Flashback: What if the U.S. Government Paid Off Its Debt?


The current projections for U.S. government debt are grim. According to the Congressional Budget Office, national debt held by the public will hit $18 trillion in 2021, up from about $10 trillion today. As a percentage of GDP, public debt is forecast to go from 69% today to 84% by 2035.

Most Americans are all too aware of these numbers. In an NBC/Wall Street Journal poll earlier this year, eight in 10 said they were worried about the national debt. In July, a Gallup survey showed 42% of Americans were against raising the debt ceiling.

But it's easy to forget how different the outlook was just 10 years ago. Back then, the government was running record surpluses, and was forecast to repay all public debt by 2012. In his 2001 State of the Union speech, President George W. Bush minced no words: "I hope you will join me to pay down $2 trillion in debt during the next 10 years," he said. "At the end of those 10 years, we will have paid down all the debt that is available to retire."

That never happened, of course. But interestingly, the prospect created almost as much angst as today's record deficits.

Planet Money, part of NPR, recently obtained "a secret government report" through the Freedom of Information Act. The report, titled "Life After Debt" (you can see it here) is dated November 2000, and goes through a list of problems the government anticipated it would face once it repaid all of its debts.

The Federal Reserve in particular worried how it would conduct monetary policy. The Fed normally buys and sells Treasury securities to influence interest rates. What would it do once there were no more Treasuries to buy?

One idea was that rather than using Treasuries, the Fed could buy and sell private assets like CDOs. The report writes:

The Fed, if granted authorization could use private securities to conduct monetary policy.

Private institutions could provide a relatively sanitary solution to the Fed' s problem of replacing Treasury securities in the conduct of monetary policy by creating new, very low-risk securities constructed from a pool of private debt securities. Such securities would be packaged in a way similar to mortgage-based securities currently issued by ... Freddie Mac and Fannie Mae...

If you're familiar with the genesis of the housing bubble, this should make you shudder. The housing market took a fatal turn when Wall Street began packaging "very low-risk securities" into collateralized-debt obligations, rating them triple-A, and selling them to global investors who had an insatiable appetite for the products. How much worse would the bubble have been if the Fed were a major buyer of private CDOs early in the decade? It's almost incomprehensible to think.

The Fed didn't have to stop at CDOs, of course. As the report notes, "In principle, the Fed can conduct open market operations on any number of assets including corporate bonds, agency debt, sovereign debt, and even equities." More bubbles to be blown -- particularly in stocks, since the report was issued in 2000, during the dot-com bubble.

And then there's the federal government itself. Ten years ago, the government was on track to run budget surpluses as far as the eye could see. If those surpluses couldn't be used to pay off debt, where would the money go?

One idea was for the government to start buying up private assets. The report calls this "accumulating a federal asset." "Other governments have pursued a strategy of investing in equities and other financial market offerings, domestically and internationally," it writes.

The obvious problem with this idea: Whose stock do you buy? If you thought the Solyndra scandal was bad, just wait. "Of course significant and legitimate concern revolves around governments' ability to passively invest sizable sums in private ventures," the report notes. In 2001, then-Federal Reserve Chairman Alan Greenspan argued against buying up private assets for the same reason. "It would be exceptionally difficult to insulate the government's investment decisions from political pressures," he said.

Ironically, the government did end up buying hundreds of billions of dollars' worth of private assets, but for a very different reason: The 2008 bailouts left taxpayers with huge stakes in General Motors (NYS: GM) , Bank of America (NYS: BAC) , Citigroup (NYS: C) , JPMorgan Chase (NYS: JPM) , and hundreds of other companies.

There's one big lesson to take away from all of this: If we were so spectacularly unable to foresee the future of our public finances ten years ago, why do pretend like we can see it today? Today's estimates of future deficits mentioned at the beginning of this article are based on the same methodology as the ones used ten years ago. Yet while we laugh at the dismal track record of pasts forecasts, we tend to take current ones very seriously.

That makes me wonder: What widely accepted forecasts are people making today that be will comically wrong 10 years from now? There's no way of knowing -- only that it's bound to happen.

Fool contributorMorgan Houselowns B of A preferred. Follow him on Twitter @TMFHousel.The Motley Fool owns shares of JPMorgan Chase, Citigroup, and Bank of America. Motley Fool newsletter services have recommended buying shares of General Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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