Wall Street Cassandra: U.S. debt crisis could happen very soon 

David Einhorn has a very scary op-ed about America’s fiscal future in the New York Times today. Why should you care? Well, for one thing Einhorn is a hedge fund manager who made his reputation in short selling. Einhorn famously started short selling Lehmann Brothers in July of 2007, ahead of the liquidity crisis that hit in August of that year and months before the broader economic catastrophe brought down the storied investment bank the next year.

Essentially, Einhorn says that the governmental response to the economic problem has made things worse. Specifically, the “stimulus” was no such thing:

Before this recession it appeared that absent action, the government’s long-term commitments would become a problem in a few decades. I believe the government response to the recession has created budgetary stress sufficient to bring about the crisis much sooner. Our generation — not our grandchildren’s — will have to deal with the consequences.

According to the Bank for International Settlements, the United States’ structural deficit — the amount of our deficit adjusted for the economic cycle — has increased from 3.1 percent of gross domestic product in 2007 to 9.2 percent in 2010. This does not take into account the very large liabilities the government has taken on by socializing losses in the housing market. We have not seen the bills for bailing out Fannie Mae and Freddie Mac and even more so the Federal Housing Administration, which is issuing government-guaranteed loans to non-creditworthy borrowers on terms easier than anything offered during the housing bubble. Government accounting is done on a cash basis, so promises to pay in the future — whether Social Security benefits or loan guarantees — do not count in the budget until the money goes out the door.

A good percentage of the structural increase in the deficit is because last year’s “stimulus” was not stimulus in the traditional sense. Rather than a one-time injection of spending to replace a cyclical reduction in private demand, the vast majority of the stimulus has been a permanent increase in the base level of government spending — including spending on federal jobs. How different is the government today from what General Motors was a decade ago? Government employees are expensive and difficult to fire. Bloomberg News reported that from the last peak businesses have let go 8.5 million people, or 7.4 percent of the work force, while local governments have cut only 141,000 workers, or less than 1 percent.

Einhorn is also alarmed by the imbalance between government and private-sector salaries, the over reliance on Keynesian economics and perhaps most alarmingly, he says: “I don’t see the political will to steer the country away from crisis.”

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Mark Hemingway

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