What a Greek default could mean for you

 

The Greek government has been in a financial crisis for the past several years. There have been several attempts to restructure Greek debts and pass “austerity budgets” with draconian cuts to government spending, but the nation is edging ever closer to a default on its national debts. The situation has deteriorated to the point where Bloomberg estimates that there is a 98 percent chance that Greece will default within five years.

The fundamental problem is that Greece has spending much more than it earns in revenues. It has been making up the shortfall in revenues with loans, primarily from European banks. The problem for the European banks is similar to the U.S. banking crisis of 2008. In the U.S., the crisis was caused by the epidemic of mortgage defaults, which led to freezing of capital markets. Banks could not lend because no one knew the extent of the “toxic assets” in their holdings. They were forced to keep their cash on hand to cover possible defaults.

In Europe, the problem is several orders of magnitude larger. Instead of homeowners defaulting, the prospect is that entire nations will default on their loans. Greece is merely the first. Beyond Greece, there is also the possibility that Ireland, Portugal, Italy, and Spain will default. CNN Money notes that while Greece has over $400 billion in loans, the combined total for all five nations is $3.8 trillion.

Although most of the loans at risk are held by European banks, that does not mean that the United States is immune from the financial crisis. Nations around the world are interconnected through trade and a European financial crisis could easily spread across the Atlantic.

The panic of 2008 was set off when one company, Lehman Brothers, went bankrupt. Investors knew that the same systemic problems affected many other companies as well and reacted accordingly. Similarly, if Greece defaults, the ripples will be felt throughout the European and world economies. Dexia, a Belgian bank that failed and was nationalized in early October due to its large exposure to Greek and Italian debt, may be the Bear Stearns of the European crisis. Bear Stearns failed in March 2008 and was bought by J.P. Morgan Chase at a bargain-basement price in a deal orchestrated by the federal government.

American banks may not have many loans that are directly at risk in the crisis, but American companies do business in Europe. If the European economy crashes, it will affect the bottom line of American companies who have operations in Europe. European manufacturers would likely be caught in a credit crunch forcing a slowdown of operations and massive layoffs. Georgia companies such as Coca-Cola, Gulfstream Aerospace, Delta Air Lines, and UPS that are heavily involved in international business might be among the first American businesses to feel the effects of the crisis.

The crisis would quickly spread to the American Main Street as European investment evaporated and imports from Europe slow to a trickle. With the weak U.S. economy already verging on a double-dip recession, the crisis would likely spread quickly. Americans could soon be experiencing an economic crisis as bad or worse than the 2008 crash. Companies that depend on exports to Europe would quickly find their markets closed, leading to more layoffs and higher unemployment rates.

As in 2008, the effects would then ripple throughout the economy. As more workers lose their jobs, demand for goods and services would plummet, causing layoffs in other companies. The crisis would spread from country to country and company to company until many of the world’s economies were stricken.

In 2008, the federal government’s solution was TARP, the Troubled Asset Relief Program. TARP was essentially a bank bailout in which the federal government made loans and took equity stakes (purchased stock) in banks to provide an infusion of capital and liquidity. Although much criticized on both sides of the political spectrum, the original TARP did stem the crisis.

A program modeled on TARP for European banks and debtor countries might be a viable solution to the crisis. One potential problem is that Europe is 17 nations instead of one. A bailout deal must be approved by multiple national legislatures. As in the United States, bailouts of banks are not always popular in Europe and there may find significant political resistance to bailout plans.

A second problem is that the European Central Bank may not be up to the task. A Columbia University study cited in the Wall Street Journal suggests that the bank holds enough risky bonds that its own survival may be at stake. Instead of allowing the Greeks to write off as much as 50 percent of their debts, the ECB may elect to enact their own “quantitative easing” by printing money and allowing Greece to pay its debts with inflated euros.

