Posts Tagged ‘debt ceiling’

The only downgrade that matters

22 December 2012

Remember these words: “means of extinguishment.” The full quote is “The creation of debt should always be accompanied with the means of extinguishment,” and it’s from Alexander Hamilton, the father of our national debt. Hamilton believed that the federal government could do the nation a big favor by carrying a debt as long as it had sufficient revenue streams to eventually pay it off; such an arrangement, he said, would give the US “immortal credit,” which could come in very handy whenever we had pressing needs or good public investment opportunities that justified borrowing more money.

This has been on my mind because the (yawn) “fiscal cliff” negotiations, whatever their outcome, are really just the latest round in an endless series of self-destructive battles over whether to honor our own budget commitments by raising the debt ceiling so that we can pay for them. I’ve written about Congress’s debt-ceiling looniness before, and how it would be better not to have such votes at all. Think the proposed budget has too big a deficit? Fine, then don’t vote for it. But to vote for it and then refuse to pay for it is not only cynical and hypocritical, but sows suspicion that the government is a deadbeat.

Standard & Poor’s (S&P) famously downgraded the federal government’s debt in August 2011 (from AAA to AA+), and the other two major bond rating agencies (Moody’s, Fitch) are threatening to do the same if Congress can’t reach some kind of agreement to reduce the debt/GDP ratio in the long term. After the subprime scandal, in which the rating agencies routinely rubber-stamped dodgy subprime mortgage-backed securities as AAA, these agencies have zero credibility, but that doesn’t mean they’re always wrong. The S&P said its downgrade “was pretty much motivated by all of the debate about the raising of the debt ceiling. . . . It involved a level of brinksmanship greater than what we had expected earlier in the year.” Yes — if Congress can’t be counted upon to honor its own commitments, which include paying back the principal and interest on previously issued Treasury bonds, then why should bond buyers regard Treasury bonds as completely safe? The more Congress continues to play these games, the more rational it is to conclude that maybe Treasury bonds are not so safe. (more…)

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Epic fail

21 November 2011

The so-called “supercommittee” of six Democrats and six Republicans, charged last summer with drafting a deal for $1.2 trillion in spending cuts over ten years, failed to do so by today’s deadline. The so-called teeth in last summer’s agreement to form a supercommittee was that Congress would either accept their proposal or submit to $1.2 trillion in automatic, across-the-board spending cuts. Is this good news, bad news, or irrelevant?

Good, says Paul Krugman. To be precise, he said that last week. His reasoning was that cutting spending is counterproductive in a time of economic depression, as it will just exacerbate the depression, so it’s best that they didn’t make a deal to cut spending. Today, he’s a bit more nuanced, noting a Bloomberg.com story about how the supercommittee’s failure is rattling markets but highlighting this aspect of the story (Krugman’s words):

‘. . . what it actually says is that market players fear that the absence of a debt deal means no stimulus. So the actual fear is not that spending won’t be cut enough, it is that it will be cut too much — which actually makes sense, and is consistent with the action in stock and bond markets.

‘But how many readers will get that? The way it’s presented reinforces the false notion that the deficit is the problem.’

Bad, says Kevin Drum. At least if you’re someone like Kevin Drum, Paul Krugman, or me, who thinks it’s foolish to cut social spending in a depression and really isn’t all that keen on slashing the social safety net in general. Unlike Krugman, Drum thinks many if not most of the automatic spending cuts will go into effect. The deal is only good if you’re a Republican who lives to cut social programs. In other words, the Democrats got rolled again, just as in the bogus “debt ceiling authorization” debate. Drum:

‘In any case, this should basically be viewed as a total victory for Republicans. Any alternative plan would have included some tax increases, so failure to come up with an alternative means that we get a big deficit reduction that’s 100% spending cuts, just like they wanted. And the 50-50 split between domestic and defense cuts was always sort of a joke. Republicans never had any intention of allowing the Pentagon’s half of the cuts to materialize, and the domestic spending half of the cuts was about as big as they wanted them to be. Big talk aside, they know bigger cuts would run the risk of seriously pissing off voters.

