Chapter 3: Why Budgeting Matters

Promises make debt, and debt makes promises.
-Dutch Proverb

When plunder has become a way of life for a group of people living together in society, they create for themselves in the course of time a legal system that authorizes it, and a moral code that glorifies it.
- Frédéric Bastiat

To understand government budgets, it is first necessary to understand current economic theory under which the receipts and expenditures are based.

Keynesian Economics: When the Economy is in a slump, spend your way out of it

One of the major tenants of this generation of economists is that governments can use their financial authority to spur on the economy when we reach a state of recession. According to that logic, the government can create demand that keeps the economy chugging at times when the consumer is unable to do so. This subsidy by the government is then paid for by the increased production and should even lead to more income than costs in the long run when certain multipliers are used.

Most current economists are afraid of deflation. Any dip in prices is dangerous and should not be allowed. They reason that if prices decline, businesses will have less profit and will therefore lay off workers. Laid off workers lack income, and can therefore not buy goods, which reduces economic production more. This leads to a recessionary spiral that should be avoided at all costs.

While at face value this logic seems to make sense, subsequent study of the factors of production and employment paint a different picture. Without consumer demand, product prices will fall; this is true. This helps the poor as goods historically become more affordable, even when a corresponding fall in wages takes place. Modest deflation benefits the poor and middle classes by making products cheaper every year.

However, when the government buys from the market, they use borrowed funds which are paid back by the people with added costs.

The multipliers cited by John Maynard Keynes that are supposed to generate even more production through government spending lack adequate mathematical foundation and have not proven true in practice. (1). The actual result is that government spending provides a modest short term boost but generally higher long term costs (once interest rates are factored in). The higher costs then reduce overall long term purchasing power as more money is diverted from future earnings to pay current finance charges. We always have to pay the piper!

In addition, the government subsidies subvert the market by preventing true supply and demand from finding the right equilibrium. When this happens, a true market price cannot be found. When the true market price cannot be found, then business owners cannot plan profits and revenues; therefore, owners seeking equilibrium may increase and reduce employment levels many times.

Why would the government subvert the market price? Because the economic foundation we have been taught shows us that any rate of interest over zero is bad. According to Keynes, interest rates get in the way of production and reduce employment levels because they add to business borrowing costs. Keynes appeared to think that nearly free money would ensure high employment levels which would ensure that goods produced could always be bought.

However, interest rates are the most important part of the market function. Rates will go up when money is scarce, which slows demand. If demand for money falls, so will interest rates, and more investment and growth will occur. If at any time this crucial market function is tampered with, the economy cannot figure out whether we are growing too much or too little. Therefore, the inevitable rise and fall of the business cycle turns into larger versions of the same thing, known as booms and busts. More government intervention and toying leads to greater distortion of the equilibrium between demand and supply of money. Central banks don’t inflate only during periods of recession and depression, they inflate the money supply at all times. 1

At this current point in time, the measures of economic equilibrium are so out of whack that even the smartest economists have a hard time forecasting the direction of the economy. In 2009, most headlines told us that we were easing out of the recession as “fewer bad” things were happening to the economy. Then, in early 2010, unemployment numbers spiked again, consumer confidence fell along with purchases, and mortgage loan applications and home sales dropped.

The main issue with the current economic approach is that while governments can print money and borrow into near oblivion, certainly at higher levels than consumers can get in open markets on their own, no trued up accounting is made for the costs of doing so. Government debt will rise and printed money will create inflation, but the players all keep the shell game going. This works until buyers of US debt get antsy and demand higher and higher rates of interest on subsequent lending to the US. Higher financing rates increases costs of rolling over previous debt with new issues. In addition, consumers begin to protest at large price increases.

The US debt has become so burdensome that the rating agencies, while entwined with the government and not completely independent, are forced to consider lowering the “grade level” of debt. The grade level has many subjective components and is therefore very flexible. Challenging US solvency is considered by many to be unthinkable. Why is that? I believe this is because the United States dollar/debt scheme underpins the financial system, and to question the US questions the entire system, and not just one country. Nobody wants to be the first person to cast doubt on the entire world economic system.

Therefore, when a sovereign the size of the United States get threatened with a rating change, the factors that underlie the rating have already begun to change for the worse. For example, recent reports suggest the US could be downgraded by a rating agency. Moody’s reports that “The credit ratings of the world’s four largest triple-A sovereign debt issuers as well as Spain are safe but risks to their blue-chip status have grown, a report from Moody’s Investors Service said on Monday.” 2

The United States, the United Kingdom, France, and Germany are apparently current good risks (we doubt that), but given the current trajectory, even sovereign credit has become a problem. Once the government credit is damaged, who is there to continue the spending spree?

