Detroit did not just happen. Over decades, politicians, unions heads, business leaders and state officials conspired to perpetrate a fraud on the public. When they sat down with the unions and promised pension benefits, they knew they could never hold up their end of the bargain. The union bosses knew it too. The same people also knew the GO bonds were never going to be repaid. That’s a fraud on the bond holders and the tax payers.
Detroit highlights another problem, one that is going to bring the nation to its knees. That’s the problem of public debt. For most of human history, government was subject to the same market forces as everyone else. When they borrowed, they did so at a rate set by lenders. They were also constrained by the types of debt available. The government could finance a bridge by pledging the tolls as collateral. They could borrow without pledging collateral, but those rates were higher as bond holders factored in risk.
Many states forbid high interest borrowing schemes by state and local government, for the obvious reason. Now, one way the government could get money without raising taxes was to inflate the currency and that only applied to national governments. With hard money, this was very difficult to do for obvious reasons, but not impossible. The Romans slowly debased their currency throughout the period of empire. The Habsburgs largely financed the Thirty Years War this way. This is just taxing people by deception.
Today, governments have many new ways to borrow money to buy votes. Pensions are a promise to pay tomorrow for services today. This allows the politicians to buy votes, the service today, and leave someone else with the bill. General Obligation Bonds are another way to get around the problem. They borrow to finance community programs and the associated patronage jobs. To make matters worse, the government only pays interest until maturity. When a bond matures, the bond holder gets their principal.
In all cases, the government issues new bonds to pay old bond holders, thus rolling over debt without ever paying it down. This disguises the problem further, which makes it grow bigger and faster. If the employees knew twenty years ago that their pensions were at risk, they would have made different decisions. That’s the point of promising to pay tomorrow for the hamburger today. The assumption is the other side of the deal is unable to assess the long term risk. They can’t know that the next politician will default.
Detroit finally reached a point where it could no longer pay interest on the debt and operate basic services. Most of the states in this country are on the same path. If interest rates revert to historic norms, states like Illinois will be bankrupt. The Federal government would add another $400 billion a year in debt payments. If you believe government will reform and avoid this catastrophe you have not been paying attention. If you think interest rates will remain near zero forever, you should seek professional help.
The math of public debt is stark. Most pension funds are seriously underfunded and many states have actually borrowed against their pension assets. At some point, the inevitable will happen and we will see a public debt crisis. Given that public debt is now the basis of world currencies, a public debt crisis threatens the world as we know it. Maybe it works itself out in time, but that is not the way to bet. Decades from now, people will look back at this age and curse the people who decided to let the debt pile up.