Is the US credit rating too high?

Considering the government’s debt is more than 600% of their income, and that they make interest only payments, maybe the US credit rating is too high. Photo: michael busler

WASHINGTON, October 25, 2013 — The US public debt, the total of all annual budget deficits, now exceeds $17 trillion and is climbing rapidly. By the time President Obama leaves office, the public debt will likely be more than $20 trillion, almost double what it was when he took office. In other words, the current President will have incurred almost as much debt as all other 43 presidents combined.

Why is the debt so big?


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The problem started in the 1940’s. In order to finance World War II, the federalgovernment sold war bonds. These were primarily 20 year bonds, which meant they would have to be repaid in the 1960’s.The problem was that there was never any mechanism put in place to repay the bonds, so that when they matured, the debt was simply “rolled over” which meant new bonds were sold to repay the existing bonds. This practice continues today. 

Presidents Kennedy and Johnson ran up large deficits to finance their tax cut and the Great Society programs including Medicare. President Nixon ran deficits primarily to stimulate the stagnant economy and defense spending. President Reagan ran deficits caused by his large tax cut. President Clinton was more conservative and actually ran surpluses in three years. President Bush incurred deficits to finance large increases in defense spending and increases in Medicare spending. 

And then President Obama ran massive deficits to finance huge increases in government spending mainly for social programs.

Each of those Presidents financed their deficits by selling bonds with no mechanism in place to ever repay them. Each time a bond matured, the debt was simply rolled over. Now we have a huge problem that is really more troublesome than has been noted. 


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We measure the debt burden by comparing debt to income. The conventional wisdom says that since total annual income in the US is about $16 trillion, the total public debt is about 110% of annual income, which is not really excessive. But is that an accurate measure?

The public debt is defined as the total financial obligation incurred by the government. So if the debt is the obligation of the government, we should measure the debt against the government’s income. The federal government currently raises about $2.8 trillion in revenue which means that the public debt is more than 600% of annual income. An analogy would be a person with a $50,000 annual income wants to buy a house and applies for a $300,000 mortgage. The person simply does not have the income to carry a mortgage of that size.  And if an individual with that income level and a mortgage of that size did exist, he would be deemed a poor credit risk when seeking future debt.

The other problem when evaluating credit worthiness is the efforts made to repay and reduce debt. The US government is making no effort to reduce debt. In fact all of the negotiations in Congress are geared to figuring out ways to slow the growth of the debt, not reduce it. In the business world, when a corporation sells bonds, they usually establish a sinking fund. This means they make some annual payment into a fund so that at the end of twenty years, when the bond matures, the borrowed money can be repaid rather than simply rolled over. Since this is the practice for credit-worthy borrowers, perhaps the government should follow that lead.

Even when an individual borrows by securing a mortgage, the monthly payments to the lender are not just for interest, but rather to cover interest and principle so that at the end of a 25 year mortgage the principle balance is zero. 


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The federal government has a debt that is more than 600% of their annual income. The government is carrying more than $17 trillion in debt and makes interest only payments, with no intention of every paying down the principle
balance. By any credit standard, that is certainly not an AAA rated borrower, even though the government can have the Federal Reserve virtually print more money to cover deficits and make necessary payments, thereby eliminating any real chance of default. Essentially the Federal Reserve has beendoing this for more than a year. In fact, it is this ability by the Federal Reserve that is really what is keeping the credit rating so high.

But the reality is that an AAA rating for US debt may be too high?

 

 


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Michael Busler

Michael Busler, Ph.D. is a public policy analyst and an Associate professor at Richard Stockton College teaching Finance, Financial Institutions, Introduction to Financial Management, Game Theory, Graduate Managerial Economics, Graduate Financial Management. 

 

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