We Are So Screwed: Federal Financial Analysis

[Mempho]

I'm going to post this whole thing that I wrote, but if it's a little much and you just want the bottom line, scroll down to 2nd post where I make the comparison.


Analysis of the Financial Position of the Federal Government


I’m going to attempt to summarize the federal government’s financial position in layman’s terms because the vast majority of people have never read the financial statements of the federal government. The federal government has only been issuing financial statements since 1998 and you will see that there is plenty of reason for certain people in power to not want you to know. I will present the actual numbers and will make my analysis as objectively as possible. I would like to thank those current and past Congressional members who have allowed us to have financial statements to analyze. I think they will serve us well in identifying the problems and providing the solutions that will, hopefully, provide a bright future despite our current situation. If you’d like to go ahead and download the full set of financial statements, they can be found at http://www.gao.gov/financial/fy2005financialreport.html . Otherwise, I’ll supply links as I go along.

As I walk you through these financial statements, I will be adding commentary along the way. This commentary might not be perceived as objective by all readers and it may contain some political content. Since I would like people to be able to read this as an educational tool first and as a editorial on our state of affairs second, I will be labeling the sections as either “Analysis” or “Commentary.” Analysis is meant to be objective while commentary is of an editorial nature and may include political opinions. You may, at your own discretion, read only the analysis sections and skip the commentary altogether. In fact, I would urge you to read analysis only first so you can make your own decisions on the subject matter presented and read the commentary second (if at all) and see if you agree or disagree.

Analysis:
The first thing that you, a taxpayer and a voter, need to know is that these financial statements are supposed to be audited like any other company or publicly-traded corporation. Audited financial statements are used by businesses of all types and sizes mainly for the purposes of obtaining debt financing, obtaining ownership financing (such as those traded on the NYSE, NASDAQ, and AMEX), and meeting statutory requirements. All state and local governments are required to have their financial statements audited in order to meet statutory requirements.

Three things are very unique about the auditing of the federal government’s financial statements. First, the financial statements are not audited by an independent accounting firm like PriceWaterhouseCoopers, Deloitte & Touche, Ernst & Young, KPMG, or the infamous and now defunct Andersen. They are instead audited by the internal Government Accountability Office, best known as the GAO.

The second unique thing you need to know about the auditing of these financial statements is that they have never received an unqualified opinion. An unqualified opinion, in Wall Street terms, if often referred to as a “clean opinion.” It basically means that the accounting firm conducting the audit believes that the financials are a fair representation of the economic condition of the company. It does not mean that the auditors believe that the financial condition is either “good” or “bad.” It only means that the numbers have been subjected to audit procedures in order to estimate their accuracy and the auditor believes that those numbers are generally accurate.

Unfortunately, and I think I can say this in an objective section; the government’s financial statements have never received an unqualified or “clean” opinion. Instead, they have received a disclaimer of opinion for nine straight years (available at http://www.gao.gov/consolidatedfinreport121505.pdf). A disclaimer of opinion means that the auditor is unable to provide an opinion on the financial statements. In the above-linked GAO release, the GAO states:

“For the ninth straight year, the U.S. Government Accountability Office (GAO) is unable to provide and opinion as to whether the consolidated financial statements of the U.S. government are presented fairly, in all material respects, in conformity with generally accepted accounting principles.”

“Comptroller General of the United States David M. Walker, who heads the GAO, said material deficiencies in financial reporting and other matters in the Fiscal Year 2005, most notably at the Department of Defense, ‘have resulted in conditions that prevent us from being able to render and opinion to the Congress and the American people.’”

You can view the actual audit report at http://www.gao.gov/financial/fy2005/05gao2.pdf .


Commentary:
A disclaimer of opinion is terrible. Many auditors go through their entire careers and never disclaim an opinion much less nine straight disclaimed opinions. If a publicly-traded corporation has an opinion disclaimed, the stock plummets, the debt gets reduced to junk bond status, and the company is no longer able to bank loans and any financing except from a few “speculators.” In many cases, auditors refuse to continue working with such clients believing that they either have no ability to keep records or that the integrity of management is in doubt. No company would last through nine straight disclaimed opinions to my knowledge. The report basically states the Defense Department either refuses to give the GAO the information in order to conduct audit procedures or that the accounting function at the DOD is so bad that they are unauditable. It means that the accuracy of the very financial statements we are viewing is in substantial doubt.

