Baby Boom Gloom From Bernanke
Joshua Lipton, 01.18.07, 6:00 PM ET
Addressing a panel of graying baby boomers, Ben Bernanke testified before the Senate Budget Committee on Thursday morning, delivering a blunt, dire warning: As millions of boomers begin to retire, the Federal Reserve chairman said to the senators, the rising costs of entitlement programs could seriously weaken the U.S. economy.
“We are experiencing what seems likely to be the calm before the storm,” Bernanke said.
It was the Fed chairman's first appearance on Capitol Hill since the Democrats won narrow control of Congress, and while his comments were politically neutral, his message was that discretionary government spending could not be raised without significant tax increases, nor could taxes be reduced from current levels without slashing federal outlays.
The Fed chief pointed out that spending on entitlement programs will begin to climb quickly during the next decade. In fiscal 2006, he said, federal spending on Social Security, Medicare and Medicaid together totaled about 40% of federal expenditures, or about 8.5% of American's gross domestic product.
Looking ahead, he noted, the Congressional Budget Office projects these outlays will increase to 10.5% of GDP by 2015. By 2030, they will reach 15%.
“These rising entitlement programs will put enormous pressure on the federal budget in coming years,” Bernanke said.
Why the jump in spending? Bernanke pointed to two reasons. First, the number of people of retirement age will grow relative both to the population as a whole and to the number of potential workers. Currently, people 65 years and older make up 12% of the U.S. population. In 2030, the proportion will be 19%.
“If current law is maintained, that aging U.S. population will lead to sustained increases in federal entitlement spending on programs that benefit older Americans, such as Social Security and Medicare,” Bernanke said.
A second cause of rising entitlement spending, Bernanke noted, is the expected continued increase in medical costs.
“These costs are likely to continue to rise more quickly than income at least for the foreseeable future,” he testified.
A particular worrisome aspect of these projects, Bernanke argued, is the implied evolution of the national debt and associated interest payment to government bondholders. He said that higher levels of debt imply increased expenditures on interest payments to bondholders, which would exacerbate the deficit problem.
“Thus, a vicious cycle may develop, in which large deficits lead to rapid growth in debt and interest payments, which in turn adds to subsequent deficits,” Bernanke said.
The warnings of potential problems down the road, while scary, were also familiar to investors, who seemed nonplussed by the testimony. On Thursday, the Dow Jones industrial average slipped 9.22 points, or a scant 0.1%, to 12,567.93, and the broader Standard & Poor's 500 was down just 0.3%.
The Nasdaq composite, with a higher weighting of technology issues, was down a sharper 1.5%, but it had been lower before Bernanke's speech, possibly because of developments at Apple (nasdaq: AAPL - news - people ). (See " Investors Dump Tech.")
Elsewhere, market movers included AT&T (nyse: T - news - people ), which jumped 1.4%, or 48 cents, to $34.97, and Verizon (nyse: VZ - news - people ), which rose 1.9%, or 70 cents, to $37.58.
On the flip side, CACI International (nyse: CAI - news - people ), plunged 16%, or $8.57, to $46.53, after the defense contractor slashed its fiscal 2007 guidance. Shares of SRA International (nyse: SRX - news - people ), a provider of technology and strategic services, fell 7.5%, or $1.99, to $24.64 after a JPMorgan Chase analyst downgraded the stock, arguing that Congress isn’t prioritizing civil budgets.
Andrew Tilton, an economist at Goldman Sachs, said he agreed with Bernanke’s analysis of the economy. “All he did was present the fundamental, long-term imbalances in the U.S. fiscal picture,” Tilton said. “He did so in a clear way, and he didn’t mince words. When that’s done, it doesn’t look pretty.”
Tilton agreed with Bernanke that the increasing number of retiring baby boomers will pressure Social Security and Medicare spending. Current tax revenue streams aren’t sufficient to fulfill those obligations, Tilton argued.
“We’ll need some combination of tax increases or benefit decreases,” Tilton said.
He added, “To those of us who watch the budget data closely, the speech was a fair and accurate portrayal of the reality.”
In other economic news, the number of newly laid off workers filing claims for unemployment benefits dropped last week to a 11-month low of 290,000. However, Tilton said that drop can largely be explained by the unusually warm weather.
“That week was warm,” he said. “It was 70 degrees in New York. If that’s the case, you have fewer seasonal layoffs than normal. As the weather returns this week, those numbers will come up.”
Separately, the Commerce Department reported that construction of new homes rose for a second consecutive month in December, to a seasonally adjusted annual rate of 1.642 million units.
Again, Tilton said that picture was distorted by warm weather. “Typically, in December, the ground is frozen and it’s harder to do construction. But the weather was warmer, so that effect was less severe.”
The Associated Press contributed to this report.
mfg J.B.
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