Tag Archives: Boomergeddon

A World of Failed States, Militias and Refugees

refugeesThe flood of refugees from war-torn Africa and the Middle East into Europe got me to thinking about something I wrote five years ago in “Boomergeddon,” back when the world still seemed relatively sane. I recognized that fiscal constraints would prevent the United States from maintaining its role as the world’s policeman. Despite all the criticism of America for its arrogance and clumsiness in dealing with other countries, I argued, the world would miss us when we were gone.

The future of a world without a U.S. to police it will be more failed states, more militias, more drug lords, more insurgents, more genocide, more refugees, more economic migrants, more sanctuaries for terrorists and more haven for privates. The expanse of territory subject to barbarism and warlordism will expand, and the expanse subject to the rule of law will shrink.

I guess I was right about that one.

Indeed, I wasn’t pessimistic enough. I never imagined the ability of millions of migrants from impoverished developing countries to slip into Europe. Human smuggling channels, once created, are not easily shut down, as we have learned in the United States. National frontiers are more porous than ever, and when confronted with human tragedy, western democratic societies do not have the stomach to seal their borders while millions suffer. But our welfare states are living on borrowed money and borrowed time. Absorbing tens of millions of the world’s poor will only hasten the inevitable reckoning.

What can the United States do? Not much. Sequestration has shrunk the size of the military to the smallest it’s been since before World War II, and Americans have little appetite for foreign intervention. Making matters worse, it’s getting harder and harder to tell the good guys from the bad guys. Europe, even with global chaos spilling over its borders, is even more impotent to act. Meanwhile, the global collapse of commodity prices will undermine the economies of resource-exporting countries from Brazil to Angola; as economic chaos spreads, social and political turmoil will follow. And don’t forget: Iran will acquire nuclear weapons in ten years, if not before, giving its mullahs North Korean-style impunity for its provocations.

What some believe to be the “arc of history” — the lifting of millions from poverty and the spread of human rights — soon will be seen as anything but inevitable. As much of the world slips into a new Dark Age, political, economic and social progress around the world over the past century will be seen as the product of one thing: pax Americana. As America retreats, chaos will fill the vacuum.

Have a nice day. Enjoy the respite from history while you can. Prepare your children for the world to come.


Another Idol Has Fallen: Virginia’s Fiscal Condition Not So Great

Virginia state finances -- not the gold standard we thought.

Virginia state finances — not the gold standard we thought.

by James A. Bacon

Once upon a time, Virginia was widely regarded as the Best State to Do Business. No longer. That reality is slowly making an impression in government and economic development circles, and I sense a growing awareness that Virginia can’t continue doing things the same way it always has.

Virginia also has long enjoyed a reputation for fiscal rectitude, due mainly to its AAA bond rating, the maintenance of which is a bipartisan priority. However, Virginia’s fiscal solvency is slipping, too — and the problem runs deeper than temporary problems caused by cutbacks in federal spending. I don’t get the sense that this reality is yet sinking in.

In research for George Mason University’s Mercatus Institute, “Ranking the States by Fiscal Condition,” Eileen Norcross rates the financial health of U.S. states in FY 2013 based on short-and long-term criteria. Virginia ranks only 21st on the list, lagging Alabama and South Carolina, among other states. (For those on Boomergeddon watch, the states with the most precarious finances are New York, Connecticut, Massachusetts, New Jersey and, of course, the U.S. poster boy for fiscal irresponsibility, Illinois.)

The key insight here is that balancing the budget is only one measure of fiscal health. “State spending may be large relative to the economy and thus be a drain on resources,” writes Norcross. Also, she adds, “The state may define budgetary balance to exclude certain funds or to mask debts, thus obscuring the true cost of spending or the resources required to finance long-term obligations.”

The report compiles five measures of financial strength:

Cash solvency. Can the government pay bills that are due over a 30- to 60-day horizon? On average, the states have a ratio of cash to short-term liabilities of 2.3 to one. Virginia ranks 30th most solvent by this measure.

Budget solvency. Can the state government meet its fiscal year obligations? In other words, are revenues running ahead of spending? Virginia’s capacity by this measure ranked 29th nationally.

