Bernanke headlines a day of grim warnings about the nation’s fiscal standing

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If Washington had grown fuzzy about the razor’s edge the U.S. economy is currently balanced on, it got a bracing reminder Thursday.

Federal Reserve Chairman Ben Bernanke warned that the nation’s projected deficit and debt levels “cannot actually happen” because creditors would refuse, at some future point, to finance the government’s spending.

“By definition, the unsustainable trajectories of deficits and debt that the [Congressional Budget Office] outlines cannot actually happen, because creditors would never be willing to lend to a government whose debt, relative to national income, is rising without limit,” Bernanke said at the National Press Club.

The national debt is currently about 60 percent of the economy, or Gross Domestic Product, he said, adding that it is projected to reach 90 percent of GDP by 2020 and 150 percent of GDP by 2030.

But Bernanke’s citation of $9.5 trillion in national debt didn’t include the $4.6 trillion owed by the government to trust funds for things such as Social Security and Medicare, which have paid out cash to the Treasury in exchange for promisory notes. The full national debt – when both forms of debt are included – is already just under 100 percent of GDP, which is currently around $14.6 trillion.

Bernanke quoted economist Herbert Stein as saying, “If something can’t go on forever, it will stop.”

The audience at the Press Club laughed. But Bernanke’s point echoed mainly because of its absurdity.

The Fed chairman once again warned that if Congress does not act soon to cut spending or increase revenues, or some mix of the two, the U.S. economy will be forced by crisis to correct.

“One way or the other, fiscal adjustments sufficient to stabilize the federal budget must occur at some point,” he said.

Bernanke did not give a prediction of when he thought the U.S. could experience a debt crisis similar to the ones that have shaken Europe over the past year. Republicans and some Democrats fear a crisis could come at any point given the right mix of circumstances, and will happen for sure in the next few years. President Obama has shown far less concern about the near term and has said he is focused on the mid- to long-term future.

As for the looming fight between Obama and Republicans over whether to raise the government debt ceiling from its current $14.3 trillion mark, Bernanke warned lawmakers against playing a game of chicken with the issue.

“I would very much urge Congress not to focus on the debt limit as being the bargaining chip in this discussion, but rather to address directly the spending and tax issues that we all have to deal with if we’re going to make progress on this fiscal situation,” he said.

But Bernanke also appeared to give some credence to the argument put forward by Republicans such as Sen. Pat Toomey of Pennsylvania, who say that hitting the debt ceiling will not mean immediate default on the government’s debts.

“Under current law, if the debt limit is not extended, for a time, the Treasury has various resources that it can use to make payments on our national debt,” he said.

But Bernanke’s emphasis was clearly on the need to handle the debt ceiling with extreme caution.

“Beyond a certain point, [the government] would not have those resources and the United States could conceivably — I think this is very remote, but it’s not something you want to play around with — the United States would be forced into a position of defaulting on its debt,” he said. “And the implications of that for our financial system, for our fiscal policy, for our economy would be catastrophic.”

The chief driver of the nation’s unsustainable debt path, Bernanke noted, continues to be the double barrel impact of rising health care costs and exploding baby boomer retirements on entitlement programs such as Medicare, Medicaid and Social Security.

“The ability to control health care costs, while still providing high-quality care to those who need it, will be critical for bringing the federal budget onto a more sustainable path,” he said.

Bernanke’s stern words were delivered alongside a mildly optimistic update on the economy’s current state. He noted “increased evidence that a self-sustaining recovery in consumer and business spending may be taking hold,” but cautioned that while the economy “does look to be growing more quickly, [it] is still in a deep hole, is still very far from where we’d like to be.”

On Capitol Hill, the Senate Budget Committee heard from a range of experts about the most serious threats to the immediate economic recovery: the ongoing and persistent housing crisis, huge budget shortfalls at the state and local level, the unrest in Egypt and its impact on energy prices, and continued tremors in Europe from past and potentially future debt crises.

