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If
you've ever had to deal with teenagers or IT workers, you know the drill:
whatever they tell you something will cost usually turns out to be less --
often much less -- than you end up paying. Politicians, too, are especially
good at this game, which is not surprising given that most don't expect to be
around when the final bill comes in. So, in theory at least, no one should be
unsettled by the fact, as the following National
Review commentary, "The Other National Debt," by
deputy managing editor Kevin D. Williamson, reveals, that the amount of money
we (and our ancestors) are currently on the hook for is around ten times
what our leaders say it is -- right?
About
that $14 trillion national debt: Get ready to tack some zeroes onto it. Taken
alone, the amount of debt issued by the federal government — that $14
trillion figure that shows up on the national ledger — is a terrifying,
awesome, hellacious number: Fourteen trillion seconds ago, Greenland was
covered by lush and verdant forests, and the Neanderthals had not yet been
outwitted and driven into extinction by Homo sapiens sapiens, because we did
not yet exist. Big number, 14 trillion, and yet it doesn’t even begin
to cover the real indebtedness of American governments at the federal, state,
and local levels, because governments don’t count up their liabilities
the same way businesses do.
Accountants
get a bad rap — boring, green-eyeshades-wearing, nebbishy little men
chained to their desks down in the fluorescent-lit basements of Corporate
America — but, in truth, accountants wield an awesome power. In the
case of the federal government, they wield the power to make vast
amounts of debt disappear — from the public discourse, at least. A
couple of months ago, you may recall, Rep. Henry Waxman (D., State of
Bankruptcy) got his Fruit of the Looms in a full-on buntline hitch when
AT&T, Caterpillar, Verizon, and a host of other blue-chip behemoths
started taking plus-size writedowns in response to some of the more punitive
provisions of the health-care legislation Mr. Waxman had helped to pass. His
little mustache no doubt bristling in indignation, Representative Waxman sent
dunning letters to the CEOs of these companies and demanded that they come
before Congress to explain their accounting practices. One White House
staffer told reporters that the writedowns appeared to be designed “to
embarrass the president and Democrats.”
A few
discreet whispers from better-informed Democrats, along with a helpful
explanation from The Atlantic’s Megan McArdle under the headline
“Henry Waxman’s War on Accounting,” helped to clarify the
issue: The companies in question are required by law to adjust their
financial statements to reflect the new liabilities: “When a company
experiences what accountants call ‘a material adverse impact’ on
its expected future earnings, and those changes affect an item that is
already on the balance sheet, the company is required to record the negative
impact — ‘to take the charge against earnings’ — as
soon as it knows that the change is reasonably likely to occur,”
McArdle wrote. “The Democrats, however, seem to believe that Generally
Accepted Accounting Principles are some sort of conspiracy against Obamacare,
and all that is good and right in America.” But don’t be too hard
on the gentleman from California: Government does not work that way. If
governments did follow normal accounting practices, taking account of future
liabilities today instead of pretending they don’t exist, then the
national-debt numbers we talk about would be worse — far worse,
dreadfully worse — than that monster $14
trillion–and–ratcheting–upward figure we throw around.
Beyond
the official federal debt, there is another $2.5 trillion or so in state and
local debt, according to Federal Reserve figures. Why so much? A lot of that
debt comes from spending that is extraordinarily stupid and wasteful, even by
government standards. Because state and local authorities can issue tax-free
securities — municipal bonds — there’s a lot of appetite
for their debt on the marketplace, and a whole platoon of local
special-interest hustlers looking to get a piece. This results in a lot of
misallocated capital: By shacking up with your local economic-development
authority, you can build yourself a new major-league sports stadium with
tax-free bonds, but you have to use old-fashioned financing, with no tax
benefits, if you want to build a factory — which is to say, you can use
tax-free municipal bonds to help create jobs, so long as those jobs are
selling hot dogs to sports fans.
Also,
local political machines tend to be dominated by politically connected law
firms that enjoy a steady stream of basically free money from legal fees
charged when those municipal bonds are issued, so they have every incentive
to push for more and more indebtedness at the state and local levels. For
instance, the Philadelphia law firm of Ballard, Spahr kept Ed Rendell on the
payroll to the tune of $250,000 a year while he was running for governor
— he described his duties at the firm as “very little”
— and the firm’s partners donated nearly $1 million to his
campaign. They’re big in the bond-counsel business, as they advertise
in their marketing materials: “We have one of the premier public
finance practices in the country, participating since 1987 in the issuance of
more than $250 billion of tax-exempt obligations in 49 states, the District
of Columbia, and three territories.” Other Pennsylvania bond-counsel
firms were big Rendell donors, too, and they get paid from 35 cents to 50
cents per $1,000 in municipal bonds issued, so they love it when the local
powers borrow money.
So
that’s $14 trillion in federal debt and $2.5 trillion in
state-and-local debt: $16.5 trillion. But I’ve got some bad news for
you, Sunshine: We haven’t even hit all the big-ticket items.
One of
the biggest is the pension payments owed to government workers. And
here’s where the state-and-local story actually gets quite a bit worse
than what’s happening in Washington — it’s the sort of
thing that might make you rethink that whole federalism business. While the
federal government runs a reasonably well-administered retirement program for
its workers, the states, in their capacity as the laboratories of democracy,
have been running a mad-scientist experiment in their pension funds, making
huge promises but skipping the part where they sock away the money to pay for
them. Every year, the pension funds’ actuaries calculate how much money
must be saved and invested that year to fund future benefits, and every year
the fund managers ignore them. In 2009, for instance, the New Jersey
public-school teachers’ pension system invested just 6 percent of the
amount of money its actuaries calculated was needed. And New Jersey is hardly
alone in this. With a handful of exceptions, practically every state’s
pension fund is poised to run out of money in the coming decades. A federal
bailout is almost inevitable, which means that those state obligations will
probably end up on the national balance sheet in one form or another.
