The NEXT Financial Crisis

Some talk as though financial crises are entirely avoidable events caused only by misfeasance or stupidity. But in an imperfect world of imperfect human beings, such things will always happen. We would be living in a stagnant, undynamic world if we did not have periodic crises. They are akin to a “cost of doing business;” the price we pay for the far greater benefits of the kind of civilization we have.

Now, the federal government’s financial pickle is obvious, what with ballooning entitlement spending and the impossibility of taxing enough. The recently mooted proposals of the Bowles-Simpson Commission – higher retirement age, reduced Medicare allowances, reforming the tax structure, etc. – no-brainers, really, mainly curbing “welfare for the rich” – met with the depressingly predictable and irresponsible ideological responses from both left and right. Sacred cows remain sacred. But at least Washington is not close to maxing out its borrowing ability. And it can also literally print money.

Not so the states.

They face the same fiscal pincers, but their borrowing ability is much restricted, often by constitutional balanced-budget requirements. They’ve been bailed out temporarily by the 2009 stimulus bill, giving them massive hand-outs, but that’s not going to be repeated.

Take New York (please). It’s deeply in hock to retired employees (like me), whose unions negotiated gold-plated pension deals when politicians had nothing to gain from resisting. (Greed is not restricted to Wall Street.) We have a “Cadillac” Medicaid program, with the nation’s highest costs. Our infrastructure of roads and bridges, etc., is crumbling because upkeep has continuously been sacrificed to pay current bills, and the backlog of must-do work grows impossibly huge. Meantime New York already has one of the nation’s highest tax burdens, and raising it would only serve to drive people and businesses out of the state, worsening the crunch.

In the face of all this, what did New York’s politicians do, in the latest fiscal year, with its $9+ billion deficit? Raised spending by 7%.

This fiscal cancer is metastasizing in most other states too. California is another poster boy, with notoriously extravagant pensions for prison guards, whose union keeps politicians in terror. Nationwide, underfunded pension liabilities are a ticking time-bomb. (Sorry for my over-use of metaphors.) State pension funds have been socked by Wall Street losses, and the formulas for funding them tend to reflect assumed future rates of return (typically 8%) which today are wildly unrealistic.

Moreover, future retiree pension and health costs are likely to be grossly underestimated, as longevity keeps rising. A lot of retirees are going to live practically forever, consuming ever more health care and merrily collecting their pensions. And while benefits for future public employees might conceivably be curbed, they’re securely locked in for existing workers and retirees.

This is the next financial crisis. Unlike the last one, it’s not going to blow up all at once. It will be slow torture.

Well (in keeping with my optimism remit), I do have one happy thought to offer. There’s no way lefties can blame this one on their bugbear, “capitalism.” Nope, the blame lies squarely with government – and, in particular, the expansive conception of government fostered by lefty thinking. Liberals keep nattering about how the greed of Wall Street has screwed us. Soon we will see how the liberality of liberalism has screwed us.

4 Responses to “The NEXT Financial Crisis”

  1. Lee Says:

    1. Is it not the case that we want our government to increase spending during financial crises, or at the very least to not decrease spending? In my opinion, the time for cuts in spending is when things are going well in the business cycle. At the federal level, Clinton understood this, giving us a federal surpluses, but the righty-thinking government-expansive Bush did not. At the state level, I am less knowledgeable. I recall Pataki cutting back the state workforce during the times of plenty; so that is good. Spitzer’s tenure was a bit short to appraise. Patterson, who inherited the down business cycle / crisis, did, in my opinion, a good job of increasing / not cutting spending.

    2. While I agree that simplifying the tax structure is a plus, and that cutting back financially on the military approach to conflicts — aggressive diplomacy would be far cheaper and more effective — are terrific ways to save money, I am not so sure I can agree with you on the “no-brainer” status of the social security cutbacks. First, social security has been indexed only to inflation since 1975; for our income, the rest of us have seen both a nominal increase (due to inflation) and a real increase (due to increased productivity). Mathematically, seniors would be owed a 50% increase to bring in the productivity gains that the rest of us take for granted. In short, many of our poorer seniors are already falling behind.

    Second, it is not at all clear to me that the poorer among us are living significantly longer lives than they were. If we really are planning to cut social security for actuarial reasons, let’s do the math right. Perhaps the way to go is to compute lifespan as a function of the amount paid into social security. I suspect that those who had lower annual income and who receive smaller amounts of social security, will not see much of an affect from an accurate actuarial adjustment for their lifespans. Those of us with higher annual income and larger social security benefits may see a bigger actuarial adjustment. I could live with that, especially if it were somehow coupled with a correction for the productivity gains over the last 35 years.