Mark Zandi, chief economist at Moody’s Analytics, told the committee that there are currently 14 million American homeowners who are “underwater,” who own homes or properties that are worth less than what they owe on their mortgage.

And that number – which is probably closer to 17 million using Deutsche Bank’s estimates – is only going to grow, Zandi said, since home prices are expected to fall another five percent this year, completing what would be a 35 percent drop since 2007.

“With house prices falling, more people will be underwater. That’s the fodder for more default. You get more default, that puts more foreclosure, short sales, more downward pressure on prices,” Zandi said. “And you can construct a scenario where you get into a very vicious cycle, the very same … vicious cycle that we were in back in ’08 and early 09.”

“I don’t think this is the most likely scenario, but certainly it is a very significant threat and risk, a challenge to the economic recovery,” he added.

Much of the hearing focused on how large banks who finance mortgages for home buyers, including government-owned mortgage giants Fannie Mae and Freddie Mac, throw an impenetrable maze of bureaucracy at homeowners trying to refinance or take advantage of government programs to reduce their payments.

Fannie and Freddie, Zandi said, also throw up road blocks to refinancing by charging higher interest rates to homeowners with lower credit scores, even if the loan is owned by Fannie or Freddie.

“They own the credit risk. But they’re still charging these higher rates, which is forestalling refinancing activity,” Zandi said. “So I would suggest that there’s a requirement on Fannie and Freddie not to charge those higher loan-level pricing adjustments, those higher rates, to facilitate more refinancing activity.”

As for state budgets, Ray Scheppach, the executive director of the National Governors Association, said that an explosion of growth in Medicaid enrollment was “the 400-pound gorilla.”

“Rolls will increase by 11.6 million people in 2014 and almost 20 million people by 2019,” Scheppach said, citing government numbers showing the additional cost over 10 years to be $190 billion.

The cause of the massive spike in Medicaid costs, Scheppach said, is threefold: the recession is driving more people on to the rolls, aid from the federal government included in the $814 billion stimulus in 2009 runs out this year, and “then you’ve got the impact of health care reform,” he said, referring to Obama’s health overhaul.

Obama’s health law alone will add 20 million Americans to Medicaid, the programs chief actuary said last week, and while the federal government will use money from the Medicare trust fund to pay for much of it, a small percentage of the cost will still be borne by state governments.

“I’d have to say as we get on the telephone with state budget directors every other week and what they will tell you is we don’t know how to get from here to there largely on the Medicaid issue,” Scheppach said.

And Committee Chairman Kent Conrad, North Dakota Democrat, noted that the political climate makes it highly unlikely that states will be bailed out by the federal government.

“I think it’s very clear there is little appetite in Congress for providing further help to states,” Conrad said.

The hearing touched only briefly, however, on the problems in Europe, which played a role in slowing economic recovery last year and continue to threaten the global economy with contagion.

“The European debt situation remains very unsettled,” Zandi said. “Policymakers there need to do more, and until they do, obviously that’s a concern.”

As for the ongoing unrest in Egypt, Bernanke declined to speculate on what impact it might have on energy prices, but said that in general, such spikes would be “even more serious if they begin to feed into other prices.”

“So for example, if they begin to feed into wages or goods and services that are produced using energy, then you might be getting a broader inflation problem,” he said. “And we are absolutely determined that we will do whatever’s necessary to keep inflation low and stable. And in that respect, that is a challenge that we have to address.”

As for the U.S. government’s ability to address its many challenges, Bernanke said that the plan put forward in December by the president’s fiscal commission “just demonstrated that there are some various ways that we could go about doing this without ripping apart our social safety net and without radically raising taxes.”

“So it can be done. I think the question will be, do we have the political capacity, the political will to do it? And I think that’s what the markets will be — will be following,” he said.

Asked to answer his own question, Bernanke was less certain: “Well, it’s, yeah, it’s, it’s difficult to say.”

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