A strange thing is happening in Washington. Many politicians, pundits, and commentators are starting to confuse two interrelated but substantively different ideas: fiscal crises and financial crises. While not everyone is guilty of this inadvertent or perhaps intentional mix-up, we are beginning to witness a recurrent pattern of attempts to paint the 2008 financial crisis as one that was primarily fiscal in nature. Confused yet? I don’t blame you.
Fiscal crises most commonly refer to ongoing institutional problems with managing debt loads, with the institution in this instance being the federal government. Financial crises, on the other hand, typically connote systemic problems within the financial sector of an economy – stemming from some combination of bad corporate choices and government policies – that ultimately lead to an economic retraction of some sort. Getting these two things straight in the minds of the American public will go a long way towards informing robust public debate about necessary next steps: the banking crisis that led to a near-economic collapse in 2008 was primarily financial in nature, whereas the consequences of that crisis have resulted in short- to medium-term fiscal problems at the local, state, and national level. There is meanwhile an additional long-term fiscal crisis that has been quietly chugging along for many years – indeed decades – now, and this particular problem is largely linked to long-term imbalances between tax revenues and spending on entitlement programs and defense.
In case you were wondering, there is a very good reason for some politicians to paint the 2008 crisis as a fiscal rather than financial one. By confusing these two terms and ideas together, self-described “fiscal hawks” in Washington can bolster their claims of out-of-control government spending by the Obama administration, conveniently shifting any blame away from themselves. The argument goes something like this: the reason we are in this mess today is because of excessive government spending by the current administration, and the only way to turn the economy around is to therefore cut this same irresponsible spending.
This argument makes for a convenient cable television sound bite, but it unfortunately smacks more of theater than reality. The 2008 recession was in large part caused by an enormous financial collapse, and this financial recession was itself primarily the end result of years of financial deregulation and loose monetary policy coupled with bad financial business practices. Ironically, many of the same politicians who are today calling for federal fiscal discipline tend be the same ones who in years past promoted this very financial deregulation and increased federal spending on mortgages and entitlements. The financial deregulation in particular consisted of allowing or promoting loose credit standards at banks, increasingly irresponsible leverage ratios, and little or no regulation of complex derivatives and other esoteric financial products. In other words, it was the banking sector, and not the federal government, that was the primary driver of the recession, though the government played its part in enabling the banks’ worst practices over the past couple of decades. Indeed, had government been more involved in responsibly and smartly regulating these banks rather than supplying them with monetary cocaine, we would likely not have witnessed such a severe recession in 2008.
That said, in response to this financial recession, both the Bush and Obama administrations embarked upon a series of unprecedented temporary fiscal stimulus measures in order to help boost consumer demand and keep our financial institutions afloat (think: TARP, tax cuts, Recovery Act spending). Most economists, though not all, tended to believe that this overwhelming response was necessary to stave off an even more severe economic contraction, as many of them have argued that a lack of government stimulus in the face of similar recession led to the prolonging of both the Great Depression and the Japanese “lost decade.” Whether or not this economic theory withstands the test of time and continued trial and error in economic policymaking, the consequences of the massive government intervention in 2009 up through today include a series of fiscal deficits that are alarming in their size and seeming longevity. Most projections continue to show sustained large budget deficits throughout this decade, in large part the result of stimulus spending and tax cuts that are meant to help ease the United States out of the recent recession and into a more “normal” economic cycle.
It has therefore been easy for some politicians to latch on to this ballooning federal government spending and construe it as the primary reason for today’s – and tomorrow’s – fiscal messes, but the reality is much more complicated than that. In addition to the expected deficits that are a consequence of all of this post-recession government spending, there are also enormous anticipated long-term deficits that stem from unfunded liabilities in both healthcare and social security – the so-called “entitlements” – spending. Of course, this long-term entitlements problem is by no means a new thing; many honest politicians and policymakers alike have been shouting from the rooftops – oftentimes into a howling and indifferent public wind – about our long-term structural problems for decades. With increasingly more unhealthy Baby Boomers retiring en masse today expecting costlier technological fixes to keep the them alive in old age, entitlement funding shortfalls are only likely to get worse in coming years and decades: hence, the complementary long-term fiscal dilemma that we face.