‘So Republicans got domestic spending cuts that were about as big as they really wanted. They know they’ll never have to implement most of the defense cuts. And there are no tax increases.’

Irrelevant, say the bond markets. The demand for ten-year U.S. Treasury bonds was actually up slightly today, whereas really bad news about the long-term U.S. fiscal position should send demand down and interest rates up. Either the market regards $1.2 trillion over 10 years as no big deal (and it is rather small compared with a national debt of $14 trillion), or they were expecting the supercommittee to fail all along. Or both.

U.S. 10-year 1.959% -0.051

The beatings will continue until morale improves

4 August 2011

The stock markets are looking pretty Keynesian today. A 512-point (4.3%) drop in the Dow Jones average today, and drops of 4.8% and 5.1% in the S&P 500 and Nasdsaq; overall a drop of more than 10% (a.k.a. a “market correction”) in the past 10 days. Might it have something to do with the fact that Washington is obsessed with deficit-cutting while the rest of the world is obsessed with jobs and economic growth, or the lack thereof?

Jeff Macke of Yahoo! Finance’s Breakout blog puts it this way:

‘There’s a growing realization among even the most optimistic investors that the United States is entering a new recession — a dreaded “double-dip.” Adding to the pain is the sense that the government and Federal Reserve are out of both ideas and ways to stimulate the economy. Corporate America is sitting on record amounts of cash but is refusing to make new investments with so little end demand for its products. Consumers and corporations are hoarding cash, and the economy appears to be seizing. The debt ceiling debate was a fiasco, snuffing any remaining confidence traders had for help from Washington, D.C.’

Yes, Mr. President (and happy birthday, by the way), the time-suck that was the debt-ceiling negotiations was a “self-inflicted wound,” as you said last night. Now why couldn’t you have said the same about the debt ceiling itself? Worldwide investor confidence could not possibly have been inspired by this fight over a redundant institution that no other democratic country (besides Denmark) has and which serves no purpose besides political grandstanding. You may have looked like the only grownup in the room during that whole travesty, but I think the world would like to see a grownup with a clue. You’re talking about focusing on jobs now, but how on earth are you going to do that having just committed yourself to cutting government spending? If you were a Republican, the (specious) answer would be deregulate the hell out of everything, but traditionally Democrats have looked to fiscal stimuli, be they spending programs (Roosevelt), tax cuts (Kennedy-Johnson), or both (you in 2009). It looks to me like you’ve let the Republicans box you into a corner, and you’ve boxed yourself in even further by parroting their rhetoric about the primacy of deficit reduction and how government, like a family, has to spend less in hard times.

The Budget Control Act of 2011 took another hit today when Defense Secretary Leon Panetta said that the Pentagon could not absorb any more cuts beyond the $350 billion over 10 years in the first round of cuts. The second round calls for across-the-board cuts of $1.5 trillion, including $600 billion from the defense budget, if Congress can’t agree on specific cuts. Panetta said that would “do real damage to our security, our troops and their families, and our ability to protect the nation.” I’ll pass on whether or not he’s right, but I’m pretty sure his objection and the military-industrial complex will carry the day. Which makes it more likely that (a) the budget ax falls even harder on ordinary families who would spend the money they’d receive from the government, or (b) the spending cuts just don’t happen, which is better for the economy but bad for the government’s credibility. The battle over that second round of cuts looks to be nasty, brutish, and horrifying.

Uh oh, the 14th amendment might not help here

30 July 2011

Many, including Bill Clinton, have said the debt ceiling is unconstitutional because it goes against the 14th amendment’s clause that the validity of the public debt shall not be questioned. However, it’s also been pointed out that interest on the debt is a relatively small obligation of the government and can easily be paid for out of incoming revenues ($29 B in interest, $172 B in revenues, for August after the 2nd). So it seems to me that a reasonable interpretation of the 14th amendment is that it applies to the government’s debt obligations but not to their obligations to anyone else — government employees, contractors, retirees, veterans, etc. Perhaps that’s why President Obama has said his lawyers don’t think invoking the 14th amendment is a promising solution.

