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1 Myles Watts and Doug Young Department of Agricultural Economics and Economics Montana State University Public Debt & Deficits February 2012.

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Presentation on theme: "1 Myles Watts and Doug Young Department of Agricultural Economics and Economics Montana State University Public Debt & Deficits February 2012."— Presentation transcript:

1 1 Myles Watts and Doug Young Department of Agricultural Economics and Economics Montana State University Public Debt & Deficits February 2012

2 Links to the General Economy Gross Domestic Product (GDP) Debt Strength of the Dollar Aged Dependency Ratio Housing Employment 2

3 3 Economy Sizes International Monetary Fund (2010 GDP Trillions $) Population (Million) World636,895 USA14.5 310 Eurozone (17 countries) 12.2 330 Japan 5.5 127 China 5.91,341 Germany 3.3 82 Rest of World24.94,787 International Monetary Fund, World Economic Outlook Database, September 2011 United Nations, Department of Economic and Social Affairs, Population Division (2011)

4 4 World GDP: Historical Trend World Bank national accounts data

5 5 U.S. and Eurozone GDP: Historical Trend World Bank national accounts data

6 6 Strength of U.S. Dollar: GDP of Eurozone Countries NationGDPNationGDP Austria 377* Italy2,055 Belgium 468Luxembourg 55 Cyprus 23Malta 8 Estonia 19Netherlands 781 Finland 239* Portugal 229 France2,563Slovakia 87 Germany3,286Slovenia 48 * Greece 305* Spain1,410 * Ireland 207 GDP in 2010 billion U.S. Dollars International Monetary Fund, World Economic Outlook Database, September 2011

7 7 Debt as a Percent of GDP (2010) Net DebtTotal Debt Greece143 Japan117220 Portugal8993 France7782 Italy99119 Ireland7895 Spain4960 USA6894 World6480 International Monetary Fund, World Economic Outlook Database, September 2011

8 8 Aged Dependency Ratio

9 9 199020102030 Greece.23.30.41 Japan.19.38.57 Italy.25.34.48 Portugal.24.29.43 France.24.29.43 Ireland.22.19.31 Spain.24.27.40 USA.21.22.37 World.12.13.20 United Nations, Department of Economic and Social Affairs, Population Division (2011). World Population Prospects

10 10 U.S. Debt ($15 Trillion) Debt Down Grade Change Bps Cost Billions $ 2030 5075

11 11 U.S. House Mortgages S&P/Experian Consumer Credit Default Indices

12 12 Case-Shiller 10 City House Price Index BLS CPI Index & S&P Case-Shiller

13 Employment (2010) 13 Education Median Weekly Earnings (2010 $) Unemployment Rate (%) No H.S. Diploma44414.9 H.S. Diploma62610.3 Bachelor’s Degree 1,0385.4 Doctoral Degree1,5501.9 Bureau of Labor Statistics/CPS “Education Pays”

14 14 Education Earnings Ratio (College Diploma/High School Diploma) Bureau of Labor Statistics, Current Population Survey

15 Deficits and Debts 1.The Deficit and Debt Definition 2.The Federal Debt in Perspective 3.How Much is “Too Much?” 4.The Long Term Outlook 5.What Can be Done 15

16 1. Definitions Deficit = Expenditure – Revenue –Usually, per year –“The Federal Government’s deficit in 2011 was $1.3 trillion.” Debt = Accumulation over time of deficits less surpluses –At a point in time –“The Federal Government’s Debt on January 13, 2012 was $15.2 trillion.” 16

17 Federal Revenues and Outlays (As a % of GDP) 17 Historical Budget Data, as presented in Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2011 to 2021 (January 2011).

18 2. The Debt – How Big is It? (As of January, 13 2012) Federal Debt $15.2 Trillion –Held by the public $10.5 Trillion –Held by governmental holdings $4.7 Trillion Non-Financial Corporate Business (As of December 8, 2011) –Debt = $13.5 Trillion –Assets = $29.3 Trillion Household + Nonprofit Sector (As of December 8, 2011) –Debt = $13.8 Trillion –Assets = $71.1 Trillion 18

19 Ownership of Federal Debt Trillions of Dollars – December 16, 2011 19 Federal Government Debt, FRED Economic Data, St. Louis Fed

20 Federal Debt (As a % of GDP) Whitehouse Historical Budget Data 20

21 3. How Much Debt is “Too Much?” When lenders worry that the country won’t be willing and/or able to pay it back, so Interest rates rise to compensate lenders for: – Default Risk and/or – Inflation Risk 21

22 22 When Lenders Loose Faith…. Bond yields from: www.tradingeconomics.com

23 US Interest Rates Haven’t Risen (Yet) 23

24 As of December 8, 2011 … The US Government Debt is NOT “Too Much” in the sense that it Threatens the Economic and Financial System But Neither Debt nor Deficits, as Conventionally Measured, Include “Promises” Made to Future Generations 24

