By Kelly McCutchen
It was not Webvan or Pets.com this time. It was Lehman Brothers, Merrill Lynch, AIG and Wachovia. Gone or sold for pennies on the dollar. It was $700 billion – taxpayer dollars – rushed through Congress to avert the “greatest crisis of our time.” What actually happened, and what can we learn from it?
As pundits increasingly confirm, privatizing profits and socializing losses is no recipe for financial stability. Congress failed to balance the noble goals of encouraging homeownership and affordable housing with the compelling need for financial stability. As economist Russell Roberts explained in The Wall Street Journal, the problem is that “Congress designed Fannie Mae and Freddie Mac to serve both their investors and the political class. Demanding that Fannie and Freddie do more to increase home ownership among poor people allowed Congress and the White House to subsidize low-income housing outside of the budget at least in the short run. It was a political free lunch.” Adding fuel to the fire, Fannie and Freddie magnified their profits (and losses) by leveraging their balance sheet, taking on far more debt than any regulated commercial bank or insurance company.
Las Vegas would have loved the odds on Fannie and Freddie. Bet big on risky loans. If it works, you make big profits. If you lose, taxpayers are stuck with the bill. It was the classic “heads I win, tails you lose” trick.
Investment banks were just as guilty. Also highly leveraged, sometimes as much as 30:1, they created new, complex financial products based on the underlying value of mortgage-backed securities. The key difference is the investment banks were supposedly savvy investors gambling with private money. They made millions while it lasted. They do not deserve sympathy – or rescue – now that their investments have turned sour.
Lesson learned: Excessive debt leaves no margin of error for borrowers or investors. Homeowners who maxed out their credit were unable to make their mortgage payments. Highly leveraged investors faced a liquidity crisis. “Mark to market” accounting rules exacerbated the crisis, creating a domino effect throughout the financial system. In the end, there was no free lunch.
The good news is that much of this crisis is short term. It will be painful, but as liquidity returns to the market, housing prices and stock prices will eventually recover. The bad news is that we have a much more fundamental, long-term problem. In essence, the federal government now has another mortgage crisis on its hands – it has mortgaged our future.
Former Comptroller General of the United States David Walker and others have sounded the warning bells for years. “The federal government – like too many Americans – has become addicted to debt,” Walker says. Our elected officials continue to make big promises even though they know that at some point in the near future, programs such as Social Security and Medicare will begin running massive deficits. Yet, just as with Fannie Mae and Freddie Mac, few leaders have had the courage to call for fiscal restraint and systematic reform. “The current federal fiscal policy has created a disconnect between today’s citizens and future taxpayers,” says Walker. “Baby boomers and current retirees benefit from today’s government spending and tax policies, while our children, grandchildren and generations to come will be expected to pay the bill for today’s excess consumption.”
The enormity of that “excess” is sobering. The future liabilities of the federal government today total $52.7 trillion, according to the U.S. Government Accountability Office (GAO). That’s a whopping $455,000 per household.
Any solution must include substantial cuts in spending and/or increased taxes, but the size of our deficit limits our options. Consider that from 1962 to 2008, federal revenues have averaged 18.2 percent of Gross Domestic Product (GDP). And if we do nothing, federal spending is projected to increase to nearly 40 percent of GDP over the next 30 years.
If history is an accurate guide, even significant increases in tax rates will not be enough. From 1950 to 2007, the top individual income tax rate ranged from a high of 91 percent to a low of 28 percent while tax revenues as a percentage of GDP hovered around a narrow range from 16.4 percent to 20.9 percent. That leaves us with the final option of making tough choices to scale back the federal spending spree.
Americans have seen the dangers of excessive debt: a legacy of ruined lives and toppled corporate giants. It’s clear that creative financing merely delays the day that debts must be repaid. How long will it be before we learn the hard way that the bill has come due for years of political promises? Americans can continue to pretend everything is fine, or demand that elected officials address the problem. We continue to ignore this fiscal wakeup call at our own peril.
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Federal Tax Revenue and Marginal Tax Rates |
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Kelly McCutchen is executive vice president of the Georgia Public Policy Foundation, an independent think tank that proposes practical, market-oriented approaches to public policy to improve the lives of Georgians. Nothing written here is to be construed as necessarily reflecting the views of the Georgia Public Policy Foundation or as an attempt to aid or hinder the passage of any bill before the U.S. Congress or the Georgia Legislature.
© Georgia Public Policy Foundation (November 14, 2008). Permission to reprint in whole or in part is hereby granted, provided the author and his affiliations are cited.
