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Public Debt & Deficits
Myles Watts
and Doug Young
Department of Agricultural Economics and Economics
Montana State University
February 2012
1
Links to the
General Economy
•
•
•
•
•
•
Gross Domestic Product (GDP)
Debt
Strength of the Dollar
Aged Dependency Ratio
Housing
Employment
2
Economy Sizes
International
Monetary Fund
Population
(Million)
63
14.5
6,895
310
12.2
330
5.5
5.9
3.3
24.9
127
1,341
82
4,787
(2010 GDP Trillions $)
World
USA
Eurozone
(17 countries)
Japan
China
Germany
Rest of World
International Monetary Fund, World Economic Outlook Database, September 2011
United Nations, Department of Economic and Social Affairs, Population Division (2011)
3
World GDP: Historical Trend
70
Trillions of Dollars
60
50
40
30
20
10
0
World Bank national accounts data
4
U.S. and Eurozone GDP:
Historical Trend
5
World Bank national accounts data
Strength of U.S. Dollar:
GDP of Eurozone Countries
Nation
GDP
Nation
GDP
Austria
377
* Italy
2,055
Belgium
468
Luxembourg
Cyprus
23
Malta
Estonia
19
Netherlands
781
Finland
239
* Portugal
229
France
2,563
Slovakia
87
Germany
3,286
Slovenia
48
* Greece
305
* Spain
* Ireland
207
GDP in 2010 billion U.S. Dollars
International Monetary Fund, World Economic Outlook Database, September 2011
55
8
1,410
6
Debt as a Percent of GDP (2010)
Net Debt
Total Debt
Greece
143
143
Japan
117
220
Portugal
89
93
France
77
82
Italy
99
119
Ireland
78
95
Spain
49
60
USA
68
94
World
64
80
International Monetary Fund, World Economic Outlook Database, September 2011
7
Aged Dependency Ratio

Population
Aged
65

Population Aged 20  64
8
Aged Dependency Ratio
1990
2010
2030
Greece
.23
.30
.41
Japan
.19
.38
.57
Italy
.25
.34
.48
Portugal
.24
.29
.43
France
.24
.29
.43
Ireland
.22
.19
.31
Spain
.24
.27
.40
USA
.21
.22
.37
World
.12
.13
.20
9
United Nations, Department of Economic and Social Affairs, Population Division (2011). World Population Prospects
U.S. Debt
($15 Trillion)
Debt Down Grade
Change
Bps
20
50
Cost
Billions $
30
75
10
U.S. House Mortgages
S&P/Experian Consumer Credit Default Indices
11
Case-Shiller
10 City House Price Index
BLS CPI Index & S&P Case-Shiller
12
Employment (2010)
Education
Median Weekly Unemployment
Earnings (2010 $)
Rate (%)
No H.S. Diploma
444
14.9
H.S. Diploma
626
10.3
Bachelor’s
Degree
1,038
5.4
Doctoral Degree
1,550
1.9
Bureau of Labor Statistics/CPS “Education Pays”
13
Education Earnings Ratio
(College Diploma/High School Diploma)
1.87
1.73
1.61
1.31
1980
1990
Bureau of Labor Statistics, Current Population Survey
2000
2010
14
Deficits and Debts
1. The Deficit and Debt Definition
2. The Federal Debt in
Perspective
3. How Much is “Too Much?”
4. The Long Term Outlook
5. What Can be Done
15
1. Definitions
• Deficit = Expenditure – Revenue
– Usually, per year
– “The Federal Government’s deficit in 2011
was $1.3 trillion.”
• Debt = Accumulation over time of deficits
less surpluses
– At a point in time
– “The Federal Government’s Debt on January
13, 2012 was $15.2 trillion.”
16
Federal Revenues and Outlays
(As a % of GDP)
Historical Budget Data, as presented in Congressional Budget Office, The Budget and Economic Outlook:
Fiscal Years 2011 to 2021 (January 2011).
