Lawrence Light
How serious is the problem of too much debt in our world, an ever-growing burden that will crush us? Very serious. In Crash, our character Spencer Nast, the chief White House economist, aptly dubs the situation the “debt bomb.” As a financial journalist who has covered the economy and Wall Street for many years, I know that forecasting holds perils. As the great Yankees player and all-around sage Yogi Berra put it: “I never make predictions, especially about the future.” But odds are strong that a debt bomb is set to go off in the U.S. in just a few years.
It’s built of a combustible mixture of obligations owed by the federal government, corporate America, public pension plans, and households. When will it go off? A good bet is when the next recession arrives. A downturn is inevitable: The economy moves in cycles. Then watch the whole cursed concoction go kerblooey, as the revenue to pay interest and principal dwindles.
Economics is like physics. Nothing can last forever. Like debt. A limit exists on how much public and private borrowers can go into hock. At some point, for instance, fixed-income buyers will grow leery of Treasury paper, even though now federally backed bonds are in great demand. But once Washington’s debts reach an unsustainable level, that sentiment likely will change, and with a vengeance.
People don’t want to face this, and Congress’s attempts to cap federal spending always end in abject failure. Think of the Road Runner cartoon where the clever bird maneuvers Wile E. Coyote’s shack onto railroad tracks. Coyote, busy inside fussing with dynamite to blow up the Road Runner, looks up and sees outside his window the locomotive bearing down on him. His response: Draw the blinds. This doesn’t end well for the hapless canine.
FEDERAL DEBT. Right now the national debt is slightly higher than the gross domestic product, thanks to escalating federal spending to fight two wars and two recessions, and large tax cuts enacted under the Trump administration.
When Social Security was enacted in the 1930s, the system had forty-two workers for every recipient, hence a lot of taxpayers funded benefits for the elderly. Now the ratio is 3 to 1, and in another ten years that will be almost 2 to 1. A similar scary math governs Medicare. People are living longer, which means they will need more medical care. And health-care prices are burgeoning with no end in sight.
CORPORATE DEBT. This has exploded, as nonfinancial companies took advantage of low interest rates to expand their bond debt to a record $6.4 trillion, by the St. Louis Fed’s count, a 75 percent increase. When it comes due, a reckoning will occur. The companies will have to dig deep to pay off the debt or attempt to refinance at much higher rates than today’s. While corporations in general have ample cash, some $2.6 trillion, to service that debt, the problem is that the cash is concentrated among a few behemoths, like Apple.
There also has been a surge of speculative bonds, issued by companies carrying an abundance of debt. These securities, known as junk bonds, are 20 percent of the corporate bond market. Those on the brink of junk, rated BBB, are twice that size, meaning they are at risk of being downgraded.
Time and again, recessions have amped up defaults among junk issues. While today only 3 percent of junk bonds default, that figure typically more than triples in an economic downtown. At the same time, investors eager for a yield in a low-interest-rate time—junk pays higher interest than investment-grade bonds due to its elevated risk—have fewer protections. Bonds normally carry covenants, restrictions that prevent issuing companies from doing investor-unfriendly things like adding yet more debt. Not anymore; in the land of junk, “covenant-light” bonds are the rule.
PENSION OBLIGATIONS. Years ago, states and municipalities pleased their workforces by promising nice retirement benefits. This is, in effect, debt these governments owe to their workers. The upshot is that a lot of them can’t meet their obligations.
The average funding ratio, the amount in their investment portfolios compared to what they must give to pensioners, is around a third. Put another way, using unfunded liabilities as a percent of state revenues, the picture is even more frightening. The worst off is Illinois, whose unfunded liability is seven times the state government’s annual revenue.
HOUSEHOLD DEBT. Consumer debt is back. After the financial crisis of ’08, household borrowing declined sharply, especially for mortgages as home buying ebbed. But lately it has rebounded, and then some. By 2018, loans—for credit cards, homes, autos, college, etc.—had exceeded even the bloated total of 2008, now standing at $13.7 trillion.
Student loans, for example, have doubled over the past ten years to stand at $1.5 trillion, with an average at just under $40,000. Many young people, who start out in low-paying jobs, can’t afford to pay them, and the ninety-day-plus delinquency rate is at 11 percent.
Making matters worse, after a brief postrecession spate of thrift, Americans are back to their precrisis habit of saving very little, in favor of running up debt. The personal savings rate (savings as a percent of disposable personal income) is back to near precrisis levels at 2.4 percent. A big reason for all the borrowing is not a heedless orgy of spendthrift purchasing; rather it’s that wages have been stagnant for years when adjusted for inflation. A growing economy has disproportionately shoveled its bounty to the upper tenth of the population.
While low interest rates have made carrying the extra debt bearable for more Americans, these days will end eventually. The Federal Reserve has nudged them up from near zero in a bid to reach the old levels, despite a pushback from the White House. A chilling statistic from a Federal Reserve survey found that 35 percent of U.S. adults couldn’t pay their bills if faced with a $400 emergency.
WHAT’S NEXT? Either massive defaults occur—think of the chaos if Washington can’t pay interest and principal on Treasury bonds—or Americans see their taxes double. Or both. The doubling of taxes is predicted by the former U.S. comptroller general, David Walker.
If companies, states, and individuals go bust, the nation has a big problem. And America has an even bigger problem if the federal government can’t cover its obligations. The United States, its full faith and credit, and its universally used currency, underpin the entire world’s economy.
That’s the nightmare scenario we explore in Crash.