The debt ceiling drama continues. As with before, I’ve refrained from commenting on specific plans here, mainly because the plans change so quickly and I’m a weekend warrior blogger who can’t keep up with that.
I watched the dueling speeches Monday night from Obama and Boehner. My general impression of the speakers is that Boehner came across to me as firmer and perhaps even a bit combative versus Obama coming across as more flexible and conciliatory. Both had a vibe about them that they were the ones truly speaking on behalf of the American people. I think these speeches ultimately pave the way for a deal to be done. I’ve said all along a deal will happen, but I’m getting a bit nervous that the deal won’t be good enough to dodge a downgrade. I’m sticking with that, as I believe the leaders in Washington are starting to realize that voters will probably be more angry about a default than a suboptimal deal (whether it’s followed by a downgrade or not). I also think they're seeing that voters will be angry in a few months time if we do get downgraded. The leaders in Washington wanted two things first, however.
First, Obama and Boehner wanted one more opportunity to address their voters in prime time to allow each other to save face, paint themselves as the true voice of America, and bash the other side. Both sides wanted to tell the story of, “I did the best I could for America. This was mostly, if not entirely, the other party’s fault. I compromised a little, but I held firm most of the way, and we got a deal done.” We all know both parties are to blame for decades of fiscal mismanagement, with this past decade being one of the worst ever.
Seriously, though, how long can Obama continue to blame Bush Jr.? Obama’s 2.5 years into his presidency, and at some point, he has to stop blaming the previous administration and assume ownership. It’s no longer good enough to blame the previous administration. On the flip side, Boehner can’t fairly deny his party’s responsibility and can’t entirely blame the Democrats, either. The GOP wasn’t the pinnacle of fiscal discipline under Bush Jr., either. The GOP has a reasonable point that may not really own the first two years of Obama’s presidency since the Democrats had majorities in both houses of Congress and the White House, but now the GOP has a house of Congress and they now have some responsibility. Similarly, the Democrats can argue that the GOP had the White House and Congress for some of Bush Jr.’s time. I can appreciate that, but I’m personally tired of hearing the excuses from both sides.
(On a side note, am I the only one who thought Obama has come across as, for lack of a better term, offended that Congress isn’t meekly bending to his will? Congress is doing as it’s supposed to per the Constitution by asserting its responsibility and refusing to be the president’s lackey, which is a refreshing change of pace.)
Second, both sides wanted to create some panic, and if the action in the stock and bond markets this week is any indication, the markets are starting to cooperate a bit, but this isn’t panic like we saw in 2008 as the global financial system was collapsing. Friday’s major miss on advanced Q2 GDP (1.3% versus 1.9% expected) and the even bigger downward revision to Q1 GDP (from 1.9% to 0.4%) factored in, as well. Add in Boehner’s inability to get a vote in the House on Thursday night, too, which creates the impression that Boehner is losing control of the GOP.
Politically, they’d each like to be able to say, “The other party is crashing your retirement funds and home prices by being obstinate.” However, there’s more to it than that. As I’ve said in the past, politics is show-business for ugly people, and so we think about drama. Addressing a minor problem well ahead of time before it becomes a crisis isn’t very exciting, no matter how prudent such a course of action often is. Saving America from a crisis, on the other hand, is riveting. Sure, we know that it’s a crisis the politicians not only created, but have actively fueled recently, but that’s beside the point because the politicians would look good saving the day.
I suspect this will be a hectic weekend here. Now, there are even questions of whether that’s the real deadline. They’ve moved the deadline a few times in the past and some private sector analysts suggest there may be as much as two weeks extra. I don’t know about you, but I don’t think I can handle two more weeks of this travesty of leadership.
Anyway, stay tuned. This whole ordeal isn’t over yet.
Friday, July 29, 2011
Friday, July 22, 2011
Is the Debt Ceiling Legal and Do We Really Have One?
In the frenzied debt ceiling debate, we should stop to ask ourselves an important question. Is the debt ceiling legal? I recently had a discussion with someone who contends the debt ceiling is inherently illegal. I disagree with his conclusion, but the discussion is blog-worthy, in my opinion. He cited Section 4 of the 14th Amendment as his rationale, which I’ve put below in its entirety.
“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. But neither the United States nor any State shall
assume or pay any debt or obligation incurred in aid of insurrection or rebellion against
the United States, or any claim for the loss or emancipation of any slave; but all such
debts, obligations and claims shall be held illegal and void.”
He contended that this makes a debt ceiling unconstitutional because it says we have to honor our debts. If we violate the debt ceiling, then we default on our debt, which would mean we’re not honoring our debt. I suppose I see his point because if we default, then the rest of the world would question our debt, however, under this theory, we would also have to say that the credit ratings agencies downgrading our debt is illegal. I don’t really agree with this for two main reasons.
The first reason is that I think he’s misreading this section of the 14th Amendment and misunderstanding the history behind the excerpt in question. This doesn’t read to me as thought it means we cannot legally default on our debt (note that we never have defaulted on our debt, so there’s no actual legal precedent here). It’s not addressing whether we can or cannot default, but whether anyone has any standing to question the legitimacy of the debt.
As for the history, it basically was put in there for two reasons. One was to prevent former Confederates from questioning the legitimacy of US government bonds. However, as you read further, you see that the main purpose of this section is to ensure that the former Confederates (as well as the foreigners who financed the Confederacy, such as the English and French) don’t get reimbursed for their losses of war costs and/or slaves by the US government. In essence, this second part was done to ensure that anyone who tried to finance our downfall/division never gets any of their money back.