And the second question is, when others stop buying our debt, who pays for the current government spending spree that we cannot finance ourselves out of?

Chris Dillow of Investor’s Chronicle notes in a June 2009 article that the Government Accountability Office sees our long term fiscal outlook as unsustainable.

The long-term outlook for US public finances is awful. Only last month the Government Accountability Office warned that ‘the long-term fiscal outlook is unsustainable’ and that government debt would rise above 100 per cent of GDP after 2020. This is because of an ageing population combined with high social security and Medicare spending. Cutting those entitlements will be politically very difficult indeed. 3

The Debt Monster

Debt can be a good thing when used sparingly to finance production and healthy growth. Uncontrolled debt can lead to a major fiscal crisis. As money is borrowed from government today, the cost (rate of interest) adds more burden to future budgets. It is never free to borrow from other nations, or even from within the nation. The interest must always be paid.

It used to be that the US consumer purchased most of the US government debt. “Buy US bonds!” was a familiar cry during war times. Many economists reasoned that debt wasn’t an issue as long as we just owed it to ourselves. Why worry, if we just print more money and pay it off later? There are obvious flaws in this grand plan. First, we still owe a rate of interest. Just because we owe it to ourselves does not diminish its impact. If we pay it off, then we have just reduced our future living standards to pay for the current consumption. If we choose to print nonsense paper money to pay it off (inflate it away), we still reduce our future living standards in the form of higher future prices to pay for current consumption. The real result is that we shift the payments for our excess lifestyles to our children so we can live for today.

Now, however, other countries are getting in on the act. Why not? If US bonds were so safe because the citizens just gobbled them up and the US government promised against defaulting, other countries surely could take advantage of the consistent interest payments and safety of their principal. This idea works at low levels of debt, but it breaks down when debt levels get so high that our creditors begin to renounce our debt issues.

One March 15, 2010, it was reported that China reduced holdings of US Treasuries for the third straight month, and Japan trimmed their holdings of US debt as well.4 The previous month, China cut their US debt holdings so much that Japan passed them to become the new largest holder of US debt. Japan, subsequently, did the same thing to put China back on top. The race to deleverage out of US debt is on!

While the two largest US creditors, China and Japan, reduced their holdings of US debt, Great Britain and some oil exporting countries expanded theirs. This appears to be a wash and therefore not a warning sign, until we look at the recent numbers of purchases of US debt and where they come from.

In 2000, America’s public debt was less than half of the current amount as of the end of 2009. In addition, the government holdings of US debt have soared.5 This means that the US government is purchasing its own debt! So while all current US debt purchases are being bought, which keeps interest rates on US borrowing low, they are at an increasingly rapid pace being funded internally just to keep the debt pyramid propped up.

Why is this a concern? First, it shows that foreign governments have started to leverage out of our debt, indicating a lack of confidence in our ability to repay. Therefore, current interest rates on US Treasuries do not reflect internally the real risk of US debt that other countries see. This is the result of more toying by our government and gives false confidence in the ability to pay our bills.

Second, the money used to buy these treasuries will hit the open market and through inflation, increase prices. When that happens, we have just further reduced our future purchasing power to fuel today’s consumption. At that point, the government has a choice. Either they can continue to issue more bonds and buy them from themselves, or as other countries increasingly reduce their US debt holdings, the public will realize the truth and the jig is up. The government can only then, if they want to keep spending wildly, print more money. This leads to hyperinflation of prices, and consumers find out what happens to their budgets when consumer prices rise extremely fast.

How do we know prices are rising? Remember our discussion of CPI and Core Inflation from Chapter 2 in which we showed that government-reported inflation rates did not account for the changes in quality of life and are therefore inadequate. In addition, we know that the Bush and Obama administrations have recently flooded the market with new money.

According to the St. Louis Federal Reserve, the country’s monetary base is expected to rise from $830 billion in 2007 to $2.4 trillion in 2010.6 That is a tripling of available US dollars in the market. If the entire monetary base triples, can we safely say that inflation is not a concern?

To answer this question, we examine the latest Producer Price Index (PPI) from the Bureau of Labor Statistics. The PPI shows the change in prices for producers of our goods, who will see inflation first from the inputs to their production. The costs of inflation will then pass to consumers in the form of higher prices of goods.

