Sovereign Debt: A Modern Greek Tragedy - Audience Q&A, Part 2
Christopher Waller of the St. Louis Fed is joined by economists Fernando Martin and Christopher Neely to take questions from the audience. In this second part of the Q&A, participants asked about the situation in Spain, why Canada avoided the crises that hit the U.S. and Europe, and at what level of debt the U.S. could experience a sovereign debt crisis of its own.
Part 1: Welcoming Remarks, Julie Stackhouse (5:44)
Part 2: The Ability vs. the Willingness To Repay Debt (14:45)
Part 3: Why Is Europe Having a Sovereign Debt Crisis Now? (8:19)
Part 4: Waking Up to the Great Shocks (6:20)
Part 5: Insuring Against Default and Higher Rollover Risk (4:54)
Part 6: Austerity Measures and the Real Default Threats (8:55)
Part 7: The Moral of the Tragedy (8:29)
Part 8: Q&A Part 1 (14:25)
Part 9: Q&A Part 2 (18:18)
Q: Can you talk about the Spanish problem? I understand they have the highest unemployment rate in the EU for people under 24, they've got a collapsing banking system, they've got problems in the property market. So what do you see as their long-term future, and do they have willingness?
Christopher Waller: I should have some of my Spanish staff members answer that question. They're sitting in the back somewhere.
Q: It's such a big part of the EU. It's one of the bigger economies, so I think what happens there is very important.
Christopher Waller: You want to take a whack at this one?
Fernando Martin: I can take a shot. You're absolutely right. I mean, both Spain and Portugal share this similar feature which is unemployment has been going up quite a lot. I mean, Portugal for a longer time, Spain more recently. Now, as to the willingness to fix those problems, that's a question for the politicians there and for the public that elects them. But all these countries share the same feature which is, you know, besides their more structural problem, expenditure has been going up since 2007 and only now has been coming down. And that's what's generating the political conflict which is on top of the labor market problem. So now you have a battle being fought on many fronts, and the point is that that's a political conflict. So as economists we can only say so much.
Christopher Waller: Yeah, just an observation—Carlos, you're in the back there somewhere. But Spanish unemployment was at 20 percent for a long time—decades. And then it came way down. Now it's back up to 25. So I've heard the argument that the temporary drop in Spanish unemployment was an outlier.
Q: Was that through the property market inflation that they had?
Christopher Waller: Spain had a huge property bubble. And maybe a large part of their employment gains was all in construction which is now effectively gone.
Q: To what extent has the American investment banking industry contributed to the sovereign debt crisis?
Christopher Waller: Boy, it's fun to let those guys have it, isn't it?
Christopher Neely: I can't image that we can—I mean, I'd like to blame Goldman-Sachs as much as anybody, but I can't imagine we can blame—I mean, there was the deal with Greece where they capitalized part of Greece's future income in, what, 2000 or 2001...
Christopher Waller: It was to help them with these...
Christopher Neely: ...but, you know, we're talking about a tiny, tiny deal.
Christopher Waller: Yeah.
Q: How did Canada avoid the financial crisis that's infected the U.S. and Europe? And are there any lessons that can be learned from their performance?
Christopher Waller: That's a great question for my Canadian colleague over here.
[Laughter and over-talking]
Fernando Martin: So, I mean, what you say is correct. Canada has not been having any financial crisis, and the reason is they're less dynamic. Their banking sector is basically eight big banks and then lots of very small banks, and these banks are very conservative. They work very closely with the Bank of Canada. They don't do crazy stuff, let's put it that way. Which is good when a crisis hits because you're not exposed to new problems. But on the other hand, it means that you don't get to explore self-progress. Right? I mean, they don't even do as much as American banks. So you don't get the good stuff but you also don't get the bad stuff. It all depends on what you prefer. Do you prefer something like this? Or do you prefer something like that? And like I said before, I mean, countries solve these problems in different ways.
Q: One of the propositions you talked about early on was that wars many times drive the debt that countries incur. A couple of questions. One, it's safe to say that the cost of fighting a war is not what's behind the European crisis. And then projecting that out, at what point will the U.S. funding multiple wars get to a point where it in fact is having a negative impact on Europe?
Christopher Neely: Where the U.S. is having a negative impact on Europe?
Q: Well, when our debt limit gets to a point and continues to grow by the funding that we have to do to support the various wars, where at some point is that projection that we can't take care of ourselves but we're having a bigger impact on Europe than it's having on itself?