Tom Geoghegan, one of my favorite writers on politics and the law (his book Which Side Are You On? even manages to make organized labor funny), suggests a different “constitutional option”: Article I. Sections 8 and 9 of Article I list the powers of Congress and the limits on those powers, which are quite limited. Article 10, Powers Prohibited of States, says no state shall pass any “Law impairing the Obligation of Contracts.” (Geoghegan’s March article on the subject is also worth reading.) Geoghegan says it’s implied that this would extend to Congress, too, but I’m not so sure — Section 8 gives Congress all sorts of powers that are prohibited of states, as well as the power to “provide for .. the general welfare of the United States,” and the Supreme Court’s interpretation of the “general welfare” clause became a lot more expansive around 1937 (after the kerfuffle over the Court’s resistance to the New Deal and FDR’s attempt to pack the court by increasing the number of justices; the so-called “switch in time that saved nine”). The conservative majority on the Court could conceivably rule that keeping the debt ceiling constant would aid the general welfare by forcing reductions in the size of government or in the burden of the debt on future generations. Lame, far-fetched arguments, to be sure, but those have carried the day rather recently with the Court.

So it’s unclear what the way out of this morass will be. If the debt ceiling is not raised, we most likely get a partial government shutdown, which will go on until the Republicans in Congress decide that it’s hurting them at least as much as it’s hurting Obama and the Democrats (see: 1995-96). If we’re lucky, the Republicans realize that before Aug. 2, and the nation is spared a shutdown.

What Treasury triage might look like

29 July 2011

Good piece here by Jane Sasseen of Yahoo News, about what might happen on Aug. 3, if Congress doesn’t raise the debt ceiling. Without being able to borrow any more money, the government would have a shortfall of $135 billion for the rest of August. That is, the government’s legally obligated payments would still be $307 billion and its expected revenues from all sources would be only $172 billion. Altogether, the “federal government makes payments to some 80 million individuals, companies and entities every month.” Who would get stiffed?

There’s no official order of triage, but it’s widely agreed that Treasury bondholders would get paid first. They’re owed hundreds of billions, but most of that comes from selling new bonds. Only the interest ($29 billion for August) comes out the budget, so the government can be counted on to cover it, rather than do any more damage to its credit rating and future interest rates than it already has.

What seems most likely, according to an expert quoted in the article, is a partial government shutdown, as in 1995:

‘”A de facto shutdown of the government is the real threat, not default, ” says Greg Valliere, chief political strategist for the Potomac Research Group.’

Bad time to work for the federal government. Humorist Andy Borowitz had it right: Let’s save money by paying Congressmen per accomplishment.

Feeling 1932 (updated, Aug. 1)

28 July 2011

I’ve written already that the best deal on the debt ceiling would simply be to raise it (or better still, abolish it), without attaching it to a bill that punishes the economy further by slashing spending and/or raising taxes. The last thing this ailing economy needs is a Grand Bargain to reduce the current deficit. It was disastrous policy during the Great Depression — first by Congress and President Hoover in 1932, then by Congress and President Roosevelt in 1937. I would have thought those historic blunders would not be repeated, but I guess it’s always a mistake to assume that politicians know economics or history. But I’ve said all that before.

What I want to point out here is that we’re due for some ill-timed spending cuts (and maybe tax increases), regardless of what Congress does in the next week. Remember that $787 billion stimulus package that Congress passed in early 2009? It was spread out over two years, so roughly $400 billion a year, about $250 billion of which was spending and $150 billion tax cuts, almost all in 2009-2011. So that stimulus is just about “spent.” The main tax cuts, like extending the patch for the alternative minimum tax, will probably be maintained because they’re politically popular, but the spending almost surely will not. So that’s an abrupt drop of about $250 billion in government spending, or about 2% of GDP, over the next year. This chart from James Fallows’ blog for The Atlantic shows the projected big drop in fiscal stimulus from “Relief measures.” That’s the trouble with stimulus — it’s finite. Congress passes these things reluctantly, and if the economy still needs stimulating when it’s over, people are more likely to conclude that it failed rather than that it was too small (which it was) or that it spared us even worse devastation (which it did).

