Ending the Debt Ceiling Stand-Off

Here’s how I’m hoping this might work out.

Let’s begin by reviewing what would happen when the Treasury runs out of accounting gimmicks yet Congress refuses to authorize further debt issue. Aside from deciding simply to ignore the debt ceiling, what options would the President have? One would be to defer payment of coupons and/or principal on outstanding Treasury securities. Of course the holder of these securities could still try to sell them on the secondary market. Flooding the market with sell orders would of necessity generate a spike in interest rates. Depending on how confident people were that the situation would be quickly resolved, in a worst case scenario, selling and asset shifting could turn into an outright financial panic. Effects on financial payment logistics could be pretty scary, and it could easily be worse than what we saw in the fall of 2008. Don’t want to go there.

Or, the President could withhold payments to various individuals entitled to those payments by law, such as government employees and contractors, or social security and welfare beneficiaries. Perhaps these people could be issued federal IOU’s that banks would accept, though the logistics of doing so seem insurmountable. It’s quite plausible to expect that the spending by those affected parties would come crashing down at a time when the economy seems precariously near stall speed. Don’t want to go there, either.

And so the negotiating calculation of each party seems to be, this is such an awful outcome, the other side will surely accede to our position rather than allow it to happen. Jeff Frankel likens it to the cliff race “game” in the movie Rebel Without a Cause.

I also appreciate David Merkel’s advice: don’t play near the edge of the cliff. Holders of Treasury securities are already thinking through what this might mean for them. Nervousness now may make us more vulnerable to problems a few years down the road as the longer-term pressures of Treasury borrowing needs begin to meet with some natural market resistance and the Fed begins its exit strategy. And apprehensions by consumers about how this will all play out could be one factor in this month’s sharp decline in consumer sentiment. That deterioration of sentiment is another development that’s already adding to our economic problems, right here and right now.

Bill McBride has been saying there’s little to worry about:

Congress will probably push this to the brink, but they will raise the debt ceiling before the country defaults. The first rule for most politicians is to get re-elected, and the easiest way to guarantee losing in 2012 is to throw the country back into recession. If that happened, I believe the voters would correctly blame the leaders of Congress, and I think Congress knows that too. Therefore it won’t happen.

But Robert Reich thinks that some congressional leaders don’t see it that way:

I’ve spent enough of my life in Washington to take its theatrics with as much seriousness as a Seinfeld episode. A large portion of what passes for policy debate isn’t at all– it’s play-acting for various constituencies. The actors know they’re acting, as do their protagonists on the other side who are busily putting on their own plays for their own audiences.

Typically, though, back stage is different. When the costumes and grease paint come off, compromises are made, deals put together, legislation hammered out. Then at show time the players announce the results– spinning them to make it seem they’ve kept to their parts.

At least that’s the standard playbook.

But this time there’s no back stage. The kids in the GOP have trashed it. The GOP’s experienced actors– House Speaker John Boehner and Senate Minority Leader Mitch McConnell– have been upstaged by juveniles like Eric Cantor and Michele Bachmann, who don’t know the difference between playacting and governing. They’re in league with tea party fanatics who hate government so much they’re willing to destroy the full faith and credit of the United States.

Senator Mitch McConnell’s (R-KY) counterproposal is one that ought to appeal to any grown-ups on Capitol Hill. Keith Hennessey explains the idea:

  • The President could ask Congress to increase the debt limit by $700 B.
  • The President would have to simultaneously submit a plan to cut spending by more than $700 B.
  • The Presidential request and submission would trigger an immediate $100 B increase in the debt limit, thus giving the Administration the ability to make it into September without having to slow down cash outlays for benefit checks or anything else.
  • The President’s $700 B debt limit increase request would be automatically approved unless Congress blocked it. To block it, a majority of the House and Senate would vote to disapprove. That resolution of disapproval would go to the President, who would presumably veto it. If more than 2/3 of the House and Senate overrode the President’s veto, then the $700 B request would be denied and the original $100 B authorization rescinded. This resolution of disapproval would be governed by “fast track” legislative procedures so it couldn’t be delayed, amended, or filibustered.
  • If either the House or Senate voted down the resolution of disapproval, or if 1/3 or more of the House or the Senate sustained a Presidential veto, then the $700 B would be automatically authorized. In other words, the President knows he will get his $700 B as long as (a) he submits his spending cuts and (b) he knows he can get 1/3 of the House or the Senate to sustain his veto, should it be necessary.
  • This process would be repeated in the fall of 2011 and again in the summer of 2012, with the President authorized to ask for an additional $900 B each time, again matched by a greater amount of spending cuts. The President could begin this process only when Treasury was within $100 B of the debt limit.
  • The authority would expire in early 2013, around the end of this Presidential term.

That sounds to me like the perfect solution. It allows Congress to play the political game the way it likes. A majority of members can vote to “disapprove” of raising the debt ceiling, despite the fact that those same representatives have voted to approve the spending and revenue measures that made additional borrowing unavoidable. It allows the debt to be issued anyway, despite the congressional vote. It might seem to do so in a way that allows Republicans to score some political points, in that by vetoing the disapproval resolution, the President would accept more of the political responsibility for the dreaded symbolic act of issuing more debt. But I think there’s an opportunity for Obama to do so with a speech like this one and end up looking, if I may say so, all the more presidential.

Something for each party to take away from the negotiations, and moving the game a safer distance from the cliff, is the best I could hope for from this situation.

Ending the debt ceiling stand-off

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About James D. Hamilton 244 Articles

James D. Hamilton is Professor of Economics at the University of California, San Diego.

Visit: Econbrowser

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