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Consumer Credit Depression, CBO Deficit Armageddon, Government Warnings of Financial Fiascos!

Economics / Great Depression II Sep 27, 2010 - 07:57 AM GMT

By: Martin_D_Weiss


Diamond Rated - Best Financial Markets Analysis ArticleFor my family, fiscal balance is not — and never was — a partisan issue. My father, for example, had little interest in politics but was passionate about savings, hard work and avoiding waste.

When I was a toddler, he used to sit me on his knee, teaching me and my older brother that money is not a toy or a game; it’s to be valued, kept in a piggy bank, and treated with due respect.

And later, by the time I was a teenager, that same lesson had evolved into an equally serious discussion about sound banking, avoiding excess debt and balancing the government’s books.

Also at the time, Dad was fighting the greatest budget battle of the 20th century. He had just founded our nonpartisan Sound Dollar Committee. And with the blessing of friends like Democrat Bernard Baruch and Republican Herbert Hoover, he was busily rallying grassroots support for President Eisenhower’s extremely unpopular proposal to balance the budget of fiscal year 1960.

Dad taught us that when any country, family, or corporation lets its debts grow beyond reason, they follow one of three paths. —

  • They go bankrupt …
  • They cheat the system, or …
  • They do the right thing by tightening their belt and trying to work even harder.

Most of the time, Dad explained, most people and institutions do the right thing.

Some get the idea right away. Some take longer to figure it out. But sooner or later, voluntarily or involuntarily, they realize it’s the only real choice.

Households, start shunning credit, saving more, and spending less.

Banks that don’t go under move swiftly to cut back lending and build up cash reserves.

Politicians, he’d say with a laugh, are not nearly as smart. But even they eventually get it.

The tipping point, he estimated, comes when federal deficits grow beyond around 5 percent of GDP. Then, beyond that threshold, there are only three conceivable scenarios:

Scenario A — Bankruptcy. The government defaults on its debts and is promptly blacklisted by lenders, plunging the nation into extreme poverty and political upheaval.

Scenario B — The Cheating and Stealth. The government prints paper money to fund its debts, trashing its currency and leading to a calamity similar to the default scenario.

Scenario CAusterity. The government makes swift spending cuts, shrinks in size, and encourages the entire society to make similar sacrifices.

martinandirving 3 Government Warnings of Financial Fiascos!

Given the nature of politics, he admitted the austerity scenario might sound unlikely.

But given the hard realities, Dad insisted it was actually the ONLY viable option for the United States.

Why After Seven 50 Years of Wild Spending, Austerity Is Now Inevitable

Dad won the battle of the budget in 1960. It was balanced, and the country suffered a moderate recession as a result. But throughout the half century since, even in years when the federal government supposedly ran a “surplus,” government spending has continued to grow by leaps and bounds.

What’s different today? Simply this: Previously, the federal deficit rarely exceeded 3 percent of GDP.

Now, it is running close to 10 percent — DOUBLE the level that we felt would be the tipping point of a fiscal crisis … and it’s doing so year after year!

But here’s the key: While Washington continues to treat money like a game, and while Wall Street enjoys its final fling of fantasy, three government entities have issued major warnings or taken actions that harken back directly to Dad’s lessons.

Each foretells of financial fiascos ahead — and each has the potential to outweigh any stock market rally.

Warning #1 Fed: Consumers Shunning Credit

chart 3 Government Warnings of Financial Fiascos!

The folks in Washington and on Wall Street may still be in la-la land, but average American families are finally waking up to the real world …

The Federal Reserve has now released new, landmark data proving that consumer credit is in the deepest depression on record.

Look. For decades, the U.S. economy was fueled and sustained by American consumers on a nonstop binge of borrowing and spending.

Indeed, in almost every year since World War II, consumers consistently borrowed more than they did in the prior year. The more consumers borrowed, the more they spent … and the more they spent, the bigger the revenues at the nation’s manufacturers and retailers.

But now, all that has changed! For the first time since the Great Depression, consumers are not only borrowing LESS, but they are also cutting back on prior borrowings — either because they’re defaulting and being FORCED out of the debt market or because they’re voluntarily trying to AVOID that outcome.

Ultimately, debt reduction in any form can help clean the slate for a future recovery. But right now, it means only one thing: Massive cutbacks in consumer spending!

The basic principle is very simple: No more easy credit; no more big spending! Instead, for the first time in at least two generations, we are witnessing a radical shift in consumer psychology — from splurging to cutting … from exuberance to prudence.

I repeat: In the long term, debt reduction is a good thing. But right now, it’s threatening to drive the U.S. economy into another tailspin.

Warning #2 NCUA Seizes Biggest Credit Unions

This warning comes in the form of stern action: On Friday, the National Credit Union Administration (NCUA) seized three wholesale credit unions that provide financing and investment services to more than 7,000 retail credit unions around the country.

The problem: Like the bailed-out banks and failed mortgage giants of recent years, these giant credit unions made big bets on commercial and residential mortgages. Their mortgages collapsed in value. They ran out of cash to cover the losses. And on Friday, regulators decided they were too far gone to save.

Result: All three will be shuttered … their executives will be fired … and their toxic assets will be scooped up by the government.

Moreover, this wasn’t the first time the government has been forced to act. All told, since March of last year, FIVE of the nation’s largest wholesale credit unions have gone under, representing a whopping SEVENTY percent of the assets among ALL of the nation’s wholesale credit unions.

