The World’s Largest Subprime Debtor: The US Government

Lehman Brothers filed for Chapter 11 bankruptcy protection six years ago this month. The event has become famous as the spark that ignited the global financial crisis. Since that date, millions have lost their jobs and livelihoods, and countless others have seen their futures evaporate before their eyes, sometimes permanently.
At the heart of the crisis of 2008 was a common cause acknowledged by almost all commentators. Borrowers now infamously known as ‘subprime’ (or more politely, ‘non-prime’) were the main reason behind the meltdown. As financial institutions extended loans to those with less than stable means to repay their debts, the foundation of the financial world was destabilized.
Six years on and these subprime debtors are largely a relic of the past. That fact notwithstanding, there is a new threat lurking in the global financial arena. This one borrower is far larger than all the previous subprime characters combined, and poses a far more dangerous hazard to the financial stability of nearly all (if not all) of the world’s citizens. I am speaking, of course, of the United States government.
Subprime borrowers are defined by FICA scores which are largely inapplicable to sovereign nations. We can instead look at the type of loans that these borrowers took on to understand how precarious the United States federal government’s finances are.
To simplify matters greatly, consider three types of loans that made debt attractive to subprime borrowers. The first was the adjustable rate mortgage. After a short period at a low introductory teaser rate, the interest rate would reset higher. Second was the interest only loan. Borrowers could take out a sum of money and for a period not worry about paying down the principle. An extreme form of the interest only loan is the final type: the negative amortization loan. In this case, not only does the payment not reduce the principle of the loan, it doesn’t even cover all the accrued interest! The effect is that each month that goes by, the borrower slips further in debt as interest deferral is added to the principle to be repaid.

This post was published at Ludwig von Mises Institute on Wednesday, September 24, 2014.