Now Yer Talkin': Will US Run a $2T Budget Deficit?

I previously proposed playing a fun parlor game called "How Much More Will Sammy the Beggar Owe in 2009?" At that time, my head was already spinning while trying to come to grips with America running a trillion and a half dollar deficit. Imagine my reaction when economist David Greenlaw suggested that the US deficit could run closer to $2 trillion. In the time since I wrote the initial post, all sorts of newfangled costs have been added to the tab. These include the following:

- commitments to purchase short-term commercial paper in that now-dormant market;
- states unable to raise funds in the moribund muni bond market cadging Sammy;
- underestimated costs in recapitalizing banks;
- massive pork [oink, oink] dished out while passing bailout legislation.

Such a monstrous deficit would represent an estimated 12.5% of GDP--over twice the previous record set during the Reagan years. Given that the US government is now effectively the mortgage market, the commercial paper market, and the municipal debt market all rolled into one, this state of affairs is not very surprising. I am in agreement with Chris Martenson on this matter: the dollar rally will soon prove inexplicable given the oodles of debt which will soon emanate from every pore of Sammy the Beggar's spendthrift hide. The figures are certainly mind-boggling as we play this scary guessing game. Certainly, neither presidential candidate looks nor sounds like the thrifty money manager America needs as it downsizes its expectations for the future. Pssst...treasuries, anyone? From Bloomberg:

The global financial crisis is turning into a bigger drain on the U.S. federal budget than experts estimated two weeks ago, ballooning the deficit toward $2 trillion.

Bailouts of American International Group, Fannie Mae and Freddie Mac likely will be more expensive than expected. States are turning to Washington for fiscal help. The Federal Reserve said this week it will begin buying commercial paper, the short- term loans companies used to conduct day-to-day business, further increasing costs. And analysts now say the $700 billion bank- rescue plan passed by Congress last week may have to be significantly larger.

``I always assumed they would be asking for more money along the way if it was necessary, and it looks like it's going to be necessary,'' said Stan Collender, a former analyst for the House and Senate budget committees, now at Qorvis Communications in Washington. ``At the moment, there's nothing happening here that's positive for the budget. Nothing.''

The 2009 budget deficit could be close to $2 trillion, or 12.5 percent of gross domestic product, more than twice the record of 6 percent set in 1983, according to David Greenlaw, Morgan Stanley's chief economist. Two weeks ago, budget analysts said the measures might push deficit to as much as $1.5 trillion.

That means a lot more borrowing by Treasury, which will push up interest rates, said Greenlaw. ``The Treasury's going to be ramping up supply dramatically over the course of coming months to meet this enormous federal budget obligation,'' Greenlaw told Bloomberg this week. ``The supply will trigger some elevation in yields...''

Payments the government allocated to keep vital companies solvent are beginning to look insufficient. AIG, the giant insurance company that was taken over by the government in mid-September, said this week it may access $37.8 billion from the Federal Reserve Bank of New York, in addition to the $85 billion the government already loaned it to stave off bankruptcy. ``You're in for a dime, you're in for a dollar on this one,'' said David Havens, a credit analyst at UBS AG...

California, Alabama and Massachusetts are urging the Fed and Treasury to include their securities in rescue plans designed for banks and businesses. The $2.66 trillion U.S. market for state and city bonds has been all but frozen since Lehman Brothers Holdings Inc., weighed down by losses in mortgage-backed bonds, declared history's largest bankruptcy on Sept. 15.

California has said it needs to sell as much as $7 billion in notes to maintain its schools, health system and other public services. The Bush administration said it is reviewing the states' financial positions...

Meanwhile, Treasury Secretary Henry Paulson indicated two days ago that he is considering buying stakes in a wide range of banks in coming weeks to help recapitalize them.

Such a move is allowed under the $700 billion bailout package Congress passed last week. Edmund Phelps, winner of the 2006 Nobel Prize for economics and a professor at Columbia University, said such action is necessary -- and will likely turn out to increase the measure's cost. Spending beyond the amount set in last week's bill would require further Congressional approval.

``We have to recapitalize the banks,'' Phelps told Bloomberg Television this week. ``I don't imagine that there's enough money in the first Paulson plan to be able to do all that needs to be done in that direction.''

The additional borrowing could push the national debt well past 70 percent of GDP, the highest since the immediate aftermath of World War II, when the U.S. was still paying off war debt.

Gross U.S. debt, which includes debt held by the public and by government agencies, this year reached about $9.6 trillion, or about 68 percent of gross domestic product. The rescue legislation increased the government's debt limit to more than $11.3 trillion from $10.6 trillion.

On top of all that, budget watchdogs say the sheer size of the interventions is making Washington more profligate than usual. To attract votes in Congress, leaders added several costly items to the $700 billion rescue, including extensions of some tax credits and tax breaks for makers of wooden arrows and stock- car racetrack owners.

Under normal circumstances, there would have been more resistance to such expenses, said Robert Bixby, executive director of the Concord Coalition, a non-partisan budget watchdog. The rescue legislation ``creates a mask for all sorts of fiscal irresponsibility,'' said Bixby. ``It covers up a multitude of sins.''