Federal Shortfall To Double This Year

By Lori Montgomery
Washington Post Staff Writer
Wednesday, September 10, 2008

A weak economy and a sharp increase in government spending will drive the federal budget deficit to a near-record $407 billion when the budget year ends later this month, and the next president is likely to face a shortfall in January of well over $500 billion, congressional budget analysts said yesterday.

A deficit of that magnitude could severely constrain the next administration's agenda, regardless of whether Sen. John McCain (Ariz.), the Republican candidate, or Sen. Barack Obama (Ill.), his Democratic opponent, wins in November. Each has promised billions in new tax cuts or new spending. The expanding deficit also will increase the national debt and could impair future economic growth, particularly if lawmakers are forced to pay down that debt by raising taxes.

This year's deficit will be more than double last year's $161 billion, and it will rise from 1.2 percent of the gross domestic product to nearly 3 percent. If the next president extends some or all of President Bush's signature tax cuts, as both candidates have promised, annual deficits could balloon to as much as 5 percent of the economy, rivaling the dark fiscal days of the early-1990s and those of the Reagan administration, said Peter Orszag, director of the Congressional Budget Office.

The budget picture is likely to grow even bleaker once government analysts factor in the anticipated costs of the Treasury Department's decision last weekend to take over struggling mortgage-finance giants Fannie Mae and Freddie Mac.

Orszag declined yesterday to attach a price tag to the takeover, under which Treasury Secretary Henry M. Paulson Jr. has pledged to invest as much as $200 billion to keep the companies solvent. However, Orszag said Paulson's action has bound the government so tightly to the two companies that he will incorporate them directly into the federal budget when he reexamines the nation's fiscal picture in January.

The massive companies, which together hold or guarantee about half the nation's 12 million residential mortgages, claimed more than $1.5 trillion in debt at the end of the second quarter. Because that debt is backed by a nearly equal amount in assets, Orszag said it will not significantly increase the nation's indebtedness.

Orszag said it was also unclear how the takeover will affect the annual budget deficit. Government accounting methods do not reflect the risk inherent in assuming control of billions of dollars worth of mortgage-backed securities in the middle of the worst housing bust since the Great Depression. As a result, budget analysts said it is possible that the takeover could add tens of billions of dollars to the deficit -- or little to nothing.

"One of the ironies of what we're experiencing is the shortcomings in the way in which the federal government currently accounts for credit transactions. When you engage in actions that do contain risk, it can look like there's a profitable opportunity because the system does not reflect the cost of risk," Orszag said.

The complex question of how to value the companies and their assets on the government's books will be decided in coming weeks. Meanwhile, the White House budget office has yet to decide whether to follow Orszag's lead and fully incorporate the companies into its budget, an act that could increase the perception of complete government control.

Regardless of the White House's decision, the government's underlying financial condition is likely to get worse, an administration budget official said. "Treasury will still have to raise money to keep these guys whole," the official said, speaking on condition of anonymity in order to speak candidly. "We will be spending money on these companies. It would be hard to say we're going to make money on this."

On Capitol Hill, lawmakers were less focused on the implications of taking over Fannie Mae and Freddie Mac than on casting blame for the rapidly rising deficit.

"This is a doubling by the Democratic Congress, and Congress controls the purse strings," said Sen. Judd Gregg (R-N.H.).

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