The Upcoming US Financial Crisis

Laid out in one piece.  Excerpts:

Over the longer term, the U.S. also faces a debt crisis. Borrowing more than a trillion dollars a year is swelling the debt faster than the economy can grow. That means debt will continue to rise relative to GDP, putting the U.S. on track to economic instability. It will be some years, however, until the country reaches an acute crisis. At present, the ballooning debt – and the Federal Reserve’s easy-money policies that finance it – have not significantly pushed up either interest rates or inflation. The key to any permanent deficit solution will be reform of the major entitlements, including Social Security and health care. And that will require extraordinarily difficult compromises...

Here’s a closer look at what the country faces over the next few months:


The sequester. In the absence of a more comprehensive agreement to reduce the deficit, last year’s deal to raise the debt ceiling required automatic spending cuts – almost $55 billion in defense cuts that would take effect in 2013, as well as $38 billion in non-defense cuts. This so-called fiscal cliff, which is already having a depressive effect on the economy, includes spending reductions of at least 7% for a wide range of Federal activities, from health and education to the immigration service and the court system. No one really wants this to happen, but preventing it will require a compromise on deficit reduction that hasn’t been reached after more than a year.

Expiration of the Bush tax cuts. The 2010 extension of the Bush tax cuts is scheduled to expire, which would raise Federal revenue by more than $250 billion a year. If that happens, income tax rates for most Americans would rise by two-to-four percentage points, costing the typical family more than $1,200 in 2013, according to calculations by the Tax Policy Center. Other tax increases would bring the total cost to more than $2,000 a year for the typical family and more than $3,500 for the affluent. The question of who should pay how much more continues to be a stumbling block. 

Expiration of the payroll tax cut. Among the other tax increases that could expire in 2013 are several that were part of President Obama’s stimulus package. The most important is a temporary two-percentage-point reduction in the payroll tax for Social Security (worth $670 for the typical family and more than $1,200 for the affluent). Miscellaneous stimulus benefits vary from household to household, but add another hundred bucks, on average.

Expiration of unemployment insurance. In February, the Federal government offered additional unemployment benefits – typically 14 to 20 weeks – beyond the 26 weeks of jobless benefits that states normally provide. Under current law, however, no payments can be made after the week ending on Dec. 29, which would save the Federal government an estimated $26 billion in 2013.

Health-care cuts. Obamacare’s reductions in Medicare payments will begin, saving $11 billion in 2013, with hospitals taking the biggest hit. In addition, to help fund Obamacare, wealthy households will pay an additional 0.9% tax on income above $250,000 ($200,000 for singles), as well as additional taxes on capital gains, dividends, and interest of up to 3.8%.

Hitting the debt ceiling. The U.S. has been borrowing money so fast that it is likely to hit the debt ceiling again before the end of the year. The Treasury estimates that it could extend the deadline to mid-February through various technical measures. Any delay, however, could be damaging to the government’s credit rating.

As if domestic problems weren’t enough, financial turmoil in Europe continues to worsen. Five of the 17 countries that make up the euro zone are already in recession, and unemployment has risen to a record high of 11.6%. Neither the President nor Congress can affect the timing of troubles overseas, of course, and the odds will only increase over the coming months that a financial crisis in the euro zone will send a major shock throughout the global banking system.  No one expects that all the scheduled spending cuts and tax increases will take place – if they did, it would probably throw the U.S. back into a serious recession...