Long-Run solvency. This ratio represents the proportion of long-term liabilities — bonds, outstanding loans, claims and judgments, compensated employee absences — relative to total assets. Virginia ranks 27th by this measure.

Service-level solvency. This measure captures how much “fiscal slack” states have by measuring the size of taxes, expenses and revenues relative to state personal income. It is a general measure of whether a government  has room to raise taxes or increase spending. Virginia ranks 5th — the only measure it which it stands out as being in solid shape.

Trust fund solvency. The final measure factors in long-term obligations such as long-term debt, pension obligations and other post-employment obligations (such as health insurance for retirees). Virginia ranks 15th by this measure.

(Hat tip: Tim Wise)

Federal Bailouts and the Buildup of Risk


Graphic credit: Federal Reserve Bank of Richmond

by James A. Bacon

The federal government plays a much bigger role in shaping the United States economy than is evident in its taxing and spending policies. Uncle Sam funnels credit to favored constituencies through subsidized credit programs like TIFIA transportation loans and the Import-Export bank as well as by protecting lenders from losses due to a borrower’s default. Members of Congress are exercised, as well they ought to be, by the dispensing of subsidized credits to corporate interests. But loan guarantees have a far bigger impact — and expose the federal government, and the U.S. economy — to far greater risk.

Sixty percent of the U.S. financial system’s loans are explicitly or implicitly backed by the federal government, the Federal Reserve Board of Richmond has found in its updated Bailout Barometer. That’s up from roughly 45% as recently as 1999.

The capitalist financial system is inherently prone to booms and busts. Busts lead to corporate failures, and big corporate failures can trigger panics, in which even financially sound firms get caught in the undertow. The U.S. has sought to alleviate this pain by providing loan guarantees. Some guarantees are self-financing, such as federal insurance on bank deposits. Other guarantees are policed by regulators, and yet others are implied but ambiguous and not spelled out in advance. But the end result is that actors in the financial system adjust their behavior — taking on more risk than they would otherwise — in ways that could create new, bigger problems in the future. As the Richmond Fed explains:

Implicit guarantees effectively subsidize risk. Investors in implicitly protected markets feel little need to demand higher yields to compensate for the risk of loss. Implicitly protected funding sources are therefore cheaper, causing market participants to rely more heavily on them. At the same time, risk is more likely to accumulate in protected areas since market participants are less likely to prepare for the possibility of distress — for example, by holding adequate capital to cushion against losses, or by building safeguarding features into contracts — and creditors are less likely to monitor their activities. This is the so-called “moral hazard” problem of the financial safety net: The expectation of government support weakens the private sector’s ability and willingness to limit risk, resulting in excessive risk-taking. …

The Richmond Fed’s view is that the moral hazard from the [Too Big To Fail] problem is pervasive in our financial system. The U.S. government’s history of market interventions — from the bailout of Continental Illinois National Bank and Trust Company in 1984 to the public concerns raised during the Long-Term Capital Management crisis in 1998 — shaped market participants’ expectations of official support leading up to the events of 2007-08. According to Richmond Fed estimates, the proportion of total U.S. financial firms’ liabilities covered by the federal financial safety net has increased by one-third since our first estimate in 1999. The safety net covered 60 percent of financial sector liabilities as of 2013. More than 40 percent of that support is implicit and ambiguous.

Bacon’s bottom line: While the current financial regime did alleviate the pain of the 2007 market collapse, the system could be allowing even bigger risks to build up. Like generals fighting the last war, regulators are fighting the last panic. The new risks will not be the same as the old ones, and we won’t know what they are until they explode in the next financial debacle. But spurred by the Fed’s near-zero interest rate policies, investors are chasing higher returns by taking greater risks, and financial markets are concocting elaborate new financial instruments to circumvent the regulators.

The global derivatives market was calculated in 2013 to be roughly $1.2 quadrillion in notional value, or about 20 times the global economy. Admittedly, most of that is tied to interest rates, currency values and stock indexes, not the economic sectors guaranteed by the federal government. But it illustrates how arcane financial instruments can magnify or hedge risks in ways we mere mortals — and government bureaucrats earning low, six-figure salaries — can barely comprehend.