The prices for crude goods rose 6.1% in October 2009, 5.1% in November, 0.8% in December, and 9.6% in January 2010. That is an average of 5.4% for those months! Furthermore, if we look at changes in finished goods, one step farther in the manufacturing process, we see an average 4.5% change for December 2009 and January 2010.

All of these numbers are higher than the government reported rate of inflation. The flooding of money into the market, a large portion of which the US government used to buy their own debt, is being paid for by rising prices for companies and ultimately consumers. Looking at the BLS data, it would not be a surprise to expect close to double digit inflation in consumer prices in the near future.7

As a specific example, recent reports on iron ore purchasing show that steel prices are expected to rise by 30%. These costs will eventually be pushed down to the consumer level.8

Whether it is debt or inflation or both, the price always has to be paid! According to Alan Meltzer, Federal Reserve historian, the new Fed money printing will eventually produce a price inflation “higher than … in the 1970′s.”1 The total of $15 trillion of committed bailout expenditures averages to $42,000 for every person in America and to $131,000 for each tax payer.

Our Federal Budget

So what is all of this debt for? Our government is paying for something, and it is not just unemployment benefits. The government divides the expenditures into discretionary and mandatory expenses. Mandatory expenses include social insurance, benefits, interest payments, and other entitlements. Discretionary expenses include defense, education, housing, homeland security, energy, etc.

The Chart 3.1, from the 2011 Whitehouse Budget Summary Tables Document, shows major expenditure categories.

Chart 3.1: 2011 Major Expenditures

The government receipts come from several sources. The largest categories are individual income and social security taxes and borrowed money. Corporation income taxes, payroll Medicare taxes, unemployment insurance, and excise taxes round out the major receipts.

The Chart 3.2, from the 2011 Whitehouse Budget Summary Tables Document, shows major receipt categories. Note that individuals will pay for all but one of the largest categories. Individual taxes and financing borrowing, which is paid for by inflation and interest expense, all get paid by the people. Corporations, comparatively, pay for a much smaller portion of all government receipts.

Chart 3.2: 2011 Major Receipts

While it is easy to see that a lot of our current spending is being financed, the Obama administration has no intent to curb the spending and bring the budget back in balance. The Whitehouse Budget Tables (whitehouse.gov March 2010) show total expenditures increasing from $3.5 trillion in 2009 to $5.7 trillion in 2020, an increase of 63% in eleven years. If we cannot pay our current bills with current taxes, borrowing, and money printing, how are we going to pay for yearly budget increases of this scale?

According to Keynes, the government spending will lead to increased future revenues sufficient to cover past expenditures, by a factor of twelve.1 This multiplier breaks down in current government projections, as shown in Chart 3.3 produced from the Whitehouse Budget Summary Tables.

Chart 3.3: Deficit Spending Yearly and Cumulative totals

Another way to look at the effects of spending policies is to examine the ratio of our debt to the GDP, or yearly production. The higher the debt to GDP ratio, the more money from current budgets is used to finance the interest on the debt, which reduces current purchasing power and quality of life. Chart 3.4 illustrates the current administration projections, as taken from the Summary Tables made available at whitehouse.gov.

The first thing we notice is that debt will exceed our annual GDP in 2012. This assumes a rise in GDP of 2.7% in 2010, 4.6% in 2011, and 5.9% in 2012. What indicates that our GDP is going to go up in the future? Is it the high unemployment we are currently experiencing? There is not a lot of data to suggest the government stimulus spending is having a positive effect on unemployment or growth substantial enough for what we would need to cover rising expenses.

Chart 3.4: Debt and GDP Levels

But Wait, There is More

Now is a good time to discuss the other part of our debt problem which we have not accounted for: unfunded liabilities. These are debts the government will owe in the future that are not payable with current receipts. The spending on entitlements is broken down into the following seven categories.9

Deposit Insurance: Paid to keep our bank accounts “guaranteed” up to a specific amount, currently $250,000. If the bank goes insolvent, governments pledge to cover each bank account up to this amount using deposit insurance. This also includes FDIC and NCUSIF insurance designed to protect larger banks and credit unions from becoming insolvent.

Social Security: Pension plan design to help people after they retire.

Medicare and Medicaid: Assistance with health-related and medical costs.

Federal Employee Retirement Benefits: Retirement and disability benefits for federal employees.

Insurance of Private Pensions: Pension Benefit Guarantee Corporation (PBGC) insures defined benefit pension payments for private firms.

Nuclear Waste from Weapons Production: Funding Department of Energy facilities responsible for nuclear weapons program.

