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“How did you go bankrupt?” Bill asked. “Two ways,” Mike Said. “Gradually and then suddenly.”
-The Sun Also Rises, By Earnest Hemingway
I’ve been thinking and writing about debt a lot lately. My clients have been more concerned about it as well. That makes sense. Many of you out there may have had a Home Equity Line or a very low interest credit card that gave you travel rewards, and when the Home Equity rate was 2% or the credit card was only 6% (and only if you missed or underpaid a payment) it wasn’t that big a deal. If you owed $25,000 on a Home Equity line at 2%, and you could pay interest only, your monthly payment would only be $42. At 8%, that monthly payment grows to $167. So needless to say, I’ve been getting a lot of inquiries about paying off loans and credit cards that many people were more than happy to just make the payments on a year ago. Of course what to do about those loans varies widely based on the individual and their circumstances so I’m not offering solutions here, just to point out that if it’s becoming an issue for my clients – most of whom are pretty well off and have very low debt loads compared to their assets and income – then it must be a much bigger issue for all the people and families out there that live paycheck to paycheck. If you’re lucky enough to have a fixed mortgage rate that you took out when rates were in the 2’s and 3’s then you might not be feeling the pinch, but if you have home equity loans, adjustable-rate mortgages, or credit cards – those payments have tripled or even quadrupled over the last 18 months. As of now the economy seems to be shaking it off, growth in the third quarter of 2023 came in at 4.9% and so far, there’s been no noticeable uptick in unemployment. I’m of the mind that while the Fed is going to keep rates at this level for a while, they simply can’t keep them this high for too long or we may reach a spillover effect that we can’t handle. But beyond the 1–3-year rates and their contribution or non-contribution to a future recession, we have a much bigger debt problem that will ultimately have to be resolved at some point – and I don’t know how we do that.
But before I get into “The Debt” which I’m using as a proxy for the National Debt, let’s talk about corporate debt because that may have more impact in the short-term. According to Bloomberg, U.S. Corporations had to refinance about $303 Billion dollars in corporate debt during 2023. Those were bonds that were originally issued at much lower rates, that came due and were reissued at higher rates, or direct borrowing from banks that was refinanced also at higher rates – costing those companies more money in debt servicing. According to the St. Louis Federal Reserve, total corporate indebtedness is approximately $13 Trillion dollars, so as big a number as $303 Billion may seem it still only represented about 2.3% of all U.S. corporate debt. But in 2024 more than twice that much rolls over, $644 Billion and then in 2025 $819 Billion, representing 4.9% and 6.3% respectively of all U.S. corporate debt. Meaning if rates don’t go down over the next couple years, almost 14% of all current corporate debt will be refinanced at not just higher rates, but significantly higher rates – 3-4 times higher. Do the math and that could lead to U.S. corporations paying almost 50% more in debt service than they were paying in 2022, and that’s just the reissuing of existing bonds or refinancing of existing debt – that doesn’t include the new borrowing. When does the Fed realize the rates can’t stay this high?
That’s just Corporate America and us little individual people and all our little debts. The debt load I get asked about the most is the National Debt, which by the time you read this could have reached $34 Trillion dollars. (All National Debt info from U.S.DebtClock.org) That number in a vacuum, doesn’t mean very much. Having $100,000 in credit card debt sounds like a lot and if you’re a regular family pulling in $110,000 a year it’s a tremendous amount. But if you’re a hedge fund manager on Wall Street who put the private plane, chartered yacht, Mediterranean vacation for their family on the credit card and they make $10 million a year – it’s not that much. What matters is how that debt number compares to what the economy generates, and that’s getting very concerning as well. In the year 2000, when nobody was talking about the National Debt being small, the debt to GDP ratio of the U.S. was 56% - in other words the total debt represented about 56% of what the economy generates in one year. Now that ratio is rapidly approaching 125%, we owe more than we take in on an annual basis. This spike in the debt was caused by many things over the past 23 years, things in some cases championed by one side of the political spectrum and in some cases the other. The response to 9/11 and the wars in Afghanistan and Iraq, the response to the 2008 financial collapse and the corporate bailouts as well as money sent directly to taxpayers, the big tax cuts in 2003 & 2017 and then finally Covid and all the money sent to individuals, small businesses, the unemployed etc. This was on top of extra spending we already knew was coming, with the Baby Boomers retiring Medicare and Social Security obligations have grown tremendously – and that’s only been accelerated by the large number of retirement age people who during Covid decided to just fully retire, earlier than was previously projected. The Treasury just announced it will be issuing $776 Billion in new bonds before year end – most to replace older bonds that are coming due but plenty of new borrowing, and then another $816 Billion in the first calendar quarter of 2024 – also most of it replacing maturing bonds, that were probably issued at lower rates, plus the new borrowing. Adding this new debt and refinancing this older debt at presumably higher rates, means that by the middle of the next fiscal year (which runs October to September, and we don’t yet have a budget for the year we’re living in – but that’s different problem,) the entire tax revenue of the U.S. Government will be spent on Medicare and Medicaid, Social Security, Defense Spending and paying interest on our debt. In fact, interest on the debt will likely equal defense spending by that point next year. That means that if all the other things the Government does, from the things that most people like, like the National Parks, to the things lots of people think we should get rid of (fill in your thing here) were eliminated we would barely have a balance budget and not pay down our debt at all. If we want to stop the growth of the debt or pay it down in any capacity, it will require cuts to Medicare, Medicaid, Social Security or Defense, or an increase in taxes, or a combination of both.
