By Simon Johnson
The world’s largest banks have been accused of many things in recent years, including taking excessive risk in the run-up to 2008, doing great damage to the American economy by blowing themselves up and then working hard to resist any sensible notions of financial reform.
All of this is true, but it misses what is likely to be the most profound negative impact of the banks’ behavior on most Americans. The banks’ actions led directly to an increase in government debt, which in turn has made the reduction of that debt by “cutting runaway spending” a centerpiece of the Republican presidential campaign to date.
As a result of this pressure, Medicare now stands on the brink of being eliminated as a viable form of social insurance. Yet the executives who lead these banks – and the politicians with whom they work closely – will not be held accountable this election season.
How is this possible? The economic mechanism through which a bank-led financial crisis has a broader adverse fiscal impact is straightforward. The recession that deepened sharply in 2008 implied a deep loss of tax revenue, mostly because people lost their jobs. Lower revenue means larger government deficits, particularly when the government also provides unemployment insurance. This deficit implies a surge in government annual borrowing and in its stock of debt.
The Congressional Budget Office estimates that the total increase in federal government debt because of the severe financial crisis will end up around 50 percent of gross domestic product. Let’s call that $7.5 trillion in today’s money (our G.D.P. per year is currently around $15 trillion).
Here’s how that calculation works. In January 2008, when almost no one expected a financial disaster, the C.B.O. forecast that by 2018 federal government debt would be just over 20 percent of G.D.P. Once the severity of the problems brought on by the credit contraction after the collapse of Lehman in September 2008 became clear, the C.B.O. redid this medium-range forecast – now taking a view on what debt would be after a difficult economic recovery to trend growth.
In its forecast of August 2009, the C.B.O. expected that debt would reach nearly 70 percent of G.D.P. in 2018. The change in this C.B.O. forecast for 2018 – to 70 percent of G.D.P. from 20 percent – is the likely total fiscal impact of the 2008 crisis and deep recession.
To be clear, there was already a potential fiscal issue looming in the distance, in the 2020s and beyond – with the retirement of the baby boomers, increase in life expectancy and, most of all, our collective failure to control health-care spending.
But until 2008 we had time to deal with this – and gradual solutions seemed most likely, preferably including ways to control the growth of health-care spending more broadly across the economy.
But the perception of a “fiscal crisis” brought the longer-run budget issues forward in time and the jump in government debt created a sense of panic in some quarters, so measures to “fix” the budget in a dramatic fashion are now on the front burner in Washington.
Ironically, although the main reason for the recent increase in public debt was the financial crisis, brought on by extreme deregulation, the situation has strengthened the hand of people who want, above all, to cut spending.
Medicare had been in the sights of conservatives for some time, but providing health care for Americans at age 65 is a very popular program, and with good reason. Before Medicare was created, it was very hard for people in their 70s, 80, and 90s to buy health insurance. If Medicare were to end, the adverse impact on older Americans with limited resources, including almost everyone who is not very wealthy, would be significant.
Yet that is what those committed to reducing the size of government and its programs are prepared to do. Whether they can convert this popular theme in the Republican primaries into political momentum that carries through the general election and gives the G.O.P. the presidency and control of Congress remains to be seen.
It is not surprising Paul D. Ryan, Republican of Wisconsin and chairman of the House Budget Committee, is suggesting that we effectively eliminate Medicare over the next decade or so (for the details of how this would happen, see this piece by my colleague James Kwak, drawing on the analysis of the C.B.O.). The New York Times reports,
“Medicare would be turned into a subsidized set of private insurance plans, with the option of buying into the existing fee-for-service program. The annual growth of those subsidies would be capped just above economic growth, well below the current health care inflation rate.”
The surprise should be that his proposal is being so warmly welcomed by many people who see themselves as centrists in American politics; in the past they would have been more skeptical.
It does not have to be this way. Social insurance programs like Medicare can be kept in place at the same time as the federal budget is brought under control. To be sure, we need to adjust Medicare’s terms and some features of how it operates, but moderate and gradual changes would be sufficient, along with returning tax rates to where they were in the mid-1990s. (In Chapter 7 of White House Burning, we propose one way to do exactly this.)
Few people want to engage with this issue in a substantive way. The right is focused on not raising tax revenue. The left wants to protect Medicare and Social Security but for the most part does not discuss the details of how this can be done while limiting debt relative to G.D.P. over the next two decades.
This is a tactical mistake, opening those on the left to charges of fiscal irresponsibility. In fact, it was the administration of George W. Bush that oversaw big tax cuts, two foreign wars and a runaway banking system.
Part of the problem is that the Obama administration saved the failing big banks in 2009 and then defended them against being broken up in 2010 – the president’s top advisers consistently asserted that we need highly leveraged and very large financial institutions, irrespective of the damage they cause.
It will be very hard for the president to change his narrative at this point.
And it may be too late; many in the center have become enamored of Mr. Ryan, who also appeals to the Republican base and may even become Mitt Romney’s vice-presidential running mate. Certainly his ideas are likely to become a prominent part of the Republican platform for the general election.
In financial crises, it is people at the bottom of income distribution who end up being hurt; most of the rich do fine. When I made this point in “The Quiet Coup” in April 2009, some commentators shrugged off the comparison of the United States and emerging markets that had experienced crises, such as Russia or Indonesia or Brazil.
Surely, they argued, the United States had a much stronger democracy. But while the precise mechanism differs across countries, the link from financial elite misbehavior to squeezing the lower half of society is present everywhere. In the United States, it most likely will take the form of ending Medicare.
To many people, the financial crisis of 2008 seems but a distant memory. If you kept your job or found another, you might feel that the adverse consequences are behind you.
That would be a mistake. The worst is yet to come. When you are 85 and cannot afford decent health care, think about the banks.
An edited version of this post appeared yesterday morning on the NYT.com’s Economix blog; it is used here with permission. If you would like to reproduce this material in full, please contact the New York Times.