I don’t know what will trigger the next financial crisis. Most likely, it will come from a quarter that most people would never expect. I don’t know when it will come. But the history of capitalism since the South Sea Bubble of 1720 suggests that one will come along eventually. If a bunch of multibillionaire hedge fund managers lose multibillion dollar bets and wind up selling apples on the street, I will lose no sleep. But if those hedge fund multibillionaires’ losses are back-stopped by federal loan guarantees, effectively socializing their losses, I will have a deep and abiding rage.

Turning 62: Take the Social Security and Run?


Not me!

by James A. Bacon

I turn 62 years old today, and one of the few perks of advancing age is the prospect of collecting Social Security. I, like thousands of other Baby Boomers who turn 62 every day, face the decision whether to start pocketing Social Security now, wait until full retirement at 66 or delay taking benefits even longer in the expectation of bigger checks down the road.

The conventional wisdom is that it makes sense to wait to 66, or even older if you can, because each year you delay, your SS benefits increase by roughly 8% to compensate for the actuarial reality that you’ll have one year less to collect before you die. If you’re in good health and expect to live longer than average life expectancy for male 62-year-olds — 83.8 years — delaying retirement is an especially good idea.

But what if you don’t have faith in the system to deliver on its promises, as I do not? What if you share the widely held belief that, barring heroic action by Congress, that the Social Security Trust Fund will run out by 2030? If the trust fund runs dry, the system can pay out no more than it brings in through payroll taxes, or about 75% of current promised levels.? Should we adopt the attitude of take the money and run? Get what’s yours while you can?

It’s a big decision, so I punched some numbers into a spreadsheet to see how the Retire-at-62 scenario compares to the Retire-at-66 scenario. (The numbers below are rough estimates only, not official Social Security Administration estimates.)

This chart compares the cumulative payout under a Retire-at-66 scenario receiving $2,000 per month or $24,000 per year compared to a Retire-at-62 scenario of $1,500 per month or $18,000 per year.

Waiting until 66 means no Social Security income for the first four years. During that period, you’d end up a cumulative $72,000 in the hole. But then, beginning at 66, your annual payout would be roughly $6,000 per  year higher. You’d whittle away at that $72,000 hole until, at age 77, you broke even. After that, you’d be ahead of the game by increasingly large margins each  year.

Then comes Boomergeddon. Around 2030 — the left vertical line — the trust fund runs out of money and Uncle Sam reduces the payout to what it brings in through payroll taxes, or about 25%. (The actual number would vary, depending upon economic and employment conditions.) In one sense, you’re screwed — you’re getting less than promised. But you’d be screwed if you retired early, too. You’d still be ahead of the game compared to retiring at 62 — just by a smaller margin, ahead by only $4,500 per year instead of $6,000 per year.

If you live until 83.8, your life expectancy at 62 years old today — the right vertical line — you’d still be ahead. If you’re healthier and more long-lived than average and live past 83.8 — and half of all males do — then the cumulative payout surpasses the early retirement scenario by an increasingly large margin.

This calculation does not take into account inflation, but that’s a non-factor because the Social Security program adjusts the payout each year to reflect the higher cost of living. Neither does it take into account the time value of money. A dollar earned in 2015 is much more valuable than one earned in 2030. That’s especially true if you actually save your money and earn a return on your investment. But most people (including me) don’t anticipate saving money during retirement; they anticipate spending down some or all of their savings. They view Social Security payments as income to be spent. Thus, the time value of money really has no application here.

What if, as I argued in my book “Boomergeddon,” Uncle Sam changes the payout in a Boomergeddon scenario to make Social Security even more of an income-redistribution engine than it already is? People living on the margin, say $1,000 a month, live a marginal existence as it is; they would truly suffer if their payments were cut when the trust fund is exhausted. There is a high degree of probability that politicians would give low-income households smaller cuts and take the balance out of the hides of higher-income households. But that still doesn’t change the bottom line that most middle-class Americans would be better off retiring at 66 — they would be better off by a smaller margin. Anyone with a lick of sense would anticipate the possibility of changes to the payout formulas and adjust their lifestyles accordingly, but the prospect of Boomergeddon shouldn’t change the decision when to retire.

