The U.S. Debt Crisis: How It Happened and What Can Be Done Updated Nov 2012

The U.S. Debt Crisis: How it Happened and What Can be Done Updated Nov 2012

Pat Obi

1 OUTLINE

1. 2007 Mortgage crisis 2. Federal budget 3. Debt buildup 4. The debt crisis 5. Failed attempts by Congress 6. Suggested path to debt elimination Pat Obi, Purdue University Calumet 2 Perspective…

Our total debt as of …

June 2002 = $6.13Tr [as % of GDP: 60%] GDP = Gross Domestic Product, measure of the size of our economy. A Debt/GDP ratio of 100% means we owe as much as we produce. June 2012 = $15.86Tr [as % of GDP: 103%] Pat Obi, Purdue University Calumet 3 When the bottom fell out…

2007 Mortgage Crisis 2008 Financial Crisis

Pat Obi, Purdue University Calumet 4 Median Home Price: 1990-2008 Data source: U.S. Census. www.census.gov/const/uspricemon.pdf

$280,000

$260,000 g = 60% $240,000 $220,000

$200,000 g = 17%

$180,000 g = 9% $160,000 Focus Point $140,000

$120,000

$100,000

Jul-94 Jul-90 Jul-91 Jul-92 Jul-93 Jul-95 Jul-96 Jul-97 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08

Jan-91 Jan-98 Jan-90 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

Pat Obi, Purdue University Calumet 5 Household Debt v. Disposable Income (in billions of $)

16,000 The level and rate of growth of household Household Debt 14,000 debt exceeded how much American g = 11% households earned in income during the 12,000 6-year period before the housing market 10,000 collapse in 2007. 8,000 6,000 Disp. Income g = 5% 4,000

2,000

1980 1993 2006 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2007 2008 1981

Sources: Bureau of Economic Analysis (income); Federal Reserve Flow of Funds (household debt) What went wrong between 2000 and 2007 1. Steep jump in household debt to $14Tr 2. Decline in mortgage underwriting standards 3. Rising default risk in the mortgage market 4. Complex Wall Street financial derivatives 5. Unsustainable home and stock price levels

• 2008 Stock market plunge = -40% • Household wealth loss of > $13Tr, 2007-2008 • Financial crisis – from 2008

Pat Obi, Purdue University Calumet 7 My scholarly contributions with respect to the 2008 Financial Crisis

• Obi, Pat, Jeong-gil Choi, and Shomir Sil (2010). “A Look Back at the 2008 Financial Crisis: The Disconnect between Credit and Market Risks,” Czech Journal of Economics and Finance. 60(5): 400-413.

• Obi, Pat, Saul Lerner, and Shomir Sil (2010). “The 2008 Global Financial Crisis: A Discussion of Causes, Consequences, and Remedies,” Journal of Global Commerce Research, 2(4): 1-11.

• Obi, Pat, Paolo Miranda, and Shomir Sil (2011). “An Inquiry into the Time Series Dynamics of Short-Term Interest Rates and Stock Returns,” Journal of Business and Economic Studies, 17(1): 16-28.

• Obi, Pat, Job Dhubihlela, and Jeong-Gil Choi (forthcoming 2012). “Equity Market Valuation, Systematic Risk, and Monetary Policy,” Applied Economics.

Pat Obi, Purdue University Calumet 8 Government bailouts = National debt

SIGNED BAILOUT LEGISLATION DATE BY AMOUNT 1. Econ Stimulus Act, 2008 2/13/2008 Bush $152B

2. Emergency Econ Stabilization Act , 2008 9/28/2008 Bush $700B 3. American Recovery and Reinvestment Act, 2009 2/17/2009 Obama $787B

TOTAL $1.6Tr9

A Look at our Federal Budget

Pat Obi, Purdue University Calumet 10 Tax Receipts – Fiscal Year 2011 ($Billions)

