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Worried About The Size of The Federal Debt? There’s Another Number That Should Really Scare You.

Fat Chance - Banks Take Responsibility for the Financial Crisis by Michael Smith via Flikr

$53 trillion.

More than THREE TIMES the entire federal debt.

According to Saturday’s New York Times, that’s the amount of money currently held by US-based “too-big-to-fail” financial institutions.

“Too-big-to-fail” has been around for a while.  It dates back to the Reagan administration’s takeover of Continental Illinois National Bank and Trust Company, which was then the seventh-largest US bank.

And it’s been a growing problem ever since.

Here’s why: “TBTF” distorts the economy.  In theory, in a capitalist economy, there should be a relationship between risk and reward.  In theory, people who can’t afford to lose their money will chose “safe” investments, even though they have a lower rate of return; and even those people who can afford to lose money will take fewer risks.

But that’s only in theory.  In reality, TBTF has separated “risk” from “reward”.  The financial industry is now operating on the belief that if the loss is big enough, the government will step in.

It’s sort of like insurance… only, the financial industry doesn’t have to pay for it.

A year and a half ago, one Federal Reserve Bank economist estimated the TBTF effect is worth between $450 and $900 billion a year.

“The existence of the implicit subsidy enabled these companies to become larger and more complex than otherwise would have been the case. TBTF institutions respond to the subsidy by increasing their risk through either engaging in riskier activities or increasing their leverage. While these actions may be privately optimal, the response to the TBTF subsidy is not socially optimal, as it can pose huge risks to the financial system.”

(Gotta love that economist-speak…“Not socially optimal,” indeed.)

Even since the 2007 Wall Street meltdown, financial institutions have continued to take advantage of their TBTF status.  TBTF institutions are still getting bigger and taking more risks.  Here’s how Forbes described the situation last year:  “Banks today are bigger and more opaque than ever, and they continue to trade in derivatives in many of the same ways they did before the crash, but on a larger scale and with precisely the same unknown risks.”

And now, a half-decade after the bailout, the TBTF institutions are worth $53 trillion.

So why am I comparing the size of the financial industry with the size of the federal debt?

I was trying to figure out the current level of taxpayer exposure, in this “not socially optimal” arrangement.  In other words: if the financial industry implodes again, how much government money is it going to cost us?  And I figured the best way to figure that out was to look at what happened in the most-recent TBTF bailout.

As near as I could figure, from what’s easily available on the Internet: back before the 2007 meltdown, TBTF institutions were worth a total of about $2 trillion.  The 2008 bailout bill appropriated $700 billion to deal with the crisis — or, roughly one-third of the total value of TBTF institutions, before they started to fail.

The federal budget was already running a deficit.  That means: in order to fund the bailout, Congress had to borrow an amount equal to one-third of the pre-crisis value of those TBTF institutions (using my “as near as I can figure” estimate).

But those TBTF institutions are bigger now; and that means if they fail, any federal government bailout would need to be bigger, too.

TBTF are now worth $53 trillion. Do the math.  If there is another Wall Street meltdown; and another bailout; and this next bailout also requires the government to borrow an amount equal to one-third of what TBTF institutions are worth now…

Well…one-third of $53 trillion is…almost exactly the current amount of the federal debt.

In other words, the next financial meltdown could double the national debt.

Are you scared yet?

Starting in Detroit… next stop: Social Security

Frederick Bancroft, prince of magicians: the wizard's enchantments, performing arts poster, ca. 1895Buried on the PBS website, there is a blog post that ought to strike fear into the heart of every working-age American.

“Detroit Today, Washington Tomorrow” takes dead aim at the Social Security system, using the same “inflate the numbers” messaging strategy that Kevyn Orr and Gov. Rick Snyder have been using lately in Detroit.

What’s the strategy?

  1. Just pick the biggest number that you can find, and use it to scare the bejeezus out of people.
  2. Once you’ve got folks focused on that huge number, it’s easy to convince them that “oh, we’re so sorry! But Detroit can’t afford to pay the retirement benefits we’ve been promising all these decades.”
  3. Nevermind that all those Detroit workers have been paying into the system, all these decades, and planning their futures based on the promises that were made.
  4. Just keep everyone’s eyes focused on that really huge number – and they won’t even think about questioning your claim that “oh, so sorry! We can’t afford it!”

It’s the rhetorical equivalent of old-fashioned magic tricks.  And just like those old-fashioned magic tricks, it will work so long as people don’t pay attention to what’s really going on.

In Detroit, they’re hiding a $326 million accumulated deficit under the rhetorical handkerchief of $18 billion in total outstanding debt.  They’re basically saying: “don’t look at that smaller deficit number (caused by cutbacks in state revenue-sharing) – look at this huge number over here!  Look at how much Detroit is supposed to pay bondholders back, over the next 30 years!  Look here, Detroit can’t afford to pay back $18 billion right now!  (Nevermind that it’s not supposed to be paid back, for decades yet.)  Look here, if we can’t afford to pay back $18 billion, then we should declare bankruptcy and get rid of the debt (that we owe to our public employees).  We just can’t afford to keep our promises!”

Can’t you just hear the calliope music?   (If not, here’s a YouTube to help get you into a properly gullible mood.)

Now, read that PBS post by Boston University professor (and presidential candidate) Larry Kotlikoff.

  1. All of a sudden, our federal debt isn’t just $12 trillion (the number that outrages Republicans, as long as nobody suggests increasing taxes to pay it back). According to Professor Kotlikoff, “the true measure of our debt – the one suggested by economic theory – is the fiscal gap, which totals $222 trillion.”
  2. Now, keep looking at this number over here – it’s really, really huge.  According to Professor Kotlikoff, “Given the $222 trillion fiscal gap … current policy is clearly not sustainable. Making it sustainable requires either an immediate and permanent 64 percent increase in all federal taxes or an immediate and permanent 38 percent cut in all spending or some combination of tax increases and spending cuts.”
  3. Nevermind all those decades that workers have been paying into the Social Security system. Again, here’s Professor Kotlikoff: “If anything, the Social Security benefits, and not the Treasury bond payments, should be recorded as official debt.”
  4. Keep folks paying attention to that really big number.  Professor Kotlikoff borrows the authoritative voice of former Secretary of State George Shultz to finish his performance: “Our country doesn’t have a lot of elder statesmen to guide us. But this tough ex-marine knows our country is broke, knows our children are threatened, and knows we’ve been hiding the truth.”

Yep, that’s where things are headed.  Detroit today, Washington tomorrow.

They’ve been trying to “reform” Social Security since Barry Goldwater ran for President.

And they’re still trying.

And they’re about to have the biggest Congress-created crisis yet.

  • Read about January’s Fiscal Cliff crisis here and here.
  • Read about the March Sequestration crisis here and here.

There is another “perfect storm” of crises coming up in the next two months: the current federal budget will expire at about the same time that the Treasury runs out of debt limit “headroom” (again, thank our federal and postal service employees, whose retirement contributions provide this reprieve!).

What sorts of magic tricks do you think they’re going to try, then?

Detroit today, Washington tomorrow.

My recommendation?  Remember Professor Kotlikoff’s patter, and keep your eyes on the magicians’ hands.

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Read the LTE in response to this post.

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