A Greek default of some sort is almost guaranteed. Once the defaults start, no one knows for sure how fast and far it will spread, but given the weak economic situation in the United States, it is likely that European defaults would cause the American economy to slip back into recession. An old adage states that “when America sneezes, the world catches cold.” In this case, it is likely that a Greek sneeze will cause America to contract the Greek flu.

Read this article on Examiner.com:

http://www.examiner.com/conservative-in-atlanta/what-a-greek-default-could-mean-for-you

Barack Obama’s awful, no good, very bad day

Barack Obama has had a bad day. His bad day actually started last Friday when the stock market dropped 500 points on news of Europe’s failure to deal with its own debt crisis. After the close of markets that day, Standard and Poors, one of the rating agencies for financial bonds, made a long feared announcement that it was downgrading the credit rating of the United States. To make matters worse, the U.S. federal debt was revealed to have reached 100 percent of GDP a few days earlier, a milestone not seen since 1947.

Over the weekend, investors and ordinary Americans (who are one and the same if they have a pension, an IRA, or a 401k) contemplated how the downgrade would affect Wall Street and Main Street. To add to the somber mood, on Saturday, August 6, an Afghan insurgent shot down a U.S. Army CH-47 Chinook transport helicopter killing thirty Americans, including members of a U.S. Navy SEAL team. Seven Afghan soldiers and a civilian interpreter were also killed.

There was much speculation as to what would happen when the financial markets around the world opened today, the first trading day after the announcement of the downgrade. What happened was what some observers called a financial “bloodbath.” The stock market crashed for the second time in two trading days. The Dow Jones Industrial Average fell 635 points to a level that erased almost ten months of gains. Financial markets around the world were hit.

At this point, many economists are warning that the United States is likely entering a second recession. In a Dick Morris column, James Fitzgibbon, director of the Highland Fund called today “the second phase of the meltdown.” Fitzgibbon believes that “stocks, real estate will collapse and keep falling into 2013. The lows of 2009 will be easily taken out on the downside.” Chillingly, Fitzgibbon believes that the worst is yet to come: “The real horror will be later in the year when the U.S. Treasury Bond goes into a freefall. Then a depression is possible. Soaring interest rates. Collapsing asset values. Contracting economic activity. Surging unemployment. And business closures.”

This is a particularly bad day for Barack Obama for several reasons. ABC News notes that the selloff sharpened after the president spoke in the afternoon and called for more taxes. This shows that investors have lost faith in President Obama’s vision for the nation. They realize that the fiscal problems of the United States are too great to be fixed by raising taxes on the wealthy. The only solution to the problem of overspending and deficit reduction is to cut spending, a prescription that President Obama and the Democrats have steadfastly resisted.

The second reason that today was a bad day for President Obama is that he must realize that the new crisis is his fault. This is not a crisis that he inherited from George Bush. This one is purely of his own making. The debt crisis is due to the fact that President Obama’s Keynesian stimulus projects have failed miserably while increasing the federal debt by a third. President Obama has no serious plan to repay any of the money that he has borrowed in the name of the American people.

The president must also realize that, as the U.S. economy sinks into another recession, his hopes for re-election also diminish. Voters generally vote their wallets. If times are good economically, they vote for the incumbent. If times are hard, they vote against the incumbent. In a Gallup poll taken before the recent stock market crashes, President Obama’s approval rating was down to 43 percent (with 48 percent disapproving). With the bad economic news, his approval rating will only fall further.

This is not altogether unfair. The current carnage in the world’s financial markets is the logical end result of his policies. His administration has been an unending saga of new regulations on business, not the least of which is Obamacare, that stifle job growth. His solution to the first economic crisis was to borrow money and spend it on pet projects. An additional attempt to resolve the crisis was to print more money through the Federal Reserve’s quantitative easing programs. As a result, the United States has the highest unemployment in recent history, a downgraded credit rating, and a devalued dollar, all due to President Obama.