25 4. The Long Term Outlook Federal Debt Held by the Public Under CBO’s Long Term Budget Scenarios (As a % of GDP) CBO 2011 Long Term Budget Projections 25 ActualProjected

26 Flat Revenues; Growing Spending Alternative Fiscal Scenario (As a % of GDP) CBO 2011 Long Term Budget Projections 26 ActualProjected

27 5. What Can be Done? Cut Spending (from what it would otherwise be) –Health Care –Social Security –Other (Discretionary) Spending Raise Revenues –Tax Reform 27

28 Healthcare Expenditure (As a % of GDP) OECD.StatExtracts 28

29 Health Care Reduce Fraud Legal (Malpractice) Reform Require minimum deductibles and cost- sharing in Medicare supplements Accountable Care Organizations –Salary (v. Fee for Service) –Coordinated (v. Fragmented) Care 29

30 CBO 2011 Long Term Projections for Social Security 30 Social Security Tax Revenues and Outlays, with Scheduled and Payable Benefits (As a % of GDP) ActualProjected

31 Social Security “Freeze” benefits (adjusted for inflation) today. Gradually increase early and full retirement ages Increase taxable earnings to cover more earnings (86% today) Use the “chained” CPI for inflation Cover all new government workers 31

32 Tax Reform-1 Lower tax rates and broaden the base Reduce the top personal rate from 35% to 23-29% Repeal the AMT and phase out of deductions and exemptions Tax capital gains (indexed for inflation) and dividends as ordinary income 32

33 Tax Reform - 2 Eliminate itemized deductions 12% tax credit for mortgage interest on principal residence (capped) 12% tax credit on charitable donations > 2% of AGI 33

34 Tax Reform - 3 Cap exclusion of employer-provided health insurance Tax interest on new S&L bonds Cap exclusion for contributions to retirement accounts at $20,000 or 20% of income Eliminate 150 other tax expenditures 34

35 Summary 1.The US government debt is not now at dangerous levels 2.A continuation of current policies for many more years is not feasible 3.Solutions do exist 4.Reform is (Politically) Possible: 1986 Tax Reform, 1993 Budget Compromise, 1996 Welfare Reform 35

36 More Information Congressional Budget Office Long Term Budget Outlook http://www.cbo.gov National Commission on Fiscal Responsibility and Reform http://www.fiscalcommission.gov 36

37 37 Myles Watts Department of Agricultural Economics and Economics Montana State University Trends in Agriculture Finance February 2012

38 Keys to the Future of Agriculture Assets and Debt Productivity and Demand Government Programs Ethanol Farmer Mac Basel Requirements International Competitiveness 38

39 Total Farm Assets - USA 39 BLS CPI Index & USDA Economic Research Service Inflation Adjusted using 2011 CPI

40 Total Farm Debt - USA 40 Inflation Adjusted using 2011 CPI BLS CPI Index & USDA Economic Research Service

41 U.S. Real Agricultural Land Prices/Acre 41 BLS CPI Index, USDA Economic Research Service & National Agricultural Statistics Service Inflation Adjusted using 2011 CPI

42 Real Land Value Appreciation (%) 2000-2010 42

43 Productivity: Wheat and Corn Yields (Per Acre) 43 USDA National Agricultural Statistics Service

44 Demographics: Males 17 to 35 Year% of Population 194015.9 195014.4 196012.2 197013.7 198016.4 199014.8 200012.8 201013.2 202012.6 203012.4 44

45 Government Programs Sequestration is about 6% in all agriculture programs including SNAP Current Discussion Eradicate direct payments Minor reduction in other commodity and resource programs About 5% reduction in SNAP 45

46 Overview of Ethanol No Government Current Program Increased Mandates Ethanol (B Gal) 8.911.014.6 Ethanol Price Base29% Increase50% Increase Corn for Ethanol (B Bu) 3.6 4.3 5.5 Corn Price Base38% Increase 102% Increase Corn Price/ Ethanol Price 1.87 2.00 2.53 From James Brown, Master’s Thesis in Department of Agricultural Economics and Economics, Montana State University, October 2011. Note: Recent corn production is about 12.4 billion bushels 46

47 Farmer Mac Secondary Markets including Farmer Mac – Most mortgages of substantial time length are resold in the secondary market. – Many are resold through Government Sponsored Enterprises (GSE). 47

48 Fannie Mae Freddie Mac Ginnie Mae Sallie Mae (until 2004) Federal Farm Credit Banks Farmer Mac GSEs 48

49 Mortgages are originated by primary lenders such as your neighborhood bank. Loans are sold to a secondary entity, some of which are GSEs, and some are very large private corporations. Secondary entities may sell or retain these loans. How Secondary Markets Work 49