Now it is possible, perhaps even probable, that Congress will fail to pass any deficit-reduction deal and will end up raising the debt ceiling anyway — after all, that’s what’s happened virtually every previous time that a debt-ceiling vote has come up. But even if Congress ends up not inflicting any new wounds on the economy, we’re looking at big-time deficit reduction that will do plenty of damage on its own.

UPDATE, 1 Aug. 2011: Actually, it looks like it’s already happened. In the dismal GDP figures released last week, the government’s contribution to real GDP growth was negative 1.2 percentage points in the first quarter of 2011, with about two-thirds of the decline coming from the federal government. Government purchases account for about 20% of GDP, so cuts in government purchases reduce GDP. “Fiscal drag,” the economists call it. Federal government purchases fell 9.4% in the first quarter (the unwinding of the stimulus surely had much to do with this), and state and local government purchases fell 3.4%. (In the second quarter federal purchases rose 2.2% and state and local purchases again fell 3.4%.)

P.S. The title’s musical inspiration is forty years off and I’ve used it before, but hey, it’s a good song.

Not shaken, not stirred

25 July 2011

So far, the Treasury bond market seems remarkably unconcerned about Washington politicians’ abject failure to reach an agreement on raising the debt ceiling. As of 3:20 pm Monday, after a weekend of dashed hopes for a bipartisan agreement for deficit reduction, the interest rate on 10-year T-bonds was 3.00%, up just 4 basis points from Friday’s close of 2.96%. I admit, I woke up expecting more of a negative reaction from the bond market. What gives?

From what I’ve read, there seem to be two factors at work here, of which the bond market is well aware:

(1) The debt ceiling drama has happened before, and those in the bond market expect Congress to raise the ceiling in time, just as they always have before (with the exception of 1979*). In all, Congress has raised the debt ceiling 74 times since 1962, including an average of once a year since 2001. Barry Ritholtz provides an excellent compendium of newsbites about past debt ceiling votes.

(2) Washington tends to go down to the wire on these deals, and this year “the wire” is Aug. 2, i.e., eight days away. Again, history suggests they’ll get a deal done this time, too.

* The 1979 episode has oddly disappeared down the memory hole, despite two months of hostage-taking over the current debt ceiling and despite the fact that the temporary default of 1979 — it lasted two weeks and was caused by a combination of Capitol Hill shenanigans and computer problems at the Treasury — caused Treasury interest rates to be an estimated 50 basis points higher for years, costing taxpayers billions in increased interest payments on the debt and slowing the economy. (Hat tips: Andrew Sullivan, Bruce Bartlett. The 50-basis-points estimate is from finance professors Terry Zivney & Dick Marcus.)

So is this summer’s repugnant, reckless, Republican posturing over this issue all that different from past obstruction by Democrats and Republicans over the necessary and obvious business of raising the debt limit so that the government can honor its commitments to creditors, employees, contractors, retirees, etc.? I haven’t seen anything this extreme since I started following politics, but then again that’s only been 30 years, and this time-wasting exercise that is the debt-ceiling vote has been around since 1917. (It probably served a purpose back then, as we were entering a world war.) If this time is different, the difference may be the simple fact that a great many Republicans (not just Michele Bachmann and the Tea Partiers but 53% of all Republicans, according to a Pew Research Center poll) think it will be no big deal if the debt limit is not raised by Aug. 2, or perhaps if it is not raised at all. Since President Obama clearly does and is unwilling to press for a clean vote to raise the debt limit with no strings attached, they’ve got him over a table.

shaken, not stirred

Pouring water on a drowning man

10 July 2011

Today’s New York Times editorial, “The Worst Time to Slow the Economy,” says it all. Voting against raising the debt ceiling is foolish even in the best of times, and it’s insanity right now. Congress already voted to raise the debt ceiling, or to do the equivalent, when it passed a budget with a deficit. It makes no sense for Congress to vote on the budget again.