Christopher Neely: Well, I think currently the U.S. spending on forces in Afghanistan might be a little bit over 1 percent of GDP, which is not trivial. I mean, it's not a very small amount but it's certainly not what's driving the U.S. debt situation in the long run. What's driving the U.S. debt situation in the long run is almost entirely Medicare. And I'm a lot more worried about the effect of U.S. debt on the U.S. than I am about what it's going to do to people in Portugal or Greece or Denmark.
Christopher Waller: And in the back?
Q: One of the very first slides that you had today showed the current crisis is due to federal deficit. And the crisis is in part probably due to the crisis that you had listed immediately prior to that which is households unable to pay their mortgages. What do you see as the cause for that to happen since most of the mortgage and the debt rates for individual households have always been fairly high, maybe a little bit higher than normal, but nothing to have us fall off the cliff? What was it that caused that?
Christopher Waller: Well, I would say the following. We did see a pretty substantial increase in leverage of households in the form of the amount of equity they had in their house. So the less equity you have in your house, the smaller the price drop has to be to wipe you out. So that's just the first thing of—And we did see a pretty dramatic—I don't know the numbers off the top of my head. My colleague Bill Emmons here at the bank knows much more about this than I do. But the key thing in the U.S. was nobody ever believed that housing prices could fall. It was just a misbelief that prices for the nation as a whole could not go down. So if you build all your expectations, your financing, your borrowing around that and then it happens, you're in trouble.
Q: Do you believe that commodity price increases immediately preceding that—oil going to close to $150 a barrel, food prices increasing, so on and so forth—do you think that was one of the factors that may have led to it as well?
Christopher Neely: I think that that was a trigger. I think that that well could have been a trigger but not a fundamental cause.
Julie Stackhouse: Yeah, if I might jump in? The first session we did last fall—which, again, I'll put a little plug on the St. Louis Fed website—actually went through the factors leading up to the financial crisis, the issues in the mortgage market, the leverage in the market, the spur in housing prices, then, of course, all the construction and land development that followed the housing boom, and then ultimately the collapse. And many more factors than that have contributed as well. So I might just direct you to that. It will give you a good primer on the original financial crisis that we all went through a few years ago.
Q: We talked about how economies can get out of debt, basically raising taxes, cut spending, et cetera. Spain obviously is a worrisome country. Recently, I would say a couple of weeks ago, I was hearing on NPR news about this person getting interviewed, and it seems like in Spain they have a mastery for tax evasion. And the person was talking about, well, I work part time, and the other part time I get paid under the table. So it's a big issue to deal with. And what do you see were some of the measures I guess than can be taken to remedy this?
Christopher Neely: I think this is a question for the Argentinian.
Christopher Waller: He probably knows more about it than us.
Fernando Martin: I mean, we were discussing this before. Right? So the point is that these are deep structure problems that have been going on for a long time. They are not particular to this crisis. There are issues that are more longer term. I mean, the U.S. also has an informal sector. Many countries have it. What this tells you is, suppose, I mean, the connection to this particular crisis I would say would be now people realize how burdensome these informal sectors are. Because basically all government expenditure is financing everyone. Right? If you have public works, public education, et cetera, everyone benefits. But only the people in the formal sector pay taxes. So the point is that you can understand how this may revolt against people not paying taxes. So I would say that we've increased the political conflict because these guys in the formal sector are still voting. Right? They don't want to be sucked into the formal sector and have to pay the tab.
Q: Right now we have 43 percent of our budget is made up of Medicare, Social Security and Medicaid. We have two political parties in this country that seem at odds and not wanting to do anything about this problem. How long can we go theoretically before we have a huge problem here? How high can that number go up before something triggers a collapse?
Christopher Waller: Well, I'll just take a minute and plug our second Dialogue with the Fed series last fall which was Bill Emmons gave a very nice presentation on fiscal sustainability in the U.S. and addressed exactly a lot of these questions. I'm assuming that's also available on our website, so you may want to take a look at that. I mean, again, this question about sustainability. If your debt-to-GDP ratio is projected to go to a million percent, that's not going to work. But we've seen Japan go to 200 percent without some problems. Other countries get to 110, 120 and then these things go. That's the danger in this. We don't know what the magic number is that this thing finally triggers. But clearly if you go to the Congressional Budget Office and look at projections, these numbers can't be true. Something will have to happen. Either there will be cuts, there will be taxes, or the debt suddenly will be looking like Italy and Greece at some point. So the current policies are unsustainable in any way, shape or form out so many years. So something is going to have to be done.
Julie Stackhouse: I'm going to jump in here, Chris, if I might?