50 Loans are bundled into mortgage backed securities These securities may be sold in tranches to multiple buyers through the secondary markets. Tranche purchasers are repaid in a hierarchical manner with senior investor paid first. If these Loans are Sold 50

51 Simplified Hypothetical Tranche ($100 m) 51

52 Loans must meet certain requirements resulting in somewhat homogeneous loans within a bundle. Usually default risk is transferred to tranch investors. Ownership of lien becomes confused. Secondary Market (Tranching) Requirements 52

53 Ownership Retained in Secondary Market Loans are purchased from the local bank. Secondary market issues bonds or other financial instruments to finance loan purchases. Default risk is retained by the secondary market and not transferred to bond investors. 53

54 Long-term real estate loans are often sold to the secondary market. Shorter-term and smaller loans, including operating loans, are less likely to be sold in the secondary market. Scope of Secondary Markets in Agriculture 54

55 Liquidity to banks Diversify risks Spatially Sectorially Over time Facilities credit default insurance Lower interest rate Increases credit availability Benefits from Secondary Markets 55

56 Farmer Mac Overview Chartered by Congress in 1987 Provides Access to Secondary Markets for Rural Borrowers, thereby Reducing Cost of Credit GSE that is now Privately Owned (traded NYSE) 56

57 Board of Directors –10 Board members appointed by shareholders from financial institutions. –5 Board members appointed by the President with Senate confirmation. 57 Farmer Mac Overview

58 Involved in $12 Billion of Loans –50,000 Loans –600 Lenders –2/3 Loans eventually to small farmers –50 States –130 Commodities 58 Farmer Mac Overview

59 Helps various agricultural lenders –Farm credit systems –Commercial banks –Insurance companies –Rural utilities Farmer Mac Overview 59

60 Farmer Mac is restricted to – Agricultural real estate loans – USDA guaranteed loans – Rural utility loans – Other limited loans Widening spread between operating loans and real estate mortgages. Secondary markets for agricultural operating loans for all practical purposes are currently unavailable. Farmer Mac Loan Restrictions 60

61 Bank Regulation: Basel Requirements 61

62 Basel Objectives Improve the banking sector's ability to absorb shocks arising from financial and economic stress, whatever the source Improve risk management and governance Strengthen banks' transparency and disclosures 62

63 Basel History 1983: G7 agreed on rules for regulating banks including the 8 Percent Rule 1988: Basel Accord amended to use internal models for “off balance sheet” 1997: Allowed specific risk models 2007: Basel II replaced internal credit risk models with complex risk weighting 63

64 Basel Focus Bank-level, or microprudential, regulation, which will help raise the resilience of individual banking institutions to periods of stress. Macroprudential, system wide risks that can build up across the banking sector as well as the procyclical amplification of these risks over time. 64

65 “Three Pillars“ of Basel II Minimum capital requirements (addressing risk) Supervisory review Market discipline 65

66 Bank Auditing: Capital Ratio and Return on Equity –Banks are required to maintain adequate capital as measured by their Capital Ratio (or Capital Requirement Rates) Minimum Capital Requirements 66 8 Percent Rule: CR>.08

67 Risky Assets: Calculated as a Weighted Sum of Assets. Various weights for a simplified example Minimum Capital Requirements 67 AssetWeight House Mortgages0.5 Other Loans1 Cash0 Most Other Assets1 Some Off Balance SheetVaries

68 68

69 ROE, ROA, and Capital Ratio (CR) Minimum Capital Requirements 69

70 Minimum Capital Requirements ROE and CR (ROA assumed =.01) 70

71 Supervisory Review Empowers regulators with tools for the first pillar Framework for dealing with residual risk that include systemic, pension, concentration, strategic, reputational, liquidity and legal risk Resulted in the Internal Capital Adequacy Assessment Process 71

72 Market Discipline: Disclosure Requirements Facilitates assessment by investors, analysts, customers, other banks, rating agencies Disclose details on the scope of application, capital, risk exposures, risk assessment processes and the capital adequacy of the institution Must be consistent with how the senior management including the board assess and manage the risks of the institution 72

73 International Competitiveness Finance Example U.S. Developing Countries Risk Free Interest Rate Includes Inflation (LIBOR or U.S. T-Bills Based) 3.5 Bank Margin1.5 2.0 Inflation or Currency Risk 0 1.5 Default Risk1.0 8.0 Political 0 3.0 Judicial 0 2.0 Commercial Farmer Interest Rate6.020.0 Small Farmer AdjustmentNA 3.0 Small Farmer Interest Rate6.023.0 73

74 QUESTIONS 74


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