The critical variable influencing your retirement-age decision is your health. If you have diabetes, untreated hypertension, a high risk of cancer or other health threats, you have worse odds of making it to 83.8 years old. Even then, you’re not necessarily well advised to take the money and run. The break-even year is 77. If you live older than 77, you’d still come out ahead delaying your retirement.

For many people, the discussion is purely academic. If you’re working a full-time salaried job, it probably makes sense to continue working, generating income and letting your Social Security retirement benefits gain value. But there are plenty of sixty-plus people who have lost their jobs, find themselves working part-time or have fluctuating free-lance incomes for whom that Social Security income might look pretty good. Those would be well advised to think carefully before making the leap.

Boomergeddon Watch: Debt Visible and Invisible

debt_ratios2by James A. Bacon

Now that the United States has driven down its annual budget deficit to less than $500 billion a year, there is a widespread temptation to think that we’re out of the fiscal woods. By some fiscal measures, actually, we are performing better than a lot of other countries. I found this McKinsey & Company report to provide a fascinating perspective. Since the Global Financial Crisis of 2007,  the U.S. has added less to its total debt (household, business and government combined) as a ratio of its economy than any developed country but Germany and Norway.

Our relative prudence reflects two main countervailing trends: public profligacy and private thrift. American households have shed much of their debt, either through restrained spending or through bankruptcies, foreclosures and write-offs. But public spending has surged. In effect, we have shifted the risk of over- indebtedness from private balance sheets to public balance sheets. We are at less risk of a consumer-driven recession than we would have been otherwise, but at greater risk of a more systemic, Boomergeddon-style meltdown.

And it’s not as if we’re immune to excess indebtedness in other countries. We’re part of a global economy. If other countries go bust and spending collapses, our exports suffer and our growth slows (as happened this past quarter). If other governments start defaulting on debts, the shock is transmitted through banks and bond markets in unpredictable ways. If economic instability leads to political instability in a key global player like China, we could experience disruptions to supply chains.

Debt is a wonderful thing when the economy is growing and everyone can make their interest and principle payments. It’s a wretched, nausea-inducing thing when the economy tanks. One way to protect ourselves is to make sure we know how much debt is out there, and where it is. Government-issued bonds are a matter of public record and highly visible. But there’s a lot of debt stashed away in economic development authorities, colleges and universities, and other quasi-governmental institutions that we pay less attention to.

Meanwhile, according to Governing magazine, municipalities are increasingly turning to bank debt, which is less transparent. According Governing‘s Liz Farmer, localities are required to report bank loans in their annual financial reports, but such information often doesn’t surface until a year after the fact. And bank borrowing is soaring.

Over the past five years, banks have nearly doubled their municipal holdings to $425 billion in securities and loans, up from $225 billion at the end of 2009, according to a Moody’s report. The practice is becoming so prevalent that muni analysts indicate it’s contributed to the slower pace of new bond issuance over the same period.

The [Municipal Securities Rulemaking Board], which is charged with protecting investors, municipalities and the public interest by promoting a fair and efficient municipal market, can’t do its job it if doesn’t have all the data. …. The terms of these loans can directly affect bondholders. … For example, some loan deals require that a bank loan be paid back first in the event that a government can’t pay all its bills on time. That means that future bondholders’ investments could be less protected than they realized.

Is anyone keeping track of this data for localities in Virginia? Do we have the faintest clue how much debt is backed directly or indirectly by local governments? Are our finances as conservative as we think they are?

Am I the only one who’s worried?

Yes, Boomergeddon Still on Track

obamaby James A. Bacon

President Barack Obama seemed pretty darned impressed with his economic and fiscal stewardship of the United States during his State of the Union speech last night. “We’ve seen the fastest economic growth in over a decade, our deficits cut by two-thirds, a stock market that has doubled, and health care inflation at its lowest rate in 50 years,” he crowed.

Let’s unpack that statement. Yes, we have seen the fastest economic growth in ten  years — which is a real indictment of the economic growth before the last two quarters. The last time we had economic growth this strong was… yikes!… during the George W. Bush presidency!

Yes, our deficits have been cut by two-thirds. The FY 2014 deficit was “only” $483 billion — one-third the $1.4 trillion deficit in in FY 2009. Unfortunately, the deficit is still massive by historical standards, and the Congressional Budget Office (CBO) expects the deficit to start climbing in FY 2016 to nearly $1 trillion by 2024.