Christopher Waller: Okay.
Julie Stackhouse: Because we are at the end of our time, I'd like to invite those that still have questions, if at the end you want to come up and catch these guys quickly, I'm sure that they would be happy to do that. We have gotten into some issues here that are very, very important, and I would like to echo the session on the fiscal deficit. It looked at the Congressional Budget Office projections, and it was telling to see how these lines begin to grow. And while you can't say it's going to be this particular year that the U.S. will have a problem, you can say the U.S. will have a problem if there isn't some action that's taken. And importantly I think, as you've heard Federal Reserve Chairman Bernanke speak—usually the Federal Reserve is very non-political on these matters—he's made it very clear that the federal budget deficit will affect the U.S. economy eventually, and it must be addressed either through an increase in taxes, increase in revenues, a cost in spending or some combination, but it will affect the U.S. economy if it's left unaddressed. So a very important lesson and I think one for all of us to think about as we look at what might lie ahead.
I'd like to take just a moment I guess to summarize some of the things that I've heard you guys say tonight to be sure that I got it right. We did talk a lot about how did Greece get there, the fact that it was a country with leverage. And countries in Europe, countries in the U.S. all had a spike in leverage as we worked through issues associated with the financial crisis. You know, a very interesting saga of how that financial crisis may have started in the United States with our housing market, but we exported the cost of that crisis to other countries around the world as well. And so it was truly something that affected more than just us. Greece, a very small economy, has been helped. There's been a lot of financial support for Greece. There was a deal reached on how Greece would manage its budget going forward in the austerity measures. That led to a default on the part of the Greek debt. It looked like Greece was under control in terms of the ability to manage its budget. And now, more uncertainty. And I think one of the things that's interesting, if I understand it correctly, that Greece is scheduled to cut $15 billion from its budget in June of this year. And if it does not, as I understand it, then that will factor in to whether it receives additional fiscal assistance from other European Union members, which would be scheduled to occur sometimes towards the end of the summer. So very interesting. We'll see this saga unfold over the summer and see how markets think or believe Greece will respond.
So why do we care? Greece is a small economy, as Chris said. But, of course, Greece is an economy for which we will begin to see whether or not countries can operate with austerity measures, can work towards alleviating debt. And, of course, the question is, if Greece can't do it and shows that it can't, much less the chaos that could occur if there is an exit from the European Union, is the question of can Spain, can Italy manage its debt with austerity measures? So there are all the uncertainties that surround us. And, of course, in the United States we're connected with Europe in many different ways. To some degree, our financial institutions, our corporations have investments in those countries, hold debt of those countries, do business in those countries, so it's certainly not something where we can isolate ourselves from that crisis and have to be mindful that in the case of a very, very severe event, that certainly there would be some repercussions to the U.S.
Beyond that, though, is this matter of saying, what are the lessons learned in Greece? And is it a tragedy that we in the United States can first foresee it could happen and second are willing to address in our own country before it becomes a tragedy here? So I think I've got the main points. Does that sound about right?
Christopher Waller: Yep.
Julie Stackhouse: I'd like to do a couple of quick poll questions before we go tonight. So if you're ready, grab your clickers one more time. All right. Next fall we'll be offering more "Dialogue with the Fed" series. I'd love today to announce to you what they are. But as much as Europe was a session that made sense now, for a number of reasons in the fall I'm not sure what's going to make sense. So we will just say there will be something. And the question is: Do you plan to attend? Or is it a program that you'd like to attend in the fall? So we'd like your thoughts on that. Please go ahead and tell us what you think. Okay, great, thank you, 86 percent. That gives us a lot of motivation to bring this back to you. In fact, it kind of makes us do it, doesn't it? We've given you that choice.
Okay, now, this one you get to choose topics. And I'm not sure if it's going to let you choose more than one. You can try. But for sure choose the topic that you think is something that's most intriguing to you so we have a sense of what would be most valuable. Okay, it looks like we're probably close enough. That's an interesting mix. It's kind of nice to see housing go down. You know, for some of us, we've talked about housing for so many years, it's like, ah, we've had enough of housing, let's talk about something else. So great, thanks for that. Dodd-Frank, that's interesting. And that actually is a topic we talk a lot with about bankers—or bankers talk a lot with about us. But you're seeing it more in the news, so that, in fact, may be a timely topic to bring back and talk about, what does it mean for me and for my business and for some of the costs that are out there?
So with that, I'd like to thank you all for being here tonight. It's been great having you. Please come back.
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