Source:Pat Obi, CBO Purdue HistoricalUniversity Calumet Tables 11 Spending – Fiscal Year 2011 ($Billions)

Pat Obi, Purdue UniversitySource: Calumet CBO Historical Tables 12 Budget Deficits and Surpluses (bill of $) Source: CBO and OMB

4000

Bush Jr 3000 Carter -$3,537 -$253B Bush Sr Clinton -$1,036B $63B Reagan -$1,412B 2000 Spending

1000 Revenues Obama -$3,689

1982 1999 1976 1977 1978 1979 1980 1981 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

-1000 Deficit (negative) means Federal government Deficit/Surplus spent more money than was received in tax

-2000 revenues. Surplus is the opposite.

Our National Debt

Pat Obi, Purdue University Calumet 14 U.S. National Debt since 1790 Data source: Department of the Treasury

16,000,000,000,000 Our national debt rose sharply after 14,000,000,000,000 1980, and has continued to rise steadily since then. 12,000,000,000,000

10,000,000,000,000

8,000,000,000,000

6,000,000,000,000

4,000,000,000,000

2,000,000,000,000

1800 2005 1790 1795 1805 1810 1815 1820 1825 1830 1835 1840 1845 1850 1855 1860 1865 1870 1875 1880 1885 1890 1895 1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2010 15 U.S. Debt in Recent Years ($ Tr) Source: Department of the Treasury

16,000,000,000,000

14,000,000,000,000

Carter (D) Reagan (R) Bush Sr (R) Clinton (D) Bush Jr (R) 12,000,000,000,000 $206B $1.44Tr $1.06Tr $1.71Tr $3.57Tr 33% 159% 41% 42% 63%

10,000,000,000,000 Dessert - Cruise and Storm $500B stimulus in Obama (D) Pershing missiles 8,000,000,000,000 (Iraq) 1993 to fight $4.92Tr - Star wars recession - Reduced tax 46% rates but 6,000,000,000,000 eliminated many - $800B personal tax stimulus deductions - Two separate - War on

4,000,000,000,000 tax rebates Terror - War on Terror (Iraq + (Iraq) Afghan.) - TARP ($700B) 2,000,000,000,000

1996 2008 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2009 2010 2011 1976 16 The National Debt Components

1. Intragovernmental debt: Money borrowed from other government agencies, e.g. Social Security Trust Fund (SSTF) and Medicare Trust Fund (MTF)

2. Federal Reserve. Money borrowed from the Fed.

3. Debt held by the public: Money borrowed from U.S. citizens, foreigners, corporations, state and local governments, and others.

Pat Obi, Purdue University Calumet 17 Our Money Lenders Source: U.S. Department of Treasury, Ownership of Federal Securities, Table OFS-2: www.fms.treas.gov/bulletin/b2012_3ofs.doc Secondary source: http://www.gao.gov/special.pubs/longterm/debt/debtbasics.html Total Federal Debt = $15.6Tr [March 2012]

Intra-govt + Fed = $6.4Tr Foreigners = $5.14Tr [41%] [33%]

U.S. investors = $4.05Tr

[26%] Pat Obi, Purdue University Calumet 18 Our Money Lenders? Source: U.S. Department of Treasury, Ownership of Federal Securities, Table OFS-2: www.fms.treas.gov/bulletin/index.html Secondary source: http://www.gao.gov/special.pubs/longterm/debt/debtbasics.html

7,000

6,000

Intra-gov + Fed Res 5,000

4,000 Foreign investors 3,000 U.S. Investors

2,000 Debt Ownership (in billions of$) billions (in Ownership Debt Foreigners now lend more to the 1,000 U.S. government than Americans

Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10

Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10

Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Pat Obi, Purdue University Calumet 19 U.S. International Trade Source: US Census Bureau, Foreign Trade Division. www.census.gov/foreign-trade/statistics/historical/index.html Source file: “US Intl Trade” in Research folder

3,500,000 We buy more from other countries (mostly 3,000,000 China) than they buy from us. That creates Imports 2,500,000 a ‘current account deficit.’ Foreigners then use their surplus $$$ to buy U.S. Treasury 2,000,000 bonds (meaning they lend the $$$ right back to our government – so as to earn

1,500,000 interest on their surplus funds)

1,000,000

Millions of $ of Millions 500,000 Exports

1960 1982 2004 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2006 2008 2010

-500,000

-1,000,000 Current account balance

-1,500,000 20 The Big Question…

Has our debt reached a crisis point?

