Tuesday, April 19, 2011

Staying above water

kw: national debt, predictions

I had some thought of gathering data to make a chart of the monetary trouble the nation is in, but found that others have done so already.

This chart, from this Wikipedia article, is packed with information. Firstly, the shape of the area plot shows how the total National Debt compares with Gross Domestic Product, from 1940 to today. In the Wikipedia article, the author writes that the dates shown are for the end of a Federal fiscal year, so that the 2009 marker at the lower right indicates October 1, 2009, the end of the 2009 fiscal year.

Secondly, the red and blue hues with the name labels show the administration during the years in question. Finally, we see that we are approaching a level of debt not seen since the run-up to World War II. Considering that WW III began nineteen years ago, this is no surprise. The surprise is the level of denial at all levels of government.

On one hand, this is alarming, because we are mortgaging our children's futures. On the other hand, we need to consider an appropriate analogy. What does it mean for national debt to approach 100% of GDP? In family terms, the total federal debt is similar to a family's debt, and the GDP is analogous to the family income.

According to the formula in use prior to about 2002, a bank would evaluate your creditworthiness for a new loan in part by the 25/38 rule: Home mortgage payments must consume no more than 25% of your gross income, and total debt service payments, adding in car loans and credit card payments, must be 38% or less. However, even when home mortgage rates were in the 8% range, just fifteen to twenty years ago (and they have been higher at a few earlier times), the value of the loan was about 11-12 times the yearly payments. Now with 5% money available, the value of a loan is about fifteen times the yearly payments. If a home mortgage is consuming a quarter of your income, then the mortgaged amount is between three and four times your gross income. That is considered a sustainable amount of debt by a conservative banker, and does not count the extra debt that may push the amount of your payments toward 38%. Because car loans have higher interest rates (even if hidden in extra fees so they can claim 0%), and credit card rates are much, much higher, the total debt added is small compared to a mortgage.

In practical terms, the point in my life that my wife and I had the worst debt-to-income ratio, we owned two houses with mortgages totaling $62,000, and had a total income for both of us of just under $30,000. Our debt was more than 200% of our gross income. By contrast, our current debt totals 71% of our gross income. And, as a matter of fact, if we do not pay off our mortgage prior to passing away, the mortgage will be passed on to our son along with the equity in our home; we have in a way mortgaged his future.

Here the analogy breaks down. He can sell the house, which is only about 30% mortgaged at present. He'll have money left over. The Federal government can hardly sell the country to pay off its debts, although in actuality, about $1.1 trillion is held by China of a total of $4.4 trillion or 30% of the federal debt, held in foreign hands. In a sense, we've already sold off 30% of the country! That concerns me more than the total size of the national debt.

So, I am concerned, but the concern is balanced. People whose loans were foreclosed in and after 2007 had been put into situations where they'd borrowed up to six or eight times their total income, with payments that frequently exceeded 50% of their income. That was unsustainable, and if debt service payments reach 50% of federal income, our country will have entered a near-bankrupt condition. We are getting close, and that is the reason behind the S&P action, downgrading the country's credit rating.

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