Economic rescue could cost $8.5 trillion

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By Jim Puzzanghera

Heavy spending to battle the financial crisis is unlikely to abate soon. Analysts say next year's deficit could top $1 trillion.

With its decision last week to pump an additional $1 trillion into the financial crisis, the government eliminated any doubt that the nation is on a wartime footing in the battle to shore up the economy. The strategy now -- and in the coming Obama administration -- is essentially the win-at-any-cost approach previously adopted only to wage a major war.

And that means no hesitation in pledging to spend previously almost unimaginable sums of money and running up federal budget deficits on a scale not seen since World War II.

Indeed, analysts warn that the nation's next financial crisis could come from the staggering cost of battling the current one.

Just last week, new initiatives added $600 billion to lower mortgage rates, $200 billion to stimulate consumer loans and nearly $300 billion to steady Citigroup, the banking conglomerate. That pushed the potential long-term cost of the government's varied economic rescue initiatives, including direct loans and loan guarantees, to an estimated total of $8.5 trillion -- half of the entire economic output of the U.S. this year.

Nor has the cash register stopped ringing. President-elect Barack Obama and congressional Democrats are expected to enact a stimulus package of $500 billion to $700 billion soon after he takes office in January.

The spending already has had a dramatic effect on the federal budget deficit, which soared to a record $455 billion last year and began the 2009 fiscal year with an amazing $237-billion deficit for October alone. Analysts say next year's budget deficit could easily bust the $1-trillion barrier.

"I didn't think we'd see that for a long time," said Maya MacGuineas, president of the Committee for a Responsible Federal Budget. "There's a huge risk of another economic crisis, a debt crisis, once we get on the other side of this one."

But the Bush administration and the economic team that Obama is rapidly assembling like a war Cabinet are vowing to spend whatever it takes to avoid a depression; they'll worry about the effect later.

"I don't think that there's any way of denying the fact that my first priority and my first job is to get us on the path of economic recovery, to create 2.5 million jobs, to provide relief to middle-class families," Obama told reporters last week.

"But as soon as the recovery is well underway, then we've got to set up a long-term plan to reduce the structural deficit and make sure that we're not leaving a mountain of debt for the next generation."

The mountain is already there, and rising faster than at any time since the 1940s, when the United States was fighting a global war.

Analysts say the current flood of red ink calls into question Obama's ability to launch programs such as middle-class tax cuts and a healthcare overhaul. In 1993, a deficit only a third the size of next year's projected $1 trillion prompted President Clinton to abandoned his campaign pledges of tax cuts.

Once the financial crisis eases, higher interest rates and soaring inflation will be risks. If they materialize, they could dramatically increase the government's borrowing costs to meet its annual debt payments. For consumers, borrowing could become more expensive even as the price of everyday items rise, holding back economic growth.

"We could have a super sub-prime crisis associated with the meltdown of the federal government," warned David Walker, president of the Peter G. Peterson Foundation and former head of the Government Accountability Office.

But even deficit hawks such as Walker acknowledge that the immediate crisis is priority No. 1. Just as with World War II, the government can worry about paying the bills once the enemy is defeated.

"You just throw everything you have at the problem to try to fix it as quickly as you can," said David Stowell, a finance professor at Northwestern University's Kellogg School of Management. "We're mortgaging our future to a certain extent, but we're trying to do things that give us a future."

Washington could wind up spending substantially less than the sum of the commitments. Though the total estimated cost of the government's efforts adds up to $8.5 trillion, only about $3.2 trillion has been tapped, according to an analysis by Bloomberg.

And not all the money committed is direct spending. About $5.5 trillion in loan guarantees and other financial backing by the Federal Reserve is included in the total.

"The only way those commitments would become obligations would be if the economy completely collapsed, in which case it's a whole new ballgame anyway," said John Steele Gordon, a business and economic historian.

The government even stands to make money on some expenditures, such as the $330 billion it has used to buy equity in banks and other financial institutions through the Treasury Department's Troubled Asset Relief Program.

In the $1.2-billion bailout of Chrysler in 1980, the government ended up gaining $311 million when it sold stock options back to the company three years later.

But the federal efforts to forestall a depression are still historic in scope.

A $1-trillion deficit next year would represent about 7% of the nation's total economic output, or gross domestic product. That would top the 5.9% reached during the height of the Great Depression in 1934 but would fall well short of the deficits of World War II. In 1943, the high point, the deficit amounted to 30% of GDP.

The national debt is soaring too. In September, the National Debt Clock in New York City ran out of digits as the figure ticked over $10 trillion. The debt is now larger than the 45% of GDP it reached at the end of the Great Depression, but less than in 1946, when war spending had pushed the debt to 129% of GDP, said Gordon, author of "Hamilton's Blessing: The Extraordinary Life and Times of Our National Debt."

There's a potentially crucial difference, however, between the spending then and the commitments now:

Much of the Depression-World War II spending was on industrial production -- building new factories and converting existing plants to produce tanks, planes and ships. Huge sums also went into developing new technologies.

Those investments, combined with pent-up consumer demand and savings from the lean war years, quickly led to budget surpluses and sharp economic growth in the late 1940s as the baby boom began.

Analysts warn not to expect that to happen again. This time the government spending is largely ethereal, with the Federal Reserve printing more money to inject liquidity into the financial system and keep banks and other institutions afloat. And savings rates are low.

"Too many Americans have overextended themselves with regard to credit and debt, and too many have been following the bad example of the government," Walker said. "It is imperative that we recognize that this country has been living beyond its means and that we face large and growing structural deficits even after we turn the economy around."

Walker said he understands the need to attack the financial crisis. But the spending only adds to the looming problems of unfunded Social Security and Medicare commitments as baby boomers begin to retire.

He noted that the Moody's bond-rating firm fired a shot across the government's bow in January with a warning that spending on entitlement programs poses a long-term threat to the triple-A rating for government bonds. And that was before the financial crisis.

Interest rates remain low because of the crisis. But they will rise, particularly when the U.S. government starts borrowing more money to cover its growing debt, analysts predict. That could cause inflation to increase as well.

"We could easily enter into a highly inflationary situation because of all the stimulus we have and all the borrowing we have once it works its way through the economy," MacGuineas said. "The single most important priority right now is to stabilize the economy . . . but it really means that there is a huge risk on the other side."