17
2. The Debt – How Big is It?
(As of January, 13 2012)
• Federal Debt $15.2 Trillion
– Held by the public $10.5 Trillion
– Held by governmental holdings $4.7 Trillion
• Non-Financial Corporate Business
(As of
December 8, 2011)
– Debt = $13.5 Trillion
– Assets = $29.3 Trillion
• Household + Nonprofit Sector
– Debt = $13.8 Trillion
– Assets = $71.1 Trillion
(As of December 8, 2011)
18
Federal Debt
(As a % of GDP)
Whitehouse Historical Budget Data
20
3. How Much Debt is
“Too Much?”
• When lenders worry that the country won’t
be willing and/or able to pay it back, so
• Interest rates rise to compensate lenders
for:
– Default Risk and/or
– Inflation Risk
21
When Lenders Loose Faith….
10 Year Bond Yields Jan 18, 2012
40%
35%
34.4%
30%
25%
20%
15%
10%
12.5%
8.2%
6.6%
5%
5.2%
1.8%
1.9%
0%
Greece Portugal Ireland
Bond yields from: www.tradingeconomics.com
Italy
Spain Germany
U.S.
22
US Interest Rates
Haven’t Risen (Yet)
23
As of December 8, 2011 …
• The US Government Debt is NOT
“Too Much” in the sense that it
Threatens the Economic and
Financial System
• But Neither Debt nor Deficits, as
Conventionally Measured, Include
“Promises” Made to Future
Generations
24
4. The Long Term Outlook
Federal Debt Held by the Public Under CBO’s Long Term
Budget Scenarios (As a % of GDP)
Actual
Projected
CBO 2011 Long Term Budget Projections
25
Flat Revenues; Growing Spending
Alternative Fiscal Scenario (As a % of GDP)
Actual
Projected
CBO 2011 Long Term Budget Projections
26
5. What Can be Done?
• Cut Spending (from what it would
otherwise be)
– Health Care
– Social Security
– Other (Discretionary) Spending
• Raise Revenues
– Tax Reform
27
Healthcare Expenditure
(As a % of GDP)
OECD.StatExtracts
28
Health Care
• Reduce Fraud
• Legal (Malpractice) Reform
• Require minimum deductibles and costsharing in Medicare supplements
• Accountable Care Organizations
– Salary (v. Fee for Service)
– Coordinated (v. Fragmented) Care
29
Social Security Tax Revenues and Outlays,
with Scheduled and Payable Benefits
(As a % of GDP)
Actual
Projected
CBO 2011 Long Term Projections for Social Security
30
Social Security
• “Freeze” benefits (adjusted for inflation)
today.
• Gradually increase early and full
retirement ages
• Increase taxable earnings to cover more
earnings (86% today)
• Use the “chained” CPI for inflation
• Cover all new government workers
31
Tax Reform-1
Lower tax rates and broaden the base
• Reduce the top personal rate from 35% to
23-29%
• Repeal the AMT and phase out of
deductions and exemptions
• Tax capital gains (indexed for inflation)
and dividends as ordinary income
32
Tax Reform - 2
• Eliminate itemized deductions
• 12% tax credit for mortgage interest on
principal residence (capped)
• 12% tax credit on charitable donations >
2% of AGI
33
Tax Reform - 3
• Cap exclusion of employer-provided health
insurance
• Tax interest on new S&L bonds
• Cap exclusion for contributions to
retirement accounts at $20,000 or 20% of
income
• Eliminate 150 other tax expenditures
34
Summary
1. The US government debt is not now at
dangerous levels
2. A continuation of current policies for
many more years is not feasible
3. Solutions do exist
4. Reform is (Politically) Possible: 1986
Tax Reform, 1993 Budget Compromise,
1996 Welfare Reform
35
More Information
Congressional Budget Office
Long Term Budget Outlook
http://www.cbo.gov
National Commission on Fiscal
Responsibility and Reform
http://www.fiscalcommission.gov
36
Trends in Agriculture
Finance
Myles Watts
Department of Agricultural Economics and
Economics
Montana State University
February 2012
37
Keys to the Future
of Agriculture
•
•
•
•
•
•
•
Assets and Debt
Productivity and Demand