Truly responsible politicians would not shortchange the American public by confounding these different types of economic problems. They would spell out appropriate solutions to each of these interrelated but unique problems, and debate whether one methodology or another – i.e. tax cuts or government spending or likely some combination of these two – might best solve each of the fiscal problems. The financial crisis laid bare some of the shortfalls of rampant deregulation: without adequate and well-designed regulatory safeguards, the market might become too efficient for its own good. Indeed, one could argue that, in the absence of government intervention, a complete financial collapse in 2008 – something much worse than what actually happened – would have been the natural free-market corrective to excessive risk-taking and greed on Wall Street. While theoretically correct, can we as a nation accept a system-wide economic collapse every decade or so in order to allow the market to work out behavioral economic shortfalls and kinks for itself? If this seems like a rhetorical question laced with sarcasm….well, that’s because it is.
If nothing else, I’d like to leave you with my simple, 3-sentence pocket formula for fiscal versus financial crises in the 21st century: (1) a financial collapse occurred in 2008, fueled in large part by financial deregulation, cheap borrowed money from abroad, and shoddy lending practices that took place over many years. (2) As a result of this financial collapse, the government spent a lot of money via both short-term stimulus and tax cuts and contributed to a short- to medium-term fiscal problem: persistent decade-long annual deficits. (3) Meanwhile, for years and years on a parallel track alongside all of this, we as a country have indulged ourselves with lavish entitlement spending on things that we have not really paid for and, assuming no realistic legislative fixes anytime soon, this funding shortfall will likely come back to bite us in the coming years and decades in the form a long-term fiscal crisis.
Got it? Good. Now, the next time a politician, pundit, or economic know-it-all tries to sound important by blaming everything on the wrong things, at least you’ll know who not to vote for, watch, or read the next time around. It’s about time for some honest accounting of the nation’s economic woes, lest we swallow the wrong tonic for our fiscal and financial ills.
The views expressed in this article are those of the author, and do not necessarily reflect those of the U.S. Department of State or the U.S. Government.
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Financial vs. Fiscal Crises: A 21st Century Primer
July 28, 2011
A strange thing is happening in Washington. Many politicians, pundits, and commentators are starting to confuse two interrelated but substantively different ideas: fiscal crises and financial crises. While not everyone is guilty of this inadvertent or perhaps intentional mix-up, we are beginning to witness a recurrent pattern of attempts to paint the 2008 financial crisis as one that was primarily fiscal in nature. Confused yet? I don’t blame you.
Fiscal crises most commonly refer to ongoing institutional problems with managing debt loads, with the institution in this instance being the federal government. Financial crises, on the other hand, typically connote systemic problems within the financial sector of an economy – stemming from some combination of bad corporate choices and government policies – that ultimately lead to an economic retraction of some sort. Getting these two things straight in the minds of the American public will go a long way towards informing robust public debate about necessary next steps: the banking crisis that led to a near-economic collapse in 2008 was primarily financial in nature, whereas the consequences of that crisis have resulted in short- to medium-term fiscal problems at the local, state, and national level. There is meanwhile an additional long-term fiscal crisis that has been quietly chugging along for many years – indeed decades – now, and this particular problem is largely linked to long-term imbalances between tax revenues and spending on entitlement programs and defense.
In case you were wondering, there is a very good reason for some politicians to paint the 2008 crisis as a fiscal rather than financial one. By confusing these two terms and ideas together, self-described “fiscal hawks” in Washington can bolster their claims of out-of-control government spending by the Obama administration, conveniently shifting any blame away from themselves. The argument goes something like this: the reason we are in this mess today is because of excessive government spending by the current administration, and the only way to turn the economy around is to therefore cut this same irresponsible spending.