(On a side note, while we’re talking about this blurb of the Constitution, Bill Clinton contends that this empowers the White House to raise the debt ceiling via executive order without Congress’ approval. This doesn’t surprise me, but his argument, in my opinion, is simply ludicrous. Like the fellow who contends the debt ceiling itself is unconstitutional, Clinton is misreading and misinterpreting this excerpt. With some tweaks, the same basic logic I use to counter this fellow’s argument can be used to counter Clinton’s. Read on for more.)
If my first reason for disagreeing with him is his selection of what I see as an inapplicable section of the Constitution, then my second reason for disagreeing with him is naturally that I think there are more applicable sections of the Constitution. We consistently see throughout the Constitution, particularly in Article 1 Sections 7 and 8, that the so-called ‘power of the purse’ pertaining to America’s national financial matters often resides in Congress. I contend that Article 1, Section 8, the Powers of Congress, is more pertinent here, specifically Congress’ power, “To borrow money on the credit of the United States.”
My logic is simple. If Congress is empowered to borrow, then they can decide to borrow money (positive borrowing), to not borrow (said another way, zero borrowing), or to lend (which we can also think of as negative borrowing because). Under this logic, the ability to set a legal debt ceiling is well within Congress’ authority. So, the debt ceiling is legal and constitutional.
Do we actually have one? In theory and legally speaking, yes we technically do. We have laws on the books that establish the maximum level of debt we as a nation can undertake, aka a debt ceiling.
In practice, however, we really don’t have a debt ceiling because we consistently raise it every year or every couple years. We set the ceiling, then when we get close to bumping our heads on it, we raise the ceiling. Having a limit we ourselves can move kind of defeats the purpose of having a limit.
It’d be like me calling my credit card company if I get near my credit limit and telling them I’m going to increase my credit limit so I can rack up more debt. It doesn’t work that way in the real world. The credit card company would tell me no. The USA sets the limit on its own credit card, in other words. Sure, one could argue that the market for Treasury bonds sets the limit, but I highly doubt the market will ever completely stop buying Treasuries in the same way a credit card company could refuse to raise my limit and even cut off my credit card.
I think the debt ceiling is really there to appease the credit markets and ratings agencies. They know that if we have a limit, that could, in theory, act as a check on our excess borrowing. In practice, it doesn’t work that way because we can raise it at will, but it’s nice in theory.
“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. But neither the United States nor any State shall
assume or pay any debt or obligation incurred in aid of insurrection or rebellion against
the United States, or any claim for the loss or emancipation of any slave; but all such
debts, obligations and claims shall be held illegal and void.”
He contended that this makes a debt ceiling unconstitutional because it says we have to honor our debts. If we violate the debt ceiling, then we default on our debt, which would mean we’re not honoring our debt. I suppose I see his point because if we default, then the rest of the world would question our debt, however, under this theory, we would also have to say that the credit ratings agencies downgrading our debt is illegal. I don’t really agree with this for two main reasons.
The first reason is that I think he’s misreading this section of the 14th Amendment and misunderstanding the history behind the excerpt in question. This doesn’t read to me as thought it means we cannot legally default on our debt (note that we never have defaulted on our debt, so there’s no actual legal precedent here). It’s not addressing whether we can or cannot default, but whether anyone has any standing to question the legitimacy of the debt.
As for the history, it basically was put in there for two reasons. One was to prevent former Confederates from questioning the legitimacy of US government bonds. However, as you read further, you see that the main purpose of this section is to ensure that the former Confederates (as well as the foreigners who financed the Confederacy, such as the English and French) don’t get reimbursed for their losses of war costs and/or slaves by the US government. In essence, this second part was done to ensure that anyone who tried to finance our downfall/division never gets any of their money back.
(On a side note, while we’re talking about this blurb of the Constitution, Bill Clinton contends that this empowers the White House to raise the debt ceiling via executive order without Congress’ approval. This doesn’t surprise me, but his argument, in my opinion, is simply ludicrous. Like the fellow who contends the debt ceiling itself is unconstitutional, Clinton is misreading and misinterpreting this excerpt. With some tweaks, the same basic logic I use to counter this fellow’s argument can be used to counter Clinton’s. Read on for more.)
If my first reason for disagreeing with him is his selection of what I see as an inapplicable section of the Constitution, then my second reason for disagreeing with him is naturally that I think there are more applicable sections of the Constitution. We consistently see throughout the Constitution, particularly in Article 1 Sections 7 and 8, that the so-called ‘power of the purse’ pertaining to America’s national financial matters often resides in Congress. I contend that Article 1, Section 8, the Powers of Congress, is more pertinent here, specifically Congress’ power, “To borrow money on the credit of the United States.”
My logic is simple. If Congress is empowered to borrow, then they can decide to borrow money (positive borrowing), to not borrow (said another way, zero borrowing), or to lend (which we can also think of as negative borrowing because). Under this logic, the ability to set a legal debt ceiling is well within Congress’ authority. So, the debt ceiling is legal and constitutional.
Do we actually have one? In theory and legally speaking, yes we technically do. We have laws on the books that establish the maximum level of debt we as a nation can undertake, aka a debt ceiling.
In practice, however, we really don’t have a debt ceiling because we consistently raise it every year or every couple years. We set the ceiling, then when we get close to bumping our heads on it, we raise the ceiling. Having a limit we ourselves can move kind of defeats the purpose of having a limit.
