Almost two decades ago, when trillions of dollars in private housing debt proved unsustainable, governments had to step in to prevent the worst financial crisis since the Great Depression from eclipsing it. But now governments have their own debt problems, and if they don’t get them under control soon, there will be nobody to step in next time.
Not since World War II have the finances of advanced economies looked so precarious. The problem predates 2020, but it accelerated that year, when governments took on major debt to prevent the pandemic’s economic shocks from becoming cataclysmic. In the years since, they have continued high levels of deficit spending, and as a result, their total debt has surged from about 70% of gross domestic product in 2007 to 110% in 2025.
The problem has been most severe in the US, where elected officials have acted as though debt no longer matters and bills can go on endlessly piling up. US total debt as a percentage of GDP is now higher than it was even during and after World War II. And what have Americans gotten in exchange for this debt?
Not a transformation of its infrastructure, which continues to lag behind other advanced economies. Nor major improvements to health and educational outcomes, which continue to decline. Nor a vast stock of critical military weapons, which have been severely depleted this year. Nor a boom in housing construction, which remains slow. Taxpayers are right to be frustrated and angry.
How long can the borrowing spree last before the bill comes due?
If investors have faith that governments will, in the long run, keep budget deficits and inflation in check, they’ll lend at relatively low interest rates, making it easier to keep the debt from growing faster than the economy. But, as anyone who has tried to borrow money to buy a house or a car knows, investors’ faith has waned. And just as borrowing has gotten more expensive for consumers, it’s also gotten more expensive for governments, compounding their budget problems.
Yields on longer-term advanced-nation bonds have risen sharply since the war in Iran upended global energy markets — reflecting, among other things, concerns about fiscal profligacy, inflation, geopolitical uncertainty and the cost of rearmament. Those higher rates translate into higher tax bills. American taxpayers are now spending $1 trillion a year to pay the interest on the debt, nearly triple the 2020 sum.
Meanwhile, holders of government debt are employing private debt like never before. Pension funds and other institutional investors are increasingly using derivatives that require little money down — a trade facilitated by hedge funds that in turn buy actual bonds, often with 100% borrowed money.
This makes markets fragile: When prices move sharply, sudden collateral demands can force investors to sell en masse, as happened during the 2020 “dash for cash” and the UK’s 2022 gilt crisis, which toppled the government. Yet the practice keeps growing: Hedge funds’ exposure to US Treasuries, as well as their total borrowing, are much greater than they were ahead of the 2020 turmoil.
All this increases the risk of a vicious cycle in which investors’ worries about public finances become self-fulfilling, sending interest rates so high that debts become truly unsustainable. It’s not hard to imagine a crisis in which governments are unable to stabilize the financial system because their own troubles are the driver. The repercussions — economic, political and otherwise — could be far-reaching.
There is still time for governments to act. To start, they should address market fragility. Instead of encouraging leverage by lowering banks’ capital requirements, regulators should limit the amount of leverage that pension and hedge funds can obtain in derivatives and lending markets. Systemwide stress tests can help identify dangerous concentrations of risk. Should forced selling by leveraged investors push interest rates too far, central banks must be prepared to step in and stabilize markets.
These steps can help mitigate risks and harms, but the only true solution to the problem is the most obvious — and most difficult: getting public finances in order. This requires making tough decisions about reining in spending and raising tax revenue. With the former appealing to conservatives and the latter to liberals, deals should be possible, but forging them will require stronger leadership and more political courage than either group has shown.
The more government debt burdens grow, the more it will test markets’ capacity and threaten economies’ stability. Nobody can say exactly where the breaking point might be — only that it’s getting too close.
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