Smaller retail credit unions, which deal directly with the public, are in better financial shape. But the large failed credit unions are at the core of the entire industry. They are the institutions that thousands of credit unions depend upon for financing and other services. And they are mostly in ruins, with the entire industry relying on yet ANOTHER government bailout to keep it running.

It’s a stark reminder of what happens when banks treat your money like a speculative game. And it’s one of many telltale signs that the financial crisis is NOT over. Quite the contrary, as Mike Larson has detailed here repeatedly, the housing bust, which triggered the crisis in the first place, is continuing — and so are its repercussions.

Meanwhile, banks that have not gone under are doing the only logical thing: They’re cutting back on lending, making it ever more difficult for consumers and businesses to get credit.

Warning #3 CBO: Deficit Armageddon!

The nonpartisan Congressional Budget Office (CBO), serving all of Congress regardless of party affiliation, is now raising the exact same alarms Dad raised years ago.

The CBO has announced that this year’s federal deficit will be the second largest in history.

It has disclosed data showing that, had it not been for some fancy accounting, this year’s deficit would actually be the LARGEST in history.

And it has issued the following very explicit warnings …

Rising probability of a fiscal crisis! The CBO writes: “In such a crisis, investors become unwilling to finance all of a government’s borrowing needs unless they are compensated with very high interest rates.”

My take: It is a vicious cycle that can spiral out of control. The more the government borrows, the more interest it has to pay … and the higher the government’s interest costs, the more investors would question the government’s finances.

Timing of crisis unpredictable! CBO: “Unfortunately, there is no way to predict with any confidence whether and when such a crisis might occur in the United States; in particular, there is no identifiable tipping point of debt relative to GDP indicating that a crisis is likely or imminent. But all else being equal, the higher the debt, the greater the risk of such a crisis.”

My comment: Typically, some outside event tips the shaky balance of supply and demand in the global marketplace for U.S. government debt. It could be a collapse in the dollar. It could be a major Fed announcement of a new round of money printing (”QE2″). Or it could be the sense that America’s political leadership is in disarray. But regardless of the specific trigger, the result is the same: Surging interest rates and severe difficulties in raising funds.

Fiscal crises and recessions can happen at the same time! Typically, interest rates go down in a recession and up in a boom. But when deficits are out of control, the opposite can happen. The CBO writes: “Fiscal crises around the world have often begun during recessions and, in turn, have often exacerbated them. Frequently, such a crisis was triggered by news that a government would, for any number of reasons, need to borrow an unexpectedly large amount of money.”

My analysis: Right now, the official federal deficit (before adjusting for accounting gimmicks) is running at about $1.3 trillion, or 9.1 percent of GDP, despite the so-called “recovery.” If, due to sinking consumer spending and more bank failures, we see a double-dip recession, the deficit could easily explode to $2 trillion.

Worse than Greece and Ireland? Unlike smaller countries, the U.S. benefits from its status as a safe-haven nation. But, warns the CBO, “the United States may not be able to issue as much debt as the governments of other countries can because the private saving rate has been lower in the United States than in most developed countries, and a significant share of U.S. debt has been sold to foreign investors.”

My view: As I explained here last week, this is the key factor that differentiates the U.S. from Japan. Japan’s savings rates are still very high, and they finance almost all of their debt from domestic savings. In contrast, America’s savings rates, despite some recent improvements, are still among the lowest in the world, and the U.S. finances most of our debts by borrowing from investors overseas.

Recession is actually the LESSER of the evils! Turning to the possible government responses to the problem, the CBO follows Dad’s logic almost to the letter, writing that …

  • Bankruptcy — defaulting on U.S. debt — would be a disaster, making it extremely difficult for America to borrow for many years to come.
  • Cheating and stealing (e.g., printing money) — which, as Mike Larson explained on Friday, now seems to be what Fed Chairman Bernanke favors — would also be a huge mistake, again making it much harder for the U.S. to borrow in the future.
  • In conclusion, the ONLY viable option, says the CBO, is … austerity. Yes, they admit, it would have negative consequences, driving the economy into a deeper recession. But, they say, a deeper recession would be the lesser of the evils.

This is the urgent dilemma America faces right now: Do we want to continue playing games with our money … or do we want to treat it with the respect it deserves?

If we do the wrong thing, we will doom future generations — and ourselves — to impoverishment. If we do the right thing, more economic pain is inevitable. But outside the fantasyland of Washington and Wall Street, it’s the only viable option.

Whether you agree or not, I warmly welcome your comments. Click here to join the lively debate now under way on my blog.

And no matter what you believe, please don’t be hoodwinked by the same old tricks that Wall Street and Washington have always played in this kind of crisis.

Good luck and God bless!


This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit

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mr. reason
27 Sep 10, 16:29
which will the politically connected benefit from most

which of these 3 supposed options would benefit the poltically connected the most...i.e banks...big industry?

then you have your answer.

30 Sep 10, 12:08
credit union bailout

The Corporate (wholesale) Credit Unions did not make the mortgages. They bought mortgages from our good friends at Goldman. J.P. Morgan, B of A, etc. Retail credit unions can only invest in government-insured instruments - CD's, Treasuries, GNMA's, etc. They strtched for yield. One of those taken over had 70% MBS's. Our credit union is paying for the bailout. Shameful!

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