Is the economy already in a double-dip recession? The rising unemployment rate (up to 9.2% for June, as announced on Friday, or 16.2% using the more inclusive U-6 unemployment rate) suggests it might be. See John Nichols’s column in The Nation for a good account of the unemployment crisis. Nichols says this is President Obama’s biggest problem, pointing out that no president since FDR has won reelection when unemployment was over 8%. (Nichols said over 7%, but he may have meant “over 7% and change,” as Reagan won reelection in 1984 when unemployment was about 7.5%. But at least it was falling, as it was for FDR in 1936 and 1940.)

While Nichols is correct that high unemployment is Obama’s biggest problem, it’s still true that the debt-ceiling impasse is Obama’s biggest worry. An act of supreme self-sabotage like not raising the debt ceiling could put the economy into free fall. As far as I can tell, Republicans who say it’s no big deal, like most of their presidential candidates, either (1) cynically are hoping it brings about an economic avalanche that sweeps Obama out of power or (2) cluelessly believe the Tea Party rhetoric about how “spending” has caused our current woes and think any shock that compels spending cuts will actually be good for the economy. It’s as if they were taught government purchases were a negative entry into GDP instead of a positive, i.e., GDP = Consumption + Investment + Net eXports – Government purchases, instead of GDP = C + I + G + NX.

If we’re lucky, the Constitution — in particular, the line in the 14th Amendment that says “The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned” — will save the day. The whole concept of a debt ceiling as something that Congress can refuse to raise, even to pay off previously issued debt, looks unconstitutional to me. (Former Reagan adviser Bruce Bartlett has forcefully raised this option.) But then again, it’s up to the Supreme Court to make that determination, and, as far as I know, nobody has asked them to yet. Harvard Law School Professor Laurence Tribe, in a New York Times op-ed that I otherwise tended to find unconvincing, points out that someone with standing would have to sue the government and that “increased interest rates would have already inflicted terrible damage by the time the Supreme Court ruled on the matter.”

So maybe the Constitution won’t ride to the rescue. Is there hope for a long-term bipartisan budget deal that could convince Congressional Republicans to raise the debt ceiling? And could such a deal be amenable to those of us who don’t want to shred the social safety net? I guess we’ll find out in a couple weeks.

Bummer in the summer (updated)

22 June 2011

In today’s press conference Bernanke acknowledges the obvious: the economy is worse than we thought and likely to stay that way into 2012.  The Fed lowered its official economic growth forecasts and raised its unemployment rate forecasts for 2011-2012. After almost two years of slow but steady recovery and myriad positive straws that one could grasp, the last couple of months have brought mostly lousy news, notably the latest jobs report, which showed a gain of just 54,000 jobs last month, only about a quarter or a sixth as many as we’d need to get unemployment down to normal levels in five years or so.

It’s notable that the imminent end of the Fed’s quantitative easing, all $600 billion of which will be over by the end of the month, brings few calls for another round — everyone seems to agree that we’re in a liquidity trap, in which further monetary stimulus fails to stimulate, because interest rates are already practically 0%, banks are not eager to lend, and companies are not eager to invest in new capital.*

Our best hope, it seems to me, is an almost nihilistic one: the economy somehow recovers on its own, through black-box mechanisms that we still don’t really understand. Business confidence returns, hiring finally picks up, and the economy roars forth. This may be a vain hope, but the “animal spirits” of investors (and consumers) that Keynes wrote about in The General Theory are not really visible, despite the several monthly surveys of business sentiment that are out there.

