When Good Loans Go Bad

July 29, 2011by Hoy Grimm0

As the Federal debt ceiling debate speeds to climax and everyone is chiming in on the topic I feel compelled to simplify the topic and strip away some of the jargon. Not surprisingly, media outlets are fixated on the potential for the US to Default on their obligations and the aftermath of a default.  They need to sell papers and “if it bleeds it leads” which includes red ink in Washington.

Bankers learn three basic principals about lending money on their first day at work. Before you lend money to someone answer these three questions:

Does your borrower:

1. Have the ability to repay you?
2. Do they have the willingness to pay you?
3. Do you have enough collateral to secure your loan?

Lending money profitably boils down to these three criteria. If you own a government obligation-Savings Bond, Treasury Bills, Notes and Bonds, then you have loaned that money to the US government. If you are a business owner, you hold the other end of a contract with the government to provide goods or services to the government. Retirees receive an obligatory payment from the government each month in the form of social security.

Let’s apply our simplistic lending criteria to our Uncle Sam and see how credit worthy he is. Are our loans to him really at risk of default if the debt ceiling isn’t raised.

  1. Does the US have the ability to repay you? Do they have sufficient resources to tap in to?
    Answer: Yes? As the wealthiest country on the planet with the largest economy our nation has the economic wherewithal to easily pay our accumulated obligations in full. If the stalemate persists and the debt ceiling stays out, it will have no effect on our wealth as a nation or our ability to pay our obligations from that collective wealth.
  2. Does the US have the willingness to repay you? In other words, do they pay their bills on time or does the banker have to call and harass them to pay up every month when their note is due?
    Answer: Yes. The US has never missed a payment due on any obligations. While primarily a political one, the debate in Washington is about how to address future budget problems. Even if Washington fails to raise the debt ceiling, it doesn’t mean that they stop paying their obligations it simply means that they will not be able to borrow more money and spend beyond what they are currently receiving in tax revenue each month. At some point, the government would be forced to prioritize the dollars that they have to spend.

    The Treasury has more than enough income to pay what needs to be paid right now – defense, social security, Medicare, Treasury obligations. They would be forced to cut spending in other areas, layoff non-essential workers, defund pork barrel projects and stop spending beyond their income. If they are non-essential then why are they there in the first place? This pressure would also force Washington to enact budgets that are balanced against income every year since deficits would be prohibited (they would add more debt).

  3. Does the US have enough collateral to secure their obligations? Is there something of value in this country to assure our debt owners that they made a good loan?
    Answer: You, dear citizen and the economy you work in and support are collateral, the engine for all government spending and future promises to pay. Even in the midst of this great recession, 99% of you are working and paying taxes every week to fund our government and guarantee its obligations. That ultimately makes you the boss. Unfortunately the representatives we elect tend to lose sight of this reality and cut deals in Washington that benefit them personally more than their constituents. This behavior engulfs both Republicans and Democrats. As a result, you should realize that the current debate is an important opportunity to hold your representatives accountable for doing what is in the country’s long term interests instead of their short term personal gain.

Maintaining the current debt ceiling would force Washington to make tough decisions that would benefit our country in the long run. These forced actions would come at a short term cost to our economy. As the government is forced to reduce spending, economic activity would shift away from the government back to consumers and businesses. This will not be a pain free transition but it is unavoidable. Americans have come to realize that most Washington spending is relatively unproductive, because it is rife with corruption, cronyism and fraud. As we redirect these activities back into the private sector, the economy (and eventually our new, smaller government) will benefit.

If Washington begins to act more responsible with the public trust, Businesses and consumers will gain confidence that their hard work will not be rendered meaningless by political folly and our economy will roar back to life.

If you build a mountain of debt there are only two options- pay it back or go bankrupt and leave someone else to pay it back. If the market feared a government default, bond rates would already be skyrocketing. That is what is happening in Italy right now

Source Bloomberg

Today the ten year US Treasury yields less than 3%:

Source Bloomberg

Bond market investors know the answer to the three questions above. Don’t let the headlines scare you into believing default is even a remote option.

Hoy Grimm

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