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We are being subject to substantial political rhetoric from both political parties at this time. I am sure that we are not getting the information we need on the true state of economic affairs associated with our environment. How about the facts on the federal deficit? The numbers are as follows:
2007 $161 billion 1% of GDP
2008 $459 billion 3% of GDP
2009 $1,413 billion 10% of GDP
2010 $1,293 billion 9% of GDP
2011 $1,300 billion 9% of GDP
The trend is clear and it is not very good. If we put this dynamic in a historic prospective, we learn that the deficit was 10% of GDP in the early 1860s, 15% of GDP in 1920 and 29% of GDP in 1942. These were times of military conflict just as we are experiencing at this time; however, since military conflict has been a fact of life since 2001, it is more likely that our current budget deficits are due to the poor economic climate and government reaction to it. Federal debt trends are as follows:
2008 $10 trillion
2009 $11.9 trillion
2010 $13.5 trillion
2011 $16.4 tillion
This is an unsustainable trend. Clearly there are many factors that lend to this condition. It must be clear that a lack of budget discipline is a key element along with declining federal revenues. How about unfunded federal liabilities? USA Today tells us that the number is $61.6 trillion or $528,000 per household. The majority of these liabilities rest with the Medicare program, the Medicaid program, the Social Security program and federal pension obligations. How about conditions in the banking industry?
1992 179 bank failures
2009 140 bank failures
2010 157 bank failures
Banks took a big hit after the savings and loan crisis and once again currently in the mortgage lending crisis. Sorry for the bad news, but this is our current state of affairs.
The Federal Reserve Bank was created as a result of the 1907 depression to stop financial panics and provided emergency reserve funds for the banking system (the lender of last resort). The Fed’s mandate has expanded to include setting certain interest rates, controlling inflation, regulating banks and achieving full employment. The Fed in effect, manages the nation’s money supply. The gold standard was ended in 1933 under the Roosevelt administration when ownership of gold by citizens was banned and severed completely in 1971 under the Nixon administration. The gold standard brought about long run price stability, but also acted as a limiting factor in economic growth. The Fed is independent of the Executive and the Congress. In the 100 years prior to the existence of the Fed, we had 44 recessions and 6 depressions. In the 100 years of Fed control, we have had 22 recessions and 1 depression. There is much controversy regarding monetary policy engaged by the Fed recently. It is clear that the Fed and the Treasury have been poor stewards of our currency. We will pay for this in the form of higher inflation in the future; however, the Fed has certainly propped up the US banking system. It may very well be that the function of the Fed should change. We also need a stable and stronger currency. I have many reservations regarding the Dodd-Frank financial reform legislation. The intent is to strengthen the banking system and reduce the chance that tax payers will be on the hook for bank system bail outs. The 5,230 pages of rules is mind-boggling. Who could possible understand all of it? What happened to the Glass-Steagall 35 page style of legislation. It is disappointing that Dodd-Frank does not address the activities of Fannie Mae and Freddie Mac in the mortgage debt crisis. After all these GSEs along with the invention of mortgage-backed securities, poor under writing discipline on the part of lenders and government pressures on the industry to lend to unqualified borrowers contributed greatly to our financial disaster of late. The regulatory burden which this legislation is expected to impose on the banking industry (some $12 billion dollars in compliance costs) will be a burden on the banking system and its customers. The additional personnel required to administer the legislation will swell the federal ranks of regulators by an estimated 2,850 people.
A big part of the reason that European banks are in the fix that they find themselves is the Basel rules. I suspect that not many of us have heard of these agreements, but they have been adopted by European banks. Their content will tell you why banks have been clearly irresponsible in their lending practices in Europe. Commercial banks are required to hold an 8% capital reserve against business loans, 4% against mortgage loans, 1.6% against mortgage back securities and 0% against government debt. It is easy to understand the bias that banks will adopt since tying up capital reserves is not profitable.
According to Forbes publishing, the next financial crisis is likely to involve student debt. Student borrowing topped $100 billion in 2010 for the first time. Total student debt exceeds $1 trillion and is larger that total credit card debt in the US. Given the hefty unemployment situation, there is great concern that these student loans cannot be paid back. We will have to see just how this issue unfolds. The Federal government has a significant stake in this problem as it is the issuer or guarantor of most of this loan burden.
Currently, interest rates are very low. This is not going to be a constant well into the future. As interest rates do increase, the portion of the federal budget which will have to be dedicated to servicing the US debt will be staggering. Our debt status will be with us on into an extended future time.
For the Record:
DJIA 12,897.35
NASDQ 2,958.01
S&P500 1,361.80
Suggested Reading:
“Security Analysis” by Benjamin Graham
Leonesmoneymonitormonthly's Blog 
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