|
|||
|
|
|
Make the Right Debt Your Friend
The warning alarms sounded loudly in Washington. We watched the exhausting political posturing for two torturous weeks. In the end, we saw the U.S. debt limit raised. We did not default on our obligations. We still paid our bills. Soon after, we saw rating agencies showing new muscle and teeth with the first ever AAA downgrade in the U.S. suggesting a slightly higher risk of debt repayment. We saw market behavior that took us on a nauseating rollercoaster ride. And now we sit confused and frustrated as to what this all really means.
Do you remember the expression "make debt your friend"? Can you imagine anyone daring to say that out loud, especially in Washington now a day? If you had $5,000 cash on hand, do you use it as a down payment on a new $10,000 dollar living room furniture set and finance the rest at a 5 percent interest? Or do you buy $10,000 worth of dividend-bearing stock with $5,000 and finance the rest at 5 percent interest? In both scenarios you will be indebted $5,000.
The usdebtclock.org website tells our dynamic U.S. financial rolling story quite dramatically: $14 trillion in debt, $3.6 trillion in spending, $2.2 trillion in revenues and interest payments amounting to $215 billion. That means about 6 percent of all U.S. federal spending goes toward interest expense. Thus, the cost of carrying all of that debt is about 6 cents on the dollar. Is that a lot? Is that a little? The simple answer is "it depends." Depending on income and other obligations most people would likely struggle carrying a $10 millionloan but maybe someone like Warren Buffet would find it much less stressful. Similarly, if the U.S. government can make ends meet including that cost of debt, the total amount of debt should technically not be of too much concern. So why bother setting a debt limit? My past column "Hitting the Debt Ceiling" highlighted the value of setting a debt limit. It is set deliberately to act as a trigger or tool to ensure we routinely look at how entities spend money and ensures we have steady cash-flow control mechanisms in place to avoid default. Moreover, agencies that measure our credit scores or worthiness often don't distinguish between good and bad debt when evaluating our risk of default. So it is important that we respect the discipline behind credit limits especially in the absence of such discernment. Be it government, corporate, or individual debt, the same basic rules and risks apply. Borrow money to buy things that go up in value. Borrow money if it improves productivity and eventually it makes you even more money. So maybe a more focused question to ask government should be: What things are we buying with this borrowed money? Are we spending it on systems or infrastructure? Social welfare or education programs? Foreign aid? Science and technology?The bottom line is, is this spending amounting to good or bad debt, and who distinguishes? If we don't ask the government to reconcile these spending decisions, this debt can become our national risk. JOANNA MAKOMASKI is a specialist in innovative enterprise risk management methods and implementation techniques. September 15, 2011 Copyright 2011© LRP Publications |
|
|
|
Entire contents copyright © 2013 Risk and Insurance® All rights reserved.
May not be reproduced in any form without written permission.
|