Yes, the stock market has doubled. That’s one thing we truly can credit Obama’s economic policies for. The Federal Reserve Board’s zero-interest rate policy, pursued with the full backing of the administration, has pushed the stock market to record highs. As a small-time stock investor, I’m grateful. I’m sure America’s millionaires and billionaires are grateful, too. The poor and middle class, not so much.

Yes, health care inflation is at its lowest rate in 50 years. Of course, that has absolutely nothing to do with Obamacare, as many assume. The cost curve in health care started bending before Obamacare was implemented, and the slowdown in increasing costs mainly reflects private-sector strategies: (a) efficiencies gained by the consolidation of the hospital industry into health systems, and (b) the shifting of private-sector plans of costs to employees, in effect forcing them to exercise more diligence as health care consumers. To quote PWC:

Doctors and hospitals are adopting standardized processes that offer the prospect of better value for our health dollar. At the same time, consumers are starting to price-shop for health services and put new demands on the delivery of care. Over one-quarter of employers have a high-deductible health plan as their highest enrolled medical plan in 2014—the highest percentage ever. With more individuals making healthcare purchasing decisions, value and price are the new mantra.

Ironically, the federal government, which pays for Medicare and Medicaid, is the biggest beneficiary of these changes. Because health care is the biggest single driver of expected deficits, “bending the curve” of health care inflation could make a big difference over the long term. Let’s just be clear where those cost savings are coming from.

So, is the U.S. still headed to Boomergeddon? The spending discipline imposed by sequestration has made a difference. My prediction, made in 2010, of fiscal calamity by 2025 to 2027 now looks excessively pessimistic. Calamity may be forestalled until 2030 or so.

Only a fool would think the U.S. is out of the fiscal woods. The CBO says that, without major policy changes, built-in structural deficits will grow relentlessly from hereon out. The projection goes out only ten years, but by year eleven, the deficit likely will be running at 1 trillion annually. Meanwhile, we have unresolved problems looming like the Social Security Disability Insurance trust fund running out of money next year, triggering a 20% cut in benefits to the disabled. Congress likely will shore up the program by reallocating funds from the Social Security Old Age & Survivors Insurance fund, but that will accelerate the day when both funds run out of money — in 2030.

In effect, that means we have 15 years to fix the largest and most critical component of the U.S. social safety net. It is theoretically possible to restore the Social Security system to health if we make a series of tweaks that make a difference over a long period of time. But the longer we wait — and it doesn’t look like anyone is in a hurry to act — the bigger and more politically painful those tweaks will have to be.

The U.S. is deep into one of the longest (though weakest) economic recoveries in its history. Another 10 years of steady economic growth would be unprecedented. There will be another recession. Hopefully, it won’t be nearly as calamitous as the last one, but it will drive deficits higher. The reversal of Federal Reserve Bank’s quantitative easing will have an impact, too. The Fed has been handing over nearly $100 billion a year in profits, resulting from its purchase of long-term bonds and its manipulation of interest rates, to the U.S. Treasury. As interest rates resume their climb, that source of pain-free deficit reduction will evaporate. Meanwhile, it’s becoming increasingly evident that our precipitous withdrawal from the Middle East is not sustainable from a geopolitical perspective. We would like to walk away from the Middle East but al Qaeda and ISIS don’t seem to want to walk away from us. There will be considerable pressure for defense spending to increase.

Without dramatic corrective action, we’re still heading to Boomergeddon. I would expect a major fiscal-financial crisis around 2030 when the combined Social Security trust fund runs out. With a divided government in Washington, D.C., there’s no chance of getting that corrective action over the next two years. After that? Who knows.

At Last, a Chance to Address Fundamental Issues

Image source: Congressional Budget Office

Image source: Congressional Budget Office

by James A. Bacon

With yesterday’s elections, the Republican Party has taken control of the United States Senate and padded its lead in the House of Representatives, assuring a markedly different political dynamic in the two years ahead. The big question on everybody’s minds is, “Can Republicans govern?” Or will we see two more years dominated by Ted Cruz trying to shut down government?