In Georgia, the unemployment rate is even higher than the national average. According to the Georgia Department of Labor, Georgia’s unemployment rate is at 9.9 percent while the national rate is 9.2 percent. Three years after the initial crash of 2008, Georgia’s foreclosure rate remains the sixth highest in the nation according to the Atlanta Business Chronicle. This has led to falling tax revenues for the state and local governments, which has in turn led to massive layoffs of government workers and teachers. Untold numbers of Georgia businesses have failed. Georgians have watched their retirement plans dwindle year after year. After the events of the past few days, it seems that all of this will get worse. Barack Obama lost Georgia by five percent of the vote in 2008. He will likely lose by much more in 2012.

The last bad thing that happened to Barack Obama today is that Timothy Geithner informed the president that he would not resign as secretary of the treasury. As one of President Obama’s most trusted economic advisors, Geithner bears much of the responsibility for the current economic fiasco. Federal Reserve Chairman Ben Bernanke and Austan Goolsbee, chairman of the president’s Council of Economic Advisors, are also reportedly not resigning.

It is a bad day for President Obama. Unless he reverses his economic course, a change that he is most likely incapable of making, he will go down in history as a latter-day Herbert Hoover. He will be the president who spent the United States into an economic calamity, the likes of which has not been seen in eighty years. That is bad for President Obama, but worse for the rest of us.

If you disagree with the analysis presented in this article, please read “Serious questions for liberals, Democrats, and other Obama supporters.” If you can answer the questions presented, the author would welcome your response, either through email at thorntondavid@yahoo.com or as a comment.

Photo credit:  Elizabeth Cromwell/Wikimedia

Read this article on Examiner.com

http://www.examiner.com/conservative-in-atlanta/barack-obama-s-awful-no-good-very-bad-day

What the downgrade of federal debt means to you

When the world financial markets open today, it will be the first chance that they have had to react to the news of the downgraded U.S. debt. The announcement of the downgrade by Standard and Poors came last Friday after the close of the markets on a day that had already seen a huge decline in stock markets around the world.

As Georgians learned in 2008, what happens on Wall Street and Washington affects lives in Georgia. The financial crisis that began in New York’s banks and investment houses froze credit in Atlanta and caused the local real estate market to crash. Next, new construction projects stalled and Georgia’s unemployment rate skyrocketed as the effects of the deepening recession spread throughout the state and the country.

The current crisis is different from 2008 in many ways. The debt crisis has been long in coming and was not unexpected. For over a year, rating agencies have warned that a downgrade of U.S. debt was possible if the government did not take steps to reduce borrowing and deficit spending. With the recent debt limit crisis, many investors had already included concerns about the national economy in the value of their investments.

Adding to the seriousness of the new crisis is that, in a flurry of borrowing after congress raised the debt limit, the federal debt exceeded the gross domestic product (GDP) of the entire country. Last Wednesday, August 3, the treasury borrowed $238 billion which put the national debt at over 100 percent of GDP. The last time that the national debt exceeded GDP was in 1947 as the country demobilized after World War II according to Yahoo News.

This will undoubtedly be a volatile day of trading around the world as many investors panic and sell. The fact that the downgrade occurred on a weekend and investors have had two days to calm down may temper some of the trades.

The twin shocks to the market will likely cause more long-term economic damage. As Martin Feldstein, former chairman of President Reagan’s Council of Economic Advisors, recently pointed out in the Wall Street Journal, the Obama Administration’s policies of spending borrowed money and devaluing the dollar have led to the slow growth in GDP. Employment is closely related to GDP. If the economy is not growing, jobs are not being created, and it is difficult for the unemployed to find work.

The Wall Street Journal points out that different commodities may be affected in different ways. Copper, which is used in many products, is considered a bellwether for the economy and is already down eight percent in the past week. This signals fears of a second dip in the recession. Because oil prices often rise and fall with the larger economy, if investors believe another economic downturn is likely oil prices may fall. This could translate into cheaper gas prices for Georgia drivers and lower energy costs. On the other hand, gold prices often rise in times of economic uncertainty. Gold may be driven higher as the debt continues to increase and the dollar continues to weaken. Gold is already trading near record highs.

