U.S. Debt Could Drive the Next Financial Crisis

I have seen more than my fair share of financial crises during my time in the U.S. government. I was the assistant secretary of the U.S. Treasury for financial institutions during the 9/11 terrorist attacks and chair of the Federal Deposit Insurance Corp. during the 2007-2008 financial crisis. The U.S. government resorted to deficit-financed spending and tax relief to these crises, and to the pandemic. Those decisions were right.

Unfortunately, once the crises passed, we just kept spending as if nothing had changed. Now, the resulting overhang of federal debt could itself be the cause of a future crisis.

Our gross national debt exceeds $35 trillion. This puts the federal debt held by the public at a staggering 99% of U.S. gross domestic product, nearly as high as its peak at the end of World War II. After the war, our “greatest generation” of political leadership steadily restored our nation’s finances, bringing the debt down to about 31% of GDP by 1981.

Unfortunately, more recent political leadership has concluded that deficits do not matter. Both Republicans and Democrats have settled on deficits as the easiest way to pay for politically popular initiatives, be they lower taxes (Republicans) or higher spending (Democrats). Elected officials are wary of braving the political pain of deficit reduction, knowing their successors could easily squander those hard-fought battles with more deficit-financed spending and tax cuts.

Case in point is the current election. Both presidential candidates are proposing tax and spending giveaways to curry favor with voters. The nonpartisan Committee for a Responsible Federal Budget projects that Vice President Kamala Harris’ proposals will increase the debt by $3.95 trillion over the next 10 years, which pales in comparison to Donald Trump’s plans, which will increase it by $7.75 trillion. Neither candidate is talking seriously about our unsustainable fiscal position, much less the related issue of projected funding shortfalls in two of our most important safety net programs, Social Security and Medicare. Based on current projections, the Social Security trust fund will run out by 2035, while Medicare’s Hospital Insurance fund will be depleted by 2036. Absent reforms to shore up these programs—and avoid automatic cuts—funding gaps will have to be filled with hundreds of billions in new deficit financing each year.

The dollar’s privileged status as the world’s reserve currency enables our fiscal indulgences. As the late Sen. Alan Simpson (R., Wyo.) once famously said, investors keep buying our debt because we are “the best-looking horse in the glue factory.” But as we continue to climb in the rankings of the world’s most indebted nations—we rank 4th among the other advanced economies in the Organization for Cooperation and Development—that perception could easily change.

There are hints that our privileged status is already eroding. Foreign ownership of U.S. Treasuries has fallen from 34% in 2012 to 28% in 2024. The dollar’s share of global reserves has fallen from more than 70% in 2000 to 58% today.

Make no mistake, if we continue on this path, investors will eventually lose confidence in our debt. The change could be gradual or sudden, but the consequences will be painful, no matter the pace. The federal government’s interest costs, already at $892 billion for 2024, will increase dramatically, as investors demand a higher risk premium. That will force painful tax hikes or spending cuts. Private sector borrowing costs tied to Treasury rates will also spike, damaging economic growth. Banks, managed funds, insurance companies, pensions, and other investors will be exposed to trillions of dollars in market losses as the Treasuries they hold lose value, precipitating widespread distress in our financial system.

The Chartered Financial Analysts Institute recently surveyed over 4,000 of its members about the state of U.S. finances. These are investment analysts who have received the CFA Institute’s gold standard certification of competence and integrity in investment analysis. A supermajority (77%) believed the U.S.’ finances were on an unsustainable trajectory. A significant majority (61%) believed that the U.S. lacks the political will to reduce its debt-to-GDP ratio, while 63% believed we will begin to lose our reserve currency status within the next 5-15 years.

Our political leadership needs to listen to these seasoned professionals and others warning of danger ahead. Those include major credit rating firms who have downgraded our debt or lowered its outlook. The time to act is now, when the economy is strong. At some point, there will be another economic downturn. It may well provide the inflection point for lost investor confidence. How much higher will our debt need to go to provide relief during the next recession? Will investors still buy our debt when our economy is struggling? And at what rate?

In the past, deficits have provided the means to respond to crisis. In the future, they may well be the cause of it.