Dec 06 2012
Senator Mike Lee: Thank you very much. I’d like to take a step back for a minute and step in a slightly different direction from the fiscal cliff and talk about the long term and medium term economic realities that we face.
Mr Zandi, in your written testimony to this committee you warned against kicking the can down the road indefinitely because of the adverse effect that might have on the economy, the medium and long term impact that might have, and I thought your analysis was definitely something we need to pay attention to on this point.
As you observed that any failure to make progress in this area now could signal that we’ve got bigger troubles ahead, and as you pointed out the Moody’s analytics model that you use breaks down in about 2028 and the reason it does that is because at that point the interest on our ballooning national debt will start to swamp and cripple our economy, thwarting our ability to fund everything from defense and entitlements and everything in between, and we’ll be left without much recourse. At that moment I’m not sure there’s a tax increase on the planet that can suddenly fix that. I’m not sure we can print money fast enough to fix that and if we did we would go the way of Argentina and other countries that have tried that and that doesn’t ever end except in blood and tears.
I tend to think of this medium and long-term risk as the fiscal avalanche. The cliff is something we can see now, we’re approaching where it is based on our current location, our direction and our velocity we know we’re going to hit the cliff if we’re going to hit it. But the avalanche is different. I come from a mountainous state where avalanches happen all the time. The only thing you know about avalanches – you know when the conditions are present, when they might occur. You know when the snow pack has built up to the point where it could happen. You don’t know exactly when it’s going to happen, you just know it’s coming. And you try to deal with the risk of it, but once it hits you the avalanche becomes completely impossible to control. Do you agree with this characterization about the avalanche and could you sort of elaborate to us about that kind of threat?
Dr. Mark Zandi: Would you mind if I steal that from you? And I’ll give you credit…
Lee: That’d be great. It’s not copyrighted.
Zandi: … but I love that imagery and the metaphor – I think it’s right. I do think that that’s why what you’re doing now is so important. I really think this is a once in a generation opportunity for you to nail these things down, and we’re not that far apart. I really don’t think we are. So if you’re able to put us on a credible fiscal path to sustainable responsibility, roughly get to my 3 trillion dollars, do it in a roughly balanced way, I think we’re golden. I really do. And we’re going to avoid that avalanche. But if we don’t do that, if we kind of kick the can down the road, then ultimately I think we’re never really going to do it until we’re forced by that avalanche.
Lee: How soon would we need to do that in order to avoid the conditions that would lead to the avalanche? How soon would we need to get to balance?
Zandi: I don’t know the answer to that but I do know and that’s why I put it into the testimony – my model breaks down. Of course it’s going to happen long before that point.
Lee: Right. And we’re not going to get to that point. We’re not going to get anywhere close to 2028 without it happening. In fact, it could happen within the next 4, 5, 6 years, certainly the next 10 years, couldn’t it if yield rates start to jump.
Zandi: Certainly. Here’s the thing. The problem is that if we don’t address this and we kick the can, we’re going to be stuck in this slow growth netherworld going forward and most importantly, we’re going to get nailed by something. You know? I don’t know what it is, but something bad is going to happen, and when that bad thing happens that’s going to be the thing that sets off that avalanche, right?
Lee: You mean a credit downgrade … ?
Zandi: No, no no it’s going to be something that we’re not even contemplating that happens in the world to oil prices, to other geopolitical ?? even to our own economy you know it’s just … we don’t know what that will be but it will happen. And we will have set ourselves up for that avalanche because we didn’t get our fundamentals in the right place. That’s’ why it’s so important to get this right, right now.
Lee: What about a credit downgrade? If that were to happen, doesn’t that call into question all kinds of things like money market funds and other types of investment funds are chartered to invest only in a certain grade of funds and if all of a sudden U.S. treasuries were downgraded wouldn’t that have a pretty significant effect on where we are relative to the avalanche?
Zandi: If there is downgrade to treasury debt, this will likely trigger other downgrades. Anything that’s backstopped by the government will be downgraded. Fannie Mae/Freddie Mac debt. Federal home owned bank debt, too big to fail banks … they’re still implicitly backstopped – they’ll get downgraded. JP Morgan, Citi’s of the world. State and local government debt will get downgraded. And you’re right. Money managers have, in their relationships with their clients, agreements not to invest in bonds that have ratings below a certain grade, and they will divest themselves because of the downgrades, and this will cause problems in the credit markets. The credit markets will ultimately adjust because the reality of what’s happened to the value of these bonds has not changed, the economics have not changed for Fannie Mae and Freddie Mac, so you’ll see hedge funds and private equity firms and other players come in, but that’s a process. And it’ll take time, and between now and then it’ll create a great deal of turmoil. The most important thing isn’t what the credit rating agencies do or say, it’s what this means. It means we do not have the political will to nail this thing down. And we won’t until we’re forced by that avalanche. And people will recognize that and we will go nowhere.
Lee: So what you’re saying is if we want to preserve entitlements, get us to balance. If you want to preserve our ability to fund national defense, get us to balance.
Zandi: Get us to sustainability.