Granted, the tea party came to Washington and changed the nature of the debate. Last December, two debt commissions reported out long-term solutions to the issue of chronic budgetary reliance on debt. Both commission reports recommended a balance of actions affecting expenditure and revenues. Both commissions projected long-term moderation in debt levels. President Obama could have embraced his debt commission, and as Senator Judd Gregg noted on one senior RNC official, had Obama endorsed his commission, Senate Republicans would have been hard-pressed not to fall in line.
But last December was eons ago in the life of Washington, and while that path not taken might have seemed immoderate at the time for the President and Democrats, it is a stark reminder of how far the tea party has moved the debate in a few short months.
But for the tea party—the House radicals and their fellow travelers—the end of Debt Ceiling Crisis of 2011 may loom as the great opportunity lost. Their goals were not to move the debate or incrementally shift the culture, but rather to make radical change, to stop the spending and impose a balanced budget on the nation. Rhetorically at least, they have been unmoved by arguments that rapidly curtailing federal spending would send an already weak economy into a tailspin. Instead, their stance has ranged from the moralistic—that the accumulation of debt must stop—to the contrarian—that based on their own economic calculus a cut-back in federal spending would have curative powers on the private sector and stimulate economic growth.
This week, pointing to the risks of credit downgrades and sovereign default, John Boehner finally brought his caucus into line behind a debt ceiling bill, and it now appears that before the August 2nd deadline, the political parties will agree on some deal that purports to reduce the trajectory of national spending by some trillions of dollars over ten years. But as the numbers are crunched, the reality will look increasingly marginal. And the House radicals find themselves complicit in a process that was closer to business as usual than to radical change.
As the denouement approaches, and a resolution to the debt crisis appears to be at hand, one has to ask how many of the participants continue to believe that a default on U.S. Treasury obligations was ever at risk. Yet that was the hammer held over the heads of the House radicals.
The meaning of a default U.S. Treasury bonds is narrow and specific: It means that principal on maturing Treasury bonds or interest due on any outstanding bonds is not paid when due. A default on our Treasury bonds has been the hammer hanging over negotiations, yet such a default would not be caused by a failure to raise the debt ceiling.
While there appears to have been little public discussion of the process by which default would be averted, it is actually not complicated. First, all maturing Treasury bonds would be rolled over (refinanced) into new bonds, as is currently the practice with all maturing Treasury securities. Refinancing the principal amount of maturing obligations does not impact the par amount of bonds outstanding subject to the debt ceiling, it simply replaces old maturing bonds with new bonds on a dollar for dollar basis. Second, unlike current practice, interest due on such obligations would have to be paid from resources other than the issuance of new bonds. Whether through Federal Reserve credits—effectively the creation of new money—or the utilization of tax receipts flowing into the Treasury, the approximately $15 billion per month of interest payable on outstanding Treasury obligations—a relative pittance—would be prioritized over other uses of funds, as both common sense and the 14th Amendment would dictate.
Two months ago, Tim Geithner made clear that the default argument was a ruse.
I think there are some people who are pretending not to understand it, who think there's leverage for them in threatening a default. I don't understand it as a negotiating position
Ironically, notwithstanding Geithner's assertion that there would not be a circumstance leading to a default, and lack of any risk premium priced into U.S. securities in the Treasury bond or credit default swap markets, for the past two months the debate over the debt ceiling has continued under the specific pretense—the leverage suggested by the fear of default—that Geithner dismisses.
Default has not been at issue in the current debacle in Washington, DC. Rather, it is the fear of default that has been used so effectively as the hammer by the so-called "adults" in the political establishment. Why the language of default risk persists is itself an interesting question, as a bi-partisan spectrum of Congressional leaders and pundits continue to push the default crisis paradigm. More curious still is why it continues to hold sway.
This week, that leverage was brought to bear in full force on the radical members of the House Republican caucus, as those House members finally cow-towed to their elders. Just at the moment of their greatest power, the recalcitrant House members were brought to heel by the John McCains and Mitch McConnells who knew well that a rapid deceleration of federal spending would hurt Republican constituencies as well as Democrat, and who had much to fear of a failure to raise the spending cap. If the House radicals had held firm for one more week—and no default transpired—the Washington debate would have been turned on its head. Instead of raising the debt ceiling to resolve a purported crisis, in such a post-August 2nd world with no threats of default and bond market calamities, raising the debt ceiling would only be done once there was explicit agreement on what actually spending warranted incurring new debt.
