When my wife and I bought our condo we also wanted an amazing, new mattress so we got memory foam. It's a terrific mattress, but a little bit expensive. So we put it on our credit card.
Although we no longer use that mattress, we're still paying down that purchase on our credit card. That is how debt works. Smart purchases, dumb purchases, or just someplace to lay your head. Sometimes I think that it would be nice to just stop paying old debt. There is a downside though: If we don't pay our debt then lenders will stop offering us credit.
My wife and I have a long-run view of our personal finances, but from the actions of many government officials, big and small in just the last few months, it is obvious that they don't.
Just before Congress recessed for the summer, the body pushed through a bill that will allow Puerto Rico to escape some of the bad debt its leaders knowingly issued to fund its excesses over the last several decades. Puerto Rico's debt burden is something that they could have stopped, Congress should have stopped, and yet the Puerto Rican government was allowed to keep spending and issuing more and more bad debt until the island found itself $70 billion in the hole and unable to pay.
The problem with the bill that Congress passed won't be felt in the short run, it's that the bailout of Puerto Rico has the chance of creating contagion in the bond market. In fact, as Ike Brannon pointed out in Real Clear Markets, the Puerto Rican debt relief bill has already had an effect:
There is evidence that the mere introduction of this legislation is already having adverse effects on the market. The cost of credit default swaps on Illinois general obligation debt, which essentially function as insurance against default, has gone up nearly 100 percent this year, signaling a burgeoning uncertainty over the protections afforded to "full faith and credit" debt.
Politicians and short-run investors think the Puerto Rican debt crisis is over, but given the instability their solution caused it is likely that the real problems are just beginning to metastasize.
A similar story, but on the other end of the spectrum, is Lamar, a small town in Colorado.
Lamar is a member of the Arkansas River Power Authority (ARPA), which provides electricity to six small Colorado cities. ARPA was founded in 1979, but in 2004 it decided to undertake a plant repurposing that turned out to be a disaster. After three rounds of debt, the Lamar Repowering Project (LRP) failed and the plant was shuttered. But the $155 million in debt issued by ARPA remains.
Instead of paying its debt, the city of Lamar has sued to get out of paying back its share.
Lamar has filed suit in an attempt to avoid purchasing electricity from ARPA or to pay for the LRP's costs, including the debt service on the bonds—despite the fact the city had a seat at the table throughout the financing process and voted in favor of borrowing every single time. Future lenders will not likely look kindly on a city that is fighting tooth-and-nail to run away from its debt obligations. But it could be even worse if Lamar is successful, which would be a terrible precedent for any city looking to improve infrastructure, whose costs could now rise.
Cities, states, territories, and individuals can take on debt they later regret. That's not some horrible miscarriage of justice. That's life. But if our elected officials continue to find ways to escape debt then the contagion in the debt markets will likely depress economic growth. This will happen because large projects like ARPA won't be able to find cheap debt and whole governments like Puerto Rico will find it harder and harder to maintain their current spending rates.
I would like to stop paying for the mattress that we irrationally bought, but I also want to be able to finance a car, a house, or the college education of my three girls in a few years. To do that I have to pay for that mattress today. Lamar and Puerto Rico must take responsibility for the debt they incurred or they will find it harder to find lenders in the future.
Worse, as evidenced by the increased cost of the Illinois debt, others will find it more expensive as well.
Charles Sauer is president of the Market Institute.