What happened to Lehman is now happening to the U.S. government

U.S. risks default

The United States Government is on a trajectory to default on its obligations. In its current financial condition, it will not be able to fund its forecasted budget deficits and unfunded Social Security and Medicare promises on top of its current debt obligations.

This isn’t official yet, and we don’t know when the market will react to it, but there is no longer any doubt about the extent of its trajectory.

There simply isn’t enough taxing power, value creation or outside capital willing to support its egregious spending.

Stating the obvious may be construed by some as fear mongering or worse but our view is not as severe as you might think. In the Federal Reserve Bank of St. Louis Review from July/August 2006, Lawrence Kotlikoff stated that

“partial-equilibrium analysis strongly suggests that the U.S. government is, indeed, bankrupt, insofar as it will be unable to pay its creditors, who, in this context, are current and future generations to whom it has explicitly or implicitly promised future net payments of various kinds.”

He went on to suggest that the U.S. should immediately close the Social Security program to reduce future liabilities (could you imagine?), use a voucher system for Medicare to limit costs, and replace personal, corporate, payroll and estate taxes with a single federal sales tax. All this, published in an article from 2006, well before the credit crisis and subsequent meltdown had even begun!

Three years later, the financial condition of the U.S. government is completely untenable. The projected U.S. deficit from 2009 to 2019 is now slated to be almost $9-trillion.

How on Earth does anyone expect it to raise this capital?

In order to satisfy U.S. capital requirements, all existing investors would have had to increase their U.S. bond purchases by 200% in fiscal 2009.

Foreigners, however, only increased their purchases by a mere 28% from September 2008 to July 2009 — far short of what the U.S. government required.

The U.S. taxpayer can’t cover the difference either.

According to recent estimates, tax revenue from all sources would have to increase by 61% in order to balance the 2010 fiscal budget.

Given that state government income tax revenues were down 27.5% in the second quarter, the U.S. government will be lucky just to maintain its current level of tax revenue, let alone increase it.

The bottom line is that there is serious cause for concern here. Don’t be fooled into thinking this crisis will fix itself when (and if) the economy recovers. Just how bad is it?

The total U.S. government obligations, using actuarial reports from the Social Security Administration and the Medicare Trustees Reports, amounts to $114.7-trillion.

The total Federal obligations according to GAAP accounting provided by Shadow Government Statistics, calculated on a U.S. fiscal year end basis with estimates for 2009, amounts to $74.6-trillion.

Regardless of whose assumptions you use, the total number is preposterously large.

From 2004 to 2009, U.S. unfunded obligations increased by an average of almost 50% over this six-year period under both calculation methods, while U.S. government revenue increased by only 12%.

No company or government can increase its liabilities by more than four times the rate of its revenue and stay solvent for an extended period of time.

And as the numbers imply, the hole that the U.S. government is digging is getting deeper by the minute.

On a GAAP basis, U.S. government unfunded obligations increased by more than $9-trillion from last year alone!

The numbers are surreal, and we must ask ourselves how much longer the world will continue to support this spending frenzy.

The Federal Deposit Insurance Corp. is another major problem for the U.S. The FDIC’s Deposit Insurance Fund, which had $10.4-billion at the end of June, has spent so much covering bank failures over the last three months that it is now completely out of money.

This means there is no capital set aside to insure the $4.8-trillion of deposits and $320-billion worth of FDIC-guaranteed debt that U.S. banks and other financial companies have issued.

Another shocker is that FDIC “funds” were never even held in a segregated account.

The fees collected from the banks are accounted for as a part of the government’s general revenues that go towards military spending, bailouts, interest costs and other government programs.

The FDIC “fund” merely consisted of IOU’s from the general revenues accounts.

And now that the Deposit Insurance Fund balance as of September 30, 2009 is negative, the FDIC wants the institutions to prepay their assessments for all of 2010, 2011 and 2012.

In effect, the FDIC wants to borrow money from the banks it provides insurance for. Does this not strike you as surreal? Why would anyone have any confidence in anything the FDIC guarantees?

We do not mean to pick on the United States alone.

The proclivity to overspend has spread to most governments throughout the developed world.

According to recent estimates, the countries that make up the G20 will face a combined budget deficit of 10.2% of GDP in 2009, the biggest since World War II.

The U.S. leads this “rogues gallery” of government spending on a percentage of GDP basis at 13.5%, followed closely by Britain and Japan at 11.6% and 10.3%, respectively.

If governments choose to continue down this path, where will all their funding come from?

If fiscal abuses continue unabated, confidence eventually erodes until investors just stop lending.

It happened famously to Lehman in September 2008, and it is happening now to the U.S. government.

The Q2 Flow of Funds Report published by the Federal Reserve revealed that the Federal Reserve purchased as much as half of the newly issued treasuries in the second quarter.

This means that the Federal Reserve isn’t merely supporting the market for U.S. treasuries — it is the market for U.S. treasuries.

Printing new dollars to support an almost $9-trillion budget deficit that stretches out over the next 10 years puts the U.S. on the road to ruin, and the major governments of the world have noticed and are taking action.