Friday, August 9, 2013

The Coming Debt Ceiling Crisis

“Failing to increase the debt limit would have catastrophic economic consequences. It would cause the government to default on its legal obligations. That would precipitate another financial crisis.”

--US Treasury
“I urge Congress to protect America's good credit and avoid the potentially catastrophic consequences of failing to act by increasing the debt limit in a timely fashion. Waiting until the last possible moment to act would risk financial market and economic damage that is completely avoidable and irresponsible to our investors and our country.”
--Jacob Lew, Sec. of the Treasury
“The Treasury has no room under the limit to increase total borrowing. If the debt limit is not increased before extraordinary measures are exhausted, the Treasury will not be authorized to issue additional debt that increases the amount outstanding. That restriction could lead to delays of payments for government activities and possibly a default on the government’s debt obligations. Which of the government’s various financial obligations would be paid and which would not would be determined by the Administration.”
--Congressional Budget Office
The House and the president are dead set on another debt ceiling drama. Both sides seem to want it.
Since the GOP controls the House, the debt ceiling is its principal tool to influence fiscal policy. The House is effectively controlled by the Tea Party which has a policy agenda that doesn’t match that of the Executive Branch. Another game of chicken, who will swerve first, global default, etc. etc. We’ve seen this movie a number of times. High drama, last minute deals, mutual denunciation.
This problem was caused by the founders’ decision to create co-equal branches of government which could be led by different political parties, known in France as cohabitation, and in America as gridlock. The founders were afraid of presidential kingship, on the mistaken idea that poor George III was a tyrant. The revolutionaries believed their own propaganda. Whatever Britain’s sins, they were not the fault of the king, but of the British legislature.
Conflict between the executive and the legislature began the day that George Washington left office. From that moment on, the battle has raged. Interestingly enough, the charter gives ultimate power to the the legislative branch: the right to impeach both the president and the vice president and install the House Speaker as president (a legal coup d'etat). But that has never happened, and is quite unlikely to happen this go-round.
The debt ceiling is a misinterpretation of the Constitution that causes artificial crises and hurts America’s credit. It was never meant to work the way it does today, and I am pretty sure that the Supreme Court would agree, if it were asked (paging Dr. Scalia). It is a legislative mythology, nothing more. The founders did not intend that the legislature could appropriate funds and then refuse to pay for them. But, because the ceiling is a useful weapon in the war between the branches, it is not going away. Obama should do his duty and litigate it, but he has decided not to do so, probably because he sees this "crisis" as a political opportunity. He has no interest in good governance as a desideratum.
Aside from the Constitutional nonsense, the debt ceiling is also a manufactured financial crisis. The Treasury implies that, when it hits the debt ceiling, the government must shut down and default on its debts. That is false.
The Treasury spends about $10B a day, and borrows at most $1 billion of that (and the daily borrow is declining sharply thanks to the Fiscal Cliff). When Treasury maxes out on its credit at the end of October, it will need to find $1B a day to meet payroll, fight wars, and send Grandma her check. When an American citizen is maxed out, he sells his motorcycle or his gun collection. That is all that the Treasury has to do. The Treasury very cleverly does not publish a balance sheet for the USA, but here are some of the known assets:
1. An enormous amount of financial assets that could be sold or repoed with the Fed.
2. Almost all of Alaska, including huge oil and mineral reserves.
3. Most of the American West, including huge oil and mineral reserves.
4. The GSA’s massive portfolio of commercial real estate.
5. Hundreds of redundant domestic military bases in some very expensive real estate markets. (The federal government gave away Governor’s Island in Downtown Manhattan, the Presidio in San Francisco, and is now giving away the Brooklyn Navy Yard. We can't pay our debts, but we can give away our crown jewels. Maybe T-bonds should have a general lien.)
6. The Strategic Petroleum Reserve.
7. Dulles and Reagan airports.
8. A big chunk of Puerto Rico.
9. The embassy in Tokyo.
10. Yellowstone.

