A financial crisis and a tornado: prepare and prevent

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On the morning of Monday, October 19, 1987, after troubling trade data and rumors in Washington over the previous week, stock markets around the world went into a tailspin. During this day, the Dow Jones Industrial Average fell 22.6%, the biggest one-day drop in the history of the index. Fourteen markets around the world fell by more than 20%, including three more than 40 percent. There were even widespread doubts about the stability of the entire financial services sector.

On the evening of Friday, December 10, 2021, a large swath of the eastern United States was beset by a deadly tornado outbreak. Nearly 100 people in five states were killed, with an economic loss of approximately $18 billion. It was the worst tornado disaster in a decade.

An enormous amount of skill, effort, and technology had gone into detecting such tornado outbreaks, and the prediction of this one was actually much better than anything in the previous story. There was general notice days in advance, but for an individual tornado touchdown in a specific location, there was at best 45 minute warning.

These two disparate experiences show that weather – and financial – forces can quietly build, then suddenly become critical and cause surprisingly rapid and damaging change.

Tornadoes – and other weather phenomena – are caused by complex physical processes that suddenly align to produce violent outcomes that can cause enormous damage and loss of life.

Markets, on the other hand, are marked by complex human and psychological interactions, in addition to numerical and statistical variables. No mathematical model can predict how people will react to a given change in circumstances. However, we have a bit of history to guide us. Over the centuries, governments have tried to please their citizens – or please themselves – by spending more than they receive. It can be nice for citizens – for a while – to get more government than they pay for.

But ultimately, public debt is not totally different from household debt, although many politicians would have you believe that. The borrower must pay the interest and repay the debt securities when due. Because governments are ostensibly immortal, they can “refinance” debt in perpetuity – if their lenders trust them. But if lenders find that borrowers are having difficulty making payments or are borrowing irresponsibly, they will charge higher interest rates or not lend at all.

And for several years, the US government has been sending worrying signals to the financial markets. For most of the past 40 years, the national debt has been grows faster than the national economy — as if your mortgage balance was not only rising rather than falling, but also growing faster than your income. For most of the past 20 years, with the financial crisis and the coronavirus pandemic, debt has been steadily increasing, much faster than before. The federal government has a legal “debt limit” — like a household credit limit — and turned passing a law raising that limit from a formality into a horror movie. Congress has rarely adopted a formal budget in the last quarter centuryeven if required by law, and almost always has been late enacting its annual funding of government agencies, sometimes even allowing a real stop of operations. If you behaved this way, what do you think would happen to your interest rates on a new mortgage or car, or on your credit cards?

The federal government is vulnerable for two other reasons. On the one hand, it relies on the governments and investors of other countries to about half of his credit. They won’t cut us a break out of patriotism. And also, about a third of all federal debt matures within one year. If interest rates go up, the federal government’s interest bill goes up very quickly. One-year treasury bills now yield a little more 1.5 percent. If that interest rate rises to 3% – still very low by historical standards – the cost of servicing those bills doubles. And the Treasury already has trouble paying interest at today’s low rates. If rates were to rise to what they were 40 years agothe results would be catastrophic.

People can protect their own lives when they receive a tornado warning. They may even run for shelter when a storm is approaching. But they can’t stop the storm.

On the other hand, it is difficult to take shelter in a financial panic; how can you sell when everyone is trying to sell too? But we can prevent a financial crisis – simply by facing the facts and getting our finances in order.

The budget figures are awful and beyond the scope of our experience. We take huge risks. Meteorologists can tell us that a tornado is brewing. Fortunately, as with sheltering from the elements, we really can do something about this coming financial storm, but we have to start now.

Joseph Minarik is the former senior vice president and director of research at the Committee for Economic Development, the public policy center of the Conference Board (CED), a non-profit, non-partisan, corporate-run policy center that provides well-researched analysis and reasoned solutions in the interest of the nation. Dr. Joel Myers is the founder and CEO of AccuWeather and is a director of CED.

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