Is the U.S. Bankrupt?

The Administrative Office of the U.S. Courts recently reported that bankruptcy filings between April and June hit a four-year high. Consumer bankruptcies rose 21 percent while business bankruptcies increased eight percent. The list of corporate bankruptcies over the last couple of years includes big names like Lehman Brothers, Washington Mutual, and GM.  And financial institutions like Bank of America (NYSE: BAC  ) , Citigroup (NYSE: C  ) , Wells Fargo (NYSE: WFC  ) received billions of dollars through the federal government's Troubled Asset Relief Program.

Should investors add the U.S. government to that list of big name bankruptcies?  I recently asked Boston University economics professor Lawrence Kotlikoff, author of Jimmy Stewart is Dead: Ending the World's Ongoing Financial Plague with Limited Purpose Banking.

Mac Greer: Larry, I noticed the headline or the title of a recent article that you wrote, US is Bankrupt and We Don't Even Know It. So with that in mind, what is your take on the economy these days?

Larry Kotlikoff: Well there is a lot of uncertainty, as rightfully there should be. We have seen the financial sector implode basically because of the systematic production and sale of trillions of dollars of fraudulent securities under the cover of proprietary information, so nobody really had the ability to look inside big companies like Bear Sterns or Merrill Lynch to see exactly what they owned or owed. That problem remains today, even with the passage of Dodd-Frank. There is no requirement that the financial industry come clean with respect to what it is doing with our money, so every major financial player says you can't see what we are doing because we have the Midas touch. We are going to beat the market, and if we show you, everybody will see our secret formula for making you a mint.

As a result, they have a great cover to produce fraudulent securities. And then when there is a sniff of fraud, one can easily presume that everything they are doing is fraudulent, which may not at all be the case. And then there is a run against those institutions as we saw with Bear Sterns and Lehman Brothers and all the other ones because of the perception that so much of their holdings were fraudulent and that their reporting was fraudulent. And of course the rating companies and the regulators and the boards of directors and the members of Congress were all, in effect, in bed with each other to achieve this result.

I don't see anything that has fundamentally changed, so that is one major area of fragility. We could have another meltdown in the financial market tomorrow because as Dick Fuld [Lehman former CEO] said, he claims that their balance sheet was just fine and that this was all just a panic, it was not connected with any facts. Well, he said that every institution on Wall Street --- Goldman Sachs (NYSE: GS  ) , JP Morgan (NYSE: JPM  ) -- could have experienced the same thing. His concern about this happening to other companies is well taken. So we have a financial system that is set up to fail again, and we have a fiscal situation which is a complete and dire mess. It could lead to a financial panic that could lead to a much bigger meltdown of the financial system than we have seen.

Greer: Is the U.S. bankrupt?

Kotlikoff: Bankruptcy means not being able to pay your future bills. If you can't pay your current bills, your creditors are already after you so you already are bankrupt.  If you can't pay your future bills, that really is the operational definition of going bankrupt or being bankrupt.

The U.S. government can't pay its future bills. These bills, in total, in present value, exceed the revenues by $202 trillion. This is based on taking the data projected by CBO (Congressional Budget Office) back on June 26 of this year, when they put out their alternative fiscal scenario, which is their best long-term projection of government spending, including servicing the official debt, and government revenues. And if you present value the differential between spending and revenues, including extrapolating beyond their projection which is important to do, you get a fiscal gap of $202 trillion.  To come up with $202 trillion in present value, you'd have to immediately and permanently double all taxes we have.  You'd have to do it immediately. We're talking here about running a 5% GDP surplus this year instead of running a 9% deficit. So I don't see that happening. We have to cut spending or we have to print money. Either way you're cutting spending so either way you're, in effect, reining in spending promises. And that suits my definition of bankruptcy. And I think there are ways of cutting spending and getting our fiscal house in order but we need to engage in radical surgery here and not putting on the band-aid that this administration is so fond of.

Greer: One of our Motley Fool writers recently interviewed Euro Pacific Capital President Peter Schiff. In 2006, he was predicting the economic downturn, and he now says that we are, "In the early stages of a depression now. It is going to be a horrific experience for average Americans who are going to watch their standard of living plunge." Do you agree?

Kotlikoff: Well, this has been a depression so far for millions of Americans. It didn't have to happen. It is really man-made. We have the same physical capital and human capital sitting here in place. We don't have to stay in a depressed state. The problem is that things are not coordinated. We don't have buyers optimistic about getting paid salaries and we don't have sellers optimistic about being able to find buyers, so everybody is kind of sitting on their hands.

We can have some, a bunch of KISS's, which are "keep it simple, stupid" solutions to our problems, and lots of people throughout the country realize this, that we need to fix things fundamentally. We can't do it with 2,000 page bills that make bureaucratic structures that are basically clogging up our economic arteries, even more bureaucratic.

In our next installment, Lawrence Kotlikoff outlines his proposal to fix the financial system.

Worried about what all this economic doom and gloom means for you as an investor? Motley Fool writer Morgan Housel says you should ignore those reports about the death of the individual investor.

Mac Greer doesn't own any of the stocks discussed. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.   

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  • Report this Comment On August 26, 2010, at 10:15 PM, Quantemonics wrote:

    Sounds to me like more and more people are coming to the conclusions I outlined 9 months ago, regarding some "real" fixes to get our economy growing again and confidence in America restored.

    Asking Warren Buffett to replace Ben Bernanke as the Federal Reserve Chairman would work wonders for "confidence" in the U.S. financial system, bring credibility to the position again and some common sense policies... Obama should call him up tonight!

    How in the world can the captain of two sunk ships (real estate bust and Lehman failure) be given yet more chances to screw up the hard work of hundreds of millions of Americans is beyond my comprehension. Bringing in fresh economic leadership would not "cost" Americans a dime, but provide the nation with a fighting chance. Other intelligently run nations change economic leadership all the time - why are we stuck on the same losers?

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