While European leaders and the International Monetary Fund scramble to respond to the latest Greek financial crisis that is threatening to spread across the continent, some U.S. lawmakers and policy experts warn that this country could be headed down a similar path unless it begins to deal with its own mounting debt.
Prominent figures ranging from former President Bill Clinton and former Treasury Secretary Robert Rubin, to former Federal Reserve Board Chairman Alan Greenspan and Rep. Paul Ryan, R-Wis., this week all made uneasy comparisons between Greece’s debt-ridden government and the federal government which is facing its second $1.4 trillion annual budget deficit in a row.
“We’re not Greece, but Greece is certainly a useful lesson,” Alice Rivlin, a former Congressional Budget Office director, said during a Washington conference Wednesday on fiscal issues. “If you build up massive debt, eventually your creditors will lose confidence.”
Earlier this week, stocks tumbled after Standard & Poor’s downgraded the credit rating of Greece and Portugal to junk status. Greece’s defense minister on Thursday promised “colossal” cuts in military operating costs to help his near-bankrupt country emerge from its financial crisis and speed up plans to modernize the armed forces. Meanwhile, the IMF promised to increase the 45 billion euro aid package for Greece to as much as 120 billion euros over three years to help quell the crisis.
Rubin, who served as Treasury secretary from 1995 to 1999, stressed that the fiscal situation in the United States is “massively different” from that of Greece, Spain and other budget-challenged countries in Europe. But he noted that market psychology “can change quickly and dramatically,” and the country’s huge deficit and low savings rate could lead to an unexpected downgrading of the U.S. credit rating and force up interest rates.
The crisis in Europe has been building for some time. In Greece, Spain and other countries, runaway spending on social programs, a flood of cheap money and repeated failure to implement financial reforms left governments badly vulnerable when the financial meltdown and global economic crisis erupted two years ago. The crisis also exposed deceptive Greek budgetary practices, which had disguised the true extent of the country’s debt, that exceeded limits imposed by the eurozone.
Greece’s national accumulated debt, pegged at $413.6 billion, far exceeds the country’s economy, with some estimates that it will reach 120 percent of gross domestic product in 2010. The deficit-to-GDP ratio — how much more the country spends each year than it raises in revenues, compared to the nation’s economic output — is 12.7 percent.
By contrast, the U.S. deficit-to-GDP ratio is expected to exceed 9 percent this year and ratio of publicly-held federal debt to GDP is expected to approach 60 percent. Measured in dollars, the annual gap between spending and revenue hit $1.4 trillion last year, a post-World War II record that is expected to be almost matched this year.
Carmen Reinhart, an economist at the University of Maryland and co-author of an exhaustive review of financial crises dating back eight centuries, said the United States does not face the same kind of peril as Greece. But, she warned, the U.S. does face a real risk that global investors will abruptly become anxious about its debt and demand much higher “risk premiums’’ – which means higher interest rates for U.S. debt.
“In this environment, where you are highly leveraged and there is great uncertainty, it doesn’t take a meltdown to bring about an adverse outcome,’’ Reinhart said in an interview on Thursday. “I am talking about a substantive increase in risk premia.” In a recent paper, Reinhart and Kenneth Rogoff of Harvard University warned that past financial crises highlight the looming risks. Over the past several centuries, including the most recent one, countries with government debt equal to more than 90 percent of Gross Domestic Product saw their economic growth slow by one percentage point on average. For the U.S., that would be an enduring slowdown from annual growth of 3 percent to about 2 percent.
The United States’ federal debt load is heading toward that red zone. The Congressional Budget Office, analyzing the fiscal impact of President Obama’s budget proposals, estimates that publicly-held federal debt will hit 90 percent of GDP in 2020.
But analysts caution that those estimates understate Washington’s true debt burden, because they omit both the huge federal guarantees on debt issued by financial institutions like Fannie Mae as well as debt amassed by state and local governments. Though the federal government isn’t technically liable for state obligations, Reinhart said Washington would likely shoulder them to prevent a state like California from defaulting.
To be sure, the president has also created a bipartisan deficit commission to come up with proposals for further reducing the deficit by 2015. But on Thursday, economists at the Brookings Institution warned that federal deficits could be bigger than either the White House or the Congressional Budget Office is predicting.
In the Brookings report, William G. Gale and Alan Auerbach estimated the budget outcome if Congress “acts more or less like previous Congresses” and doesn’t rescind any tax cuts that are scheduled to expire. Under that scenario, annual budget deficits would total $11.3 trillion by 2020 – about $2 trillion more than current official projections.
Some lawmakers and policy experts are already drawing comparisons between the United States and the plight of Greece. Republican Paul Ryan told the same fiscal conference that the problems in Europe pointed to a coming debt crisis in the United States. "We know interest compounds viciously once interest rates go up. This is something that is obvious, easy to predict and therefore something we should tackle," said Ryan, the top Republican on the House Budget Committee and a member of the deficit commission.
The House Democratic leader Steny Hoyer, D-Md., recently raised the Greek specter as well. “It is enough to look across the Atlantic at Greece’s extreme economic crisis and understand: it can happen here. If we don’t change course, it will happen here.”