The real cost of US debt

President Obama’s National Commission on Fiscal Responsibility and Reform met for the first time recently to tackle the difficult task of reversing America's unsustainable fiscal path. Before we can understand how to tackle future debt, however, we need an honest estimate for the debts we’ve already incurred.

The current national debt estimate of $14 trillion is misleading. The government’s deceptive accounting practices fail to include its ownership in the automotive and financial sectors as part of the national debt, which would increase it by trillions of dollars.

It’s time for this administration to bring transparency to the federal budget process by properly accounting for companies now held by the federal government through the Troubled Asset Relief Program (TARP).

When Office of Management and Budget Director Peter Orszag ran the Congressional Budget Office, he unsuccessfully nudged the Bush administration to include the debt of federally backed mortgage enterprises Fannie Mae and Freddie Mac in the national budget. His position was that two principles of government accounting require such debts to be on the government’s books: principle one, we control these companies; principle two, we guarantee their debt.

The Obama administration disputes its control of TARP companies. But not only does the government tell GM what kind of cars to build and Citigroup which directors to elect, it also tells Fannie and Freddie which mortgages to subsidize. Principle one, check.

Treasury Secretary Timothy Geithner affirms that we stand behind the banks, which means we stand behind their debt as well. Principle two, check.

Mr. Orszag has been noticeably silent since joining the Obama administration, but his argument is still valid. Omitting appropriate liabilities from our government’s books allows us to borrow more than we should and feeds our habit for deficit spending.

This doesn’t mean we should include the debt of all companies taking TARP money. Yet when the government acts like a private investor by purchasing common stock, private financial accounting principles should be employed.

The first rule in financial accounting is that consolidation of debt (putting it on the books) is appropriate when a parent company controls another company by owning a majority of its stock. This covers GM at 60 percent Treasury ownership, AIG at 80 percent, and Fannie Mae and Freddie Mac at 80 percent.

The second rule is that even if a shareholder has less than 50 percent ownership, if it is the beneficiary of most of the company’s future profits, consolidation is appropriate. This may also cover the government’s stock, warrants, and debt interest in Citigroup and some of the other banks.

Counting only outstanding debt of these five TARP companies (out of more than 600): Citigroup has $1.8 trillion in debt; AIG, $760 billion; Fannie and Freddie, $5.7 trillion; and GM, $43 billion. This means at least $8.3 trillion of the national debt is missing from the government’s books. If the government is able to privatize these companies, then we can remove their debt from our books, until then their debt is the government’s debt.

The statutory limit on the national debt is the one real limit on runaway government spending. Lifting that limit requires legislators to go on the record voting in favor of an increase, something they try to avoid however they can.

Congress is required to vote every few years on whether to raise the national debt ceiling. The debts of bailed-out banks, however, aren’t included. If they were, the president may have a reason to privatize banks he now controls to evade that politically inconvenient vote for his party.

When Britain recently recognized the debt from its two large bank bailouts, its national debt doubled overnight. Warnings later emerged from the credit rating agencies that the safety of British bonds was in jeopardy, unprecedented for a modern Western nation.

If Washington properly accounted for its debt and deficit, we might be in the same situation. A threat to the US credit rating may even be beneficial, a sign that we’ve hit rock bottom and need to recover from this deficit addiction. Credit warnings would result in a diminished appetite for Treasury bonds, forcing the Treasury Department to borrow at higher interest rates and curb its habit for runaway spending.

The full faith and credit of the US is not a depthless well. Future generations bear the risk of high inflation, increased taxes, and interest payments on Treasury bonds that take up an ever-increasing share of the federal budget.

It’s time to change the definition of the national debt ceiling to include the debt of companies controlled by the government via bailouts. As such, the government would have a stronger incentive not to bail out companies in the first place.

J.W. Verret is a senior scholar and member of the Financial Markets Working Group at George Mason University’s Mercatus Center. A version of this essay previously appeared at The Volokh Conspiracy blog.