Thursday, July 24, 2008

Yes, There Will Be Armageddon: Government Goes Bankrupt

One financial Armageddon is entirely, easily predictable: the bankruptcy of government in the U.S.A., at every level: Federal, State, County and City. The prediction follows from very simple mathematics: entitlements which grow at 8% a year cannot be supported by an economy which grows at 3% or less.

This simple truth is already playing out. San Diego is just one example. Here is a report which lays out the basis of San Diego's impending bankruptcy: structural deficits. The same can be said of California, which managed to increase state spending by 44% over the past few years even as the economy which must support those expenditures grew a total of less than half that rate.


These benefits consisted of three rounds of retroactive benefits without funding which cost taxpayers $451 million. In addition, pension officials gave away 8,000 years of pension credits to city employees for free, at a cost to taxpayers of $146 million.

Another major unfunded benefit was the Deferred Retirement Option Plan ("DROP"). It was supposed to be operated on a cost neutral basis. However, the City’s outside actuary put the cost to taxpayers at more than $200 million.

Facing a billion dollar and growing pension deficit, City officials have traded away road repair, water security, and fire prevention to pay employees more to retire than to work. The IBA described the problem as a structural deficit.

The Securities and Exchange Commission (SEC) described the problem similarly: the "City would have difficulty funding its future annual pension contributions unless it obtained new revenues, reduced pension benefits, or reduced City services."

Year after year, the City has opted to cut services.It has not raised revenues nor has it cut employee benefits. Pension officials, with the blessing of high level City officials, have continued to issue rosy predictions.

The IBA Report has brought a much needed dose of reality to the situation. In the report the IBA notes that since 2003 the City has had to annually implement budget reductions (cut departmental budgets) which translate into reductions in city services.

The City is caught in a structural deficit trap. Total contributions from the City and City employees to the pension increased from $81 million in 2000 to $236 million in 2007. Total contributions during this period were $1.42 billion. But over the same period $1.7 billion or $300 million more than contributions, poured out of the pension in benefits and costs. These costs and benefits increased from $127 million in 2000 to $315 million in 2007. On-going pension expenditures consistently exceed on-going pension contributions.

Astute reader R. provides additional insight on public pensions:

I read the latest article. Are You Part of an Elite, and Don't Know It? (July 22, 2008).

A friend told me the other day that a fireman is getting $10,000 a month in a pension. I hear this all the time. Another friend says her 92 year old uncle gets $8,500 a month from being a fireman and he retired 45 years ago.

What people do not realize is this. At today's interest rates on cash at 3% or so, You and I have to save up 3 million dollars to get $90,000 in income per year. We also risk the chance of losing our capital by a fund failure or bank failure and more.

These government pensions are better than winning a million dollar lottery. A million dollar lottery pays less than $50K a year, and stops after 20 years, with no health care.

These pensions are like being a multi millionaire, like having saved, put away, 3 million dollars of after tax money. And we know it would have taken many more millions in order to save 3 million after taxes.

These pensions make people millionaires, or as you said, Elite. But the pensioners never had to save it up. It is one thing to pay someone while they are working, but it is outrageous to pay them that much when they are not working. And they are allowed to work elsewhere, collect other pensions, and earn income from other investments, while the taxpayer continues to support them.

I have saved up quite a bit, and bought income producing assets, but have much further saving to go in order to retire with a decent income from my savings or estate.

When you understand investing and passive income, you realize that the goal in life is to create an estate that pays you income later in life. You live off the income the money or estate generates. You don't spend your savings / capital. Then you can pass income generating assets to your children, or whomever you choose. So as I said, these pensions are like having millions in an estate that is producing income. Something that I have scrimped and scraped and saved to achieve. I rent a house now that prices are falling, and shop at garage sales. I rarely buy liabilities that lose value. Boat, RV, toys, etc. I almost always buy used items. Pensioners live much better than me, and drive brand new cars, boats, RV's and other liabilities.

Even better for example, a woman who marries a male government pensioner, and maybe soon for a man, LOL, is that a woman can come along and marry the government pentioner, then take the equivalent of half the future pension in a divorce, and pay no taxes on it like most divorces, or she can inherit the pension on his death after doing no work at all. Taxpayers then support her for no work ever done. It is insane. The entire government has a spending problem, not an income problem. Yesterday, my accountant told me I owe some more in taxes. The mainstream media blames "the housing slump" for government shortfalls--for example: States Slammed by Tax Shortfalls.

The problem isn't a tax shortfall, it's a structural deficit between outlandishly generous pensions and healthcare benefits and what the economy can support.

