Tag Archives: Boomergeddon

Boomergeddon Update: Deficits Rising Again

Source: Congressional Budget Office

Source: Congressional Budget Office

by  James A. Bacon

Blame who you want for this sad state of affairs — it’s always the other guy’s fault, right? — but after six years of shrinking federal government deficits, red ink is on the rise again. And unless Congress enacts significant budget reforms, deficits will get worse every year pretty much forever until the wheels fall off the bus.

The chart above comes from a new report from the Congressional Budget Office (CBO), which, to my knowledge, is not funded by the Koch Brothers. What should be really scary is that the forecast is based upon the assumption of slow-but-steady economic growth (about 2% annually) over the next 10 years — without a recession, a totally improbable supposition. The current business cycle, though anemic, is seven years old, and the global economic situation is a mess. When a recession does occur, revenues will decline, spending will climb and deficits will shoot higher.

Some will comfort themselves from the chart above by observing that CBO’s projected deficits for the next 10 years are no worse than the deficits of the Reagan/Bush I era. That’s true, assuming we don’t have a recession, in which case it won’t be true. But such thumb-sucking ignores the fact that we have a $19 trillion national debt, which, as a percentage of the economy, is higher than at any time since the Korean War. It ignores the fact that the percentage of the budget on auto-pilot (entitlements and interest) will be far higher, which will give Congress far less latitude to cut spending should it need to. It ignores the fact that the Federal Reserve Board today is pursuing a highly stimulative, near-zero interest policy today, in contrast to the slam-on-the-brakes interest policy of the early 1980s. And it ignores the fact that the 1980s-era economy had greater growth potential than our economy today with its aging workforce, debilitating tax code, over-regulation and seriously impaired global economy.

What does this imply for us mere mortals residing south of the Potomac? President Obama and Congress made a pact with the devil to jack up discretionary spending in the latest budget, thus easing the pain of sequestration. But long-term, the prognosis for Virginia’s federally dependent economy is grim.


Expressed as a percentage of the economy, federal discretionary spending (which includes defense spending) will continue to shrink as mandated spending and interest payments hog new revenue dollars. That bodes ill for the military-intelligence-homeland security complex in Northern Virginia and Hampton Roads.

Bacon’s bottom line. First the uncontroversial: Virginia needs to ramp up its efforts to diversify its economy away from federal spending. Next, the controversial: Put state and local finances (including pension obligations) on a tighter leash. And then, the super-controversial: Don’t trust federal funding promises for anything. What Uncle Sam giveth, Uncle Sam can taketh away. And that includes federal dollars for Medicaid expansion.

Agreed, We Can’t Risk Expanding Medicaid. But What’s the Alternative?

innovationby James A. Bacon

Republican leadership in the House of Delegates once again has slammed the door on Governor Terry McAuliffe’s proposal to expand Virginia’s Medicaid program. There are good reasons both for and against extending the entitlement but the decisive and most compelling argument is the likely inability of the federal government to honor its commitment to pay 90% of the cost of the expanded program far into the future.

If you need a sobering reminder of how dismal the long-term fiscal condition of the federal government is, just read this recent Senate Budget Committee testimony by Boston University economist Laurence Kotlikoff. As everyone knows, the national debt now exceeds $18 trillion. But that’s just the tip of the fiscal iceberg. The fiscal gap, the difference between revenues and obligations projected 75 years into the future, is $210 trillion — more than 10% of GDP. The gap between revenues and promises in the U.S. is worse than that of any other developed country, Kotlikoff said, worse even than Greece. (Hat tip: Tim Wise.)

If something can’t go on forever, eventually it won’t. At some point, whether ten years from now, twenty years, or thirty, the federal government will reach a crisis. There is a high likelihood that a future Congress will decide either to radically curtail Medicaid or to dump a significant share of the funding burden on the states. Either event would be traumatic for Virginians. This is not scare-mongering, it is arithmetic.