Loans and Loan Guarantees: Government agencies make loans to individual firms, including foreign military sales, rural housing, rural electric, agricultural credit insurance, and telephone utilities.

These programs fit under mandatory spending in the budget. The collective cost of these programs has risen dramatically over time. Specifically, Social Security, Medicare, and Medicaid costs have soared as the Baby Boom Generation has started to retire. The working generation does not produce enough current tax receipts to pay for the current spending in these programs, which creates an account deficit. USA Today estimates that “over the next 25 years, the share of the population aged 65 and older is forecast to jump from 12% to 20% (effectively increasing anticipated expenditures), while the share of the nation’s population that is working and paying taxes (anticipated revenue) will decrease from 60% to approximately 55%.” 10

Theoretically, trust funds were set up to accumulate money to pay out against rising costs. But while those trust funds are accounted for, they don’t actually exist. The funds have already been used on past government spending. Therefore, these unfunded liabilities will be paid for by this and future generations.
Because mandated entitlements are increasing, they are crowding discretionary spending out of the budget. Discretionary expenses include our infrastructure, education, and defense programs. With less money for these important programs, it can be argued that our growth will slow even more over time.

According to the Bureau of Economic Analysis, healthcare spending accounted for 16% of GDP in 2006.11 And the costs are rising 1.5 times faster than our GDP is growing. According to an article in USA Today, “under current law, 30 years from now, government revenues [for Medicare] will be sufficient to cover approximately half of all anticipated expenditures.” 10

In 2008, the government accounted for $9 trillion in debt. The total exposure of unfunded liabilities is estimated to be $56 trillion.12 The $56 trillion is not accounted for on the books, so most analysts do not discuss this in public when talking about budget numbers. Most discussions in the news deal with current figures.

For planning, it is useful to look at the unfunded liabilities over a time horizon. After all, today’s decisions decide tomorrow’s debt. According to an analysis by the Whitehouse budget, the time value of the unfunded liability of Medicare alone is $101 trillion. That would be seven times our entire current GDP. The amount represents current dollar investment, meaning that if we wait the totals will go up over time and not down.

Chart 3.5: Present Value of Healthcare Unfunded Liabilities

Social Security’s unfunded liability over the next seventy-five years will be $11.9 trillion. We’ll stop there. No need to figure out the rest of the unfunded liability values. Between Medicare and Social Security, $113 trillion should be scary enough of a number.

Thomas R. Saving, former member of the Social Security Administration and Medicare Trust Funds, who now is a National Center for Policy Analysis senior fellow and Texas A&M University professor of economics, predicts, “What’s going to happen is the federal government is going to start reducing benefits, no question about that. States are going to be under a lot of pressure from their employees to give back some of the benefits that the feds cut.” 13

However, it is unlikely that economic growth will be sufficient to pay our expenses. Higher taxes and trimming entitlements may not be enough. At some point, foreign investors will stop buying our debt to pay for it when they realize the amounts keep marching higher and creating more US debt default risk.12
Government is not responding with austerity measures to reduce these deficits. The US and Europe are expected to expand existing net debt by 40% in 2010 to cover rising deficits. At the same time, bond managers are reducing their exposure to US and UK debt issues.14 We have already figured out that foreign governments are reducing US debt holdings. It appears the only avenue is for the US government to continue to purchase its own debt with fake money printed out of thin air. This is another bullish sign for coming high inflation and taxes.

Does Keynesian economics work? What ails our economy doesn’t appear to be getting any better with the current prescription. The patient keeps getting sicker.

During the 2008 Democratic Primary when Hillary Clinton and Barak Obama were running against each other, a major theme was overhauling the social health insurance system. Indeed, one of the tenets of the current Democratic health plan is reduction in costs. As Obama stated in a 2009 speech on healthcare:

Second, we’ve estimated that most of this plan can be paid for by finding savings within the existing health care system – a system that is currently full of waste and abuse… Reducing the waste and inefficiency in Medicare and Medicaid will pay for most of this plan.” 15

Overhauling the Healthcare System is in the Works

The problem with the premise that reform and a reduction in waste will pay for an historic increase in the coverage of healthcare is that there is no concrete support given that the increased costs can be paid for, much less reduce our overall expenditures on healthcare. 16, 17, 18

In analysis by the Congressional Budget Office and Centers for Medicare and Medicaid Service, overall spending would increase because of the additional people added to the plan. However, these estimates note that the rate of cost acceleration would slightly slow over time.19

