Sunday, November 23, 2008

David Walker in Fortune Magazine

It appears I.O.U.S.A. [Aug 7: I.O.U.S.A. Movie Trailer] was not quite the hit that Quantum of Solace was - shocking, indeed. Warren Buffet just does not fill seats the way Al Gore does...

As we look into the deep future [Nov 12: CNBC Europe: USA May Lose its AAA Rating] errr... as we look to address emergencies around us in the immediate now while kicking the can down the pebble road on our long term issues - there is one man who has been sounding the alarm bell for a decade now. However, since he has not appeared in Ocean's Eleven he is not getting much play except for people in my type of circles. But Mr Walker wrote a nice piece in last week's Fortune Magazine so we'll keep touting this until the day the healthcare entitlements of the country swallow up say 1 out of every 2 dollars of GDP - then as usual we'll begin to "address it" - reactive, not proactive - that's us! Sure it will cost 20x what it would to address it now, but we only deal in the here and now. Keep in mind, while this has none of the attention I think it will actually be a more destructive force than what we are going through now if left unchecked - which is saying a lot considering the damage we're taking today.
  • Staring into the abyss always focuses the mind, which can help you avoid falling in. So let's take a look at the potential catastrophe that awaits us once we survive our current crisis.
  • At the dawn of the 21st century the U.S. had $5.7 trillion in total debt. As we approach the end of George W. Bush's presidency only eight years later, that sum has nearly doubled, thanks to war costs, tax cuts, spending increases, expanded entitlement programs, and now a welter of government bailouts and rescues.
  • Yet any such calculations are penny ante compared with the fiscal disaster that is bearing down on America. It's no longer an event in the misty future. The entitlements due from Social Security and Medicare present us with that frightening abyss. The costs of these current programs, along with other health-care costs, could bankrupt our country. The abyss offers no assets, troubled or otherwise, to help us cross it.
  • Yes, some have suggested less-than-revolutionary measures that could help. Among them: budget savings that would accrue from repealing the Bush-era tax cuts, ending the Iraq war, or expanding the economy after the current downturn runs its course. But even if the economy were to grow at the level of 3.2% a year, as it did in the 1990s, and these other savings were achieved, they wouldn't come close to addressing our federal financial problem.
  • The costs of these programs start to threaten our solvency in the next several years. The only way to get across the chasm is to begin making tough choices now to change our current course. Delay will make the problem worse. (but delay we will...until the couch we are sitting on is burning we won't touch it )
  • In fact, the deteriorating financial condition of our federal government in the face of skyrocketing health-care costs and the baby-boom retirement could fairly be described as a super-subprime crisis. It would certainly dwarf what we're seeing now.
Now for the fun part - facts and figures
  • The U.S. Government Accountability Office (GAO), noting that the federal balance sheet does not reflect the government's huge unfunded promises in our nation's social-insurance programs...(fact)
  • ....estimated last year that the unfunded obligations for Medicare and Social Security alone totaled almost $41 trillion. That sum, equivalent to $352,000 per U.S. household, is the present-value shortfall between the growing cost of entitlements and the dedicated revenues intended to pay for them over the next 75 years. (figures)
So how did we get here?
  • Besides its gigantic scale, there are very disturbing similarities between the current mortgage-related crisis and our next potential disaster.
  • First, like the securitized investment vehicles that blew up, federal programs were launched without adequately thinking through who would bear the ultimate cost and related risk (shocker) Just as originators of mortgages let themselves off the hook by unloading packages of dubious loans onto others, lawmakers have increased spending, expanded entitlement programs, and cut taxes while expecting future generations to pay the bill. (every decision in America is now made on a political re-election timetable - how many goodies can I give away in 2 to 6 years - I'll be long retired before someone actually has to pay for my decisions)
  • Second, just as a lack of transparency associated with mortgage-backed securities resulted in big surprises and large losses for investors, our nation's huge off-balance-sheet obligations for Social Security and Medicare present a threat wrapped in camouflage. After all, the government's "trust funds" don't really provide much security since they don't hold anything but more government debt. (I love off balance sheet accounting - it did in Enron, our banks engaged in it, and now our federal government does it - it's a national pasttime... I mean it's been working out great so far, why change it?)
  • Third, in the same way that private sector "risk management" executives failed to prevent the subprime mortgage crisis, overseers in Congress and the executive branch have turned a blind eye to costs associated with entitlement programs and tax cuts. While lax regulation of banks fed the current subprime crisis, a lack of statutory budget controls has led to a widening gap between the government's revenues and costs.
  • At the heart of these problems is our leaders' collective failure to act in the face of known challenges. Our country has veered from its founding principles, which held to individual responsibility and accountability today in order to create more opportunity tomorrow. When our constitution was written, the concepts of thrift and prudence were no less at the center of the American spirit than liberty and justice.
  • During past financial crises and wars, the government went into debt because our nation's survival was at stake. What has changed is that piling up debt has become business as usual, even during times of prosperity. (all debt, all the time)
  • 2040 we are projected to see debt as a percentage of our economy that is double the record set at the end of World War II. Based on GAO data, balancing the budget in 2040 could require us to cut federal spending by 60% or raise overall federal tax burdens to twice today's levels. (sounds reasonable - considering about 2/3rds of our spending is in "untouchable" category)
  • Medicare, Medicaid, and Social Security already account for more than 40% of the total federal budget. And their portion of the budget is expected to grow so fast that their cost, and the cost of servicing our debt, will soon crowd out vital programs, including research and development, critical infrastructure, education, and even national defense. (those latter programs are not needed... who needs education when we can build 1 hospital every 500 yards? the shop and nurse economy - circa 2040 - even better the worse our infrastructure the more accidents we have - which leads to more of a need for healthcare - it's a virtuous cycle!)
  • Like homeowners borrowing against the value of their homes in the expectation that the values would go up forever, the American government borrowed against the future and assumed that the economy would grow fast enough to make that debt affordable. (so individuals in the country act like their leadership... hmm.... )
  • But our national debt is not limitless, and our foreign lenders are not fools.
  • These problems are not beyond our ability to master them. Social Security can be made sustainable and secure with some modest changes over time in retirement benefits, the retirement age, and the tax structure, as Republicans and Democrats did in the early 1980s.
  • As for Medicare, there are a number of good ideas that would introduce more cost sharing for the wealthy, increased competition, better cost controls, more use of technology, and other steps to curb the growth of health-care spending.
Again, social security is a drop in the bucket compared to Medicare. Should be an interesting few decades ahead - look for means testing, rationing of healthcare, older ages before getting into the program and the like. That would be IF we start working on it now. If not, just look for the national bankruptcy and we'll just promise our creditors it was a "Black Swan" event and it won't ever happen again - we promise. Our word is our bond. Speaking of bonds - would you like to buy any Mr China?

[Jul 28: US Budget Deficit to Half a Trillion]
[May 23: David Walker on CNCB this Morning]
[Mar 26: Annual Spring Entitlement Warning Falls on Deaf Ears]

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