From a fiscal stability standpoint, the US can manage a national debt up to around $20 Trillion – but paying those debts off will require huge spending cuts and tax increases.

How much can the US government borrow before it becomes a bad credit risk? How much can the government borrow before it has to resort to inflating its way out of debt rather than simply paying off the bills? On the surface, the US government does not appear overly leveraged, as analysts point to the fact that public debt is only 60% of GDP. But is this a realistic way to look at America’s debt situation? Let’s look at America’s fiscal situation through the eyes of a loan officer, and see how it fares.

1. What is the US Government’s income, its current debt, and debt-to-income ratio?

Here is the US government’s revenue over the last three years: 2007: $2,568 Billion, 2008: $2,524 Billion, 2009: $2,105 Billion

The federal government’s total debt as of 03/21/2010: $12,661 Billion

The US government’s current debt-to-income ratio is 6.01. Using the US government’s best income year (2007), its debt-to-income ratio is 4.93. In the best circumstances, an individual might be able to borrow up to a ratio of 4.

2. What is the loan-to-value ratio for funds that the US government is borrowing this year?

The US government expects to borrow $1.56 Trillion this fiscal year. The majority of the money is being spent on Social Security payments, Medicare, Medicaid, and Defense. Virtually none of the expenditures will be in tangible investments of any form. If we assume (generously) that $100 Billion of the deficit spending will be invested, the LTV of this year’s borrowing is 15. Most individuals need an LTV of 0.9 or less to get a home loan.

3. What is the US Government’s Total Debt Service Ratio? What percentage of revenue is spent on interest payments?

In 2009 the government spent $187 Billion on interest payments, for a TDS of 8.9%. The government’s interest payments are extremely low because lenders are currently willing to lend the US government money at interest rates near 0%. If, hypothetically, interest rates went up to 5%, the government would have to pay $633 Billion in interest, 30% of 2009 revenue.

4. How does it add up? How much can the US borrow?

The federal government’s DTI and LTV would be unsustainable for any private borrower. However, since individuals and governments have been willing to lend the US money at close to 0%, the US has been able to comfortably cover its debt service thus far. As the federal debt balloons that may begin to change.

Let’s assume that US government debt average yield rises to 5% (closer to historical average), and that debt service should not exceed 40% of revenue. Using the government’s highest annual income ($2.57 Trillion in 2007), this means that interest payments should not exceed $1027 Billion per year. If the average interest rate is 5%, this means that total debt carried at that point would be $20.5 Trillion.

While the US might be capable of borrowing $20 Trillion, at that point only 60% of revenue would be available for government programs. Since the government is currently spending 180% of revenue on programs, it’s unlikely that it would be able to reduce spending on government programs by almost 70%. It’s most likely that a combination of taxes, spending cuts, and inflation will have to be used to keep debt at sustainable levels at that point.