• One way to consider this question is to line up our debt against our nation's ability to pay

• The ability to pay is tied to the size of our economy – measured by GDP

Pat Obi, Purdue University Calumet 21

Our Economy

Pat Obi, Purdue University Calumet 22 U.S. Economy since Market Crash of 1929 (bill of $) Source: Department of Commerce

18,000

16,000 14,000 Our economy has grown steadily over the years – on average, about 6% per GDP 12,000 year since after WWII - until the housing market collapse in 2007.

10,000

8,000

6,000

4,000

2,000

1977 1989 2001 1931 1933 1935 1937 1939 1941 1943 1945 1947 1949 1951 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1979 1981 1983 1985 1987 1991 1993 1995 1997 1999 2003 2005 2007 2009 2011 1929 23 GDP Contribution by Recent U.S. Presidents (bill of $) Source: Department of Commerce

16,000

14,000 Carter (D) Clinton (D) Reagan (R) Bush Sr (R) $0.76Tr $3.3Tr $1.97Tr $0.86Tr 12,000 27% 33% 39% 14% Obama (D) $2Tr 10,000 12% Bush Jr (R) $4Tr 8,000 28%

6,000

4,000 Our GDP fell sharply in 2009

2,000 owing to the financial crisis.

1983 1991 1999 1978 1979 1980 1981 1982 1984 1985 1986 1987 1988 1989 1990 1992 1993 1994 1995 1996 1997 1998 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1977 24 Looking at our National Debt v. GDP through the years The only time our debt grew to more than 25,000 100% of GDP was right after WWII. But that 140 was due to the Marshall Plan. Debt as % of GDP 120 20,000

100

15,000

GDP %

to -

60 Debt GDP Billions)($ 10,000

5,000 GDP ($ Billions) 20

0 0

Pat Obi, Purdue University Calumet 25

1939 1966 1993 1900 1903 1906 1909 1912 1915 1918 1921 1924 1927 1930 1933 1936 1942 1945 1948 1951 1954 1957 1960 1963 1969 1972 1975 1978 1981 1984 1987 1990 1996 1999 2002 2005 2008 2011 2014 Year Debt (bill$) GDP(bill$) Debt/GDP President 1981 997.86 3,127 11% 32% Reagan 1982 1,142.03 3,253 4% 35% 1983 1,377.21 3,535 8% 39% 1984 1,572.27 3,931 11% 40% 1985 1,823.10 4,218 7% 43% 1986 2,125.30 4,460 6% 48% 1987 2,350.28 4,736 6% 50% 1988 2,602.34 5,100 7% 51% 19% 1989 2,857.43 5,482 7% 52% Bush, Sr. 1990 3,233.31 5,801 6% 56% 1991 3,665.30 5,992 3% 61% 1992 4,064.62 6,342 6% 64% 12% 1993 4,535.69 6,667 5% 68% Clinton 1994 4,800.15 7,085 6% 68% 1995 4,988.66 7,415 5% 67%

under each president, president, under each 1996 5,323.17 7,839 6% 68%

– 1997 5,502.39 8,332 6% 66% 1998 5,614.22 8,794 5% 64% 1999 5,776.09 9,354 6% 62% 2000 5,662.22 9,952 6% 57% -11% 2001 5,943.44 10,286 3% 58% Bush, Jr. 2002 6,405.71 10,642 3% 60%