In such a post-August 2nd world—where no default had occurred—the debate would return to a debate on spending—which has always been the central issue. But in that new world, the debt ceiling would remain in place, effectively forcing a balancing of revenues and outlays unless the votes could be cobbled together to specifically authorize new debt.
And what an odd world that would be—and we already began to see hints of the arguments that would be made: Soldiers in Afghanistan are worried they may not get their paychecks. The first argument for "patriotic" spending. Then it will be the Medicare recipients. Then Medicaid. And the farmers. Mortgage brokers. Defense contractors. Voting blocks. Major contributors.
What would that world look like, when every tax cut, every tax expenditure, every spending program and every military venture was on the table. Each one with a voting block, each one with a constituency, but each one having to be justified in the full light of day: Are we willing to pay for this? Or are we willing to vote to borrow money for this?
That is the world no one wants to see. And when the House radicals wake up on Wednesday, and see the rare opportunity that passed them by—and that it was their own leadership that sold them out—there should be hell to pay.
Sunday, July 31, 2011
Friday, July 15, 2011
Full faith and credit.
Everyone wants in on this act. Particularly the bond rating agencies. Having been caught asleep at the switch in the run-up to crises past, Moody's and Standard & Poor's are loath to let it happen again. Going back to the Drexel Burham/Michael Milken affair, they affirmed the strong ratings on Executive Life just before the junk bond world collapsed. Same with Orange County, California, before losses in its investment pool drove it into bankruptcy. They threatened the bond insurance companies with downgrades if they did not bulk up their balance sheets with housing bonds, and we are all know how that ended up...
Now, Moody's and S&P want to play in the Treasury bond/debt ceiling game of high stakes poker in Washington. This week, both rating agencies piled on, threatening the United States with downgrades on its bonds if the debt ceiling matter is not promptly resolved. These pronouncements tend to have consequences, as the leadership of united Europe has found out. Greece has become yesterday's news, as over the past two weeks Portugal and Italy have seen their bond prices tumble and interest rates skyrocket as the markets responded to rating agency comments on their fiscal fortunes. Outraged European central bankers, struggling to find an effective solution to the crumbling of the Eurozone, attacked the bond rating firms for hidden political motivations and threatened to take action to "break the oligopoly."
And what of the Treasury market? How did U.S. Treasury bond market respond to the threatened downgrades?
Not even a whimper. Actually, a rally of sorts. Yields on the benchmark 10-year Treasury declined by four basis points this week. As buyers bid up the prices, yields fell from 2.95% to 2.91% today, down from just over 3% a week ago. Europe's pain—much to their undying chagrine—continues to be our gain. From the bond market perspective, the debt ceiling debate seems almost to be a sideshow against the backdrop of the disintegration of Europe, even with only two weeks to go until Armageddon.
It's the new reality TV. Everyone is watching, everyone is talking about it, but if the markets are a measure of the real world, this most important and urgent of matters seems to have become part of the entertainment-cable-Internet-popular culture other-world that consumes our lives, but isn't really part of our lives.
Perhaps it is because we tend to believe that an actual default on U.S. Treasury obligations is simply beyond of the realm of possibility. We see all the actors yelling and screaming in Washington, playing their assigned roles, but we know deep inside that they cannot actually let the world unravel around them. Just because they are scared of Grover Norquist?
There is another point of view, which is that this is not about our debt at all, but a tug of war for which the debt ceiling is just a dramatic point of leverage. It is not about debt, because some would argue—though few appear to be listening—that constitutionally there is no crisis. The 14th Amendment would seem to be quite clear—to a lay-person—that the full faith and credit of the United States obligations cannot be questioned—and therefore cannot be undermined even by Congress. The counter-argument that has been offered is that the Constitution gives only to Congress the power to borrow. But the simple fact is that all of the bonds on which people suggest that we might default were borrowed with the full authority of Congress. And once authorized and issued, the obligation to repay cannot be questioned—or so it would seem.