Another likely effect of the downgrade is a rise in interest rates. For the past few years, the Federal Reserve has kept interest rates low in an attempt to jumpstart the economy. The downgrade means that rating agencies feel that U.S. treasury bonds are more risky due to the increasing federal debt. Since the bonds are more risky, investors are likely to want more interest for loaning money to the federal government (i.e. buying treasury bonds).

According to the Center on Budget and Policy Priorities, six percent of the federal budget is currently spent on interest. If the government has to pay more interest that percentage will grow. If more money goes to interest that means that less money will be available for spending on other programs. This will exacerbate the federal spending crisis.

Adding to the uncertainty is the fact that U.S. treasury bonds are probably still the safest investment in the world, even after being downgraded. This is not so much an endorsement of U.S. treasury bonds as an indictment of the economic status of the rest of the world. The U.S. is broke and dealing with out-of-control spending, but it is still in better shape than Greece, Spain, France, Italy and many other nations around the world. This may mute the effect of the downgrade.

Although no one knows for sure what will happen, the downgrade likely means that the unemployment rates in Georgia and the United States will remain high. Rising interest rates will mean that mortgages and other loans will be more expensive. As interest rates rise on adjustable rate mortgages, there may be more foreclosures. The upward pressure on interest rates will prevent a recovery in Atlanta’s real estate market, which has been hard hit by the recession.

As the borrow-and-spend situation eventually becomes untenable, the federal government will likely be forced to adopt austere spending cuts like those of Greece. This will eventually mean that benefits in the big entitlement programs, Social Security, Medicare and Medicaid, have to be cut. These cuts will affect millions of the poorest Georgians. Other payments from the federal government to the states, such as highway funds, may also be reduced or eliminated.

The United States has reached a point where it is obvious that the federal government must cut spending. As the price of borrowing increases, interest and debt repayment will become ever larger shares of the federal budget. As the economy falters, tax revenues will fall and make the problem even worse. The only solution is to reduce spending without raising taxes, which would also send the economy back into a recession.

 

Photo credit:  Roland Weber/Wikimedia

Read this article on Examiner.com:

http://www.examiner.com/conservative-in-atlanta/what-the-downgrade-of-federal-debt-means-to-you

Debt limit and federal default: What they are and what they mean to you

As the deadline for an agreement on raising the debt ceiling approaches on August 2, it remains to be seen whether the Democrats and Republicans in Congress can reach a compromise that will allow the federal government to continue to meet its obligations. Many Americans do not understand the background of the debt limit debate. Many others don’t believe that it will have an impact on them.

Technorati Tags: Government,Barack Obama,spending,deficit,debt limit,debt ceiling,bankrupt,default,compromise,tax,spend

The debt limit is the congressionally imposed limit on borrowing. According to Factcheck.org, the federal government is currently borrowing thirty-six cents for every dollar that it spends. Part of the problem is that tax revenues have fallen since the onset of the recession in 2008, while federal spending has increased. When the federal government reaches the limit of what Congress allows it to borrow, it will have to begin choosing what bills to pay and which ones to default on.

The situation is similar to that of many families in Atlanta, around Georgia and throughout the country that were financing a plush lifestyle with mortgages and credit cards before the recession started. The breadwinners in the family took pay cuts, like many others in the country, but imagine that in this case, rather than cutting back on spending when they realized that they were bringing home less money, they started borrowing more in an attempt to preserve their old lifestyle. In fact, with the huge increases in federal spending, it is like the family took a pay cut and then went out and bought a new luxury car on credit. Everything that they used to pay cash for, the family now charges to their credit cards. The hope is that if they can borrow until more money starts coming in and avoid making painful spending cuts entirely.

The problem is that there are consequences to excessive borrowing. The federal debt limit is analogous to the family’s credit limit. The family, like the federal government, cannot borrow indefinitely. Sooner or later, the overspending family will max out their credit cards. As their debt increases, it will get harder to find places to borrow more money and the interest rate for their borrowing will increase because loans to this family will be considered more and more risky for the lender. Eventually they will be forced to stop borrowing and make cuts to their spending when they are not able to borrow any more money.