    3. Unlike GM that produces goods to be consumed, Wal-mart that brings the goods to us, and so on, it is difficult to understand what Wall Street is producing. Oh, I have heard it argued that if it weren’t for all those financial speculators then it would be a little harder for businesses to issue bonds or for homeowners to get good mortgage interest rates, but I find the argument to be a bit tenuous, and the effect to be not all that significant. (Disclosure: I used to work for a hedge fund, so maybe that makes me jaded.) If giving free reign to Wall Street and the financial crises that come along with it are the “cost of doing business,” maybe we’re paying a little too much for this somewhat ethereal product.

    FSR RESPONSE: Re #1 & #2, in the first place it’s not so clear that the old Keynesian paradigm of boosting spending to stimulate the economy in down times, and making up for it in flush times, actually works, especially given that the hangover may cancel out whatever jollity the binge produced; in the second place it’s entirely clear that government in the real world can’t manage the trick, because spending is so largely a one-way ratchet, easy to turn on and hard or impossible to turn off; and in the third place your social welfare points simply don’t come to grips with the fact that the whole model is unsustainable because we can’t tax enough to pay for it. I have no problem with social welfare spending for the needy; it would be amply affordable if only social welfare for the rich were eliminated. Social Security should be means-based. It’s absurd that people like ME receive Social Security payments.
    Re #3, the cost of the recent financial crisis has been large, but maybe not so large in light of the worldwide economic gains over recent decades, improving lives for billions of people; Wall Street has actually played some role in that, lubricating the world economy, regulating the flows of money. Yes, that process has significant dysfunctions; but if you can figure out how to correct that and not throw the baby out with the bathwater, you are smarter than anyone in Government (Or Wall Street).

  2. Lee Says:

    1. It’s more what we spend it on rather than how much we spend, but I think it is safe to say that I will work with you full force on spending cuts … in a year or two when the economy is in better shape.

    FSR REPLY: Thanks for your willingness to work with me. Now let’s get Obama, Reid & Boehner to work with us.

    2. According to this chart, social security would have no shortfall if we devoted an additional 1.5% of GDP to it every year. That is a large amount, but it is small potatoes compared to these inefficient wars, hunger-generating agriculture subsidies, ….

    You paid for those social security benefits. If your government hand-out is too large or if your tax burden is too small, feel free to give your excess to charity. I do.

    FSR REPLY: I paid Social Security TAXES. Yes, I am “entitled” to benefits. I’ll soon be “entitled” to Medicare benefits too. There are too many people entitled to too many benefits. Encouraging me to give to charity is not an answer to the nation’s fiscal problem. Why are you unwilling to acknowledge that there’s too much welfare for the rich? I am rich and there’s no “social justice” in my having these “entitlements.”

    3. I am not smarter than everyone on Wall Street or in government, but there are the politically infeasible solutions that are simply not discussed. One good one is to legally limit financial leverage. Investment firms that have to put up only 10 cents on the dollar to buy an asset have to scramble if that asset falls by 10%; they sell the asset in the down market pushing the market further down and triggering a scramble by the next speculator. The resulting volatility has a huge impact on the innocent bystanders who are just trying to buy and hold vanilla investments for their retirement accounts.

    FSR REPLY: Beware the Law of Unintended Consequences!!

  3. Lee Says:

    2. I apologize for the omission; I do acknowledge that there is too much welfare for the rich. However, I think we perceive social security differently. I think of it as a retirement plan, similar to a corporate defined-benefit pension plan, and I am loathe to have the government start confiscating retirement plans of any sort, even if only the rich are the target.

    I think we disagree as to the nature of our nation’s fiscal problem. You opine that we spend too much. On the other hand, I think the problem is that it is spent on the wrong things. (Well, it’s too large too, but that’s a secondary issue.) IMHO, giving to charity does address many categories where spending is falling short. Addressing categories where spending is too high is a political issue. I join you in fighting against welfare for the rich. I also oppose the expensive wars because there are alternatives that are more effective and efficient.

    3. I propose to limit leverage, but not to obliterate it.

  4. Colorado Says:

    “they’re securely locked in for existing workers and retirees.”
    Every article on the pension crisis contains this thought, and it bugs me. Contracts are inviolable up until one side declares bankruptcy and then they can be negotiated or canceled. It’s only fair that the government (at what ever level) do exactly that. It is not fair, or feasible, to have retired secretaries on limited incomes paying for $150K+ pensions for firemen. Is it politically tough? Not if the tax payers get mad enough; then it’s easy. The main tenet of economics is that the market will eventually swing toward an equilibrium. To have that first sentence be correct, you have to believe equilibrium can be put off forever.

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