StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between

The Ongoing Bailout of Main Street

06 Oct 2008
Posted by Andrew Samwick

I have returned from some business travel to my familiar rant, this time on NPR's Marketplace.  The teaser:

Bailout supporters took a lot of heat for handing that cash over to Wall Street. But commentator and economist Andrew Samwick argues it's actually Main Street that's usually on the receiving end of government help.

You can follow the link to listen to the commentary. I'd be happy to follow up on any questions raised by the piece.


Annual Deficits and Main Street Bailouts

I loved your spot on Marketplace today about the history of bailouts for Main Street, it worked perfectly with something I have been pondering: How much has the US GDP been fueled by federal and personal deficit spending over the last 5 or so years?

What would real US GDP be if the US 'lived within its means'?

According to the US Treasury (BEA), total real GDP for the 5 years 2003-2007 was $62T and personal consumption accounted for $43.5T - about 70%.

Personal consumption grew 26% over the period 2003-2007, from $7.7T to $9.7T. Individuals assumed about $5T in new consumer debt to finance deficit consumption and the Treasury went about $2.5T deeper in debt over this period to do the same.

The 2003-2007 federal budget deficits were financed with Treasury securities, but would otherwise have been paid with increased taxes. Congress and the White House chose to leave those $2.5T tax dollars in the capable hands of consumers - where they were mostly spent rather than invested.

I have to believe that subtracting $7.5T of debt-financed consumption from GDP over the 5 years 2003-2007 would tell a story of an economy contracting during this period.

We're in for the epic hangover that inevitably comes the day after the swinging party. In our case, it's the administration after. We can no longer tolerate deficit spending to pay for current consumption - and that includes Social Security and Medicare.

To every thing there is a season: Must be our time to work, to export, to save, to pay taxes, to live with smaller government and fewer lattes, because we can't ride this debt train any farther.

Living Within Our Means

Yours was the reaction I was hoping for, and I like your phrasing of the question about what GDP would have been if we lived within our means.  Perhaps another answer would be to subtract the interest payments on the incremental federal debt from GDI and track its growth over a given period.

Unfortunately, most of the reaction to the commentary at the Marketplace does not get the connection between the annual deficits and the concept of a bailout that is at the heart of Main Street's bailout.  Had I anticipated that, I would have summed up the on-budget deficits since the end of the recession in 2001 and used that as the figure to make the point.

Who has done the math?

Do you know of anyone who has done the analysis of how much our annual deficits effect GDP?

Questions from Kindergarten

nonWonk... just reading what I can, trying to make some sense of the information available.

So is the addiction to debt on both the individual and governmental level exacerbated by very low interest rates? What is the role of the Fed or the markets or who/what decides on going interest rates? Why is basic economic information so hard to translate to my idiot level? No you don't need to try to answer...but if you could point to some reading that doesn't turn into a massive chore, I'm willing to give it a go.

In a word ... yes

Asset prices, whether of internet stocks or residential housing, are set by the market's perception of the value of the cash flows that would come from owning them.  How much will they pay in dividends or rent in the near term?  How much could they be sold for at some later date?

All cash flows are discounted for both time -- how distant is the payment -- and for risk -- how sure am I of receiving this cash flow?  The more distant or the more risky the cash flow, the higher the discounting and the lower the current price of that cash flow.

Suppose that you revised your perceptions of how risky some project was.  You would then apply a higher discount to its cash flows and value the project at less than before you revised your perception.  Prices would fall.  That's not necessarily a bad thing, except that it now impairs balance sheets or makes equity capital more expensive to raise.  If this happens with just a few companies, then there is no big problem.  If it happens with an entire sector of the economy -- like technology companies or residential housing -- then it is thought to be a big problem.

What does the Fed do?  It steps in to lower short-term interest rates.  It partially offsets the decline in the value of the assets due to higher discounting for risk with lower discounting for time.  This keeps the bubble sectors from crashing as hard as they otherwise would.  But it also encourages activity that would not be done but for the lower interest rates.  This is how the bursting of the internet bubble led to the housing bubble.  Now that it has burst, and we are already in the low interest rate environment, the Fed's policy choices are more limited.  The housing bubble is also more of a challenge than the internet bubble, since it involves financial institutions that are themselves quite leveraged. 

I hope this helps a bit, and I'll look for some other non-technical discussions of the issues involved.


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