At this point, the federal government has refused to make meaningful spending cuts and is seeking to raise the credit limit on its old credit card and apply for new ones. One price that the government might pay for running up the balance on its credit cards even higher is a downgrade to the United State bond ratings.

U.S. treasury bonds are currently rated AAA and are considered the safest investment in the world, but massive increases in federal debt and spending have led rating agencies to warn that they may have to downgrade the rating on U.S. bonds. This is akin to the hypothetical family’s credit score being downgraded from 700 to 600. It means that interest rates will be higher for future bond sales which will increase the cost of government borrowing. It also means that unless changes are made, further downgrades could come soon.

It is likely that the federal debt limit will be raised, but that won’t solve the federal government’s problem. The fundamental problem is that the government spends much more than it receives in taxes. Like a family with a pay cut, the federal government faces two options. First, it can cut spending and live within its means. The problem with this option is that federal spending is made up of popular but expensive programs. Any attempt to cut any federal program meets with resistance from voters and activists. It is like facing opposition from mother for cuts to the grocery budget. Brother doesn’t want to spend less on video games while sister needs her clothing allowance. Father doesn’t want to eliminate cable television from the family budget.

A second option is find a way to increase the money coming in. For the family, that means finding a job that pays more or working a second job. For Congress, it would mean raising taxes. The problem with this option is that, just as most Americans can’t find a higher-paying job, they also can’t afford to pay higher taxes without further damaging the economy.

Ironically, the Laffer Curve, an economic principle, shows that beyond a certain point even an increase in taxes won’t generate more tax revenues. As tax rates increase, so much money is leaving the private economy and going to the government that it discourages investment and production. Consequently, tax revenues fall and the government collects less money. Even if the government can generate some additional tax revenue by raising taxes, the government’s spending problem is so large that it cannot be solved without spending cuts.

If Congress fails to raise the debt limit, the government will not be broke because some tax money will be coming in; it just won’t be enough to pay everything. The government will have to choose which bills to pay and which ones to defer until it has more money, just as many families have to choose which bills to pay. Theoretically, the government could pay important bills, like Social Security payments and military salaries, while delaying payment on less important things like Senator Harry Reid’s cowboy poetry festival and the thousands of other wasteful items in the federal budget. In the final analysis, practically everything the government spends money on, especially the big-ticket items like Medicaid, Medicare, Social Security, and defense, will have to be reconsidered and restructured, but that is a long-term problem.

In the short term, the effect of a default would depend on what Treasury Secretary Tim Geithner and President Obama decide to stop paying. They could choose to stop making Social Security payments to increase pressure on Republicans. They could divert money from defense and other federal departments to keep social spending active. Many government employees might be laid off.

Companies that do business with the federal government would likely not receive payments. That might mean that workers at these companies would be laid off or go unpaid. The uncertainty in the economy could cause the stock market to crash.

Georgia and other states might not receive federal grants and subsidies which would mean tighter states budgets and more layoffs for state employees. Many of these states, like Georgia, have already made painful cuts to state government budgets and experienced rounds of layoffs rather than financing their spending with more debt. Unlike the federal government, thirty-seven states have balanced budget laws that do not allow a deficit to be carried forward according to the National Conference of State Legislatures. Georgia does not have such a law.

If the U.S. bond rating is downgraded, interest rates will likely rise on treasury bonds. The increase in interest rates will ripple through the economy. Interest rates will rise on everything from mortgages to credit cards. Borrowing will be more expensive for American companies and consumers as well as the government.

The ultimate outcome of the battles over spending, taxes and the federal debt remain to be seen. What is obvious is that the U.S. is on an unsustainable course. The failures of national economies such as Greece are a warning to Americans that reckless spending cannot be financed with borrowing indefinitely without doing serious damage to the nation.