Perhaps the bondholders who are lining up at the Fed window in D.C.—even as they are running from the same in capitals across Europe—know what seems to have eluded the bond rating agencies, which is that the debt will be paid and that the market—as is its wont—has already priced in the risk of default on our bonds, and it is a small price indeed. From a practical standpoint, the principal due on maturing Treasury bonds can be "rolled over" into newly issued Treasuries, with no debt ceiling impact. It is all the other "obligations" that are at risk. All of those obligations—the ones that impact the lives and livelihoods of all but the holders of our bonds—that are only valid if each Congress chooses to make good on the commitments of some prior Congress. And those obligations are indeed at risk, for the simple reason that as a nation we have consistently determined that we are not willing to tax ourselves for the goods and services that we seem to want, and with no action on the debt ceiling we will have neither the tax revenues nor the bond proceeds to pay for all of them.
The issue is not default. The issue is spending. In the view of House Republicans and Tea Party activists, spending should come down dramatically. Sacred cows should be slaughtered. Entitlements should be reconceived. The New Deal and the Great Society have run their course. But for the Senate Republicans the motivations are more complex. The plan put forward by Senator Mitch McConnell skillfully serves a larger set of interests and would allow the status quo ante so dear to Senators to survive. His plan would essentially would take Congress out of the debt ceiling game, and give his colleagues the best of all outcomes: The spending would continue while someone else—the President—would take the blame.
Right now, both the President and Senate leaders believe that the fear of default should provide enough motivation to get something done—along with the cover each side needs to take steps that might otherwise be unthinkable: Cutting entitlements, raising taxes, trimming the military. But so far, the House leadership is not biting. For the Democrats, the McConnell proposal may well emerge as a middle ground of sorts. But for the House Republicans and the Tea Party—those who truly want to reduce the size of government—McConnell's success would constitute a stinging defeat, an historic moment lost, and a movement scorned.
The ultimate question is what the President plans to do on August 2nd if there is no agreement. One must presume that there is a plan in place: The 14th Amendment will be upheld, the bonds will be paid, the full faith and credit of the nation will be reaffirmed—and massive cuts and sequesters will be put into effect.
As great as the fear of default might be, both the President and Mitch McConnell must fear even more what would happen next. If the markets are right, and no default ensues, the motivation to reach a middle ground or face-saving solution will dissipate, and each side will once again be captive to their base. Caught in a lie—that he knew there would be no default—the President would lose the high ground. Vindicated for their obstinance, the House leadership will have even less reason to negotiate.
That may well be the endgame that true believers among the new breed of House Republicans have in mind. And it does not make them crazy, just strategic. If they believe that default will not be allowed to occur—as a matter of Constitutional obligation and proven bi-partisan deference to the bond markets—then reaching August 3rd with no agreement might reasonably be their goal. In three weeks, they can achieve their objective of an America forced to live within her means. And ironically, from that perspective the only thing the President could do to stop them would be to allow a default to occur even when it is within his power and authority to prevent it.
Now, Moody's and S&P want to play in the Treasury bond/debt ceiling game of high stakes poker in Washington. This week, both rating agencies piled on, threatening the United States with downgrades on its bonds if the debt ceiling matter is not promptly resolved. These pronouncements tend to have consequences, as the leadership of united Europe has found out. Greece has become yesterday's news, as over the past two weeks Portugal and Italy have seen their bond prices tumble and interest rates skyrocket as the markets responded to rating agency comments on their fiscal fortunes. Outraged European central bankers, struggling to find an effective solution to the crumbling of the Eurozone, attacked the bond rating firms for hidden political motivations and threatened to take action to "break the oligopoly."
And what of the Treasury market? How did U.S. Treasury bond market respond to the threatened downgrades?
Not even a whimper. Actually, a rally of sorts. Yields on the benchmark 10-year Treasury declined by four basis points this week. As buyers bid up the prices, yields fell from 2.95% to 2.91% today, down from just over 3% a week ago. Europe's pain—much to their undying chagrine—continues to be our gain. From the bond market perspective, the debt ceiling debate seems almost to be a sideshow against the backdrop of the disintegration of Europe, even with only two weeks to go until Armageddon.