My sense is that Republicans are very serious about governing, certainly more serious than was outgoing Senate Majority Leader Harry Reid, the one-man algae bloom who rendered the Senate a dead zone for new legislation over the past four years. Republicans are likely to pass a passel of new laws. The question then will be, “Is President Barack Obama serious about governing?” Will he  work with Congress or will he veto everything that comes across his desk?

While the last four years have been a big battle over nothing, rest assured that the next two years will grapple with issues of fundamental importance. As the United States hurtles toward Boomergeddon, Republicans will tackle budgetary issues that Obama has been studiously avoiding since he disavowed the recommendations of his own Bowles-Simpson budget-balancing commission. The issues will be debated in a way they haven’t been for far too long.

This year, the budget situation looks relatively benign. Economic growth is puttering along and the Congressional Budget Office (CBO) projects that the deficit will shrink to its smallest size since 2007, equivalent to about three percent of the economy. That’s roughly equal to the rate of economic growth, so the national debt, while growing, is not growing as a percentage of the economy. But the CBO does not expect this balmy scenario to last. Says the CBO:

The pressures stemming from an aging population, rising health care costs, and an expansion of federal subsidies for health insurance would cause spending for some of the largest federal programs to increase relative to GDP. Moreover, CBO expects interest rates to rebound in coming years from their current unusually low levels, raising the government’s interest payments. That additional spending would contribute to larger budget deficits—equaling close to 4 percent of GDP—toward the end of the 10-year period spanned by the baseline, CBO anticipates. Altogether, deficits during that 2015–2024 period would total about $7.6 trillion.

That sounds bad but not Boomergeddonish. But there’s a big caveat. At some point, says the CBO, government spending crowds out economic growth in the private sector.

The large amount of federal borrowing would draw money away from private investment in productive capital in the long term, because the portion of people’s savings used to buy government securities would not be available to finance private investment. The result would be a smaller stock of capital and lower output and income than would otherwise be the case, all else being equal.

Translation: Under the current policy framework, as government spending crowds out the private sector, economic growth will slow. Slower economic growth reduces tax revenues, which increases budget deficits. I’m not certain, but I don’t believe that the CBO cranks that lower economic growth into its long-term budget forecast, which, by its own admission, is highly conjectural and based upon long-term assumptions that likely will not prove to be accurate.

Under a more pessimistic set of assumptions, the federal debt, instead of rising to 111% of Gross Domestic Product by 2039, would reach 180%.

When discussing climate change, Democrats invoke the “precautionary principle.” While we cannot know with certainty that global temperatures will increase by 4° Fahrenheit by the end of the century, as some climate models forecast, the consequences would be so disastrous that we must act to forestall the possibility. I would invoke a fiscal precautionary principle. While we cannot know with certainty that the national debt will approach 180% of GDP within twenty-five years, the consequences will be so potentially disastrous that we must act to forestall the possibility.

Republicans will be animated by the fiscal precautionary principle in the next two years. If past is precedent, the Obama administration will be driven by the desire to protect government spending at all costs. Americans will engage in the most serious debate over the size and scope of government spending, unclouded by distracting side issues, that we have seen in a generation.

Chart of the Day: Virginia’s Aging Population


This graph comparing Virginia’s age between 1980 and 2013 comes from Luke Juday’s latest post over on the Stat Chat blog, published by the demographics shop the Weldon Cooper Center for Public Service. I urge you to check out the opening chart in his post to see an animation of the changes year by year. It’s fascinating to watch the bulging Baby Boomer generation crawling up the age ladder.

I would love to see a projection of Virginia’s demographic profile over the next 20 years. We would see the big Boomer blob move up, out of the workforce and into retirement age. The implications of that massive shift cannot be over-estimated. Virginia’s working-age population won’t be increasing in size — indeed, it probably will begin shrinking within a decade. Extrapolate that trend nationally, and you’ll understand why the Congressional Budget Office (CBO) maintains that the structural U.S. budget deficit — “only” $583 billion this year, according to the Obama administration’s updated forecast, will march relentlessly higher within a few years as the growing ranks of seniors put increasing stress on the Medicare, Medicaid and Social Security programs.

