Democrats Play A Weak Hand

Our U.S. senators are on standby at the Capitol this morning, sacrificing their Independence Day recess to show that they are ready to act on a deficit-reduction package that is nowhere in sight.

Members of the House of Representatives have the day off.

While the Democrat-controlled Senate abruptly canceled this week’s recess to back up President Obama’s demand that Congress act quickly on the deficit and the federal debt limit, House Republican leaders were not inclined to ruin a long holiday weekend just to put on a show. Besides, the House was scheduled to be back in session tomorrow anyway, unlike the Senate, which had planned to take this entire week off.

As the clock ticks down to Aug. 2, when the Treasury says the national credit line will be maxed out, each political party accuses the other of posturing, which is true, and of blindly following its core ideology, also true. The political branches of government, like the electorate, are split more or less down the middle over two conflicting sets of priorities. Republicans want to cut as much federal spending as they can, and Democrats, though conceding that they will have to cut a lot, want to preserve as much as they can.

Although the split is fairly even, Republicans have a decisive advantage in the battle over what mix of spending cuts and tax increases should accompany any rise in the debt ceiling. The simple fact is that Democrats want to raise the debt limit a lot more than the Republicans do. It is not a coincidence that the Democratic Senate is at the office today, while the Republican House enjoys an extended holiday.

In politics, as in business and many other areas of life, the side with the greater desire to complete a deal usually ends up making most of the concessions.

I learned this a long time ago by observing an elderly man, a former high-powered executive, who signed a “reconciliation agreement” to get back his one-time trophy wife after she left him. The agreement gave her a large annual stipend, the home of her choice, and specified time off each year so she could spend time with her friends. In return, she stayed in the marital home and, in my direct observation, treated her husband like dirt. He knew she treated him like dirt, but insisted to his dying day that he preferred the arrangement to being alone.

After a free-spending period while George W. Bush occupied the White House, Republicans have caught the balanced-budget fever, so much so that they are calling for a constitutional amendment to mandate a balanced federal budget. A constitutional amendment would be a terrible idea, because it would put government policy in a straitjacket. It also has no chance whatsoever of passing, so Republicans can call for it without having to worry about living with the results.

But refusing to raise the federal debt ceiling would accomplish pretty much the same thing as a balanced budget amendment. Instantly, Washington would have to limit the amount it spends to the amount it takes in. New money could be borrowed only as old debts are repaid. Because of the considerable interest expense on more than $14 trillion of existing federal debt, current spending on government programs would have to be slashed to a level well below what the government collects in taxes.

Balancing the budget cold-turkey like this will mean an immediate cut of more than 40 percent in federal outlays, a cut so large that the consequences would have to be immediate and drastic. Benefits like Social Security probably would not be paid in full and on time. Men and women in military service might miss a paycheck, too. Farm programs, highway construction, student loans and other federal outlays would dry up. Trade and transportation might be disrupted as customs and immigration workers are furloughed. Forget about all that stepped-up border security. If we really have to choose between defending against terrorists and defending against busboys and gardeners, the latter are going to make it into the United States.

Will failing to raise the debt ceiling automatically throw the country into default as the Treasury fails to meet its obligations? The administration says yes, raising the threat of financial Armageddon if the national credit rating is cut, which would be an immediate and unavoidable reaction to any default.

Default, however, would be a choice rather than a consequence if the debt ceiling stays where it is. The Treasury will still have ample money coming in to pay interest on government obligations as they are due. Maturing debt can be replaced with new debt. If nobody else will buy that debt, we can be pretty confident the Federal Reserve will. Credit rating agencies don’t care about any delay in Social Security payments.

Nobody wants any of these drastic things to happen. Even the Republicans who are calling for a balanced budget amendment are not calling for an instantly balanced budget.

But many in the GOP would be prepared to live with these consequences, even another severe recession, if it meant establishing long-term control over federal spending. For Democrats, on the other hand, failing to raise the debt ceiling and keep the federal money spigot open would be an unmitigated disaster. The poor, elderly and working class Americans that Democrats claim as their base would suffer the worst financial harm, and the party’s chance of keeping control of the White House and Senate next year would be virtually nil. Obama would go into next year’s campaign as a modern-day Herbert Hoover.

So while both sides want a deal, only one side desperately needs one. When you have a weak hand, the only things you can do are bluff or fold. Right now Democrats are bluffing, saying, as the president did again over the weekend, that any agreement will have to include tax increases as well as significant spending cuts. Republicans, who have no need to bluff because they hold most of the good cards, are not buying it.

Obama and his allies will ultimately have to fold, as they did in December when the president agreed to extend all of the Bush-era tax cuts for two years despite opposition from many is his own party. I don’t think the final deal on the debt ceiling will include any broad-based tax increases. The only question is how long it will take, and how much damage will be done, before everyone lays their cards on the table.

About Larry M. Elkin 525 Articles

Affiliation: Palisades Hudson Financial Group

Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, New York in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, New York in 2002. The firm expanded to Fort Lauderdale, Florida, in 2005, and to Atlanta, Georgia, in 2008.

Larry received his B.A. in journalism from the University of Montana in 1978, and his M.B.A. in accounting from New York University in 1986. Larry was a reporter and editor for The Associated Press from 1978 to 1986. He covered government, business and legal affairs for the wire service, with assignments in Helena, Montana; Albany, New York; Washington, D.C.; and New York City’s federal courts in Brooklyn and Manhattan.

Larry established the organization’s investment advisory business, which now manages more than $800 million, in 1997. As president of Palisades Hudson, Larry maintains individual professional relationships with many of the firm’s clients, who reside in more than 25 states from Maine to California as well as in several foreign countries. He is the author of Financial Self-Defense for Unmarried Couples (Currency Doubleday, 1995), which was the first comprehensive financial planning guide for unmarried couples. He also is the editor and publisher of Sentinel, a quarterly newsletter on personal financial planning.

Larry has written many Sentinel articles, including several that anticipated future events. In “The Economic Case Against Tobacco Stocks” (February 1995), he forecast that litigation losses would eventually undermine cigarette manufacturers’ financial position. He concluded in “Is This the Beginning Of The End?” (May 1998) that there was a better-than-even chance that estate taxes would be repealed by 2010, three years before Congress enacted legislation to repeal the tax in 2010. In “IRS Takes A Shot At Split-Dollar Life” (June 1996), Larry predicted that the IRS would be able to treat split dollar arrangements as below-market loans, which came to pass with new rules issued by the Service in 2001 and 2002.

More recently, Larry has addressed the causes and consequences of the “Panic of 2008″ in his Sentinel articles. In “Have We Learned Our Lending Lesson At Last” (October 2007) and “Mortgage Lending Lessons Remain Unlearned” (October 2008), Larry questioned whether or not America has learned any lessons from the savings and loan crisis of the 1980s. In addition, he offered some practical changes that should have been made to amend the situation. In “Take Advantage Of The Panic Of 2008” (January 2009), Larry offered ways to capitalize on the wealth of opportunity that the panic presented.

Larry served as president of the Estate Planning Council of New York City, Inc., in 2005-2006. In 2009 the Council presented Larry with its first-ever Lifetime Achievement Award, citing his service to the organization and “his tireless efforts in promoting our industry by word and by personal example as a consummate estate planning professional.” He is regularly interviewed by national and regional publications, and has made nearly 100 radio and television appearances.

Visit: Palisades Hudson

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