Families, though, were not the only ones going deeper into debt. The federal government ran up large budget deficits due to massive tax cuts for the rich and a spending spree for an ill-designed Medicare prescription drug benefit and two wars in Afghanistan and Iraq. Since March 2001, foreign investors financed close to 80 percent of the federal budget deficit.
More importantly, these large capital inflows financed a massive U.S. trade deficit that still remains at an unsustainable 5 percent of gross domestic product. To finance this deficit, the U.S. economy borrowed heavily overseas, selling everything to foreign investors, including home mortgages.
The result: a vicious cycle of debt, with foreign investors fueling a housing market boom that required households to borrow money that foreigners were willing to borrow.
This process is now going into reverse. Stock market investors are selling off shares tied however tenuously to the U.S. housing market, thus fueling the financial markets downturn. This sell off is also increasing worries about a broader credit crunch that could lead to further deterioration in the U.S. housing market.
The largest drawback of the debt boom was that it let U.S. policymakers get away with not addressing the country's underlying economic problems. The fundamental weaknesses of the U.S. economy�a weak labor market, large budget deficits, and massive trade deficits, and an unsustainable housing boom�were masked by record amounts of debt, allowing the federal govern
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