It’d be like me calling my credit card company if I get near my credit limit and telling them I’m going to increase my credit limit so I can rack up more debt. It doesn’t work that way in the real world. The credit card company would tell me no. The USA sets the limit on its own credit card, in other words. Sure, one could argue that the market for Treasury bonds sets the limit, but I highly doubt the market will ever completely stop buying Treasuries in the same way a credit card company could refuse to raise my limit and even cut off my credit card.
I think the debt ceiling is really there to appease the credit markets and ratings agencies. They know that if we have a limit, that could, in theory, act as a check on our excess borrowing. In practice, it doesn’t work that way because we can raise it at will, but it’s nice in theory.
Sunday, July 17, 2011
Dangers of Default
As you know, the USA is in danger of default if we don’t either raise the debt ceiling or provide some combination of spending cuts and tax increases. I still think we’ll see a deal that entails all three of these and prevents a default, despite the political quagmire in Washington DC.
The left contends that a default would be catastrophic while the right is saying it wouldn’t be that big of a deal. The liberals’ logic is basically that life as we know it will change forever in America if we default. The conservatives’ logic is basically that countries default all the time and they still survive. Who’s correct? As usual, the truth lies somewhere in between what the conservatives and liberals say, but the question of who is more correct depends upon what timeframe we’re talking about.
In the short term (five years or less), a default would be the disaster the liberals contend it would be. America would be in a financial house of pain and it would cause an epic shockwave to reverberate through the global markets. The dreaded double-dip recession (or the continuation of the present recession if you don’t believe we exited the recent recession) would be all but certain. I suspect stock, real estate, and commodity prices would take a pounding. Interest rates would likely surge, as well.
However, in the long term (a decade or more), a default now could continue being catastrophic. Yes, it’s possible it would not only be no big deal, but it may even be a good thing because it’ll finally force us to get our fiscal house in order, as the conservatives say. I still disagree with their thinking, though. They contend that countries default all the time and they end up stronger after they default than they were before, while providing several examples. That’s true in many cases, but I don’t recall a case involving the default of the country with by far the world’s largest and most powerful economy, which happens to be the USA. It’s not a risk I’d be comfortable taking, personally.
I think we want to avoid default. Suppose we do. Does that mean we’re out of the woods? I don’t think so. We still have the ratings agencies to worry about. For a little context, the USA currently carries the best rating in the world with all three major ratings agencies, namely Moody’s, Fitch, and S&P. However, recently Moody’s and S&P recently put the USA on negative credit watch, meaning that there’s a possibility that the USA could catch a downgrade.
So is a downgrade coming? I view the risk of a downgrade as a low-probability event, though I also view the risk as more likely now than at any other time in America’s history and the risk is large enough that it’s something we have to consider.
Moody’s has made it clear that they won’t downgrade the US unless we actually miss an interest payment on our bonds (AKA default on our bonds, which has never happened, FYI). Presumably, if we raise the debt ceiling and do some blend of tax hikes and spending cuts, we’d be safe from Moody’s. That’s what their statements imply to me.
I believe that if we’re going to get a downgrade, it’ll most likely come from S&P, who, though coming to the party a bit later than Moody’s, is also being much firmer. I read the S&P negative watch report, and they left the window open for a downgrade if the US raises the debt ceiling without any tax increases or meaningful spending cuts. Basically, S&P is worried that since this potential raise of the debt ceiling has proven to be a very big fight, they aren’t comfortable banking on the US being able to raise its debt ceiling again in a year or two or whatever. Interestingly enough, S&P does their debt/GDP calculation a bit differently than I do and theirs show the USA in much better shape than mine do, but until I understand why theirs are different and I agree with their methodology, I’m sticking with mine.
So, suppose S&P does a downgrade. What would happen? In addition to the aforementioned economic calamity, we would obviously see interest rates rise, making borrowing more expensive for the government, as well as people and businesses since many interest rates are tied directly to Treasury rates.
But, wait, there’s more. What’s even worse than having a lot of interest rates tied to Treasuries is also having a lot of other securities whose ratings are tied to Treasuries. In other words, if Treasures get downgraded, all these securities get downgraded, too. We’re talking about the possibility of an immediate downgrade in all debt from Fannie Mae and Freddie Mac, mortgage-backed bonds, municipal bonds, and agency bonds. If these securities get downgraded (which is not guaranteed, but is possible and indeed likely), the holders of the securities, such as banks and insurance companies, see increased capital requirements, meaning they need to keep more money on their balance sheets to guard against the risk of default. Moody’s mentioned this in their release, saying that if the Treasury notes get downgraded, they’d take a lot of other stuff down with them (note that some of these securities, like agency-backed MBS, are not officially rated, per se, but carry an implied rating of sorts).
Personally, I want to avoid a default and I don’t buy the right-wing argument that default would be no big deal and would be good in the end. If we can get our fiscal house in order without default, then we should because that is far better than defaulting.
I’ve said it before, and I’ll say it again. The period for political partisan posturing has passed (how’s that for alliteration?). Do the deal and be done with it. I think we can get our fiscal house in order without the pain of default, but our leaders have to get serious about it.
The left contends that a default would be catastrophic while the right is saying it wouldn’t be that big of a deal. The liberals’ logic is basically that life as we know it will change forever in America if we default. The conservatives’ logic is basically that countries default all the time and they still survive. Who’s correct? As usual, the truth lies somewhere in between what the conservatives and liberals say, but the question of who is more correct depends upon what timeframe we’re talking about.
In the short term (five years or less), a default would be the disaster the liberals contend it would be. America would be in a financial house of pain and it would cause an epic shockwave to reverberate through the global markets. The dreaded double-dip recession (or the continuation of the present recession if you don’t believe we exited the recent recession) would be all but certain. I suspect stock, real estate, and commodity prices would take a pounding. Interest rates would likely surge, as well.
