Towering mountains of debt. Watch out for avalanches.
by James A. Bacon
The federal government is far more exposed to a rise in interest rates than commonly believed. As I frequently remind Bacon’s Rebellion readers, the national debt stands at $17 trillion, a sum that is increasing with no end in sight. But Uncle Sam’s total financial liabilities are far larger, says James D. Hamilton, a University of California-San Diego economist, in “Off-Balance-Sheet Federal Liabilities.”
Off-balance sheet liabilities — mortgage guarantees, deposit insurance, student loans, government trust funds, Federal Reserve instruments — amount to some $70 trillion, Hamilton calculates. Admittedly, those liabilities are not the same as the national debt. They are offset by corresponding assets. But the assets and liabilities all shift in value, depending upon economic circumstances. Should the economy tank, the feds could be on the hook for billions of dollars in bad loans. And if interest rates rise, the asset value of loans could tumble.
Things can look fine one day, then change the next. Hamilton points to the example of Ireland, which in the Great Recession responded to a banking crisis by guaranteeing all deposits and most debt of its six largest banks. Kaboom. Gross government debt soared from a responsible 25% of GDP to a disastrous 100%, and interest rates on Irish government debt shot up from 4.2% to 14%.
“I am not predicting that a similar crisis is on the verge of unfolding for the United States,” Hamilton makes clear. “But one thing seems undeniable — [off-balance-sheet debts] are huge. And implicit or explicit commitments of such a huge size have the potential to have huge economic consequences, perhaps for the better, perhaps for the worse. Acknowledging their size is a necessary first step for making wise policy decisions.”
Bacon’s bottom line: If interest rates return to the average rates experienced during the 1990s, government interest payments on the national debt, currently around $350 billion a year, would double or triple. It is simply unknowable what would happen to the $70 trillion in off-balance-sheet obligations, but the impact could be measured in the trillions of dollars. While it’s conceivable that the whole jury-rigged financial infrastructure will stay intact, only a fool would deny the possibility that things could spin horribly out of control.
Fiscal precautionary principle. Those who believe that global warming might represent an existential threat to humanity concede that the future is unknowable but they invoke the precautionary principle: If there is a reasonable chance that the global climate could spin out of control, we should make every exertion to avert the possibility. I would invoke the precautionary principle for national finances. We must take precautions. Failure to do so could lead to Great Depression-level calamity.
Personally, I have no confidence that our gridlocked political system in Washington, D.C., will enact the painful changes needed to avert a fiscal meltdown, so I don’t even bother to address the miscreants there. But I still have hope that state and local politicians are accessible to reason. Our goal in Virginia should be to create an oasis of stability capable of riding out Boomergeddon, should it come. But the clock is running out. We need to get serious. We need to start now.
