Friday, October 9, 2009

Runaway Debt?

The above chart shows a simple and straight forward ratio: Gross Debt/GDP. In the last year this ratio has moved from an unprecedented 350% to an even more unprecedented 375% of GDP, as of 3/31/2009. In other words, our nation and society is more leveraged and indebted than ever before. In fact, the recent financial crisis has thus far operated to exacerbate indebtedness rather than facilitate an orderly deleveraging.

Deleveraging is never pleasant as you can see from the chart: the last major deleveraging led to the Great Depression. Deleveraging means consumers and businesses cut back on expenditures, including employees, sell assets to pay off debt, and slash investment, all with the goal of reducing, by all means necessary, debt. Another means of deleveraging is to expand income or GDP, rapidly.

We have no policy for managing our society's debt load through law, or otherwise. In the past we at least required 20% down payments (or private mortgage insurance), and government budgets had a minimal level of integrity and sustainability. For example, Bush I/Clinton worked together in the 1990s to remedy the high deficits created in the wake of the Reagan deficits. Bush II never saw an issue that could not be resolved through tax cuts and he put the nation on a catastrophic fiscal course. The present administration has not had many options for dealing with this train wreck, but its continuation of bank bailouts and more tax cuts have neither stimulated the over leveraged economy (because banks are desperate to shore up balance sheets and are hoarding capital and consumers are desperate to pay off debt) nor remedied our long fiscal nightmare.

Meanwhile, American consumption was expected to drive global growth even in the face of eroding wages and jobs in the US. The only means available to deliver both cheap wages, fattened profits and high CEO bonuses to the transnational firms and American centered consumption was through massive debt. This model of globalization enjoyed broad support from both Democrats and Republicans.

Finally, everyone (Democrat and GOP) wanted to deregulate financial markets worldwide. All of a sudden globalization became the means of spreading toxic levels of American debt throughout the globe. These foreign investors actually drove expanding levels of debt by flooding the US with cheap capital.

So, the cards were stacked in favor of a debt binge parading as financial "innovation." No amount of innovation can spare a nation from the pain of unsustainably high debt levels.

Runaway debt combined with runaway unemployment poses a major threat to our standard of living, yet our leaders and our mainstream media seem oblivious to the problem. Mainstream Law & Economics is similarly bankrupt.

I am working on a paper entitled the "The Law and Macroeconomics of Odious Debt" that specifically seeks to articulate the appropriate legal framework for managing the risks of over-leveraging on a society wide basis. Any help would be most appreciated.


  1. So nice to see you writing about this topic. Over-leveraging in the United States has sadly become part of our way of life. I feel a bit like the kid on the beach in the "starfish" story, but I firmly believe that one way that we can start changing our society in this respect is by discussing this issue at every turn and on every level, including the individual credit level. For me, this has meant teaching my kids (now 17 and 20) about debt and discouraging them from living off debt. (I am proud to say that neither has a credit card, and both pay off their own bank fees when they overdraw.) I also tackled the issue at UT last year by investigating the terms of our arrangement for the UT affinity credit card that is marketed to (among others) students to ensure that the marketing agents for the card are not promoting it to those who cannot afford it.

    Unfortunately, as to our policymakers, they may not see the light until they are forced to face real economic pain. The more we patch the system without addressing this part of the problem, the less likely it is that we will stop living off credit. But perhaps your work can make a difference in this regard, and I applaud you for undertaking it.

  2. Bush II never saw an issue that could not be resolved through tax cuts

    Revenues to the U.S. Treasury increased dramatically (to record levels) for several years under Bush II. Your assertion that there were tax cuts is simply nonsense. Bush II did indeed put us on a catastrophic fiscal course, but not because of ax cuts: because of runaway spending. Obama has simply doubled down on this nutty course.

  3. There is much to complain about Federal and many U.S. states' tax policies. Blaming Bush and tax cuts on the Federal fiscal situation misses the point - never mind that all spending bills originate in the House and not with the Executive. During times of generally rising tax revenues in nominal and real terms [] (Yes, Heritage is No. 2 on Google for "federal revenue"), the Federal spending and debt binge has gone on and on and on, and unfortunately only gets worse during bad times without any saving during good times. []. There is too much government spending and has been for too long. BTW, George Bush and his ilk did raise my taxes.

    The great maxim applies to those who spend more than they earn or elect representatives who do so: You get what you deserve. Regards

  4. Me keeping my money = government debt.

    Who knew?

  5. Lots more on these issues at these links, from Karl Denninger. He breaks down the debt by sector, and debt-to GDP:

  6. Mr. Ramirez - nearly everyone in my circles (mid-class / engineer...) [now] recognizes that we will be crushed, perhaps to death, by the debt. I have been blowing this horn, to no avail, for all of my adult life (the last 20 years or more). My point is, there are pockets of us that are trying to - in some small way - turn it around. But, w/o ridding the society of the fundamentals of welfare, it's a lost cause. We need to replace altruism w/ egoism.