However, in the long term (a decade or more), a default now could continue being catastrophic. Yes, it’s possible it would not only be no big deal, but it may even be a good thing because it’ll finally force us to get our fiscal house in order, as the conservatives say. I still disagree with their thinking, though. They contend that countries default all the time and they end up stronger after they default than they were before, while providing several examples. That’s true in many cases, but I don’t recall a case involving the default of the country with by far the world’s largest and most powerful economy, which happens to be the USA. It’s not a risk I’d be comfortable taking, personally.
I think we want to avoid default. Suppose we do. Does that mean we’re out of the woods? I don’t think so. We still have the ratings agencies to worry about. For a little context, the USA currently carries the best rating in the world with all three major ratings agencies, namely Moody’s, Fitch, and S&P. However, recently Moody’s and S&P recently put the USA on negative credit watch, meaning that there’s a possibility that the USA could catch a downgrade.
So is a downgrade coming? I view the risk of a downgrade as a low-probability event, though I also view the risk as more likely now than at any other time in America’s history and the risk is large enough that it’s something we have to consider.
Moody’s has made it clear that they won’t downgrade the US unless we actually miss an interest payment on our bonds (AKA default on our bonds, which has never happened, FYI). Presumably, if we raise the debt ceiling and do some blend of tax hikes and spending cuts, we’d be safe from Moody’s. That’s what their statements imply to me.
I believe that if we’re going to get a downgrade, it’ll most likely come from S&P, who, though coming to the party a bit later than Moody’s, is also being much firmer. I read the S&P negative watch report, and they left the window open for a downgrade if the US raises the debt ceiling without any tax increases or meaningful spending cuts. Basically, S&P is worried that since this potential raise of the debt ceiling has proven to be a very big fight, they aren’t comfortable banking on the US being able to raise its debt ceiling again in a year or two or whatever. Interestingly enough, S&P does their debt/GDP calculation a bit differently than I do and theirs show the USA in much better shape than mine do, but until I understand why theirs are different and I agree with their methodology, I’m sticking with mine.
So, suppose S&P does a downgrade. What would happen? In addition to the aforementioned economic calamity, we would obviously see interest rates rise, making borrowing more expensive for the government, as well as people and businesses since many interest rates are tied directly to Treasury rates.
But, wait, there’s more. What’s even worse than having a lot of interest rates tied to Treasuries is also having a lot of other securities whose ratings are tied to Treasuries. In other words, if Treasures get downgraded, all these securities get downgraded, too. We’re talking about the possibility of an immediate downgrade in all debt from Fannie Mae and Freddie Mac, mortgage-backed bonds, municipal bonds, and agency bonds. If these securities get downgraded (which is not guaranteed, but is possible and indeed likely), the holders of the securities, such as banks and insurance companies, see increased capital requirements, meaning they need to keep more money on their balance sheets to guard against the risk of default. Moody’s mentioned this in their release, saying that if the Treasury notes get downgraded, they’d take a lot of other stuff down with them (note that some of these securities, like agency-backed MBS, are not officially rated, per se, but carry an implied rating of sorts).
Personally, I want to avoid a default and I don’t buy the right-wing argument that default would be no big deal and would be good in the end. If we can get our fiscal house in order without default, then we should because that is far better than defaulting.
I’ve said it before, and I’ll say it again. The period for political partisan posturing has passed (how’s that for alliteration?). Do the deal and be done with it. I think we can get our fiscal house in order without the pain of default, but our leaders have to get serious about it.
Friday, July 15, 2011
My Impressions of the Debt Ceiling Discussion So Far
This debt ceiling thing is dragging its way towards the August deadline. Here are my broad impressions so far.
It’s far too early for either side to declare victory for themselves and/or defeat for the other side, so I’m not going there. However, despite this debacle of a ‘negotiation’, I’m still sticking to my belief that a deal will be done and default will be avoided. I just want to touch on three bone-headed negotiating tactics, two on the GOP side and one from Obama.
First, before I do that, the ratings agencies, namely Moody’s, Dagong, S&P, and Fitch sort of finally realized that the debt ceiling might be a problem. It blows my mind that it took them this long to put out statements, but it’s also par for the course for them, as they’re not exactly known for getting these things right in an actionable timeframe.
The GOP idea to introduce a Balanced Budget Amendment to the Constitution into the discussions is a terrible idea. It’s not because the BBA itself is a bad idea. I think it’s a great idea if we can shape it such that it works just right, meaning it works well enough to ensure fiscal discipline and long-term fiscal sustainability while not working too well and having dangerous short to mid-term effects on the economy. However, this is the kind of idea that needs time to be carefully thought-out and written. This is not the kind of thing you try to write with such a near-term deadline. If the GOP really wants to go there as part of these discussions, I suggest they instead attach a provision to the bill stating that Congress has X deadline to craft a BBA to submit to the state legislatures/conventions for approval.
Also, on the note of poor negotiation, GOP Senate Minority Leader Mitch McConnell did a great job of knee-capping the GOP position by offering an alternative proposal that would basically expand Obama’s authority to increase the debt ceiling. So, the GOP’s first plan is to fight tooth and nail to ensure that the debt ceiling isn’t increased, and if it is increased, ensure that there are strong spending cuts. Their back-up plan is to allow Obama to increase the debt ceiling with no strings attached. That’s like a sports coach saying to the team, “Ok, we’re gonna go out there, fight hard, and win big. Or maybe win. Perhaps a tie? Screw it. If things get too tough, let’s just give up.”