In another analysis, Doctors Theodore Marmor, Jonathan Oberlander, and Joseph White make these conclusions: “Claims of savings from health information technology, prevention, P4P [pay for performance], and comparative effectiveness research are politically attractive… But these reforms are ineffective as cost-control measures.” The article goes on to state that the really effective cost control measures, including price restraint, enforcing spending targets, and enacting insurance regulation threaten the incomes of many politically powerful groups, making them less likely to be implemented. Finally, “the illusion of painless savings, however, confuses our national debate on health reform and makes the acceptance of cost control’s realities all the more difficult.” 20

In other words, the cost reductions will come with penalties. They will not be financed simply from schematic changes to healthcare. They involve sacrifices. We will see later in this chapter, in an examination of Canada’s national system, that these sacrifices include availability and quality of healthcare.
The Brookings Institution’s Henry Aaron warns that “all of the cost estimates being proffered are ‘extraordinarily treacherous,’ because many of the changes being considered are unprecedented in history at this scale.” (19) The healthcare debate involves assumptions made in both cases for and against. The facts are not yet known. We can, however, turn to other national healthcare plans to see how they control and manage costs and quality of care.

As recently as March 8, 2010, US President Obama made the following statement in relation to Canada’s healthcare system:

On one side of the spectrum, there were those at the beginning of this process who wanted to scrap our system of private insurance and replace it with a government-run health-care system like they have in some other countries. Look, it works. It works in places like Canada, but I didn’t think it was going to be practical and realistic to do it here.21

While it is true that the Democratic healthcare plan is not government-run like Canada’s healthcare system, it does include many nationalistic subsidies and controls and is moving closer to Canada’s model.22 With that in mind, we examine how efficient Canada’s healthcare is and how much quality it offers.

Canada’s Model

While the US Democrats are trumpeting Canada as a model healthcare system, analysis of the quality of care finds some interesting results. Canadian healthcare suffers from several problems. One, an unwritten “don’t ask don’t tell” policy, encourages unmonitored and unregulated application of medicine.23
Physicians avoid government controls on how they perform medicine, and as a result, the quality of care is suffering through missed diagnosis, re-hospitalization, treatment errors, and lack of technological integration into medical practice. In addition, the educational system in Canada promotes isolation that affects the level of teamwork practiced in doctor’s offices and hospitals.

Secondly, Canadians simply pay too much for their care. According to Nadeem Esmail of the Frasier Institute, “on an age-adjusted basis (older people require more care) in the most recent year for which comparable data are available, only Iceland and Switzerland spent more (as a share of GDP) on their universal access health insurance systems than Canada did.” If Canadians received higher levels of care, then costs may be justified. But the following problems illustrate this is not so.24

Waiting

In 2007, Canadians averaged an 18.3 week wait time for referral to a specialist from a general practitioner. This is among the longest for developed nations. Canadians are more likely than in other social health systems to wait six days for an appointment. Canadians are most likely to wait two hours for an emergency room.

Access to Medical Technology

Canadians have lower per capita access to CT scanners, mammographs, and lithotripters than in other socialized medicine countries.

Availability of Doctors

Among twenty-eight nations with universal healthcare plans, Canada ranked twenty-fourth in doctors per one thousand people. Nadeem Esmail notes that “it should come as no surprise that Statistics Canada determined in 2005 that more than 1.3 million Canadians could not find a regular physician, while a recent estimate suggested that the number of Canadians without a regular physician was around five million.” 24
The lack of healthcare availability, especially specialized treatment, has led to a growing medical tourism business to the United States. Patients are making arrangements with medical centers in the US to receive quality and timely healthcare, often at an 80% savings over what they would pay in Canada for those services. One of the reasons Canadians come to the US is that surgeons in Canada are often limited to just six hours per week by government legislation.25

“The Canadian system is a ponzi scheme that is just a little further along than ours,” explained Dr. Keith Smith. 25 Dr. Smith lives in the United States and works with Canadians looking for quality and timely healthcare here in the US. According to Dr. Smith, the Canadian system acts as a cartel where insurance companies and hospitals overcharge for services and perform medically unnecessary procedures. This drives up costs. In April 2001, health policy specialist Kenneth Fyke, former Deputy Minister of Health for Saskatchewan and B.C., estimated that 35% of health spending in Canada is waste.23

So it appears while the Canadian healthcare system aims to provide universal, quality care at a lower cost, it is failing to meet expectations. And based on analysis of cost accounting differences, Canada’s healthcare isn’t any cheaper than that of the United States.26

Canada’s Unfunded Liabilities for Medicare. We aren’t the only ones.