“We’re
facing a full-fledged state-level debt crisis later this decade,” says
Prof. Joshua D. Rauh of the Kellogg School of Management at Northwestern
University, who recently published a paper titled “Are State Public
Pensions Sustainable?” Good question. Professor Rauh is a bit more
nuanced than John Boehner, but he comes to the same conclusion: Hell, no.
“Half the states’ pension funds could run out of money by
2025,” he says, “and that’s assuming decent investment
returns. The federal government should be worried about its exposure. Are
these states too big to fail? If something isn’t done, we’re
facing another trillion-dollar bailout.”
The
problem, Professor Rauh explains, is that pension funds are used to hide
government borrowing. “A defined-benefit plan is politicians making
promises on time horizons that go beyond their political careers, so
it’s really cheap,” he says. “They say, ‘Maybe we
don’t want to give you a pay raise, but we’ll give you a really
generous pension in 40 years.’ It’s a way to borrow off the
books.” The resulting liability runs into the trillions of dollars.
Ground
Zero for the state-pension meltdown is Springfield, Ill., and D-Day comes
around 2018: That’s when the state that nurtured the political career
of Barack Obama is expected to be the first state to run out of money to
cover its retirees’ pension checks. Eight years — and
that’s assuming an 8 percent average return on its investments. (You
making 8 percent a year lately?) Under the same projections, Illinois will be
joined in 2019 by Connecticut, New Jersey, and Indiana. If investment returns
are 6 percent, then 31 U.S. states will run out of pension-fund money by
2025, according to Rauh’s projections.
States
aren’t going to be able to make up those pension shortfalls out of
general tax revenue, at least not at current levels of taxation. In Ohio, for
instance, the benefit payments in 2031 would total 55 percent of projected
2031 tax revenues. For most states, pension payments will total more than a
quarter of all tax revenues in the years after they run out of money. Most of
those pensions cannot be modified: Illinois, for instance, has a
constitutional provision that prevents reducing them. Unless there is a
radical restructuring of these programs, and soon, states will either have to
subsidize their pension systems with onerous new taxes or seek a bailout from
Washington.
So how
much would the states have to book to fully fund those liabilities? Drop in
another $3 trillion. Properly accounting for these obligations, that takes us
up to a total of $19.5 trillion in governmental liabilities. Bad, right? You
know how the doctor looks at you in that recurring nightmare, when the test
results come back and he has to tell you not to bother buying any green
bananas? Imagine that look on Tim Geithner’s face right now, because we
still have to account for the biggest crater in the national ledger:
entitlement liabilities.
The
debt numbers start to get really hairy when you add in liabilities under
Social Security and Medicare — in other words, when you account for the
present value of those future payments in the same way that businesses have
to account for the obligations they incur. Start with the entitlements and
those numbers get run-for-the-hills ugly in a hurry: a combined $106 trillion
in liabilities for Social Security and Medicare, or more than five times the
total federal, state, and local debt we’ve totaled up so far. In real
terms, what that means is that we’d need $106 trillion in real,
investable capital, earning 6 percent a year, on hand, today, to meet the
obligations we have under those entitlement programs. For perspective,
that’s about twice the total private net worth of the United States. (A
little more, in fact.)
Suffice
it to say, we’re a bit short of that $106 trillion. In fact,
we’re exactly $106 trillion short, since the total value of the Social
Security “trust fund” is less than the value of the change
you’ve got rattling around behind your couch cushions, its precise
worth being: $0.00. Because the “trust fund” (which is not a
trust fund) is by law “invested” (meaning, not invested) in
Treasury bonds, there is no national nest egg to fund these entitlements. As
Bruce Bartlett explained in Forbes, “The trust fund does not have any
actual resources with which to pay Social Security benefits. It’s as if
you wrote an IOU to yourself; no matter how large the IOU is it doesn’t
increase your net worth. . . . Consequently, whether there is $2.4 trillion
in the Social Security trust fund or $240 trillion has no bearing on the
federal government’s ability to pay benefits that have been
promised.” Seeing no political incentives to reduce benefits, Bartlett
calculates that an 81 percent tax increase will be necessary to pay those
obligations. “Those who think otherwise are either grossly ignorant of
the fiscal facts, in denial, or living in a fantasy world.”
There’s
more, of course. Much more. Besides those monthly pension checks, the states
are on the hook for retirees’ health care and other benefits, to the
tune of another $1 trillion. And, depending on how you account for it,
another half a trillion or so (conservatively estimated) in liabilities
related to the government’s guarantee of Fannie Mae, Freddie Mac, and securities
supported under the bailouts. Now, these aren’t perfect numbers, but
that’s the rough picture: Call it $130 trillion or so, or just under
ten times the official national debt. Putting Nancy Pelosi in a smaller jet
isn’t going to make that go away.
Michael
J. Panzner
Editor, Financialarmageddon.com
Michael J. Panzner is a
25-year veteran of the global stock, bond, and currency markets and the
author of Financial Armageddon: Protecting Your Future from Four Impending
Catastrophes, published by Kaplan Publishing.
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