By the way, former Speaker of the House and current House Democrat Minority Leader Nancy Pelosi had this to say about McConnell’s idea. “Everyone who is concerned about lifting the debt ceiling is saying bravo for Senator McConnell.” She couldn’t possibly be more wrong. You clearly see I’m concerned about it and you clearly see I’m not applauding McConnell, and I’m not the only one. The GOP is also very angry, and rightly so.
It’s not just the right that’s doing some bad negotiating because Obama trying to play the Social Security checks card is a dreadful miscalculation. He’s saying that if a deal isn’t reached, then Social Security checks may not go out. It’s a great scare tactic, but it’s a bad card to play. Obama would be opening up Pandora’s Box for the Democrats politically here. For one, the GOP could easily put forth a resolution that puts Social Security checks first or second or wherever in line to receive government money in the event of a default. If a Democrat votes against said resolution or Obama doesn’t sign it, the right can easily create a perception of someone who doesn’t care about seniors. This would also drive a wedge between Obama and his party. For two, if we already seriously need inflows from borrowing to ensure that Social Security checks go out, it sure makes Social Security look unsustainable. If we’re already at that point, how are we going to handle the baby boomers when they really begin retiring? This would make the general Democrat party line that Social Security is perfectly fine look like the foolish nonsense it really is.
I have plenty more to say on this, but I’d rather wait until we have something that looks even remotely like a deal before I go there. Some tactics, like the GOP BBA idea, McConnell’s GOP knee-capping, and Obama’s Social Security play, however, are exceptionally horrible ideas that I can’t help but highlight. In the mean time, I’ve got some other debt-related posts to put up.
It’s far too early for either side to declare victory for themselves and/or defeat for the other side, so I’m not going there. However, despite this debacle of a ‘negotiation’, I’m still sticking to my belief that a deal will be done and default will be avoided. I just want to touch on three bone-headed negotiating tactics, two on the GOP side and one from Obama.
First, before I do that, the ratings agencies, namely Moody’s, Dagong, S&P, and Fitch sort of finally realized that the debt ceiling might be a problem. It blows my mind that it took them this long to put out statements, but it’s also par for the course for them, as they’re not exactly known for getting these things right in an actionable timeframe.
The GOP idea to introduce a Balanced Budget Amendment to the Constitution into the discussions is a terrible idea. It’s not because the BBA itself is a bad idea. I think it’s a great idea if we can shape it such that it works just right, meaning it works well enough to ensure fiscal discipline and long-term fiscal sustainability while not working too well and having dangerous short to mid-term effects on the economy. However, this is the kind of idea that needs time to be carefully thought-out and written. This is not the kind of thing you try to write with such a near-term deadline. If the GOP really wants to go there as part of these discussions, I suggest they instead attach a provision to the bill stating that Congress has X deadline to craft a BBA to submit to the state legislatures/conventions for approval.
Also, on the note of poor negotiation, GOP Senate Minority Leader Mitch McConnell did a great job of knee-capping the GOP position by offering an alternative proposal that would basically expand Obama’s authority to increase the debt ceiling. So, the GOP’s first plan is to fight tooth and nail to ensure that the debt ceiling isn’t increased, and if it is increased, ensure that there are strong spending cuts. Their back-up plan is to allow Obama to increase the debt ceiling with no strings attached. That’s like a sports coach saying to the team, “Ok, we’re gonna go out there, fight hard, and win big. Or maybe win. Perhaps a tie? Screw it. If things get too tough, let’s just give up.”
By the way, former Speaker of the House and current House Democrat Minority Leader Nancy Pelosi had this to say about McConnell’s idea. “Everyone who is concerned about lifting the debt ceiling is saying bravo for Senator McConnell.” She couldn’t possibly be more wrong. You clearly see I’m concerned about it and you clearly see I’m not applauding McConnell, and I’m not the only one. The GOP is also very angry, and rightly so.
It’s not just the right that’s doing some bad negotiating because Obama trying to play the Social Security checks card is a dreadful miscalculation. He’s saying that if a deal isn’t reached, then Social Security checks may not go out. It’s a great scare tactic, but it’s a bad card to play. Obama would be opening up Pandora’s Box for the Democrats politically here. For one, the GOP could easily put forth a resolution that puts Social Security checks first or second or wherever in line to receive government money in the event of a default. If a Democrat votes against said resolution or Obama doesn’t sign it, the right can easily create a perception of someone who doesn’t care about seniors. This would also drive a wedge between Obama and his party. For two, if we already seriously need inflows from borrowing to ensure that Social Security checks go out, it sure makes Social Security look unsustainable. If we’re already at that point, how are we going to handle the baby boomers when they really begin retiring? This would make the general Democrat party line that Social Security is perfectly fine look like the foolish nonsense it really is.
I have plenty more to say on this, but I’d rather wait until we have something that looks even remotely like a deal before I go there. Some tactics, like the GOP BBA idea, McConnell’s GOP knee-capping, and Obama’s Social Security play, however, are exceptionally horrible ideas that I can’t help but highlight. In the mean time, I’ve got some other debt-related posts to put up.
Sunday, July 10, 2011
The Politics of the Debt Ceiling
My US debt ceiling series continues. We’re still at $14 trillion or so. This time, I want to look more at the politics of the situation and how I expect it to actually play out.
I’ve previously discussed how we should switch to a debt/GDP ratio instead of an absolute level of debt set as some arbitrary increase on top of the current level. I’ve also previously discussed how government finance really isn’t much different than personal or business finance, save the government being able to print money and inflate their way out of debt.