2003 6,997.96 11,142 5% 63%

% of our GDP GDP of % our since1981. This shows how much our debt grew as a a as much debt our how grew shows This 2004 7,596.14 11,853 6% 64% 2005 8,170.42 12,623 6% 65% 2006 8,680.22 13,377 6% 65% 2007 9,229.17 14,029 5% 66% 2008 10,699.80 14,292 2% 75% 17% 2009 12,311.35 13,939 -2% 88% Obama 2010 14,025.22 14,527 4% 97% 2011 15,222.94 15,094 4% 101% 26 2012 15,620.33 15,776 4% 99% as of March 11% Debt as % of GDP since after WWII

Between 1953 and 2012, Rep administrations added 30 percentage points to the national debt/GDP ratio. Dem administrations subtracted 17 percentage points from that ratio.

Pat Obi, Purdue University Calumet 27

The Debt Crisis

Pat Obi, Purdue University Calumet 28 Federal Government Revenue and Spending (% of GDP) Sources: Congressional Budget Office; Office of Management and Budget Year Revenues www.cbo.gov/publication/21999 Spending 1993 17.5 21.4 1994 18.0 21.0 1995 18.4 20.6 How much we 1996 18.8 20.2 collect in tax revenue has fallen 1997 19.2 19.5 Clinton as % of GDP. 1998 19.9 19.1 Correspondingly, 1999 19.8 18.5 government 2000 20.6 18.2 spending has risen

2001 19.5 18.2 sharply as % of 2002 17.6 19.1 GDP. The 2003 16.2 19.7 combination of these two facts has led to 2004 16.1 19.6 widening budget Bush Jr. 2005 17.3 19.9 deficits (next slide) 2006 18.2 20.1 and therefore, 2007 18.5 19.6 growing national 2008 17.5 20.7 debt. 2009 14.9 25.0 Obama 2010 14.9 23.8 29 2011 14.8 24.7 Tax Revenue and Government Spending (% of GDP) Sources: Congressional Budget Office; Office of Management and Budget

Obama 26 Carter Reagan Bush Sr Clinton Bush Jr 24

Outlays

This gaping gaping This hole is our our hole is debtcrisis!!!

16 Revenues

1983 1997 1977 1978 1979 1980 1981 1982 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 1976 30 www.cbo.gov/publication/21999 Failed Attempts to Resolve the Debt Crisis 1. Bowles-Simpson Commission (empanelled 2/18/10) – $4T in savings over 10 years – Failed to pass committee stage (required supermajority of 14/18 votes ; 11 were in favor) 2. Obama-Boehner ‘grand bargain’ (summer 2011) – Spending cut $3.5T + $1T in revenue increase (total of $4.5Tr) over 10 years – On 7/22/11, Boehner pulled out; did not want tax increase 3. Budget Control Act of 2011 (passed 8/2/11) – Only $1Tr in cuts; no revenue increase – Additional automatic $1.2Tr, if no budget agreement by Jan 2013 (this is the so-called “fiscal cliff”)

Pat Obi, Purdue University Calumet 31 National Embarrassment…

• Friday, August 5, 2011. S&P downgraded U.S. credit rating from AAA to AA+

• Stock market plunges 7% next day! • Financial markets were unhappy with the failed attempts