Why is paying down the debt important? Maybe it’s not. So far everything is working fine, the Treasury department issues debt, and it all gets bought with no real problem. Every time something scary happens in the world, people move their money into U.S. Government debt to protect it, and that has continued as we saw when Russia invaded Ukraine and when Hamas attacked Israel. There is no magic number that is suddenly “too much debt.” Japan’s debt to GDP ratio is 263% and has been over 200% for decades. So maybe everything keeps going with no issues as the debt keeps growing, and for the medium term I think that’s going to happen, it’s unlikely we have anything to worry about for maybe the rest of this decade. But like the quote above, there may come a Treasury Bond auction one of these days when they can’t find buyers for all the debt issuances, and that’s the point where gradually turns into all at once. That’s the point where the unthinkable; Republican’s supporting tax increases, Democrats discussing Medicare cuts, both sides considering cuts to defense spending – suddenly must become thinkable. Or not. Unexpectedly high, sustained economic growth, some kind of functioning Government budget process that compromises on debt and taxes, bond investors that just don’t care what the debt is no matter how high it gets – lots of things could happen to keep this possibility at bay.
I bring this up this month as I said, because we’re suddenly concerned about interest rates again for the first time in a long time so it’s top of mind, and I do think about the level of U.S. debt, and I don’t love it either. But in the medium term I don’t think it’s THE problem to worry about, and anything you do to protect yourself from that problem, which is still not guaranteed to be a problem, is likely to prevent you from dealing with more immediate problems – like how to out earn inflation and taxes so you can keep up your lifestyle and leave a legacy to your heirs. I mentioned in the last edition that the Fed because it’s made up of human beings with egos, can’t raise rates in November and then suddenly cut them in January because it looks like they don’t know what they’re doing. But they didn’t raise them in November, they haven’t raised them since July. Now a cut in March or April of next year suddenly is nine months removed from the last increase and looks more rational. This means that all those higher costs for corporations and individuals I talked about suddenly become less of an issue, and the cost of debt servicing for the Federal Government slows substantially, putting off the possible “Judgement Day” even further. It also means the share price of bonds should rise along with the higher interest rates you’re getting now, making them a very attractive asset to own. I’ve been saying that for a while, but I think that payoff may start in the first half of next year, not the latter half as I was thinking last month.
Before I go this month, I wanted to tell you about a lifestyle change for myself and my wife over the next few months. Now that the kids are out of the house, we decided we could afford to take some time in a warmer climate this winter. So from February 9 to March 10, we are going to be living in Puerto Rico. I plan to take one of those weeks as a vacation, but the other three I will be working from there, and hopefully having on-line meetings, or phone calls with all of you that I would normally meet that time of year. As the majority of my meetings (if not all) last February were online with you folks at your various warm climates – I don’t think this will change much for any of you. If one good thing came out the pandemic, it was the use of video conferencing and DocuSign that let us do business from pretty much anywhere. Lynn and Dayna will be in the physical office in Mashpee and will be available to get the mail and provide any physical documents you may need or want to drop off. This is an experiment to see if we want to make that a more permanent part of our lives, so it may not be an every year thing or it may grow from four weeks to six or eight as time goes on, who knows? I also don’t know yet exactly what week will be the vacation, but we’ll let you know if we need to schedule a meeting. That’s still a couple months away, we have 2023 to finish up and one more newsletter before this year ends, talk to you then.
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