It’s not the first time, and sadly, it won’t be the last time. In fact, it’s more like that time every couple years where you’re home sick from school/work, completely bed-ridden and miserable, and the TV is stuck on the rerun of a really bad movie. But, I digress.
First, what if we hit the ceiling? Two things happen. One, the global markets get nervous, which can lead to all kinds of unintended consequences. In theory, we could end up being the fodder for global headlines of impending fiscal doom, sort of like Greece, Spain, Portugal, and Ireland have been recently. Our borrowing rates, as measured by Treasury note rates (yields), could increase like theirs did. With bonds, yield moves in the opposite direction of price, so as bonds get sold, the price drops and yield rises, but as bonds get bought, price rises and yields drop. The Treasury rates are what the government pays to borrow money. Also, many private loans, like mortgages, cars, and business loans, are indexed to Treasury rates, meaning they rise and fall with Treasury rates. So, if the market gets nervous about the US, our Treasury bonds will get sold because investors are scared to hold them, and rates will rally. Increasing borrowing rates increases the costs of borrowing. If you can only afford a certain mortgage payment per month, with all else equal, you can buy a more expensive house if rates are at 5% versus 6% because less of your monthly payment goes to paying interest costs.
Two, the government can’t borrow any more money, so it must get creative to keep things going. Such creativity includes finding money, like Clinton Treasury Secretary Robert Rubin did when he borrowed about $60 billion from federal pension funds. It also includes deferring costs, as Reagan Treasury Secretary James Baker did when he delayed payments to the Civil Service and Social Security Trust Funds. We’ve already done some of these, too. The bottom line is there’s no shortage of band-aid fixes that can be done to handle the problem in the short-term, but the only long-term solution is to reduce spending and juice GDP to reduce the debt/GDP ratio I’ve been harping on.
It’s interesting to see how, in the world of politics, your views change depending on what side of an issue you’re presently on. A Democrat senator spoke about it during George W. Bush’s 2006 request to raise the debt ceiling to $9T. “The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the US government can’t pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance the government’s reckless fiscal policies.” That senator was none other than Barack Obama.
Has Obama’s view changed? I’m thinking yes. In the interest of fairness, I must also ask today’s GOP budget hawks a similar question. Where were they in 2006?
So how will this play out? I hope the GOP and Democrats learned from history. In recent history, the closest parallel is 1995’s government shutdown debacle. You had a first-term Democrat president and a newly-elected, bigger, bolder GOP-controlled Congress. Sound familiar?
In 1995, it was Newt Gingrich leading the GOP Congress against President Clinton. This did not work out well for the GOP. Long story short, Clinton outfoxed Gingrich and the GOP paid for it in the 1996 presidential election when Clinton easily won reelection against Bob Dole. I think the 1995 episode was a big reason Clinton won so easily…well, that and the fact that Bob Dole was not a terribly strong candidate.
Too many current Republicans were around in 1995 and remember it quite vividly. It’s unfathomable to me that they would allow it to go that way again 16 years later. On the other hand, Obama and the Democrats would love to see history repeat itself.
In the end, I think this is going to be largely a non-event (this is part of why I’ve held off on this series of posts since the first one). I also think we’ll avoid default. It’s unfathomable to me that our leadership would be foolish enough to actually allow a default to occur, though I wouldn’t put it past either side, particularly the GOP, to use it as a bargaining chip. My guess is they’ll increase the ceiling enough to make it so that we don’t have to revisit this again before the 2012 elections. Politicians are notorious for crafting “solutions” today that appear to work while in reality not only failing to work, but actually make the problem worse in the future (too many examples to list here). I don’t expect anything meaningful in the way of reform to come out of this, though I do expect some spending cuts and tax increases. Lastly, expect both sides to claim victory and blame each other for not “going further” to address the problem.
I’ve previously discussed how we should switch to a debt/GDP ratio instead of an absolute level of debt set as some arbitrary increase on top of the current level. I’ve also previously discussed how government finance really isn’t much different than personal or business finance, save the government being able to print money and inflate their way out of debt.
It’s not the first time, and sadly, it won’t be the last time. In fact, it’s more like that time every couple years where you’re home sick from school/work, completely bed-ridden and miserable, and the TV is stuck on the rerun of a really bad movie. But, I digress.
First, what if we hit the ceiling? Two things happen. One, the global markets get nervous, which can lead to all kinds of unintended consequences. In theory, we could end up being the fodder for global headlines of impending fiscal doom, sort of like Greece, Spain, Portugal, and Ireland have been recently. Our borrowing rates, as measured by Treasury note rates (yields), could increase like theirs did. With bonds, yield moves in the opposite direction of price, so as bonds get sold, the price drops and yield rises, but as bonds get bought, price rises and yields drop. The Treasury rates are what the government pays to borrow money. Also, many private loans, like mortgages, cars, and business loans, are indexed to Treasury rates, meaning they rise and fall with Treasury rates. So, if the market gets nervous about the US, our Treasury bonds will get sold because investors are scared to hold them, and rates will rally. Increasing borrowing rates increases the costs of borrowing. If you can only afford a certain mortgage payment per month, with all else equal, you can buy a more expensive house if rates are at 5% versus 6% because less of your monthly payment goes to paying interest costs.