Government Programs
Ethanol
Farmer Mac
Basel Requirements
International Competitiveness
38
Total Farm Assets - USA
Inflation Adjusted using 2011 CPI
BLS CPI Index & USDA Economic Research Service
39
Total Farm Debt - USA
Inflation Adjusted using 2011 CPI
BLS CPI Index & USDA Economic Research Service
40
U.S. Real Agricultural Land
Prices/Acre
Inflation Adjusted using 2011 CPI
BLS CPI Index, USDA Economic Research Service & National Agricultural Statistics Service
41
Real Land Value Appreciation (%)
2000-2010
42
Productivity: Wheat and
Corn Yields (Per Acre)
USDA National Agricultural Statistics Service
43
Demographics:
Males 17 to 35
Year
% of Population
1940
1950
1960
1970
1980
1990
2000
2010
2020
2030
15.9
14.4
12.2
13.7
16.4
14.8
12.8
13.2
12.6
12.4
44
Government Programs
• Sequestration is about 6% in all
agriculture programs including SNAP
• Current Discussion
• Eradicate direct payments
• Minor reduction in other commodity
and resource programs
• About 5% reduction in SNAP
45
Overview of Ethanol
Ethanol (B Gal)
No
Government
Current
Program
Increased
Mandates
8.9
11.0
14.6
Ethanol Price
Base
Corn for
Ethanol (B Bu)
3.6
Corn Price
Corn Price/
Ethanol Price
Base
1.87
29% Increase 50% Increase
4.3
5.5
38% Increase
102%
Increase
2.00
2.53
From James Brown, Master’s Thesis in Department of Agricultural Economics and Economics,
Montana State University, October 2011.
Note: Recent corn production is about 12.4 billion bushels
46
Farmer Mac
• Secondary Markets including
Farmer Mac
– Most mortgages of substantial
time length are resold in the
secondary market.
– Many are resold through
Government Sponsored
Enterprises (GSE).
47
GSEs
•
•
•
•
•
•
Fannie Mae
Freddie Mac
Ginnie Mae
Sallie Mae (until 2004)
Federal Farm Credit Banks
Farmer Mac
48
How Secondary
Markets Work
• Mortgages are originated by primary
lenders such as your neighborhood
bank.
• Loans are sold to a secondary entity,
some of which are GSEs, and some are
very large private corporations.
• Secondary entities may sell or retain
these loans.
49
If these Loans are Sold
• Loans are bundled into mortgage backed
securities
• These securities may be sold in tranches
to multiple buyers through the secondary
markets.
• Tranche purchasers are repaid in a
hierarchical manner with senior investor
paid first.
50
Simplified Hypothetical
Tranche ($100 m)
51
Secondary Market
(Tranching) Requirements
• Loans must meet certain requirements
resulting in somewhat homogeneous loans
within a bundle.
• Usually default risk is transferred to tranch
investors.
• Ownership of lien becomes confused.
52
Ownership Retained
in Secondary Market
• Loans are purchased from the local bank.
• Secondary market issues bonds or other
financial instruments to finance loan
purchases.
• Default risk is retained by the secondary
market and not transferred to bond
investors.
53
Scope of Secondary
Markets in Agriculture
• Long-term real estate loans are often sold
to the secondary market.
• Shorter-term and smaller loans, including
operating loans, are less likely to be sold
in the secondary market.
54
Benefits from
Secondary Markets
• Liquidity to banks
• Diversify risks
• Spatially
• Sectorially
• Over time
• Facilities credit default insurance
• Lower interest rate
• Increases credit availability
55
Farmer Mac Overview
• Chartered by Congress in 1987
• Provides Access to Secondary Markets
for Rural Borrowers, thereby Reducing
Cost of Credit
• GSE that is now Privately Owned (traded
NYSE)
56
Farmer Mac Overview
• Board of Directors
–10 Board members appointed by
shareholders from financial
institutions.
–5 Board members appointed by the
President with Senate confirmation.
