debt deal

Debt, deficits, divisiveness: How did we get here?

August 4, 2011: 11:52 AM ET

We've been here before, with growing deficits and political gamesmanship over the debt ceiling. Here are four factors that made it different this time.

FORTUNE – After weeks of political wrangling and name calling, Congress this week finally approved plans to cut the deficit and raise the nation's $14.3 trillion debt limit.  The move may have saved Americans from a financially disastrous default, but the experience was, at best, anti-climatic.

All the drama merely left us was a few more lawmakers with bruised egos and a public more frustrated (and confused) with the inner workings of Washington. In the end, the rushed deal didn't really address the nation's longer-term fiscal problems. It trimmed spending by more than $2 trillion over the next 10 years. But that's still well short of the $4 trillion that Standard & Poor's was looking for in order to avoid a downgrade.

But what's really new here? The U.S. has long borrowed in excess and raised the debt ceiling without much hysteria. Since 1962, the debt limit has risen 74 times – 10 of those have occurred since 2001. Admittedly, this isn't necessarily a good thing, since the limit is theoretically set to help Congress control spending. And with debt at about 80% of GDP, some say that could put us on track with debt-ridden Greece by 2025 if nothing substantial is done.

It's clear that economic realities (i.e. America's financial crisis and bank bailouts that followed) have helped feed government's borrow-and-spend addiction. The question is what finally led Washington to call rehab?

Here are four factors that made a seemingly invincible debt ceiling suddenly turn into a concrete wall.

Thanks for nothing, cable news

Yup, the media deserves a degree of blame here -- especially the 24/7-news cycle encouraged by cable TV.

Through weeks of tumultuous stop-and-go negotiations, on air personalities fueled the divisiveness, calling the ongoing talks "the showdown" and pitting Republicans against Democrats over how big government should really be.

And in a way, who could blame them? The debate over raising the debt limit and reducing budget deficit, as we look back, never really seemed to be about dealing with the country's worsening financial situation. It was about politics -- the same tired Capitol Hill game we've grown to simultaneously love and hate.

Democrats and Republicans: They're both right!

When it comes to the debate over the way Washington taxes and spends during tough economic times, it almost becomes harder to choose sides. And this only added fire to the debate.

At one end, Republicans wanted spending cuts to be larger than the amount in which the debt limit would rise. Members also wanted to keep taxes from rising, which is hard to argue against, considering the high unemployment rate and a housing market still in shambles. It's easy to see how higher tax bills could mean political suicide when more than 14 million Americans are out of work.

Meanwhile, it's tough to go against Democrats who implored Congress to raise the debt limit to avoid a default. Needless to say, nobody really wants to risk another financial collapse when the economy is still struggling to recover from the last one. What's more, Democrats didn't want to see spending on Medicaid and Social Security cut too deeply -- a reasonable demand, given how financially strained many households are today.

It seems both sides have a point. And that has only prolonged the debate over the right prescription for America's debt problems.

European contagion

With huge debt problems in parts of Europe, it's easy to see how many would flinch merely at the word "debt." Whereas U.S. lawmakers called for stimulus spending in the wake of the financial crisis, the thought of government living beyond its means has been particularly frowned upon.

It's no surprise, given that it has become almost habitual to question if America could end up like debt-ridden Greece. While plenty of economists play that down, others also wonder if perhaps the U.S. is headed down the European nation's very rocky path.

Indeed, Europe's financial situation, at least today, is far different from the U.S. But the scare in Greece, Portugal, Italy and Spain has certainly (and understandably) carried over to Capitol Hill's perception of debt.

A nation living beyond our means

Self-reflection is painful. The high debt levels across many U.S. households -- and the troublesome consequences of that -- are a harsh reminder to Washington of the sorry state of its own finances. Lawmakers can't exactly push consumers to be more financially prudent when it can't get its own house in order.

Households have been de-leveraging after finding themselves out of work and with mortgages on homes they can barely afford -- government needs to do the same. Right?

To be sure, Americans have worked vigorously to improve their finances since collapse of the housing market in 2007. Today, household debt to income ratio is approximately 120%, after peaking at 140% in 2007. However, households still have some ways to go before dropping to 2000 levels of about 100%. And it appears they're well aware of that, since the personal savings rate and monthly consumption data shows they're saving more and spending less.

Perhaps the newfound frugality has added pressures on Washington to do the same.


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    Aug 2, 2011 12:14 PM ET
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    Most of the spending cuts won't kick in until 2013, but it's not clear the U.S. economy will be ready to handle the blow even then.

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