Two, the government can’t borrow any more money, so it must get creative to keep things going. Such creativity includes finding money, like Clinton Treasury Secretary Robert Rubin did when he borrowed about $60 billion from federal pension funds. It also includes deferring costs, as Reagan Treasury Secretary James Baker did when he delayed payments to the Civil Service and Social Security Trust Funds. We’ve already done some of these, too. The bottom line is there’s no shortage of band-aid fixes that can be done to handle the problem in the short-term, but the only long-term solution is to reduce spending and juice GDP to reduce the debt/GDP ratio I’ve been harping on.
It’s interesting to see how, in the world of politics, your views change depending on what side of an issue you’re presently on. A Democrat senator spoke about it during George W. Bush’s 2006 request to raise the debt ceiling to $9T. “The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the US government can’t pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance the government’s reckless fiscal policies.” That senator was none other than Barack Obama.
Has Obama’s view changed? I’m thinking yes. In the interest of fairness, I must also ask today’s GOP budget hawks a similar question. Where were they in 2006?
So how will this play out? I hope the GOP and Democrats learned from history. In recent history, the closest parallel is 1995’s government shutdown debacle. You had a first-term Democrat president and a newly-elected, bigger, bolder GOP-controlled Congress. Sound familiar?
In 1995, it was Newt Gingrich leading the GOP Congress against President Clinton. This did not work out well for the GOP. Long story short, Clinton outfoxed Gingrich and the GOP paid for it in the 1996 presidential election when Clinton easily won reelection against Bob Dole. I think the 1995 episode was a big reason Clinton won so easily…well, that and the fact that Bob Dole was not a terribly strong candidate.
Too many current Republicans were around in 1995 and remember it quite vividly. It’s unfathomable to me that they would allow it to go that way again 16 years later. On the other hand, Obama and the Democrats would love to see history repeat itself.
In the end, I think this is going to be largely a non-event (this is part of why I’ve held off on this series of posts since the first one). I also think we’ll avoid default. It’s unfathomable to me that our leadership would be foolish enough to actually allow a default to occur, though I wouldn’t put it past either side, particularly the GOP, to use it as a bargaining chip. My guess is they’ll increase the ceiling enough to make it so that we don’t have to revisit this again before the 2012 elections. Politicians are notorious for crafting “solutions” today that appear to work while in reality not only failing to work, but actually make the problem worse in the future (too many examples to list here). I don’t expect anything meaningful in the way of reform to come out of this, though I do expect some spending cuts and tax increases. Lastly, expect both sides to claim victory and blame each other for not “going further” to address the problem.
Friday, July 8, 2011
Government Finance versus Personal and Business Finance
I'm back from vacation and I have some catching up to do on here, so two posts this weekend about the debt ceiling situation.
I wrote previously about the government debt ceiling, spending most of that post detailing the history of the (under-followed) debt/GDP ratio. That wasn’t the plan when I started the post. I wanted to do two things in that post, and I promise I’ll do them here. I kept this on the back burner until the debt ceiling finally started to appear in the news.
First, I wanted to detail the absurdity of using an arbitrary increase over the current level as a debt ceiling versus indexing the measure to growth, which the debt/GDP ratio does.
Think of it this way. $14 trillion in debt is perfectly acceptable if you have a GDP of $140T (debt/GDP = 10%), however that same $14T is a major problem if you have a GDP of $14T, like we have now (debt/GDP = 100%). Said another way, as long as GDP is much larger than debt, or GDP is growing faster than debt if they’re roughly equal, you’re in good shape.
I mentioned in my last post that 90% debt/GDP is the key level to stay under, and once you go above that, trouble can follow. That wasn’t just a random number. My source is a paper called "Growth in a Time of Debt" by Carmen Reinhart and Kenneth Rogoff. It can be found here. I share their view that wartime spikes in debt/GDP are acceptable because they often unwind quickly once the war ends (and because, many times, going to war is about survival, and if you lose, it doesn’t matter if your debt/GDP is 10% or 1,000% because you’re dead and/or conquered). I also agree that peacetime spikes in debt/GDP are more dangerous because they are harder to unwind and often accompany some sort of domestic angst.
At face value, this makes perfect sense. Debt brings with it servicing costs (aka interest). With debt, you’re taking money that could be spent on investment or consumption and you’re using it to service debt by paying interest costs. Too much debt will strangle a person, business, or a government. Investment spending is ideal. Here’s an example.
If you borrow at a 5% annual rate and make a 15% annual return on investment, your net ROI is 10% (15% AROI – 5% annual borrowing rate; assuming no inflation, taxes, or other costs – simple example here). That’s a reasonable investment case. However, if you borrow at 5% for consumption, you’re probably going to get an AROI of zero, so your net ROI is actually -5%. Obviously, we can’t invest everything because we need to consume to live.
This makes the perfect transition to the second thing I wanted to do, which is to spend more time talking about how government finance isn’t so different than personal or business finance (except for the fact that governments can print money and inflate their way out of debt, but that's a sad story for another time).
At its most basic, finance is very simple. If you bring in more money than you put out, you’re fine, and if you spend more than you earn, you’re going to have trouble eventually. Simply put, live within your means. Whether you’re a government or a business or an individual, just do that and you’re all set.
This line of thought could make someone say they never want debt, to which is I say, “Not so fast, my friend.” As I showed above, there is good debt and bad debt. I generally view good debt as something that either makes money (investment) or ensures survival (war debt or healthcare) for you and your family. Consumption is a little bit of a gray area. A reasonable level of consumption is necessary to ensure survival and happiness. Besides, you can’t take the money with you when you die. However, excess consumption is also dangerous. It’s a balancing act, but everyone’s got to live within their means and find what works for them while ensuring financial viability.
