It’s interesting to me that this article didn’t even make it to headline status in the 3/5/18 edition of USA Today … Report: Spending, tax cuts soaring to records; Debt is reaching levels not seen since World War II. It was in the Business section, and not even on the front page of that section. A better title for the article might have been The Mother Of All Balloon Notes.
Let’s Make A Deal
Using the title of a well-known TV game show, I have a proposal for a hypothetical person [I’ll call him Sam] making $197,000 a year who has a wish list of things he is convinced he needs to buy right now. Unfortunately, the things on his list add up to $200,000. With no savings at the moment and current regular living expenses eating up his entire salary and already causing him to spend a considerable amount of time managing cash flow, he is extremely frustrated.
Fortuitously, at a cocktail party he attended to get visibility among influential people in circles related to his profession, he met a guy [I’ll call him George] who made him a deal that seemed too good to be true. Here’s the essence of it:
- Sam gets a $200,000 loan, with the full principal to be deposited in his bank account immediately. No security is required. George says the fact that Sam has a good job and earns almost the same amount annually that he is borrowing now is sufficient security.
- For the next nine years, Sam will pay only interest each month, at a variable rate of 2.3% that is tied proportionately to the Federal Funds Rate [which is currently only 1.5%]. That means his first monthly interest payment will only amount to about $383.
- In the tenth year, Sam will pay interest at the then-current rate as usual, plus the entire principal of $200,000.
Sam knew that coming up with an extra $383 each month would add further complications to his already-annoying cash flow management problems, but he was confidently expecting a raise fairly soon that would make up that amount with cash to spare. He realized the variable interest rate could increase his monthly payment over the next ten years, but reasoned that future raises would probably more than offset any such increases. He was also very confident in his ability to succeed in his profession, and expected promotions over the next ten years that would enable him to accumulate money to pay the principal — banking as a fallback on his confidence that absent sufficient cash to pay the principal in full at that time, his good payment record and substantially higher income would enable him to successfully negotiate a new loan for the shortfall. And of course, during all this time, he would have been enjoying the things he needs now rather than ten years from now.
Sam didn’t know that in some states, these “balloon notes” are illegal, and many states require notices of the coming “balloon payment” to begin at least several months, maybe more, before the due date. Anyway, he signed on the dotted line and began spending his $200,000.
Back To The Article I Referenced …
I’m sure you’ve figured it out already, but Sam is Uncle Sam, aka the United States. I’m sorry, but I couldn’t come up with an American-sounding name for Sam’s creditor that would draw a parallel that easily recognizable — somehow Jinping just didn’t flow off the tongue as well as George. To relate Sam’s loan to the article I referenced at the beginning of this post, just multiply the numbers by a hundred thousand — i.e., add eight zeros. Sam’s “salary” [Gross Domestic Product] becomes $19.7 trillion , with a “t” — $19,700,000,000,000. The $200,000 loan becomes $20 trillion — $20,000,000,000,000.
Most people don’t realize this, but $20 trillion is nowhere near the total future financial obligations of this country — it doesn’t include state and local debt, so-called “agency debt” [debt issued by federal agencies such as FHLB and GNMA and government-sponsored enterprises such as Fannie Mae and Freddie Mac.] … or the biggies: unfunded liabilities of entitlement programs like Social Security and Medicare. If that isn’t enough grease on this fire, a probably even bigger amount than entitlement programs not included in this debt figure is the unfunded liability of future pension obligations of federal employees, elected officials, etc. For several decades now, corporations and many not-for-profit organizations have had to compute and “book” this latter amount in order to be compliant with Generally Accepted Accounting Principles [GAAP that external auditors use], but GAAP does not apply to governmental entities.
The Moral To This Story
In closing, I’ll just get back to my relatively simple story about Sam. I was unsuccessful in an admittedly hasty attempt to look up correct source attribution for the old adage “If it seems too good to be true, it probably is.” So, I’ll just leave it at “an old adage.” Hopefully, the wisdom of the adage will prove to be questionable and Sam’s view of the wisdom of his loan will prove to be correct. 😊
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Charles M. Jones