The US economy could suffer a massive hangover from the government’s efforts to rescue the financial system in the form of a soaring debt burden. But the alternatives look infinitely worse.
The US$700 billion the administration is seeking from Congress as the upper bounds of what it will need to take a mountain of bad loans off the books of financial firms is an eye-popping figure.
To get the funds to buy up the bad mortgage loans that have threatened to bring the financial system to its knees, the government will have to borrow. And that borrowing will come at a time when the federal budget deficit is already soaring.
The deficit for this budget year, which ends on Sept. 30, is expected to rise to US$407 billion, a figure that is more than double the US$161.5 billion imbalance for last year, reflecting what the economic slowdown and this year’s US$168 billion economic stimulus program are already doing to the government’s books.
The administration of US President George W. Bush is estimating that the deficit for the budget year that begins on Oct. 1, which will cover the new president’s first year in office, will hit US$482 billion, a record in dollar terms.
And that forecast doesn’t include the US$200 billion the administration committed to spending two weeks ago when it took over the nation’s two biggest mortgage companies, Fannie Mae and Freddie Mac.
It doesn’t have any of the US$700 billion the administration is seeking to deal with the bad mortgage-backed securities that have been at the heart of the severe credit crisis the country has been struggling with since August last year.
The legislation Congress passed this summer that gave the authority to rescue Fannie and Freddie boosted the limit on the national debt by US$800 billion to US$10.6 trillion.
The legislation the administration is now seeking to authorize the financial system bailout, according to a draft, would boost that debt limit to US$11.3 trillion, up another US$700 billion.
It is the rapidly rising debt that is cause for concern. The government is already spending more than US$400 billion a year just to pay interest on the national debt. The higher that debt goes, the higher the government’s borrowing costs and the less it has to spend on other programs.
Republican presidential candidate Senator John McCain and Democratic rival Senator Barack Obama are both making campaign promises about what new programs they will implement once in office, promises that could be severely constrained by the costs of a financial bailout.
The escalating borrowing also means that the government is competing with the private sector for loans, driving up interest rates. And then there is the matter of the country’s large trade imbalances, which mean the US has to borrow US$2 billion a day from foreigners.
Foreigners may not want to lend as much to the US if there are concerns that all the borrowing could weaken the dollar’s value against other currencies.
But even with all these threats, economists said the government has to take decisive action because the alternative of letting the financial system slide into even deeper problems which could jeopardize the routine loans that businesses and consumers need was simply not an option.
“It was critical to arrest the downward slide in financial markets,” said Sung Won Sohn, an economist at California State University, Channel Islands.