And so on. By selling its unimaginable portfolio of real and financial assets, the US government could stay afloat forever without going above the current $16.7 trillion debt ceiling. The US government is the richest institution on earth; its wealth is in the quadrillions; it ain’t broke.
But, the US government doesn’t want to sell or repo assets to avoid a crisis. Just as the Tea Party wants a crisis to force a cut in spending, the Democrats want another shutdown to be blamed on the GOP, as it was in the Clinton-Gingrich showdown in 1996. Both sides want a rerun of that stupid movie.
An important point about Treasury securities: the Constitution obliges the president to protect the country’s credit. It does not oblige him to build bridges, to buy F-35 Lightnings or to aid the Syrian rebels. He is required to pay the country’s debts before he pays any other bills. That means that he would have to curtail or postpone discretionary spending, or sell assets. He cannot prioritize his personal wishlist over paying interest and principal on the federal debt. Should he do so, he should be removed from office. Arranging a default on the national debt and turning the US into a banana republic is, at least, a misdemeanor.
The Tea Party demands that Boehner use the debt ceiling as a weapon to: force a defunding of  Obamacare which is already law, budget cuts beyond the current sequester, comprehensive entitlement reform, and who knows what else (school prayer? a national Reagan holiday?). Boehner does not want to shut down the government, and he knows that Obama won't agree to the Tea Party’s ransom demands. Therefore, he has to figure out a deal that will satisfy both the Tea Party and the Democrats--two Venn diagrams that just don’t overlap. He has an impossible task. If I prayed, he'd have my prayers; if he wanted my advice, I'd tell him to quit and become a K-Street lobbyist like Trent Lott.
We will now have the pleasure of watching a rerun of the 1996 and 2011 crises, but with better fireworks. You may recall that after the last budget crisis, Boehner said he would never negotiate personally with Obama again. We’ll see if he is able to keep that promise in October.

Comment by Vincent Truglia (

Chris, although it is interesting to debate the origins of the constitution, the immediate problem at hand is the debt ceiling.  I would have to disagree that the XIV Amendment is any help in this instance.  Since its adoption in 1868, Congress has had the sole authority to authorize debt issuance.  In fact, prior to 1917, Congress had to approve every single security, including details such as maturity, interest rate, and the purpose for which the borrowing was required.
The exigencies of World War I made approving every single security practically impossible.  Congress, after considerable debate, approved the creation of a debt ceiling to streamline the process.  However, the reason they created the ceiling, instead of doing away with the approval requirement, is that many were worried that spending would eventually get out control.  As it turns out, we know that federal spending has indeed skyrocketed. Although, I have generally approved of most federal expenditures, I have to admit that the original concern was justified.
Since the very people who approved the XIV Amendment sat in Congress for many years, and in some cases, decades, it is hard to argue that they were misinterpreting its intent.  Since approving individual federal debt securities was the practice from 1868-1917, it would be hard for even the Supreme Court to make the argument that Congressional approval is not necessary.
In recent years, Bill Clinton has made the argument that “in an emergency” the President has the right to issue debt, even without Congressional approval.  Personally I think that too is a bit of a stretch.  To justify declaring an emergency, I would think that the US would first to have defaulted, if even for a day.  Also, I am still not sure under which constitutional provision such decrees could be authorized (short of war).
I do agree that we are going to have a big battle in Congress over the debt ceiling.  The Republican House leadership faces some tough decisions.  Tea Party supporters in the House know that are mainly in generally safe Republican districts.  They do not face re-election until 2014.  Why would they want to accommodate even the Republican leadership by supporting a debt ceiling rise? That would not play well in their districts.  Also, if they did, in the next election cycle, an even more radical far-right candidate would likely replace them as a result of well-funded primaries.
The dilemma for the Republican House leadership is that if they accommodate rational arguments for the US to avoid default, will they be soon replaced by less accommodating leadership, more aligned with the Tea Party?
The only dilemma Tea Party supporters in Congress face is if the US actually does default.  You and I know, that would cause chaos in world financial markets.  Voter outrage resulting from the consequences of such a default would likely cause the end of the Tea Party movement.  However, since many of them appear to be “true believers,” they might be willing to maintain principle over reason.  Human history is full of such examples.

As you know from my arguments elsewhere, barring a crisis, I see Republican majorities in the House for at least the next two election cycles.  In addition, given demographics at the national level, it will be difficult for a Republican candidate to win the presidency.  Democrats have won the popular vote in 5 of the last 6 presidential elections.  Even the structure of the Electoral College will continue to favor Democratic candidates.
My conclusion is that gridlock will only grow worse over time. At least until 2023, the US government does not face a fiscal crisis resulting from deficits.  By 2023, entitlement costs will start to rise significantly. Given that, why would Democrats want to bargain away anything fiscal over the next 10 years?
Although by any economic argument, the US government is a AAA credit, given that investors will likely have to face issues of the debt ceiling and potential default on an on-going basis. As a result, in my mind, the US is not really AAA. An investor in AAA-rated securities should have to worry about potential near-term defaults, even if those defaults are only temporary.

1 comment:

Vinney said...

Chris, it seems to me that the answer to the debt ceiling (if it reaches a crisis) is to mint the $1T coin thus avoiding spending by borrowing. it appears to be legal and could be implemented by the President without congress approval. It is in effect nothing more than monetization of the spending and that would solve the additional problem of HH deleveraging by sending them income instead of debt. I think it's only a matter of time until this becomes the only viable solution. Call it a debt jubilee whatever. For the past 40 years it has been believed that creating 97% of the money supply as bank credit while wages stagnate and productivity increases - is sustainable - it is not.