Pat Obi, Purdue University Calumet 32 Many other industrialized economies face Debt as % of GDP Around the World mounting debt problems! Global Finance: www.gfmag.com/tools/global-database/economic-data/10394-public-debt-by-country.html#axzz1nRkIi2W5 Country 2006 2007 2008 2009 2010 2011 2012 (est) 2013 (est)) 1 Estonia 8.0 7.3 8.5 12.7 12.5 12.3 13.1 13.0 2 Australia 15.5 14.4 13.7 19.4 23.6 26.8 27.9 27.9 3 Luxembourg 11.5 11.3 18.3 18.0 24.5 28.2 30.9 34.6 4 Korea 28.5 28.7 30.4 33.5 34.6 35.5 36.3 36.8 5 Switzerland 50.2 46.8 43.6 43.7 42.6 42.0 41.2 40.7 6 Sweden 53.9 49.3 49.6 52.0 49.1 46.2 45.3 43.1 7 New Zealand 26.6 25.7 28.9 34.4 37.8 44.1 47.6 50.2 8 Czech Republic 32.6 31.0 34.4 41.1 44.5 47.1 48.7 49.7 9 Norway 59.4 57.4 55.0 49.1 49.7 56.5 51.3 48.6 10 Slovak Republic 34.1 32.9 31.8 40.0 44.8 49.8 53.4 55.3 11 Denmark 41.2 34.3 42.6 52.4 55.6 56.1 58.0 58.2 12 Slovenia 33.8 30.7 30.4 44.3 48.4 53.7 58.1 61.0 13 Poland 55.2 51.7 54.4 58.5 62.4 64.9 65.4 64.7 14 Finland 45.6 41.4 40.4 51.6 57.6 61.2 65.5 68.5 15 Israel* 84.7 78.1 77.0 79.4 76.0 74.6 73.8 72.4 16 Netherlands 54.5 51.5 64.8 67.4 70.6 72.5 75.3 76.9 17 Spain 46.2 42.3 47.7 62.9 67.1 74.1 77.2 79.0 18 Austria 66.4 63.4 68.4 74.4 78.2 79.9 81.9 83.2 19 Germany 69.8 65.6 69.7 77.4 87.1 86.9 87.3 86.4 20 Hungary 72.4 73.4 77.0 86.7 86.9 89.8 90.8 91.5 21 Canada 70.3 66.5 71.1 83.4 85.1 87.8 92.8 96.6 22 United Kingdom 46.0 47.2 57.4 72.4 82.2 90.0 97.2 102.3 23 Belgium 91.6 88.0 93.0 100.0 100.2 100.3 101.5 101.0 24 France 71.2 73.0 79.3 90.8 95.2 98.6 102.4 104.1 25 United States 60.9 62.1 71.4 85.0 94.2 97.6 103.6 108.5 26 OECD-Total 74.6 73.3 79.7 91.4 97.9 101.6 105.7 108.4 27 Ireland 29.2 28.7 49.6 71.1 98.5 112.6 118.8 122.4 28 Portugal 77.6 75.4 80.7 93.3 103.6 111.9 121.9 123.7 29 Iceland 57.4 53.3 102.1 119.8 125.0 127.3 127.4 126.2 30 Italy 116.9 112.1 114.7 127.1 126.1 127.7 128.1 126.6 31 Greece 116.9 115.0 118.1 133.5 149.1 165.1 181.2 183.9 33 32 Japan 172.1 167.0 174.1 194.1 200.0 211.7 219.1 226.8

The Path to Debt Elimination [my contribution]

This part of the presentation is slightly technical. You may find it more helpful to watch the following YouTube video to fully understand the argument: www.youtube.com/watch?v=1NdeJSqwJ7w Pat Obi, Purdue University Calumet 34 Step 1. Set max debt/GDP goal (based on historical GDP growth rate) • Avg annual GDP growth rate (1980-2006) ≈ 6% • Avg annual Debt/GDP ratio (1980-2006) ≈ 60%

Using this approach: • Based on 2011 GDP of $15T • Max debt level should be $9T (i.e. 0.6 x $15) • But 2011 debt level was $15.22T • Giving us excess debt of $6.22T (i.e. $15.22 - $9) Step 2. Set spending and revenue levels to fit within the debt ceiling Pat Obi, Purdue University Calumet 35 • Focus: Bowles-Simpson 2010 debt reduction plan – Spending cut = $3T – Revenue increase = $1T – Combined savings of $4 trillion spread over 10 years – Min spending cut = $300B / year – Min revenue increase = $100B / year – Approach is also consistent with recommendation of the Debt Reduction Task Force set up by the Bipartisan Policy Center (which Called for a national “debt reduction sales tax”)