When the Canadian healthcare system was devised, assumptions were made that the population demographics of the 1960s would remain the same. In truth, the aging population has created the same unfunded liabilities that the United States is observing in Medicare. “Statistics Canada predicts that by 2040, those under 20 will account for 17.2% of the total population, while those 65 and over will account for 26.5%.” 27

In 2008, Medicare comprised 19.5% of federal, provincial, and local revenue. This is higher than the United States ratio to GDP. Moreover, from 2001 to 2004, Canada Medicare’s unfunded liabilities grew 20% to $364 billion.27

The truth is evident. Canada’s medical coverage is substandard to the point that patients have long waits, less access to medical machinery, and have fewer qualified doctors who are restricted by the government to how much they can practice. Canadians spend about the same as Americans on their healthcare, yet they suffer from the same increase in unfunded liabilities which threaten their economic health. As a result, Canadians increasingly come to the United States for specialized care they cannot find at home.

The Canadian healthcare system does not cost less than the US model, and has inferior care.

If Democrats are moving toward a national healthcare system like Canada’s, a move espoused by President Obama, then might we in the United States expect our unfunded Medicare liabilities to continue while we also experience deteriorating levels of care? The evidence supports this conclusion.

FDIC and Other Forms of Insurance

Deposit insurance for bank accounts is largely hailed as a consumer protection. In reality, it is anything but. If a bank makes risky loans and cannot pay their depositors, then the FDIC will step in through the insurance program. While this protects consumers, it also passes those same exact costs back to consumers.

FDIC insurance is paid for by deposits made by banks into the FDIC Insurance fund. It used to be that each bank, regardless of size, made the same deposits. Now bigger banks make larger deposits. However, the sum total of all deposits is not enough to cover a serious run on banks. When one or two small banks become insolvent, the insurance scheme works. However, it should be noted here that even though the insurance system works in this type of case, banks will just pass the cost of paying into the FDIC account along to their customers in the form of higher interest rates and fees. In truth, the banks don’t ever pay those costs out of their pockets.28

In the event of a larger scale bank problem, such as the Savings and Loan crisis during the 1980s and 1990s, the FDIC insurance fund cannot cover the scale of losses. Therefore, the insolvent banks often stay open and are allowed to make risky loans in order to keep the FDIC from bankruptcy. The end result is that losses worsen and are eventually passed to the public.9

The availability of the FDIC deposit insurance gives incentive for banks to make risky loans, knowing in many cases they will be bailed out either by the insurance that is actually paid for through increased fees and interest rates to their depositors, or they will be bailed out by government using public funds. This concept is known as the “moral hazard” of offering the insurance program.

It should be noted that not all banks get bailed out. In many cases, it’s the larger banks labeled “too big to fail” that get bail outs; in many cases, smaller or regional banks are allowed to fail.28 However, the system still encourages excessive risk-taking by all banks as the chances of failure decrease.

Roy Webb of the Economic Review notes that the banking industry shares the following characteristics with the Savings and Loan Institutions that failed in the 1980s.9

(1) Deposit insurance has given banks the incentive to lower their holdings of capital.

(2) Poorly capitalized banks are allowed to stay in business. One study found 30 banks without any capital on a risk-adjusted basis in mid-1989, and another 31 with capital below 3 percent of deposits (Brumbaugh and Litan, 1990). That study was based on conventional accounting data.

(3) Banks state assets and liabilities at book value rather than market value. Many banks have thereby overstated asset values. Loans to impoverished third-world governments, for example, are routinely traded in private markets at lower values than are recognized by some large banks.

(4) Barriers to branching result in loan portfolios that are not regionally diversified and are therefore vulnerable to localized shocks to the economy. Just as banks and savings and loans in Texas in the mid-1980s were vulnerable to the weak regional economy, banks in the Northeast are now feeling effects of a regional economic downturn.

(5) The FDIC is paying more to close insolvent banks than it is receiving in premiums. In 1990 the bank insurance fund lost $3.5 billion, in 1989 it lost $2.0 million, and in 1988 it lost $4.2 billion.

The current Troubled Asset Relief Program (TARP) bailout goes much further to prop up larger lenders than using insurance. The TARP program originally passed for $700 billion by Congress in October 2008 to buy up toxic mortgage loans.29 While estimates vary, it is possible that the total cost to the taxpayers may be around $375 billion. 30 The total cost will not be known for some time, but it will be the largest bank bailout on record.

The total economic bailout estimates are up to around $15 trillion.1