Record Budget Deficit Casts Dark Shadow over Economy and Housing

Written by: David Lereah   Thu, October 22, 2009 Commentary

The Office of Management and Budget announced last week that the federal budget deficit totaled $1.42 trillion in fiscal year 2009. This was an all-time record and as a percentage of GDP was the largest deficit since World War II.

Alarmingly, the annual deficit rose 212 percent to the record dollar amount of $1.42 trillion from a $455 billion deficit a year ago. The deficit as a percentage of GDP rose to 10 percent, compared to a 3.2 percent share in 2008. Pushing aside the shock and awe of this souring financial situation, today’s deficit still pales in comparison to the 1945 budget deficit which registered a 21 percent share of GDP.

Of course, any comparisons to the days of World War II are nonsensical. In 1945, almost 80 percent of all government expenditures were directed towards military activities. Furthermore, the government borrowed most of the money from issuing government war savings bonds.

In contrast, today’s outsized deficit is largely due to an economic recession combined with extraordinary government bailout activities designed to stem the economic and financial meltdown that began towards the end of 2008. As a consequence, tax receipts dropped 16.6 percent in fiscal year 2009, while spending climbed 18.2 percent during the same period.

Unlike issuing savings bonds during the Second World War, a substantial amount of today’s government borrowings come from foreign funds. Nations such as China, Japan and the European Union have a great deal invested in U.S. securities. There is no free lunch; at some point interest rates on government bonds will eventually rise in order to keep foreign funds flowing into the U.S., helping feed our out-of-control spending habits.

At the close of September, America’s total debt obligations outstanding totaled $11.9 trillion, a number that dwarfs the GDPs of China and Japan combined. Looking forward, the Obama administration has its fiscally responsible hands tied behind its back. Until the economy rebounds and the financial markets stabilize, it would be costly for the government to cut back on spending and/or raise taxes. Word out of the Obama administration is that the government promises to have a plan in place to reduce the deficit when the economy recovers.

Using history as a guide, the fallout of running excessive budget deficits will likely be higher interest rates and slower and erratic long-term economic growth. Both would provide an unfavorable backdrop for the nation’s housing sector. Last year at this time, government policy makers were well aware of the consequences of excessive government spending and large budget deficits. Most economists today would agree that at the time, we had few options. The economy, the financial markets and the housing sector were on the verge of collapse; it was critical that the government swiftly pump money and confidence back into the economy and financial markets.

On a positive note, the government spending and bailout programs have been effective; the economy is now rebounding and the credit markets are improving. At least now we have some time to take a deep collective breath and contemplate our next move.

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