America still faces a Boomergeddon scenario, although we may have bought ourselves a few years’ grace. The CBO thinks that the slowdown in the growth rate of medical spending experienced since the 2007-2008 recession is a lasting phenomenon and will slightly bend the spending curve downward — enough to keep the Medicare Part A trust fund solvent through 2030. In February, the non-partisan budget shop had projected that the trust fund would run out of money in 2025, reports the Wall Street Journal.

The good news is that Congress has five more years to dither and procrastinate about reforming Medicare. The bad news is that Congress probably will take full advantage of that five years before making hard choices.


How the Feds Are Detroitifying the Country

Detroit is becoming a verb, to Detroitify, which is morphing back into a noun, Detroitification.

The noun “Detroitification,” from the verb, “Detroitify.”  The verb “Detroitify,” from the noun, “Detroit.”

by James A. Bacon

Richard Ravitch worries that more “Detroits” are in America’s fiscal future. Co-author with former Federal Reserve Board Chairman Paul Volker of the “Report of the State Budget Crisis Task Force,” Ravitch argues in the Wall Street Journal today that state and local governments have major fiscal problems, that those problems are structural in nature, not a passing consequence of the Great Recession, and that “the crisis is deepening.”

An advisor to the Detroit bankruptcy judge, Ravitch makes a number of unassailable points: (1) Despite stop-gap measures to shore up employee pension funds, contributions remain below levels needed to meet promises to public employees; (2) the growth in Medicaid costs will continue to outpace state tax revenues; (3) states and cities have been meeting ongoing operating expenses by peddling one-time asset sales; and (4) the federal government, which now provides almost 30% of what states spend annually, “is facing understandable pressure to rein in spending and reduce deficits.”

These things are true, they are widely known to be true, and state-local governments are grappling with them, however fitfully and incompetently. Unfortunately, Ravitch obscures one other very important reason to worry about state-local finances — the fiscal Ponzi scheme of infrastructure investment.

“We are drastically underinvesting in physical infrastructure — roads, bridges, ports, etc. — the necessary underpinning of future growth,” he writes. Thus, in his reckoning, the fiscal crisis is responsible for a looming infrastructure crisis. In point of fact, the problem is the reverse: Excess spending on infrastructure has contributed to the fiscal crisis. The problem is that this over-spending is not widely acknowledged, hence, is not being dealt with.

Interestingly, Ravitch suggests that the federal government, which controls 30% of state-local purse strings, should use its influence to encourage more responsible behavior: “The federal government could condition its continued financial support on states and local governments adopting budget systems that would require recurring expenses to be matched by current revenues.”

That last statement is hilarious on many levels, not the least of which is that the federal government is the last entity on the planet that should be lecturing anyone about matching revenues and expenses. Only slightly less guffaw-inducing is the fact that it is the federal government that has impelled state and local governments to increase spending by dangling the promise of federal funds on the condition that those funds be matched by local dollars — Medicaid is a classic example. For many programs, unlike Medicaid, federal support is temporary, lasting just long enough to build up vocal constituencies and making them almost impossible to dismantle.

Nowhere has this tactic been applied more consistently than in infrastructure spending. The Feds encourage states and localities to build new roads, mass transit facilities, ports, airports, etc. by defraying the up-front capital costs. But local governments and authorities are left with the responsibility to cover ongoing operating shortfalls and, a life-cycle later, to find the money to rebuild or replace the facility. Uncle Sam doesn’t do maintenance. Meanwhile, the state-level accounting for major transportation projects — both highways and mass transit — is so useless that it is impossible for taxpayers and voters to know if any given project augments or diminishes the nation’s net wealth. One can argue that we are maintaining considerable infrastructure — farm roads in rural areas that no longer support farms, for instance — that should have been retired long ago.

So, yes, Ravitch’s big-picture message is well taken. As the headline to his piece says, “More Detroits are on the way.” The crisis is deepening. What’s missing is an understanding that the federal government is a major contributor to the problem. States don’t need the feds to tell us what to do. We need them to back off, tend to its own looming fiscal disaster and stop stimulating the growth of state-local government spending that cannot possibly be sustained over the long run.

Trickle-Down Economics Revealed

Who's laughing now?