By Kelly McCutchen
It was not Webvan or Pets.com this time. It was Lehman Brothers, Merrill Lynch, AIG and Wachovia. Gone or sold for pennies on the dollar. It was $700 billion – taxpayer dollars – rushed through Congress to avert the “greatest crisis of our time.” What actually happened, and what can we learn from it?
As pundits increasingly confirm, privatizing profits and socializing losses is no recipe for financial stability. Congress failed to balance the noble goals of encouraging homeownership and affordable housing with the compelling need for financial stability. As economist Russell Roberts explained in The Wall Street Journal, the problem is that “Congress designed Fannie Mae and Freddie Mac to serve both their investors and the political class. Demanding that Fannie and Freddie do more to increase home ownership among poor people allowed Congress and the White House to subsidize low-income housing outside of the budget at least in the short run. It was a political free lunch.” Adding fuel to the fire, Fannie and Freddie magnified their profits (and losses) by leveraging their balance sheet, taking on far more debt than any regulated commercial bank or insurance company.
Las Vegas would have loved the odds on Fannie and Freddie. Bet big on risky loans. If it works, you make big profits. If you lose, taxpayers are stuck with the bill. It was the classic “heads I win, tails you lose” trick.
Investment banks were just as guilty. Also highly leveraged, sometimes as much as 30:1, they created new, complex financial products based on the underlying value of mortgage-backed securities. The key difference is the investment banks were supposedly savvy investors gambling with private money. They made millions while it lasted. They do not deserve sympathy – or rescue – now that their investments have turned sour.
Lesson learned: Excessive debt leaves no margin of error for borrowers or investors. Homeowners who maxed out their credit were unable to make their mortgage payments. Highly leveraged investors faced a liquidity crisis. “Mark to market” accounting rules exacerbated the crisis, creating a domino effect throughout the financial system. In the end, there was no free lunch.
The good news is that much of this crisis is short term. It will be painful, but as liquidity returns to the market, housing prices and stock prices will eventually recover. The bad news is that we have a much more fundamental, long-term problem. In essence, the federal government now has another mortgage crisis on its hands – it has mortgaged our future.
Former Comptroller General of the United States David Walker and others have sounded the warning bells for years. “The federal government – like too many Americans – has become addicted to debt,” Walker says. Our elected officials continue to make big promises even though they know that at some point in the near future, programs such as Social Security and Medicare will begin running massive deficits. Yet, just as with Fannie Mae and Freddie Mac, few leaders have had the courage to call for fiscal restraint and systematic reform. “The current federal fiscal policy has created a disconnect between today’s citizens and future taxpayers,” says Walker. “Baby boomers and current retirees benefit from today’s government spending and tax policies, while our children, grandchildren and generations to come will be expected to pay the bill for today’s excess consumption.”
The enormity of that “excess” is sobering. The future liabilities of the federal government today total $52.7 trillion, according to the U.S. Government Accountability Office (GAO). That’s a whopping $455,000 per household.
Any solution must include substantial cuts in spending and/or increased taxes, but the size of our deficit limits our options. Consider that from 1962 to 2008, federal revenues have averaged 18.2 percent of Gross Domestic Product (GDP). And if we do nothing, federal spending is projected to increase to nearly 40 percent of GDP over the next 30 years.
If history is an accurate guide, even significant increases in tax rates will not be enough. From 1950 to 2007, the top individual income tax rate ranged from a high of 91 percent to a low of 28 percent while tax revenues as a percentage of GDP hovered around a narrow range from 16.4 percent to 20.9 percent. That leaves us with the final option of making tough choices to scale back the federal spending spree.
Americans have seen the dangers of excessive debt: a legacy of ruined lives and toppled corporate giants. It’s clear that creative financing merely delays the day that debts must be repaid. How long will it be before we learn the hard way that the bill has come due for years of political promises? Americans can continue to pretend everything is fine, or demand that elected officials address the problem. We continue to ignore this fiscal wakeup call at our own peril.
|
Size of the Individual Burden Imposed by |
|
|
Federal Tax Revenue and Marginal Tax Rates |
|
Kelly McCutchen is executive vice president of the Georgia Public Policy Foundation, an independent think tank that proposes practical, market-oriented approaches to public policy to improve the lives of Georgians. Nothing written here is to be construed as necessarily reflecting the views of the Georgia Public Policy Foundation or as an attempt to aid or hinder the passage of any bill before the U.S. Congress or the Georgia Legislature.
© Georgia Public Policy Foundation (November 14, 2008). Permission to reprint in whole or in part is hereby granted, provided the author and his affiliations are cited.