It's the new reality TV. Everyone is watching, everyone is talking about it, but if the markets are a measure of the real world, this most important and urgent of matters seems to have become part of the entertainment-cable-Internet-popular culture other-world that consumes our lives, but isn't really part of our lives.
Perhaps it is because we tend to believe that an actual default on U.S. Treasury obligations is simply beyond of the realm of possibility. We see all the actors yelling and screaming in Washington, playing their assigned roles, but we know deep inside that they cannot actually let the world unravel around them. Just because they are scared of Grover Norquist?
There is another point of view, which is that this is not about our debt at all, but a tug of war for which the debt ceiling is just a dramatic point of leverage. It is not about debt, because some would argue—though few appear to be listening—that constitutionally there is no crisis. The 14th Amendment would seem to be quite clear—to a lay-person—that the full faith and credit of the United States obligations cannot be questioned—and therefore cannot be undermined even by Congress. The counter-argument that has been offered is that the Constitution gives only to Congress the power to borrow. But the simple fact is that all of the bonds on which people suggest that we might default were borrowed with the full authority of Congress. And once authorized and issued, the obligation to repay cannot be questioned—or so it would seem.
Perhaps the bondholders who are lining up at the Fed window in D.C.—even as they are running from the same in capitals across Europe—know what seems to have eluded the bond rating agencies, which is that the debt will be paid and that the market—as is its wont—has already priced in the risk of default on our bonds, and it is a small price indeed. From a practical standpoint, the principal due on maturing Treasury bonds can be "rolled over" into newly issued Treasuries, with no debt ceiling impact. It is all the other "obligations" that are at risk. All of those obligations—the ones that impact the lives and livelihoods of all but the holders of our bonds—that are only valid if each Congress chooses to make good on the commitments of some prior Congress. And those obligations are indeed at risk, for the simple reason that as a nation we have consistently determined that we are not willing to tax ourselves for the goods and services that we seem to want, and with no action on the debt ceiling we will have neither the tax revenues nor the bond proceeds to pay for all of them.
The issue is not default. The issue is spending. In the view of House Republicans and Tea Party activists, spending should come down dramatically. Sacred cows should be slaughtered. Entitlements should be reconceived. The New Deal and the Great Society have run their course. But for the Senate Republicans the motivations are more complex. The plan put forward by Senator Mitch McConnell skillfully serves a larger set of interests and would allow the status quo ante so dear to Senators to survive. His plan would essentially would take Congress out of the debt ceiling game, and give his colleagues the best of all outcomes: The spending would continue while someone else—the President—would take the blame.
Right now, both the President and Senate leaders believe that the fear of default should provide enough motivation to get something done—along with the cover each side needs to take steps that might otherwise be unthinkable: Cutting entitlements, raising taxes, trimming the military. But so far, the House leadership is not biting. For the Democrats, the McConnell proposal may well emerge as a middle ground of sorts. But for the House Republicans and the Tea Party—those who truly want to reduce the size of government—McConnell's success would constitute a stinging defeat, an historic moment lost, and a movement scorned.
The ultimate question is what the President plans to do on August 2nd if there is no agreement. One must presume that there is a plan in place: The 14th Amendment will be upheld, the bonds will be paid, the full faith and credit of the nation will be reaffirmed—and massive cuts and sequesters will be put into effect.
As great as the fear of default might be, both the President and Mitch McConnell must fear even more what would happen next. If the markets are right, and no default ensues, the motivation to reach a middle ground or face-saving solution will dissipate, and each side will once again be captive to their base. Caught in a lie—that he knew there would be no default—the President would lose the high ground. Vindicated for their obstinance, the House leadership will have even less reason to negotiate.
That may well be the endgame that true believers among the new breed of House Republicans have in mind. And it does not make them crazy, just strategic. If they believe that default will not be allowed to occur—as a matter of Constitutional obligation and proven bi-partisan deference to the bond markets—then reaching August 3rd with no agreement might reasonably be their goal. In three weeks, they can achieve their objective of an America forced to live within her means. And ironically, from that perspective the only thing the President could do to stop them would be to allow a default to occur even when it is within his power and authority to prevent it.
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