When Former Secretary of the United States Treasury Paul O'Neill was in New York for a busy week of meetings recently, he sat down with Wealth Manager Editor in Chief Kate McBride at the Waldorf Astoria for an exclusive interview. It was May 18, not long after the European Union announced a bailout of Greece at close to $1 trillion. O'Neill spoke with McBride about global economic issues, pension and tax funding and financial reform legislation.
WM: The European Union bailout of Greece: It's nearly $1 trillion; is it enough? Is it the right kind if bailout?
O'Neill: No I think it's a really bad idea--what's going on with the Greece process. I don't think it's repeatable--I don't think there's another $5 of $6 trillion that could be cobbled up. When individual countries get into fiscal difficulty, as Greece has, it's not reasonable to expect the rest of the world to basically tax their own citizens to support a legion of bad decisions by the Greece government. Even though we've masked it with high-sounding ideas like the International Monetary Fund or European Union...at the end of the day, doing what they've done transfers the default to unsuspecting, unknowing citizens in other countries. It's not only wrong because it's a precedent that can't be sustained, but it's unfair to other people around the world to have to put up their money to make good on obligations that were made by a sovereign government.
By me, a correct solution would be for the Greeks to announce to their bondholders: "We're not going to pay interest anymore because we can't; we're not going to redeem your bonds and therefore your bonds are worth zero." Instantaneously the Greek government would be in a balanced budget because it would not be able to borrow money from anyone else and it would not be able to spend more money than it takes in tax revenues.
To a degree--ideally to a 100% degree, Greece is going to have to default on its outstanding obligations and go forward from there. I think this just stretches out the pain and tries to distribute the pain to other unsuspecting people around the world. As a general matter, countries that get themselves into this kind of trouble should be left to get themselves out.
Some people are saying this would be much easier if Greece had its own currency again, and in a superficial sense, that's right. But, at the end of the day, if Greece had its own currency and if solved its financial problem by effectively having its currency devalued by the international markets, it would be basically expropriating its own people by stealth. So, then instead of having a front door announcement that we've done bad things, the relationship to other world currencies gives you the luxury of cheating your people, with it being less obvious. The consequence of where Greece is, is a reduction of the purchasing power of the people in Greece vis-?-vis other countries in Europe of about 21%. Ideally they and other governments that have borrowed more than they can fund need to deal with this thing in an upfront way.
WM: Is there any parallel that you see, from the last 50 years, of any other country doing what Greece has?
O'Neill: Really, except for the Argentinean case, it has been the tradition since the Second World War to do what the world is now doing vis-?-vis Greece. It's just an inherently flawed idea because it doesn't require people to be accountable for gross missteps they take in the management of a sovereign state.
WM: Closer to home, everybody's worried about the PIIG countries.
O'Neill: They all have the same problem, fortunately to a lesser degree. In the case of Spain you could make an argument that they were in a relatively good position until the debacle that was triggered by the housing problems in the United States, and in Spain and other countries where people had abandoned reason. It's not really reasonable to give someone who has no income, and no wealth accumulation, a home mortgage for $500,000 with nothing down. In the first six months of 2006 in the United States, 30% of the mortgages that were written were what we've now come to call liar's loans, no income, no wealth, and in fact a very big portion of those loans in 2006 never made the first payment on the mortgage. We had plenty of warning for this.
WM: Why do you think the signs that were pretty evident, at least by 2007, were swept out of sight, almost?
O'Neill: When you've got momentum, and you're flying through the air, you probably think you're a bird--even if you're a rock!
If you're able to do something over a protracted period of time and there don't seem to be any consequences, you keep raising the ante. So that, if a corporate balance sheet with 30% debt causes you to be taken over by [a] private equity [firm] so they can strip your assets, then a corporate balance sheet with 99% debt may be an okay thing--if you believe in the tooth fairy.
WM: Is there a solution to this kind of country, company risk--circling the globe?
O'Neill: As a general matter around the world, both public and private, we need to deleverage. As an operating principle for nation-states I believe when growth is in the 2% to 3% range, sovereign countries should run a surplus so that when things are not so good they have the wherewithal to borrow money to sustain themselves to the next up period, so that you don't ever let yourself get into the position where your current income can't sustain your outstanding debt obligations. The same is true for individuals.
WM: The public pension system--these year-by-year obligations are stretching beyond most localities' ability to meet them: what happens...?
O'Neill: Instead of provisioning, providing invested reserves that are adequate to pay current and future obligations into infinity--[these] have not been provided. The public pension funds are too much like a Social Security. We collect Social Security taxes but we haven't really invested the Social Security revenues, we've spent them on a current basis so we don't really have any reserves to pay future obligations of Social Security and Medicare and that's a danger we have going forward. The current account requirements to pay current obligations are not going to be serviced by the taxes we're collecting in the name of Social Security and Medicare, and therefore we'll be put in the position where we have to borrow increasing amounts of money to pay current obligations, which means getting further and further into a pit that you can't get out of.
...We need to return to an ideal of fiscal prudence. This year, arguably, we're going to have 3% real growth--maybe not this year but, by next year assuming we have something in the range of 3% to 4%, maybe on the hopeful side 5% real growth--we ought to be in surplus--we're not going to be--but we ought to be in surplus.
WM: Do you have a view on the current Administration's spending?
O'Neill: You could make a case that we were in such an extreme position that the actions that were taken at the end of the Bush Administration and were carried forward and added to by the Obama Administration--I think you can make a case for that but I don't think that you can make a case, over time, that We, the People, and our representatives have correctly discharged our responsibility to ourselves and to future generations and we need to get on with a more intelligent fiscal policy.
People think we need to raise taxes and cut spending. [But there's a third choice], people need to systematically look at places in the economy that I call low productivity sectors and [figure out] how we can improve the value that we're getting from resources consumed. The tax system is colossally inefficient...we could save hundreds of billions of dollars with efficiency improvements in the tax system, and we could simultaneously give people who are now paying their full taxes a rate reduction. Because, at the moment we are under collecting what people are supposed to pay by $400 billion a year. Those of us who are paying our full obligations have, in effect, a 15% surtax on top of what we would have to pay if the tax system was functioning at 100% of its intended revenue flow.
We're spending $2.5 trillion on health and medical, and arguably, $1 trillion of that is "waste" in the form of giving 1.7 million people a year an infection when they go into the hospital--when it's been demonstrated that it's possible to stop [that]. And it's possible with fairly straightforward ideas to stop having 300 million medication errors in this country. If we could save $1 trillion a year and improve outcomes from medical care interventions--that would be a double win for everybody in society; we'd have $1 trillion, effectively, to service the unfunded obligations and our health and medical care condition would be substantially better than where it is today.
To read what Secretary O'Neill told Wealth Manager about Wall Street reforms, more about leverage, and fiduciary duty, please read "ONeill Raises Fiduciary Standard for Officials; Ponders Greece."
Comments? Please send them to email@example.com. Kate McBride is editor in chief of Wealth Manager and a member of The Committee for the Fiduciary Standard.