While rejection of Medicaid expansion may be fiscally justified, it leaves hundreds of thousands of poor and struggling Virginians without access to health care, except in emergency room settings. If Republicans and conservatives are going to reject the fiscally improvident expansion of Medicaid, they are obligated to present a different vision for Virginia’s healthcare future. We have seen bits and pieces of such a future — repeal the Certificate of Public Need (COPN) process that protects established companies from competition, and make patient-level data more widely accessible — but no one has articulated a coherent vision. Let me advance three propositions that may lead us to such a vision:

  • The main reason that medical insurance has become so unaffordable for so many Virginians is that the underlying cost of providing that care has increased relentlessly over the decades faster than inflation and faster than the increase in wages and salaries.
  • The primary thrust of public policy in the United States and Virginia has not been to stimulate productivity and innovation, making medical care more affordable for all, but to restrain cost increases by regulatory means and to redistribute wealth from the affluent to the poor in a zero-sum game. The resulting system, marked by rampant regulation, red tape, cross subsidies and an total lack of transparency, is a colossal failure.
  • To make health care affordable and accessible, Republicans and conservatives need to champion market-driven competition and innovation that drive down costs and improve medical outcomes.

That’s the vision, but a vision is nothing more than words and generalities. Where do we go from here? There are three things we can do in the short term that will move us in the right direction:

  • Eliminate COPN, which protects established hospitals from competition, not only from other hospitals and outpatient-care facilities but from entrepreneurs who might have novel ways to organize and deliver care. In so doing, we must recognize that COPN represents a back-door means of compensating hospitals for the significant sums they spend on indigent care, and acknowledge that some kind of political settlement will be necessary.
  • Eliminate mandated health benefits, which limit the ability of health insurance companies to create innovate products for niche markets.
  • Create market transparency. Patients have little consumer power in the medical marketplace because they cannot compare the price of different medical procedures or the quality of work performed by different hospitals and doctors. The methodological issues of comparing price and quality are formidable but not insurmountable. For market-driven health care to work, we must have price transparency.

That’s just the beginning. Thinking more long-term, we need to acknowledge that the concept of hospitals — centralized medical facilities that provide a bundle of unrelated medical procedures — may be outdated. The future belongs to the factory model in which specialized medical teams (doctors, nurses and others) work in specialized facilities with specialized equipment, and stay up to speed with the latest scientific knowledge about particular procedures or diseases. This specialization and knowledge allows them to treat patients at lower cost with better outcomes.

In parallel, insurance companies need to pioneer new reimbursement strategies that cover not just individual procedures but entire courses of treatment, rewarding medical “factories” described above for superior outcomes and lower costs.

Republicans and conservatives don’t have to come up with every answer. They’re politicians, not medical practitioners. But they do need to paint a picture of the future, eliminate legal and regulatory obstacles and push the health care industry in the right direction. If they fail to do so, the end result will be fiscal insolvency, hundreds of thousands of Virginians people dispossessed of health care, or a chronic health care crisis for all.

Meanwhile, Virginia’s Debt Service Has Doubled

Source: "State Spending: 2015 Update"

Source: “State Spending: 2015 Update”

Debt service on bond issues, mainly for higher education and transportation, has been a major driver of state spending over the past 10 years. The repayment of interest and debt has increased in absolute numbers and as a percentage of total blended revenues — from $385 million (or 2.57% of revenues) in FY 2005 to $836 million (or 4.51% of revenue) in FY 2015.

Spending on debt service remains below the 5% cap recommended by the Debt Capacity Advisory Committee in order to protect Virginia’s AAA bond rating, according to the recently published “State Spending: 2015 Update.” But it still represents a long-term obligation that cannot be pared during economic downturns, thus limiting to some degree the state’s ability to respond to recessions.

Fortunately, Virginia’s debt bears no comparison to the federal ponzi scheme. The interest charges on state bonds are fixed. Payments will not increase unless state authorities choose to issue new debt. Uncle Sam is in a very different situation. Much of the $18+ trillion in federal debt consists of short-term notes (two years or less) that benefit from extremely low interest rates. However, should interest rates rise, a substantial portion of the federal debt will be rolled over at higher interest rates in short order. So even if the feds didn’t run annual deficits of $400+ billion a year for now until forever, the debt burden would increase.

Bond indebtedness does not account for other long-term obligations, such as real estate leases and, most worrisome, unfunded pension obligations. Virginia has made progress in bringing its pension obligations under control, although budget pressures could tempt the General Assembly to short-change budget contributions in the event of another recession.


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.