A dangerous game of chicken

Sometime during the next few months something very interesting might happen. Because during this period, the US Congress will be asked to raise the debt ceiling so that the US Treasury can continue to meet its obligations. The debt ceiling is a legal limit set by Congress on how much money the Treasury can borrow. In the past, it was raised from time to time. Over the past ten years, however, federal debts ballooned following the Bush administration’s 2001 tax cuts and the massive deficit spending that resulted (including for several undeclared wars). As a result, the debt ceiling has been raised ten times in the past ten years. And now Congress will be asked to do it again.

But we have a new Congress, with a House of Representatives now in the control of the Republicans, many of whom seem to be among the most intellectually challenged and ideological bunch you care to come across. As a result, the administration is starting its full court press early. Earlier this week, Obama’s chief economic advisor Austin Goolsbee was out there hitting the airwaves, talking about how crucial it was to get the debt ceiling raised. And yesterday, Treasury Secretary Tim Geithner sent a letter to Congress–in the person of the new Speaker, John Boehner, actually–reiterating the same points, pointing out that a failure to raise the debt limit would result in “catastrophic damage to the economy, potentially much more harmful than the effects of the financial crisis of 2008 and 2009.”

Of course, some Republicans seem resigned to raising the debt ceiling, like it or not. But even here, there is an air of unreality pervading the discussion. For example, there’s this:

A Treasury official urged lawmakers preparing for a new budget not to mix up the debt limit issue with calls for greater restraint in government spending.

The official, who spoke on condition of anonymity, expressed confidence that Congress will raise the debt limit if only because not doing so would be so damaging.

Well, does anyone remember what happened on the first TARP vote? A similar assumption was made then, only to have the measure voted down in the House of Representatives, and it was a pretty bi-partisan showing, too—much more so than this vote will be.

Of course, the incessant calls for further government cuts will continue, and will likely even intensify. And it may not be all Republicans, certainly, and there may even be some blue dog Democrats who might join in trying to block the increase. So we get this from that dim bulb, new Speaker John Boehner:

“The American people will not stand for such an increase unless it is accompanied by meaningful action by the President and Congress to cut spending and end the job-killing spending binge in Washington,” Boehner said.

Now, government “spending binges” generally aren’t job killing—in fact, they’re usually the reverse–but Boehner has to say something like this, if only to avoid the question of “if tax cuts are so good at stimulating job growth, how come they haven’t done diddly squat over the past decade?” And of course, when Boehner was asked yesterday what programs he would be trying to cut to meet the Republicans’ fantasy target of $100 billion in cuts this year, he couldn’t actually name any. And true to form, everything the new Republican majority accomplished yesterday (or not, as it turns out) will actually raise the deficits, not reduce them. So we all know this is bullshit. Note that Obama’s Defense Secretary, Robert Gates, yesterday proposed $78 billion of spending cuts from the bloated DOD budget, and Republicans are already howling. And the bloated Department of Homeland Security, which doesn’t even make us safer, still had a budget in the range of $55 billion in 2010—larger than the entire defense budget of the United Kingdom (which this year will be about £31.4 billion, or $51.4 billion in real money). But note that Gates’s proposals would get Republicans pretty far along in their bid to cut federal spending, so we’re already seeing some of the battle lines for a bit of a civil war among Republicans here. And as Spencer Ackerman notes above, Gates isn’t actually cutting the defense budget exactly—he’s eliminating some programs and spending the money elsewhere. So how much spending is actually being cut remains a bit of a mystery (although If I really tried, I could probably find out. I imagine someone will throw a number out before too long, though).

In fact, these battle lines will intensify, although perhaps not along the same lines. Because what we’ve got right now, I think, is a clear schism within the Republicans, between those who, like Reps. Ryan and Boehner, reluctantly agree that the debt ceiling should be raised, although perhaps only if accompanied by significant spending cuts, and those that don’t think it should be no matter what, damn the consequences. Bruce Bartlett has some choice words to describe this second group, or actually just one: insane.