This is not always easy to do in a society that still places great emphasis on the appearance of wealth, whether it’s real or not. Progress is what counts, not the illusion of progress.
Let me leave you with this last bridge between government finance and personal/business finance. This will be a bit back-of-the-envelope, but instructive nevertheless.
$14T in debt with approximately 300 million Americans translates to over $45,000 per person. But, wait, there’s more. Just like a bad infomercial. That’s per person, not per labor force participant. The American workforce is roughly 150 million, so we half the number of people involved and subsequently double that debt to over $90,000 per labor force participant.
Labor force participants include employed and unemployed people. We’re at about 10% U3 unemployment, the official headline number (yes, I know it’s a bit lower, but I’m keeping the math simple, and yes, when I refer to unemployment, I usually use U6, which is currently around 17% and it includes those who want full-time work and can only find part-time work, but U3 is more appropriate here). So, we decrease the 150 million by 10%, taking it down to 135 million. So, $14T in debt divided by 135 million is just over $100,000.
Yes, this means that every working American today, in effect, has $100,000 of extra debt. Again, this excludes state and local level debt, so depending on what kind of shape your town and state are in, it could be a little higher or a lot higher. Ouch.
Links:
http://www.aeaweb.org/aea/conference/program/retrieve.php?pdfid=460
I wrote previously about the government debt ceiling, spending most of that post detailing the history of the (under-followed) debt/GDP ratio. That wasn’t the plan when I started the post. I wanted to do two things in that post, and I promise I’ll do them here. I kept this on the back burner until the debt ceiling finally started to appear in the news.
First, I wanted to detail the absurdity of using an arbitrary increase over the current level as a debt ceiling versus indexing the measure to growth, which the debt/GDP ratio does.
Think of it this way. $14 trillion in debt is perfectly acceptable if you have a GDP of $140T (debt/GDP = 10%), however that same $14T is a major problem if you have a GDP of $14T, like we have now (debt/GDP = 100%). Said another way, as long as GDP is much larger than debt, or GDP is growing faster than debt if they’re roughly equal, you’re in good shape.
I mentioned in my last post that 90% debt/GDP is the key level to stay under, and once you go above that, trouble can follow. That wasn’t just a random number. My source is a paper called "Growth in a Time of Debt" by Carmen Reinhart and Kenneth Rogoff. It can be found here. I share their view that wartime spikes in debt/GDP are acceptable because they often unwind quickly once the war ends (and because, many times, going to war is about survival, and if you lose, it doesn’t matter if your debt/GDP is 10% or 1,000% because you’re dead and/or conquered). I also agree that peacetime spikes in debt/GDP are more dangerous because they are harder to unwind and often accompany some sort of domestic angst.
At face value, this makes perfect sense. Debt brings with it servicing costs (aka interest). With debt, you’re taking money that could be spent on investment or consumption and you’re using it to service debt by paying interest costs. Too much debt will strangle a person, business, or a government. Investment spending is ideal. Here’s an example.
If you borrow at a 5% annual rate and make a 15% annual return on investment, your net ROI is 10% (15% AROI – 5% annual borrowing rate; assuming no inflation, taxes, or other costs – simple example here). That’s a reasonable investment case. However, if you borrow at 5% for consumption, you’re probably going to get an AROI of zero, so your net ROI is actually -5%. Obviously, we can’t invest everything because we need to consume to live.
This makes the perfect transition to the second thing I wanted to do, which is to spend more time talking about how government finance isn’t so different than personal or business finance (except for the fact that governments can print money and inflate their way out of debt, but that's a sad story for another time).
At its most basic, finance is very simple. If you bring in more money than you put out, you’re fine, and if you spend more than you earn, you’re going to have trouble eventually. Simply put, live within your means. Whether you’re a government or a business or an individual, just do that and you’re all set.
This line of thought could make someone say they never want debt, to which is I say, “Not so fast, my friend.” As I showed above, there is good debt and bad debt. I generally view good debt as something that either makes money (investment) or ensures survival (war debt or healthcare) for you and your family. Consumption is a little bit of a gray area. A reasonable level of consumption is necessary to ensure survival and happiness. Besides, you can’t take the money with you when you die. However, excess consumption is also dangerous. It’s a balancing act, but everyone’s got to live within their means and find what works for them while ensuring financial viability.
This is not always easy to do in a society that still places great emphasis on the appearance of wealth, whether it’s real or not. Progress is what counts, not the illusion of progress.
Let me leave you with this last bridge between government finance and personal/business finance. This will be a bit back-of-the-envelope, but instructive nevertheless.
$14T in debt with approximately 300 million Americans translates to over $45,000 per person. But, wait, there’s more. Just like a bad infomercial. That’s per person, not per labor force participant. The American workforce is roughly 150 million, so we half the number of people involved and subsequently double that debt to over $90,000 per labor force participant.
Labor force participants include employed and unemployed people. We’re at about 10% U3 unemployment, the official headline number (yes, I know it’s a bit lower, but I’m keeping the math simple, and yes, when I refer to unemployment, I usually use U6, which is currently around 17% and it includes those who want full-time work and can only find part-time work, but U3 is more appropriate here). So, we decrease the 150 million by 10%, taking it down to 135 million. So, $14T in debt divided by 135 million is just over $100,000.
Yes, this means that every working American today, in effect, has $100,000 of extra debt. Again, this excludes state and local level debt, so depending on what kind of shape your town and state are in, it could be a little higher or a lot higher. Ouch.
Links:
http://www.aeaweb.org/aea/conference/program/retrieve.php?pdfid=460
Subscribe to:
Posts (Atom)