Pat Obi, Purdue University Calumet 36 Using our 2012 budget components as a starting point… Revenues Amount % of Total Individual income taxes $1,128 44% Corporate income taxes 279 11% Social insurance taxes 943 37% Other revenues 205 8% Total revenues $2,555 100%

Outlays Mandatory spending $2,038 56% Discretionary spending 1,352 37% Net interest 264 7% Total outlays $3,655 100%

Deficit (-) or Surplus -$1,100

Source: Congressional Budget Office (CBO’s Baseline Budget Projections) 37 • Begin with total outlay of $3.655Tr • Then reduce spending by $300B per year • Adjust each budget item based on its % contribution to budget • Correct for inflation and place selected limits, e.g. mil and Medicare

Unadjusted Deficit Adjusted Year Spending Reduction Spending 2012 $3,655 $3,655 1 3,655 $300 3,355 2 3,355 300 3,055 3 3,055 300 2,755 4 2,755 300 2,455 5 2,455 300 2,155 6 2,155 300 1,855 7 1,855 300 1,555 8 1,555 300 1,255 9 1,255 300 955 10 955 300 655 38 Ten-Year Spending Projections ($ billions)

Mandatory Spending Items

Year Social Medicare/ Other Net Defense Discretionary Security Medicaid Mandatory Interest 19% 19% 20% 23% 12% 7%

2012 + 694 694 731 841 439 256 1 637 637 671 903 403 256 2 580 580 611 970 367 256 3 523 523 551 1,041 331 256 4 466 466 491 1,118 295 256 5 409 409 431 1,201 259 256 6 400 400 500 1,290 300 256 7 400 400 500 1,386 300 256 8 400 400 500 1,488 300 256 9 400 400 500 1,598 300 256 10 400 400 500 1,717 300 256 + Base year is 2012 Pat Obi, Purdue University Calumet 39 Ten-Year Revised Budget, Debt, and GDP Projections ($ billions) Projected Projected Total Revenue GDP Year Net New Adjusted (3% growth Deficit/ Total (growth Debt- Interest Spending +$100B/yr) Surplus Debt rate = 3%) to-GDP

2012 - - $2,555 -$1,100 $15,223 $15,693 97% 1 - $3,507 2,732 -776 15,998 16,164 99% 2 $21 3,385 2,914 -471 16,470 16,649 99% 3 21 3,247 3,101 -146 16,616 17,148 97% 4 21 3,114 3,294 180 16,435 17,663 93% 5 21 2,987 3,493 506 15,929 18,192 88% 6 21 3,167 3,698 531 15,398 18,738 82% 7 21 3,262 3,909 646 14,752 19,300 76% 8 21 3,365 4,126 761 13,992 19,879 70% 9 21 3,475 4,350 874 13,117 20,476 64% 10 21 3,593 4,580 987 12,130 21,090 58% 40 Takeaways… 1. Uncontrolled debt buildup began in early 1980s 2. National debt reached a crisis point in 2010 due to: – Huge spending increases (from 19% to 25% of GDP) – Drastic tax revenue reductions (from 20% to < 15% of GDP) 3. My proposed solution: Peg debt to GDP – E.g. set long-term debt target no more than 60% of GDP – Then set budget limits: spending (ceiling) and revenue (floor) 4. There should be a national conversation on – Social Security - cuts – Medicare - cuts – Comprehensive tax reform to get rid of loopholes and simplify tax code – Corporate taxation (Focus on a corporate tax system that stimulates growth)

Pat Obi, Purdue University Calumet 41 DISCLAIMER

The material in this presentation is based on information that I considered reliable at the time of my data collection. I do not warrant that it is accurate or complete. It should therefore not be relied upon as such.

Pat Obi, Purdue University Calumet 42 The U.S. Debt Crisis

Thank you!

Questions? Please email me at [email protected] Pat Obi, Purdue University Calumet 43