000,000,000
4,000,000,000,000
6,000,000,000,000
8,000,000,000,000
10,000,000,000,000
12,000,000,000,000
14,000,000,000,000
16,000,000,000,0001
97
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Carter (D) $206B 33%
Obama (D) $4.92Tr 46%
Reagan (R) $1.44Tr 159%
Bush Jr (R) $3.57Tr 63%
Clinton (D) $1.71Tr 42%
Bush Sr (R) $1.06Tr 41%
$500B stimulus in 1993 to fight recession
- Two separate tax rebates
- War on Terror (Iraq)
- TARP ($700B)
- $800B stimulus - War on Terror (Iraq + Afghan.)
Dessert Storm (Iraq)
- Cruise and Pershing missiles
- Star wars - Reduced tax
rates but eliminated many personal tax deductions
U.S. Debt in Recent Years ($ Tr) Source: Department of the Treasury
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
The National Debt Components
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
Pat Obi, Purdue University Calumet 18
Total Federal Debt = $15.6Tr [March 2012]
Intra-govt + Fed = $6.4Tr [41%] Foreigners = $5.14Tr
[33%]
U.S. investors = $4.05Tr [26%]
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
Pat Obi, Purdue University Calumet 19
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
Mar
-01
Jul-
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No
v-0
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v-0
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Mar
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Deb
t O
wn
ersh
ip (
in b
illio
ns
of
$) Intra-gov + Fed Res
Foreign investors
U.S. Investors
Foreigners now lend more to the
U.S. government than Americans
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
20 -1,500,000
-1,000,000
-500,000
0
500,000
1,000,000
1,500,000
2,000,000
2,500,000
3,000,000
3,500,000
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Mill
ion
s o
f $
Imports
Exports
Current account balance
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)
The Big Question…
• 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
Has our debt reached a crisis point?
Our Economy
22 Pat Obi, Purdue University Calumet
23
U.S. Economy since Market Crash of 1929 (bill of $) Source: Department of Commerce
0
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GDP 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 Contribution by Recent U.S. Presidents (bill of $)
Source: Department of Commerce
24
0
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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%
Our GDP fell
sharply in 2009
owing to the
financial crisis.
Pat Obi, Purdue University Calumet 25
0
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Deb
t-to
-GD
P %
GD
P (
$ B
illi
on
s)
Debt as % of GDP
GDP ($ Billions)
Looking at our National Debt v. GDP through the years
The only time our debt grew to more than
100% of GDP was right after WWII. But that
was due to the Marshall Plan.
26
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%
2012 15,620.33 15,776 4% 99% as of March 11%
This
show
s how
much
our
deb
t gre
w a
s a
% o
f our
GD
P –
under
each
pre
siden
t,
since
1981.
Pat Obi, Purdue University Calumet 27
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.
Debt as % of GDP since after WWII
The Debt Crisis
Pat Obi, Purdue University Calumet 28
29
Year Revenues Spending 1993 17.5 21.4 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
Federal Government Revenue and Spending (% of GDP) Sources: Congressional Budget Office; Office of Management and Budget
Clinton
Obama
Bush Jr.
ww
w.cb
o.g
ov/p
ublicatio
n/2
1999
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.
30
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Carter Reagan Bush Sr Clinton Bush Jr
Obama
Revenues
Outlays
Tax Revenue and Government Spending (% of GDP) Sources: Congressional Budget Office; Office of Management and Budget
www.cbo.gov/publication/21999
This
gapin
g
hole
is
our
deb
t cr
isis
!!!
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
• 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
32 Pat Obi, Purdue University Calumet
National Embarrassment…
33
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 32 Japan 172.1 167.0 174.1 194.1 200.0 211.7 219.1 226.8
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!
The Path to Debt Elimination
[my contribution]
Pat Obi, Purdue University Calumet 34
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
• 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)
Pat Obi, Purdue University Calumet 35
Step 1. Set max debt/GDP goal (based on historical GDP growth rate)
Step 2. Set spending and revenue levels to fit within the debt ceiling
• 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 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)
• 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
38
Year
Unadjusted
Spending
Deficit
Reduction
Adjusted
Spending
2012 $3,655 $3,655
1 3,655 $300 3,355
2 3,355 300 3,055
3 3,055 300 2,755
4 2,755 300 2,455
5 2,455 300 2,155
6 2,155 300 1,855
7 1,855 300 1,555
8 1,555 300 1,255
9 1,255 300 955
10 955 300 655
Pat Obi, Purdue University Calumet 39
Mandatory Spending Items
Year Defense Discretionary
Social
Security
Medicare/
Medicaid
Other
Mandatory
Net
Interest
19% 19% 20% 23% 12% 7%
2012 +
694 694 731 841 439 256
1 637 637 671 903 403 256
2 580 580 611 970 367 256
3 523 523 551 1,041 331 256
4 466 466 491 1,118 295 256
5 409 409 431 1,201 259 256
6 400 400 500 1,290 300 256
7 400 400 500 1,386 300 256
8 400 400 500 1,488 300 256
9 400 400 500 1,598 300 256
10 400 400 500 1,717 300 256 + Base year is 2012
Ten-Year Spending Projections ($ billions)
40
Year Net New
Interest
Total
Adjusted
Spending
Projected
Revenue
(3% growth
+$100B/yr)
Deficit/
Surplus
Total
Debt
Projected
GDP
(growth
rate = 3%)
Debt-
to-GDP
2012 - - $2,555 -$1,100 $15,223 $15,693 97%
1 - $3,507 2,732 -776 15,998 16,164 99%
2 $21 3,385 2,914 -471 16,470 16,649 99%
3 21 3,247 3,101 -146 16,616 17,148 97%
4 21 3,114 3,294 180 16,435 17,663 93%
5 21 2,987 3,493 506 15,929 18,192 88%
6 21 3,167 3,698 531 15,398 18,738 82%
7 21 3,262 3,909 646 14,752 19,300 76%
8 21 3,365 4,126 761 13,992 19,879 70%
9 21 3,475 4,350 874 13,117 20,476 64%
10 21 3,593 4,580 987 12,130 21,090 58%
Ten-Year Revised Budget, Debt, and GDP Projections ($ billions)
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
Thank you!
43 Pat Obi, Purdue University Calumet
The U.S. Debt Crisis
Questions? Please email
me at [email protected]
