IOU, an Explanation

• Debt held by the public net of financial assets— the measure I find to be most meaningful — stood at $5.3 trillion (37 percent of GDP).
• Debt held by the public was equal to about $5.8 trillion (41 percent of GDP).
• Gross debt equaled $10.0 trillion (70 percent of GDP).

What do each of these concepts represent?

Let me proceed in reverse order, and begin with gross debt.  Gross debt has two components: debt held by the public—which I will discuss more in a moment— and intragovernmental debt.   Intragovernmental debt is, essentially, debt that the government owes to itself—as of the end of last year, it totaled $4.2 trillion.  The majority of this debt is issued to the Social Security Trust Fund, and most of the remainder is issued to other trust funds, such as the Civil Service Retirement and Medicare Trust Funds.  These trust funds are required to invest their surpluses in government bonds.  While the federal government will certainly make good on the IOUs issued to these trust funds, they should not be counted when assessing the financial state of the federal government as a whole.

One branch of the government issuing debt to another branch may make one branch poorer relative to the other branch—but it does not affect the overall financial state of the government.   For example, when I tell my daughter and son that I owe them each $10 for their allowances, I am poorer, and they are richer—as a family, though, there is no change in our overall finances. That’s why the Congressional Budget Office, the Office of Management and Budget (including under the prior administration), and the Government Accountability Office all agree that gross debt is not a meaningful metric for assessing the government’s current fiscal position.   Yet, the world being what it is, this number is quoted often.

If gross debt isn’t a useful concept, debt held by the public gets us closer.  Debt held by the public measures the amount that the federal government owes to others, so it is a meaningful concept when gauging the government’s fiscal condition.  If I hand an IOU to my neighbor’s son in exchange for mowing the loan, my family’s finances become poorer, and the same is true of the federal government. 

That’s not the end of the story, however.  As I said at the beginning of this post, I think the most meaningful measure of federal debt is debt held by the public net of financial assets.  If I take a $100 loan from my bank and stick that amount into my bank account without spending any of it, my family and I aren’t poorer, because even as I owe $100 to my bank, my bank owes $100 to me.  On net, and as long as the new asset is equal in value to the new liability, there’s no change in my overall financial state.  There’s a similar effect when the federal government borrows money in order to invest in financial assets.  

As the federal government has acted to stabilize the financial sector amidst the worst financial crisis since the Great Depression, the federal government has purchased significant financial assets—such as preferred equity stakes in Fannie Mae and Freddie Mac.  The federal government will likely take a loss on these purchases, but the assets have value.  And just as what my bank owes me should be netted against what I owe the bank in determining the health of my personal finances, the value of these assets should be netted against publicly held debt in determining the health of the government’s finances.

I end with a word of caution.  Debt held by the public net of financial assets is the most meaningful measure of current federal debt, but it has its limitations.  In particular, it does not capture the federal government’s fiscal position going into the future.  The federal government’s obligations aren’t limited to paying off federal bonds.  It also has future obligations to continue defending our country; investing in education, energy, and infrastructure; and paying Social Security and Medicare benefits.   On the other side of the ledger, the federal government has future assets beyond those currently carried on the books—namely, the future tax revenues it will collect.

So even as debt held by the public net of financial assets is the best measure of where we are now, the long-term fiscal gap provides the best measure of the underlying imbalance between spending and revenue. That is why this Administration is so committed to cutting the deficit in half by the end of the President’s first term and reforming the health care system – and bending that cost curve – this year.