I have often reprinted this little chart to graphically illustrate what bankruptcy looks like. We all read these mind-numbing numbers--unfunded Medicare obligations, $43 trillion, and so on--and then move on to sports or celebrity gossip or the latest bread-and-circus political "news."

That structural deficit can only be resolved by complete bankruptcy of government at all levels. You can't fund $60 trillion with tax increases, or hope that some Oil Exporting Nation's sovereign investment fund will loan us $60 trillion (the Medicare shortfall alone is $43 trillion, but let's not forget all those other promises to pay pensions and healthcare made by Federal, local and state governments).

That Medicare expenses outstrip the growth of the underlying economy can be seen in this chart: please go to to view charts.

As I have documented elsewhere, Medicare costs continue to climb at a rate far above the growth rate of the U.S. economy, and there is virtually no evidence to support the fantasy that adjusting a few parameters of payments or services will do anything to change that.

Medicare now costs over $500 billion a year, larger than any expense except Social Security (which is supposedly self-funding via the FICA payroll taxes) and the defense budget (fighting two wars, global war on terror, etc.). The trends are inescapable: Medicare will soon surpass defense spending, and then keep right on going.

Will anyone accept a reduction in their "right" to entitlements? Heck no. Remember, "I earned this" and "it's my right" and "I paid my taxes, I deserve this." Ahem. Yeah, sure. Whatever.

There is no way to gracefully cut off entitlements, and politcally it is impossible. That's why it's easy to predict bankruptcy is the only outcome: a point will have to be reached when the government simply can't tax or borrow enough money to meet its obligations.

At the Federal level, that will be reached when interest rates skyrocket and the interest on the Federal debt (National Debt) exceeds all expenses but Medicare. The interest is already pushing $300 billion--yes, half as large as the entire Social Security budget--and it takes little imagination to see it doubling and then tripling as money becomes dear globally and our non-U.S. friends who have purchased all our debt finally tire of supporting our free-spending ways.

After all, every dollar they waste, oops, I mean invest, in U.S. bonds and mortgages (debt) is a dollar not invested in their own nations' well-being. Eventually their own people will demand that the surplus be invested in their own nation rather than propping up The Empire of Debt, a.k.a. the U.S.

At the local and state level, bankruptcy will become inevitable as soon as revenues are dwarfed by expenditures and pension/benefit promises. The city of Vallejo has offered us the template which will be followed hundreds of times in the coming decade: recalcitrant public unions demand more taxes to cover the structural budget shortfalls and complain "the money's gotta be here somewhere," and after cutting services to the bone the city finally declares bankruptcy.
Look for this play to come to your town, city, county and state soon.

There will be plenty of half-measures and fantasy "solutions" along the way, of course; here in California, the latest installment is a drastic pay cut for some state workers: Governor plans to slash state workers' pay.

It's not politics, it's math. As I noted in Is the U.S. Alcoholic, or Merely Schizophrenic? (July 15, 2008), we as a nation are in deep, inpenetrable denial about our fiscal binges and addictions to "borrowing our way out of debt," i.e. "the hair of the dog that bit us."

Open a spreadsheet and enter two columns of data. Take $100 and calculate its growth over 20 years at 3%. Now calculate 8% growth for 20 years.

The economy and tax revenues rose 75% in 20 years to $175. The entitlements/pension /Medicare costs more than quadrupled to $431.

No spin, no politics, nothing fancy: that's how expenditures outrun revenues to the point that bankruptcy is the only possible endpoint. Call it whatever you want--"structural deficit" has a nice, clinical sound--but anyone claiming there won't be financial Armageddon should fire up his/her spreadsheet and do the math. There will be Armageddon, as sure as 2 + 2 = 4.

Bailout Alerts:

Astute reader Mary R.H. recommended this Vanity Fair article on the Bear Stearns collapse: and offered this comment:

See page 7 of the article, about 1/3rd down, where it says "At one point, Paulson had to sign a document confirming that, yes, in the event Bear defaulted on its securities, the American taxpayer would pay the tab." I absolutely froze when I read this. I had to reread it several times to let the full weight of that message sink in. We the common people who apparently have no rights left in this country and no say in legislated federal usury are going to pay for the ruling class to remain wealthy and in power. "A GOVERNMENT FOR THE PEOPLE AND BY THE PEOPLE"... I don't think so, not any more.

I would also suggest this absolute gutting of Fannie Mae and Freddie Mac by Paul Gigot: The Fannie Mae Gang (Wall Street Journal)

Thank you, Mike W. ($20), for your very generous donation to this site via mail "from the desk of Ron Dump". (That made my day!) I am greatly honored by your support and readership.

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