Our next best hope is another fiscal stimulus. It won’t be like the first one, which is about to run out and was too small anyway, not with a Republican majority in the House that believes spending = death and doesn’t even want to avert a financial crisis by raising the debt ceiling unless the Democrats agree to massive long-term spending cuts. But I could see the two parties agreeing on a big set of tax cuts, which is the usual form that a fiscal stimulus takes anyway (e.g., 1964, 1981, 2001).  That has a couple of disadvantages: (1) the “multiplier” effect of a tax cut on GDP is typically empirically estimated to be smaller than that of a spending increase of equal size, because not all of a tax cut gets spent; (2) tax cuts are hard to reverse, as everyone hates seeing their taxes go up, so they could make the long-term debt problem much worse. Still, it’s probably the only politically viable option for a fiscal stimulus.

* The last part of that statement (companies are not eager to invest in new capital) is less true than I had thought. As the Wall Street Journal article linked to below notes, a survey of banks indicated that small businesses were demanding more loans, at least in the first quarter of the year.

UPDATE: This Associated Press article from the next day’s newspapers adds some helpful detail. The headline from the Syracuse Post-Standard’s version of that article says it all: “Slow Economy a Puzzle: Fed chief flummoxed, says troubles could last a while.” My quick take:

(1) The economy has long been in a liquidity trap (Krugman’s definition, i.e., a slump in which monetary policy is no longer effective).

(2) Bernanke has long suspected this himself, but as Fed Chairman he feels obligated to try to stimulate the economy through monetary policy, via unusual, unprecedented channels “that just might work” like QE2.

(3) QE2 has failed to measurably stimulate the economy, because the economy was in a liquidity trap.

(4) Liquidity trap or not, it’s not easy for the Fed to just throw in the towel, so a QE3 might well happen. But I doubt the Street will get all that excited about it, considering what a dud QE2 seems to have been.

Raise the damn debt ceiling already

12 April 2011

As if the new agreement between the president and Congressional Republicans — to cut $38 billion in spending while the economy is still in a near-depression — weren’t bad enough, now the word is that the Republicans say they won’t vote to raise the debt ceiling, at least not without extracting several pounds of flesh first. Worse still, the overwhelming majority of the public opposes raising the debt ceiling.

I’ve blogged about this topic before. Not raising the debt ceiling would be like pushing the economy off a cliff. With a deficit of $1.5 trillion (and GDP of about $14 trillion), Congress would have to cut spending or raise taxes (or some combination thereof) by more than 10% of GDP. You don’t get that money back. That would be a depression of titanic proportions.  It would be ruinous under virtually any circumstances, but all the more so now, at a time of high unemployment. Herbert Hoover’s and FDR’s budget-balancing blunders during the Great Depression would be trivial by comparison. And Congress probably couldn’t come up with $1.5 trillion or anything close to that anyway. Normally we pay off our Treasury bonds as they come due by selling more bonds, which we would not be able to do anymore if the ceiling is kept constant. So we would default on all the maturing debt, and our new bonds would lose their AAA status, instantly and permanently, and we’d have to pay higher interest rates on our new bonds. With enough defaults our bonds would quickly be junk bonds, paying sky-high interest rates. This would add to the federal deficit and debt, possibly a lot.  So much for looking out for future generations.

If the Republicans pull the same game of brinkmanship that they did last week in nearly shutting down the government, by convincingly threatening to not to raise the debt ceiling and then raising it at the last minute, the bond market will still go oink (as one of my grad school professors used to say), and interest rates on Treasury bonds will still shoot up, meaning higher interest payments and a higher burden of paying them off. Bond investors hate uncertainty, and if default even looks possible, they will no longer regard Treasuries as riskless.

All of this opposition to raising the debt ceiling is a combination of cynicism, ignorance, and self-sabotage. We do have a long-term debt problem that needs to be addressed, but blowing up the economy is the most idiotic and counterproductive solution imaginable. Threatening to blow up the economy is not much better. As long as the economy is in a slump, the optimal amount of spending cuts is $0 (if continued stimulus is out of the question), not $1.5 trillion. And it would be even more optimal to have no more debt ceiling.