Analysis:
The third unique thing you need to know is that the government does not put unfunded liabilities from entitlement programs such as Social Security and Medicare on the balance sheet. Social Security and Medicare are very similar to pensions in large, publicly-traded corporations and the depending on whether the trust is overfunded or underfunded, a prepaid asset or an unfunded liability is recognized. This is not the case with our federal government. In order to make the financial statements comparable to a company’s financial statements, the unfunded liability of Medicare, Social Security, and other entitlement programs must be added to the overall liabilities. A little later, I will combine these numbers with the financial statements so you can see the presentation.


Income

The U.S. government had total revenues of 2.2 Trillion dollars in 2005 and 1.9 Trillion dollars in 2004. A comprehensive statement of operations (income statement) is available on page 38 at http://www.gao.gov/financial/fy2005/05stmt.pdf

It had operating costs of (a comprehensive schedule is available on page 37) of 2.9 Trillion dollars in 2005 as compared to 2.5 Trillion dollars in 2004.

The government had net changes (net losses) of 760 billion dollars in 2005 and 616 billion dollars in 2004 (this amount excludes unfunded Social Security, Medicare, and entitlement programs which will be added later).

The overall national net position at the end of 2005 was approximately $8.5 Trillion dollars (excluding entitlements), including a significant increase in the past few years.


Entitlements (Social Security, Medicare, Railroad Retirement, and Black Lung)

The information on these entitlement programs is available at http://www.gao.gov/financial/fy2005/05stew.pdf

The first section on page 42 of the report (page 2 of the link above) shows the contributions and the present value of the expenditures (future expenditures) for the Social Security program.

The social security program, like all of the entitlement programs, is shown at present value like pension plans are. This is done because these are projections and not absolute dollar amounts. Basically, what this does is “back up” the future amounts into 2005 dollar values. In other words, the actual dollar amounts will be much higher but these dollar amounts reflect the amount we would need “in the bank” today to fund these future expenses. They are based on interest rates. For instance, if the interest rate is 5% and I need $10,500 next year, I would need to put $10,000 in the bank today in order for it to be “funded.” If I only have $9,800 in the bank, then my unfunded liability is $200 and not $700. This is the way that publicly-traded companies report their unfunded liabilities (or prepaid assets in the case of overfunding).

The social security program had the following contributions and expenditures for future benefits for 2003, 2004, and 2005 (at present value):

2005 2004 2003

Contributions $29.5T $27.7T $26.1T

Expenditures (at PV) 35.2T 32.9T 31.0T

Deficit 5.7T 5.2T 4.9T


The deficit has been increasing 400-500 billion dollars every year since 2001.

Additional entitlement programs include Medicare Part A, Medicare Part B, Medicare Part D, and the Railroad Retirement Fund.

Medicare Part A had a deficit of $8.8 trillion; up from $8.5 trillion in 2004 (a $300 billion increase).

Medicare Part B had a deficit of $4.2 trillion; up from $3.9 trillion in 2004 (a $300 billion increase).

Medicare Part D had a deficit of $8.7 trillion; up from $8.1 trillion in 2004 (a $600 billion increase).



If we add the entitlement liability to the net operating deficit for the United States government like any publicly-traded company would, we would get the following picture:



Combining Operating Deficit with Unfunded Entitlement Liabilities

2005 2004
Operating Deficit $8.5T $7.7T

Social Security Deficit 5.7T 5.2T

Medicare Part A Deficit 8.8T 8.5T

Medicare Part B Deficit 4.2T 3.9T

Medicare Part D Deficit 8.7T 8.1T

Railroad Retirement Deficit 91B 87B

Black Lung Prepaid (Surplus) -5B -4B

Total Deficit $35.9T $33.5T


If we go further and take the increase in the deficit between 2005 and 2004, we will see an increase in the overall deficit of $2.4 trillion.

The amounts here are mind-boggling to me and I’m a person that deals with this stuff on a daily basis. As such, I like to break it down into numbers that are a little easier to think about. What we need to do to make this easier is to return to the revenues and then we can more rationally break this down.

Up above, I briefly touched on the income for the past two years for the United States. The report states that revenues were $2.9 trillion in 2005 and $2.5 trillion in 2004. Now, you may have heard of DTI if you’ve ever applied for a loan. DTI is an acronym that stands for the debt-to-income ratio. It, along with your credit score, is used to assess your overall credit worthiness. Bankers use this because even a person with a superb credit score will become a credit risk if he or she owes to much money.

I won’t bore you with the calculation here (although if you’ve read this far, then you’re probably game), but what I will do is break it down in some common-sense terms.

The Federal Government’s debt for 2004 was $33.5 trillion and its revenues were $2.5 trillion, or its debt was 13.4 times its revenues.

The Federal Government’s debt for 2005 was $35.9 trillion and its revenues were $2.9 trillion, or its debt was 12.4 times its revenues.