Bartlett makes a number of good points, and you should read the whole interview, because he goes a bit further than most do in describing some of the consequences of even letting this get close. Bartlett is hardly a flaming liberal, of course, having worked in the Reagan administration, but like David Frum, he’s been drummed out of the party because he started attacking Republican economic irresponsibility in the middle of the decade. Here’s a selection, which should scare the hell out of you:

So what happens if we get to early March, U.S. borrowing hits the limit, and House Republicans refuse to raise it? What would be the immediate consequence?

Well, first of all, the Treasury has certain ways that they can get around the limit for a little while. They have some legal authority to move things around. For example, a large part of federal employee retirement funds are covered by special securities issued by the Treasury and the Treasury is permitted to not make regular contributions to the fund on a temporary basis, as long as it makes up the difference later on. And there are other tricks of this sort. There are even some economists who believe that the Treasury has an unlimited bag of tricks to do this. Personally, I don’t think so.

I think there really is a hard limit, but when we would hit that limit I don’t know. But assuming we do, what would then happen is that the Treasury would lack the cash flow to be able to pay its bills. Every single day the Treasury has bills to pay, Social Security benefits, interest on the national debt … But if the debt ceiling is not raised, the only cash it would have to pay those bills would come from the tax revenues that come in on a day-to-day basis — from the payroll tax or from income tax withholding. But that would not be enough to pay the bills that are due that day, so somebody at the Treasury is going to have to decide — as individuals do when their pay doesn’t cover their credit cards and other debts — who gets paid this month and who doesn’t. And, of course, there is a problem with this, because not everybody can be put be off. By law, Social Security benefits have to go out on the first of the month. But the Treasury literally would not have the cash in its account to cover those benefits, or to pay interest on the debt — at which point you have a default. Any time the precise terms of a bond are not adhered to — if you don’t receive exactly the amount of money you were promised, on exactly the day it was promised — you have a default, and that is what would happen under this circumstance.

But we’ve never let that happen before.

It’s never happened before. And I think many people in financial markets, and perhaps even in Washington, just assume away the possibility. They cannot conceive of the insanity of allowing the debt to default. But what I keep trying to explain to people is that these Tea Party people really are that crazy. And I’m just tying to get people to believe me.

But isn’t there a limit to how irresponsibly politicians can act? When the House Republicans rejected the first TARP authorization vote, the reaction in financial markets swiftly changed their minds. Wouldn’t the same thing be likely to happen this time around?

Perhaps. But do we really want to pay that price? Do we really want to introduce an element of doubt into the financial markets, that a security that is primarily bought because there is assumed to be risk zero risk of default is no longer safe? There is no other security on earth that has that reputation, not even German government bonds. The U.S. Treasury is the gold standard and we have benefited enormously from this fact. Every time there is some disruption in the world financial markets, people flee to quality by buying Treasuries. As a result, we have benefited by not having to pay for the consequences of our own profligacy. Foreign central banks hold trillions of dollars of Treasuries as the backing for their own securities. The minute we introduce an element of doubt into their own minds about whether these debts will be paid, suddenly other alternative investments may start to look better to them, and we will lose market share, which will greatly increase the costs of borrowing over the long term. It’s the most monumental insanity that I can even imagine.

I really don’t think it makes a lot of sense to shoot ourselves in the foot, just to make an idiotic point about the debt being too large. If people really believe that, they should vote to increase taxes and cut spending, and thereby reduce the Treasury’s need to borrow.