Who’s laughing now?

by James A. Bacon

A generation ago, liberals mocked the so-called “trickle-down economics” of the Reagan administration, the idea that creating wealth for the rich would trickle down to the less affluent by way of expanded economic activity. While Reagan himself never used that term, his economic philosophy of tax cuts, tax-code reform and restrained federal spending did work as advertised. The 1980s were a period of great prosperity in which all income groups and ethnicities shared. The irony is that the trickle-down economics is a label more aptly applied to the policies of President Barack Obama. During O’s five years in office, the rich have gotten richer while the poor have fed on scraps. But you’ll never hear the term “trickle down” applied to Obama’s monetary policies.

There are many winners from the low interest rate policy implemented by the Federal Reserve Board with the full support of the Obama administration — most of them wealthy. One group is the “millionaires and billionaires” who benefit from rising stock and bond prices. Another is the owners of mortgages who have refinanced their debt at lower interest rates, in many cases saving hundreds of dollars a month. Needless to say, those with the highest incomes who can afford the most expensive houses benefit the most. The biggest beneficiary, of course, is the federal government, the world’s largest debtor, which saves on the order of $200 billion to $300 billion a year in interest payments on its $17 trillion debt. Finally, there is a modest trickle-down effect in the form of job creation in interest rate-sensitive industries like construction.

Of course, there are many losers, too — a mega-narrative that has gone largely unreported by the mainstream media. One group of losers is small business, which finds it more difficult to gain access to capital (it’s easier for banks to lend to the government). Another group consists of state and local governments whose retirement funds no longer generate the returns they were several years ago and now face chronic fiscal stress as they struggle to make up the difference. Fifteen years ago, for example, the Virginia pension system was fully funded. Today, even after major structural reforms, Virginia and its local governments still owe billions.

Then there are the little guys, especially the Baby Boomers who accumulated modest nest eggs to help support them in retirement. I have fulminated on this topic on and off since writing “Boomergeddon,” frustrated that the issue has drawn so little attention. But a Bloomberg News article published today in the Times-Dispatch (sorry, can’t find the link) shows the full dimension of the problem. Some key points:

A 65-year-old who wanted to pay for retirement with annuities tied to bonds needed 24% more wealth in 2013 than in 2005. National Bureau of economic Research President James Potera calculated in a research paper released in February. …

U.S. Treasury yields are at least 2 percentage points less than what they would be otherwise because of the Fed’s low-rate policies and stimulus programs, said William Ford, former Atlanta Fed president who wrote a 2011 paper estimating the impact on savers of monetary easing. That reduces their income by at least $280 billion annually, his analysis shows.

“The cost of low interest rates are being ignored,” Ford said. “It is killing savers, elderly savers who are living on life savings that have been conservatively invested.”

The Fed is engineering one of the greatest wealth transfers in American history — from the working-class and middle-class to the rich. The stock market has never been higher. Wall Street is doing better than ever. Bankers are still getting their big bonuses. And the little guys with meager savings are watching their pathetic little nest eggs lose value as inflation exceeds the income they can generate.

The extraordinary thing is that Obama then turns around and castigates the economic system for inequalities in wealth — the very same inequalities that he and former Fed Chairman Ben Bernanke (it’s too early to pin any blame on Janet Yellen yet) did to aggravate. Rather than undo the harm he has inflicted, Obama ask Americans to entrust him with even more power to “help” the poor and downtrodden. What I find mind-boggling is that this is not the delusion of a single man — it’s that liberals and leftists have so uniformly and gullibly bought into the delusion. They have become apologists for the very evil, income inequality, that they decry.

I suppose that’s inevitable. The political class always gravitates to “solutions” that entail the accumulation of more power for the political class. In Virginia, liberals’ idea is to expand the Medicaid entitlement, paid for the federal government with borrowed money. Why not? It’s “free” money. But it’s really not. Every billion dollars borrowed by the federal government requires more financial repression and more wealth transfer from savers to favored classes of borrowers, the foremost of which is the U.S. government. The favored classes do not include the poor and middle-class who rack up credit card debt, typically charges around 13% to 15%.

Liberals prattle about “social justice” and lobby for distractions like a higher minimum wage (which raises pay for some and destroys jobs for others) while aiding and abetting the trickle-down economics that leaves America’s less well-off with crumbs. The hypocrisy is almost too much to bear.