If you had a choice, would you let the U.S. government manage your money?

OK, so that's a rhetorical question. But humor me. I know I wouldn't let it.

The government's failure isn't limited to the Bush administration or the Republicans who now control Congress. For administration after administration, no matter which party held the White House and Congress, the federal government has consistently violated the standards of sound financial management. Given a choice, none of us would ever let anyone with the U.S. government's record of financial management touch our money. And any household that managed its money so foolishly would be headed for bankruptcy.

Unfortunately, most of us don't have a choice about letting the government touch our money. The government's hand reaches deep into all of our personal finances. But if we fight hard enough, we do have some say about how that money is managed in the future.

Uncle Sam Flunks

The Congressional Budget Office issued its Budget and Economic Outlook on Tuesday. And as we wait for President Bush to deliver his own budget, now is a good time to step back from arguing about the details of any specific budget plan and look at the terrible job that our government does at managing our money as well as the consequences of that mismanagement.

Let's start by looking at how the government does on my five rules for managing debt.

Why start with a look at how the government manages its debt? Because it's a useful indicator of how the government manages all of our money. With the annual budget deficit running at $400 billion to $500 billion for the next few years before accelerating as more baby boomers retire, we're likely to add the huge sum of $5 trillion to the total federal debt over the next 10 years.

The cost of servicing that debt, already 7% of the annual U.S. budget, is likely to climb, costing each household in the U.S. an extra $3,000 in interest payments each year by the end of the that 10 years, according to the Brookings Institution. And total U.S. debt is increasingly the 800-lb. gorilla that drives interest rates and the value of the U.S. dollar. It also influences decisions on how much the U.S. government can spend on "discretionary" fripperies such as education, environmental protection, food and drug safety, securities regulation and homeland security.

Overall, the government earns an 'F' on debt management. But the score is even worse when you look at how the U.S. government does on each of my five rules of smart debt management. In some areas, the government isn't merely failing to do a good job; it's actively and aggressively headed in exactly the wrong direction.

Tracking the Debts

Rule 1: Does the government draw up a separate capital budget that distinguishes between debt used to buy productive assets and debt used for day-to-day operations?

Accounting experts and budget reformers have been after the federal government to do this for years. The progress so far? Zero. Zip. Zilch. The government continues to lump capital investments that add to national wealth over time -- such as, say, additions to the Interstate Highway System or new national parks -- together with operating expenses -- such as the cost of highway maintenance or the salaries of park rangers.

The only time the government separates capital investments from its operating costs is when a politician adds up the value of the assets the government owns to demonstrate that we are financially OK or financially in peril because the value of those assets is about the size of the national debt.

Rule 2: Does the government match the duration of the debt to the life of the asset, whether it's on the capital investment or consumption side of the budget?

Well, golly gee, no way. I don't think there's a more striking example of the government's financial mismanagement than this. What do you think is at the root of the current funding crisis in Social Security and Medicare? These programs create long-term obligations: The government will pay retirement income to and the medical costs of a 20-something worker in 40-something years. That creates a predictable future obligation with a present value of about $45 trillion.

To fund this long-term obligation, the federal government collects Social Security and Medicare taxes now. Does the government invest in long-term bonds or equities so that it matches the maturity of the obligation with that of the investment asset?

Of course not. Most of the revenue collected from current taxes is used to pay current benefits. The surplus, and right now there is a surplus, goes into a trust fund for Social Security or Medicare, where it is invested in "special issue," bonds created for the trust funds and only available to the trust funds. According to the Social Security Administration, the interest rate on a special issue is the average of the interest rates on all U.S. Treasury notes and bonds of more than four-year maturities.

Can you see the three problems with this? First, because the interest rate on a special issue is an average, it is always lower than the yield on the longest U.S. Treasury bond. So in 2002, when the 30-year Treasury bond was paying 5.43%, the Social Security trust fund was buying special issues with an average yield of 4.87%.

Second, because these special issues can't be sold on the public bond market, the trust funds can't reap any capital gains on the bonds if interest rates fall. Special issues can only be redeemed by the U.S. Treasury at face value. So the trust funds missed, for example, the spectacular appreciation that other bond investors reaped as interest rates on 20-year Treasury bonds fell to 5.43% in 2002 from 13.01% in 1982.

And third, because the U.S. government has discontinued the 20-year and 30-year Treasury bond series, the trust funds are buying special issues with lower yields and implied shorter maturities even as the life span and thus the duration of the obligation owed to U.S. retirees increases.

No Repayment Plan

Rule 3: Does the government set up a sinking fund to pay the debt for those long-lived assets in its capital budget?

OK, stop laughing. This is serious. It's the future, or at least somebody's future, that we're talking about here. There is no plan to pay off the national debt. President Bush's pledge to cut the deficit in half refers only to the level of the annual deficit, not to the national debt. If he can make good on that promise, which is unlikely without exceedingly creative accounting that shifts costs to the years after this administration has left office, all it will do is slow the rate at which the national debt increases.

As of Jan. 21, the publicly held national debt came to $7.6 trillion. In November, Congress voted to raise the ceiling for how much the U.S. could borrow to $8.2 trillion, so you know where the politicians' heads are. There is no plan to ever pay off the national debt. There's only the hope that we can keep borrowing to roll over old debt as it matures and to pay for those annual budget deficits.

Rule 4: Does the government actively strive to drive down the cost of borrowing so that we'll pay less interest on existing and future debt?

Not so you'd notice it. In fact, I believe that current government budget policies will drive up interest rates on the publicly held debt in the next decade. (This follows on the decision of the previous administration to do away with the 30-year bond so the government couldn't lock in the low bond yields of the late 1990s for the long run.) Running the printing press to fund annual deficits has its cost: The government (which in this case means those of us who pay taxes) has to pay investors (in this case overseas investors, because Americans don't save enough) to buy and hold dollars (in the form of Treasury bills, notes and bonds).

At some point, especially now that the dollar's fall has put investors on notice that the dollar might decline in value in the future, we'll have to pay overseas investors more to hold dollars. Paying more means higher interest rates on U.S. debt instruments. Not yet; foreigners stepped up to the window in a big way to buy dollars in December. But it is inevitable that as long as we run huge annual deficits, we will get higher interest rates. The debt management policies of the U.S. government will add more debt and at higher interest rates to our balance sheet.

Not Even Working on It

Rule 5: Never relax. Managing that spread is an ongoing task. I don't think the U.S. government is even a player in the spread game. Congress and the president many administrations ago decided to cede economic policymaking to the Federal Reserve. Congress got to spend -- and spend without accountability. The Fed manages interest rates.

Congresses and presidents have put us in this bind by taking the easy way out, administration after administration, when it came to hard budget decisions. And those of us who vote have let the politicians get away with it.

Looking at the battles ahead over the Bush administration's budget, over Social Security and Medicare and over the tax system as a whole, I can see two distinct alternatives. One, like a family tightening its belt to avoid being overwhelmed by debt, we can start to make the tough and painful cuts we need to make. Two, we can hope that someone else will pay.
At the time of publication, Jim Jubak owned or controlled shares in none of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column. Email Jubak at jjmail@microsoft.com.

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