Just who is Bartlett worried about here? Well, guys like this guy, who thinks this is a form of taxation without representation. Then there are these guys, for whom it’s pure ideology. Is there a critical mass of these guys? Who knows? But here’s Bartlett’s concern, and I think he’s absolutely correct:

I have no doubt that there are enough rational people in the Republican Party together with enough Democrats to have the votes to increase the debt limit. The problem is that as we’ve seen in this last election, the Tea Party people have shown us that they don’t give a crap. Look, for example, at the defeat of Sen. Robert Bennett in Utah. He was one of the most conservative members of the Senate, and he was defeated primarily because he merely co-sponsored a bill with the Democrat Ron Wyden that put out an alternative approach to healthcare reform. This was deemed to be beyond the pale. He was defeated in the Republican primary, and I think this is the concern that every Republican has — of having someone run against them in the primary who says, This senator or congressman s.o.b. voted to increase the debt limit. They voted to give Obama more money to destroy our country with.

I don’t think there are very many Republicans that are going to take the risk of allowing that to happen.

So there’s a rock and hard place thing going on here. Even those Republicans who understand completely the need to do this may feel put off by the crazies out there who are ready to take them on in the next primary. Heck, even Richard Lugar, who at times seems to be the only Republican Senator left with any dignity, has been signaled that he’s going to face Tea Party opposition in his next primary. So what are those congressman who know for sure that someone to the right of them can’t wait to take them on going to do? Because those guys on the right don’t get it. Partly from ideology, and partly from a world view that derives form American exceptionalism, in which America is always privileged, and nothing really bad ever happens.

And this, I think, is crucial—the consequences just aren’t understood. I have recently finished a whole slew of books on the crisis of two years ago, and some were very good, some were less so. But all had a glaring hole in them. Which was no one really went into in detail what the consequence of letting the financial system go under would have looked like. Since this is my world, I have a pretty strong notion of what I think would have happened, and it resembles the same vision most of the people I know in this business had—the thoughtful people anyway. And to say it would have produced another great depression does get it right. But of course no one really remembers what the last one was like. No one has a clue what 25% or 30% (or more) unemployment would look like, with mass defaults on every sort of debt imaginable, with complete uncertainty on interest rates and the values of currencies, and the complete collapse of asset values in America and much of the rest of the world (much, much more than what we’ve seen). Whatever you think your house is worth, divide it by three or four or more. That’s the sort of economic carnage we’re talking about.

Think of the desolation of the abandoned industrial cities of America’s heartland, or someplace like Compton, and just spread it around. But most people in America aren’t familiar with that sort of desolation, and they prefer to believe it’s not that bad, anyway. My own view is that it would have been horrible, and would have taken decades to repair. There would have been some salutary side benefits, of course—a whole lot more localism, for example, and a lot of the barter economy. But the economy we’ve grown comfortable with over the past several decades, where all our wants can be instantly satisfied, usually on credit—that would be gone. And we were talking about the global banking system going under, a prospect that was not implausible. Which is why Henry Paulson did what he did. What we all understood was how incredibly, and dangerously, interlinked the global banking system had become–something apparently beyond the ken of your average American Congressman, probably because it hadn’t occurred to anyone to actually explain it to him or her.

Would this be similar? Well, probably, but not as bad elsewhere. It would affect mainly the US, because suddenly the dollar’s value as a reserve currency would be in question, and there’s no real alternative—but the Chinese sure would benefit, as would the other BRIC countries, Brazil, India and Russia. Interest rates would shoot up, and again we’d see massive increases in unemployment, and massive collapses of asset values. But the rest of the world would trundle along, so the global damage won’t be as severe. But the damage to the US would be significant, and long-lasting, and you know what? The US would really be broke then. Because it wouldn’t be able to borrow the way it does now. That, too, would have some benefits—we would no longer be able to be the world’s policeman (although whether this would really be a good thing is open to debate, obviously). It’s hard to sustain 737 military bases globally when you’re flat broke. Well, broke is an overstatement, probably. But the US would not have anything like the financial wherewithal it currently has. Because right now, because the US dollar is the global reserve currency, and US treasuries are the de facto AAA standard, the US gets to borrow internationally cheap. And if that goes, then everything—and I mean everything—goes off the rails in the US. The prospect of, like Africa, selling off farmland to the Chinese does not sound so far-fetched in this world.