57
Farmer Mac Overview
• Involved in $12 Billion of Loans
–50,000 Loans
–600 Lenders
–2/3 Loans eventually to small farmers
–50 States
–130 Commodities
58
Farmer Mac Overview
• Helps various agricultural lenders
–Farm credit systems
–Commercial banks
–Insurance companies
–Rural utilities
59
Farmer Mac
Loan Restrictions
• Farmer Mac is restricted to
– Agricultural real estate loans
– USDA guaranteed loans
– Rural utility loans
– Other limited loans
• Widening spread between operating loans
and real estate mortgages.
• Secondary markets for agricultural
operating loans for all practical purposes
are currently unavailable.
60
Bank Regulation:
Basel Requirements
61
Basel Objectives
• Improve the banking sector's ability to
absorb shocks arising from financial and
economic stress, whatever the source
• Improve risk management and
governance
• Strengthen banks' transparency and
disclosures
62
Basel History
• 1983: G7 agreed on rules for regulating
banks including the 8 Percent Rule
• 1988: Basel Accord amended to use
internal models for “off balance sheet”
• 1997: Allowed specific risk models
• 2007: Basel II replaced internal credit risk
models with complex risk weighting
63
Basel Focus
• Bank-level, or microprudential, regulation,
which will help raise the resilience of
individual banking institutions to periods of
stress.
• Macroprudential, system wide risks that
can build up across the banking sector as
well as the procyclical amplification of
these risks over time.
64
“Three Pillars“ of Basel II
• Minimum capital requirements
(addressing risk)
• Supervisory review
• Market discipline
65
Minimum Capital Requirements
• Bank Auditing: Capital Ratio and Return
on Equity
–Banks are required to maintain adequate
capital as measured by their Capital Ratio (or
Capital Requirement Rates)
Equity
Capital Ratio : CR =
Risky Assets
8 Percent Rule: CR>.08
66
Minimum Capital Requirements
• Risky Assets: Calculated as a Weighted Sum of
Assets. Various weights for a simplified example
Asset
Weight
House Mortgages
Other Loans
Cash
Most Other Assets
Some Off Balance Sheet
0.5
1
0
1
Varies
67
Hypothetical Illustration of Capital Ratio
Bank Balance Sheet
Million $
Assets
Cash
Gov't Securities
Loans
Operating
House Mortgages
Buildings
Total
Liabilities
Demand Deposits
Total Liabilities
Equity
Risk
Weight
3
5
0
0.2
0
1
50
40
2
100
1
0.5
1
50
20
2
73
0.1
3.5
76.5
93
93
7
Off Balance Sheet
Sold Loans (Service)
35
Total Risky Assets
Capital Ratio
Risky
Value
0.092
68
Minimum Capital Requirements
• ROE, ROA, and Capital Ratio (CR)
ROE
ROA  Asset 

=
Equity
ROA
=
Equity/Assets
ROA
=
CR
 Assumes
risk weight = 1
69
ROE
Minimum Capital Requirements
ROE and CR (ROA assumed = .01)
0.6
0.5
0.4
0.3
0.2
0.1
0.0
0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.16 0.18 0.2
CR
70
Supervisory Review
• Empowers regulators with tools for the first
pillar
• Framework for dealing with residual risk
that include systemic, pension,
concentration, strategic, reputational,
liquidity and legal risk
• Resulted in the Internal Capital Adequacy
Assessment Process
71
Market Discipline:
Disclosure Requirements
• Facilitates assessment by investors,
analysts, customers, other banks, rating
agencies
• Disclose details on the scope of application,
capital, risk exposures, risk assessment
processes and the capital adequacy of the
institution
• Must be consistent with how the senior
management including the board assess
and manage the risks of the institution
72
International Competitiveness
Finance Example
Developing
U.S.
Risk Free Interest Rate Includes
Inflation (LIBOR or U.S. T-Bills Based)
Bank Margin
Inflation or Currency Risk
Countries
3.5
3.5
1.5
0
2.0
1.5
Default Risk
Political
Judicial
1.0
0
0
8.0
3.0
2.0
Commercial Farmer Interest Rate
Small Farmer Adjustment
Small Farmer Interest Rate
6.0
NA
6.0
20.0
3.0
23.0
73
QUESTIONS
74