  7. The "appropriate legal framework for managing the risks of over-leveraging on a society wide basis"? Why not try to find the appropriate chemical formula for divorcing your wife? There ain't none. That train does not go to that destination. You are barking up the wrong tree. The "law", meaning government meddling, chiefly in the mortgage markets, got us into this mess. More meddling will only get us in deeper. How much more of your life do you want Frank and Dodd to manage?

  8. Were it only true that American business, including banking, was substantially deregulated over the past decade or so. While some barriers were dropped, the banking industry in the US is still highly regulated - which gave Congress the club they needed to force levels of subprime debt past the tipping point.
    The answer is not higher taxes and more regulation, but tax policy which 1) discourages debt, 2) encourages investment, 3) requires every citizen to pay in and 4) is stable enough to allow individuals to make long-term decisions without fear of a mid-stream change.

  9. I'd bet if you put a graph of average house prices divided by average post tax wage, you'd have the same graph.

  10. It does seem as if there is some need for some rules that prevent bubbles (including debt), but don't strangle innovation nor sustainable growth.

  11. As other commenter's have pointed out, the Bush II tax cuts resulted in an increase in revenue to the federal government and therefore helped to reduce the level of federal indebtedness. This was true with the tax cuts implemented by Kennedy and Reagan as well.

    As for the present administration not having "many options to deal with this train wreck", they have inherited a situation almost entirely of their own making. The Democrat party was in complete control of the federal purse strings during the current crisis. Barrack Obama voted, as Senator, for all of the spending that you attempt to lay at the feet of George W. Bush, making him, at the very least, complicit. In fact, it was the Republicans who voted overwhelmingly against the bailouts and the now obviously ineffective "stimulus" bill. Add to that the Democrats unwillingness to reform programs like Medicare, Medicaid and Social Security and the current situation belongs to them, period. Let's not forget that the Ponzi scheme structure of these programs is the Democrats making and they have demagogued for generations to keep it in place.

  12. LMH anesthesia departmentOctober 10, 2009 at 2:49 PM

    I like Obama! I think his social programs are the best, and I personally don't mind working to support them and our fellow citzens in need. Also, I think the DC gun ban should be expanded nationwide.

  13. Firstly sir, it appears that you have trouble reading graphs. The graph above shows clearly that the deleveraging occurred in 1935, a full 6 years AFTER the onset of the Great Depression.

    That you choose Krugman is also unfortunate, as his brilliant foresight folowing the Dot-com bubble was the need to create a real estate bubble. In short, his prescription drove us inoto this mess. I hardly think he is a great sage, regardless of the opinion unquestionably wise Nobel committee.

    I would hope that you might availa yourself of the proximity of your office to the Economics Department at the University of Chicago. Spend some time there learning a little about the subject, please. A good place to start would be considering the impact of strangling regulations, insane fincals and monetary policies, "crowding out" of investment, and, of course, the reaction of capital to uncertain, if not hostile political environments.(see "scapegoating")

    As noted above, political manipulation of mortgate markets through Fannie & Freddie, criminal accounting practices specifically around Social Security, Medicare and Medicaid (the fallacy of "The Trust Fund") and the intrusion of government into every facet of out lives is the problem. The remedy is simple, if painful to some: not deleveraging, but devolution. Cap government spending, stop new regulation (especially takeovers, cap & tax, and unfunded mandates), and get out the politicians, bureaucrats, lawyers, activists, and other non-contributors of the way.

  14. Half the reason for this mess is that what are now known as "toxic assets" were rated AAA by government ratings agencies--the same rating given to sovereign debt. We now know the SEC was wrong. If the government has shown itself to be a poor assessor of risk, why believe it will be a good manager of risk?

  15. Anonymous 3:55 - I suggest you go back to this post by Martinez.

    Martinez includes "reparations" as a form of "social justice". I understand "reparations" to mean that the US Government ought to be writing cheques to the black population for slavery; and that until it does so, the US is an unjust state.

    He's also for "universal health care" which I understand to mean, that every person in the US who can't afford a trip to Thailand is entitled to sit in the same waiting room as everyone else.

    And he's for "better education" as something we have to "afford"; despite the billions already thrown into that rathole.

    Martinez is a socialist. Don't expect great insights from the articles he contributes here.

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  17. The Government Accountability Office has been reporting on the issue of unsustainable debt for years. The GAO has been an active voice in spreading awareness of the runaway spending. Read the GAO reports, and it is easy to see why many economic experts believe we are getting to the point of not being able to tax and grow our way out of this debt. To pay off our current obligations, the figure is about $150,000 per American- every American, and growing every day! Congress needs to put forth solutions...