Why the national debt is a ticking time bomb

Posted: Sunday, July 25, 2010

Millions of Americans face potential financial ruin because they bought homes they couldn't afford. Often, these homeowners were lured by initially low interest rates that provided the illusion of affordability. After a few years, these "teaser" rates reset upward, creating unaffordably high mortgage payments.

Now, Congress is falling into the same trap - with your tax dollars. From 1789 through 2008, the United States built a $5.8 trillion national debt (plus $4 trillion more that will be needed to repay the raided Social Security trust fund). Since then, the debt has already surpassed $9 trillion, and the Congressional Budget Office projects that President Obama's budget will push the debt to $20 trillion - $166,000 per household - by the end of the decade.

In short, between 2009 and 2020, Washington is set to borrow more than three times more than in the previous 220 years combined. How has this been possible? Because Washington, like many homeowners, was lured by temporary low interest rates. Since 2000, the interest rate on the 10-year Treasury note has fallen from 6 percent to 3 percent. The U.S. Treasury has lowered its interest costs further by shifting toward cheaper short-term debt. Thus, nearly half of government debt will need to be refinanced in the next 12 months, and nearly two-thirds will require refinancing within 36 months. So even though the national debt has surged since 2000, the annual net interest costs have actually declined from $223 billion to $209 billion. Consequently, some commentators are downplaying the long-term cost of rising debt. In doing so, they display a failure to understand interest-rate trends.

Interest rates on government bonds are at historic lows for three reasons. First, the recession has dampened investment demand and thus lowered interest rates across the economy. Second, the Federal Reserve has actively kept interest rates low. Third, investors both domestic and abroad have observed unstable stock markets and European budget crises, and decided that Treasury bills are the safest place to park their money.

All three factors will reverse themselves.

At some point, the economy will recover. When that happens, those seeking home, auto and business loans will be competing with Washington to borrow from the same limited pool of savings. The result: higher interest rates.

To prevent inflation, the Federal Reserve will likely pull out the new dollars they had poured into the economy, and raise interest rates.

Finally, at some point investors will move their money back to a stabilized stock market, thus forcing the Treasury to offer higher interest rates to attract buyers.

Accordingly, interest rates on government bonds are virtually guaranteed to jump over the next few years. Had Washington relied more on long-term bonds, it could have locked in affordable interest rates. Instead, the Treasury went for short-term teaser rates, providing temporary savings but exposing the government to higher interest rates when these bonds must be refinanced in the next couple of years.

The taxpayer cost will be enormous. CBO projects that, under the president's budget, soaring debt and rising interest rates will push net interest costs to $916 billion by 2020 - costing the average household $7,000 in annual taxes. These taxes won't educate a single child, fund a single American troop, or provide retirement security to a single senior citizen.

It gets worse. Even these figures assume the interest rate on the 10-year Treasury note will converge toward 5.5 percent - lower than in the 1980s and even the 1990s. The factors described above will likely push interest rates even higher, and every percentage point above that 5.5 percent rate would add $1.2 trillion in net interest costs over the decade. Yet Congress continues to dig the debt hole even deeper.

They have passed more failed "stimulus" spending, more bailouts, and a massive health care bill that contains a new long-term care entitlement that even Sen. Kent Conrad, D-N.D., admits is "a Ponzi scheme of the first order, the kind of thing that Bernie Madoff would have been proud of." Families are working to dig out of debt, live within their means, and stop chasing "teaser rate" gimmicks. Is it too much to ask President Obama and Congress to do the same?

• Brian Riedl is the Grover M. Hermann Fellow in Federal Budgetary Affairs at The Heritage Foundation. Readers may write to the author in care of The Heritage Foundation, 214 Massachusetts Avenue NE, Washington, D.C. 20002.



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