The Wall Street Journal, by the way, will let you take a poll on whether the debt ceiling should be increased—right here. As of the time of writing, about 87% of the respondents favor not raising the debt ceiling, which tells you something, I suspect, about people who take polls offered by the Wall Street Journal. Note that one of the options is “only with billions in spending cuts.” Since the incoming Republican majority in the House doesn’t seem to have a clue what to cut, it’s not clear what this means, although in the comments we get the usual “eliminate the Departments of Education and Energy” stuff. Needless to say, since it’s the WSJ, the option of raising taxes for one of the most undertaxed major industrial countries in the OECD does not arise.

Zogby has a poll as well, which shows that 64% of those polled oppose raising the debt ceiling. As is probably the case with the WSJ polling results, there may be some selection bias among those taking the poll. Once again, diving into an analysis of why people believed what they believed shows that people don’t get it. The likely worst case scenario just doesn’t scan for most people, because most people just can’t conceive that a default is that big a deal.

Let’s hope we don’t find out. This is not an experiment we really want to conduct.

5 replies »

  1. I’m both amazed and disheartened that so many people think that America can be fixed by electing people to break it.

    Is our economy way out of whack? Obviously. But if we want to fix it we’re going to need to start with an honest discussion about it. This American Exceptionalism is the crux of the proverbial biscuit, because it’s the thing that keeps us from having an honest discussion…well, this and the fact that we don’t have any honest politicians willing to lead the conversation. (Because doing so could hurt their electoral chances.)

    I do have a question about the financial sector bailout. I understand that doing something was absolutely necessary at the time. Was what “we” did the only way to approach the issue?

  2. Lex–probably not, in hindsight. But–and there’s always a but–hindsight is wonderful when you have that luxury. I think one thing that needs to be remembered is that policymakers like Paulson and Geithner (who was head of the New York Fed at the time, and was therefore the go-to guy for getting anything done) were operating in an informational vacuum. Nobody knew anything. The regulatory guys (particularly the SEC) had no clue about what bank and asset manager exposures were to anything. The bank regulators (with the exception of Brooksley Born, who was concerned about dodgy exposures, and therefore was pushed out of her job because of that in the early 2000s) had no interest in exposures, or how uncontrolled they were. Insurance regulators had no clue about the massive exposures AIG had accumulated in a very short period of time, because AIG was under no obligation to tell them about some of them. There was a massive regulatory breakdown, so Paulson and Geithner–but mainly Paulson–were just making it up as the went along, because the information flow was changing on a daily basis–with each day worse than the one before. I don’t really like Geithner at all, and Paulson is just another Repub hack in some respects, but he turns out to have been the right Repub hack to have in that position. If anyone in this process emerged with any dignity, and it’s not clear to me that anyone did, it would be Paulson. But of course he had been head of Goldman Sachs before he became Treasury Secretary, so he was as culpable as anyone in allowing the mess to develop in the first place.

    So given what horrors they were discovering on a daily basis, it was probably the best that could be cobbled together at the time. In retrospect, I’m sure there were better solutions–there still are, in fact, but we still haven’t put them in place. When I finish Sitglitz’s Freefall I’ll be doing a post on the whole mess. But if you want to get a sense of the daily flow of events, Andrew Sorkin’s Too Big to Fail is pretty good–it won’t tell you why what happened happened, but it’s a lively chronicle of what those couple of months in 2008 were like when the whole thing unraveled, who said what when, that sort of thing. And he does a good job of showing how clueless everyone was at the time, in particular how clueless the people at the Fed and the SEC were. Investment banker beach reading.

  3. Thanks, Wuf. I’ve certainly gotten the impression from some that there were better means to the rescue end, but that makes sense that nobody really understood what was happening…which makes deciding on a solution pretty difficult.

    Perhaps we can chalk all the hatred up to the profound distrust (mostly justified) that most Americans have for their political leadership.