This argument makes for a convenient cable television sound bite, but it unfortunately smacks more of theater than reality. The 2008 recession was in large part caused by an enormous financial collapse, and this financial recession was itself primarily the end result of years of financial deregulation and loose monetary policy coupled with bad financial business practices. Ironically, many of the same politicians who are today calling for federal fiscal discipline tend be the same ones who in years past promoted this very financial deregulation and increased federal spending on mortgages and entitlements. The financial deregulation in particular consisted of allowing or promoting loose credit standards at banks, increasingly irresponsible leverage ratios, and little or no regulation of complex derivatives and other esoteric financial products. In other words, it was the banking sector, and not the federal government, that was the primary driver of the recession, though the government played its part in enabling the banks’ worst practices over the past couple of decades. Indeed, had government been more involved in responsibly and smartly regulating these banks rather than supplying them with monetary cocaine, we would likely not have witnessed such a severe recession in 2008.
That said, in response to this financial recession, both the Bush and Obama administrations embarked upon a series of unprecedented temporary fiscal stimulus measures in order to help boost consumer demand and keep our financial institutions afloat (think: TARP, tax cuts, Recovery Act spending). Most economists, though not all, tended to believe that this overwhelming response was necessary to stave off an even more severe economic contraction, as many of them have argued that a lack of government stimulus in the face of similar recession led to the prolonging of both the Great Depression and the Japanese “lost decade.” Whether or not this economic theory withstands the test of time and continued trial and error in economic policymaking, the consequences of the massive government intervention in 2009 up through today include a series of fiscal deficits that are alarming in their size and seeming longevity. Most projections continue to show sustained large budget deficits throughout this decade, in large part the result of stimulus spending and tax cuts that are meant to help ease the United States out of the recent recession and into a more “normal” economic cycle.
It has therefore been easy for some politicians to latch on to this ballooning federal government spending and construe it as the primary reason for today’s – and tomorrow’s – fiscal messes, but the reality is much more complicated than that. In addition to the expected deficits that are a consequence of all of this post-recession government spending, there are also enormous anticipated long-term deficits that stem from unfunded liabilities in both healthcare and social security – the so-called “entitlements” – spending. Of course, this long-term entitlements problem is by no means a new thing; many honest politicians and policymakers alike have been shouting from the rooftops – oftentimes into a howling and indifferent public wind – about our long-term structural problems for decades. With increasingly more unhealthy Baby Boomers retiring en masse today expecting costlier technological fixes to keep the them alive in old age, entitlement funding shortfalls are only likely to get worse in coming years and decades: hence, the complementary long-term fiscal dilemma that we face.
Truly responsible politicians would not shortchange the American public by confounding these different types of economic problems. They would spell out appropriate solutions to each of these interrelated but unique problems, and debate whether one methodology or another – i.e. tax cuts or government spending or likely some combination of these two – might best solve each of the fiscal problems. The financial crisis laid bare some of the shortfalls of rampant deregulation: without adequate and well-designed regulatory safeguards, the market might become too efficient for its own good. Indeed, one could argue that, in the absence of government intervention, a complete financial collapse in 2008 – something much worse than what actually happened – would have been the natural free-market corrective to excessive risk-taking and greed on Wall Street. While theoretically correct, can we as a nation accept a system-wide economic collapse every decade or so in order to allow the market to work out behavioral economic shortfalls and kinks for itself? If this seems like a rhetorical question laced with sarcasm….well, that’s because it is.
If nothing else, I’d like to leave you with my simple, 3-sentence pocket formula for fiscal versus financial crises in the 21st century: (1) a financial collapse occurred in 2008, fueled in large part by financial deregulation, cheap borrowed money from abroad, and shoddy lending practices that took place over many years. (2) As a result of this financial collapse, the government spent a lot of money via both short-term stimulus and tax cuts and contributed to a short- to medium-term fiscal problem: persistent decade-long annual deficits. (3) Meanwhile, for years and years on a parallel track alongside all of this, we as a country have indulged ourselves with lavish entitlement spending on things that we have not really paid for and, assuming no realistic legislative fixes anytime soon, this funding shortfall will likely come back to bite us in the coming years and decades in the form a long-term fiscal crisis.
Got it? Good. Now, the next time a politician, pundit, or economic know-it-all tries to sound important by blaming everything on the wrong things, at least you’ll know who not to vote for, watch, or read the next time around. It’s about time for some honest accounting of the nation’s economic woes, lest we swallow the wrong tonic for our fiscal and financial ills.
The views expressed in this article are those of the author, and do not necessarily reflect those of the U.S. Department of State or the U.S. Government.
