Guessing What Happens

Wednesday, July 27 – madness in Washington and worry on Wall Street:

Stocks retreated deep into negative territory on Wednesday as Congress remained stalled on resolving the debt ceiling, and an economic report showed a significant slowdown in the U.S. manufacturing sector.

The Dow has now fallen four days in a row as investors grow increasingly worried that Washington won’t solve the country’s budget woes in time to meet the August 2 debt ceiling deadline.

“We will continue to see selling each day until this debt ceiling issue is resolved,” said Stephen Carl, head equity trader at Williams Capital.

The Dow Jones industrial average sank 199 points, or 1.6%, to close at 12,303.

With the Republican-generated debt-ceiling crisis lingering – you really could have separated paying the bills for what has already been spent, raising the debt ceiling, from what to do about future spending – and with Congress inching ever-closer to next week’s default deadline, it’s been a dicey week on Wall Street. The Dow Jones lost about three hundred points in three trading days. There has been no dead cat bounce – no slight irrational reversal, just because what is essentially crap is at least momentarily cheap. It’s just been down, down, down. And the New York Times puts it this way:

Stocks were weighed down again on Wednesday by worries that the United States could default on its debt or see its credit rating cut as lawmakers in the world’s largest economy appeared no nearer to an agreement on raising the borrowing limit.

Though most investors think a last-minute deal to raise the debt limit will eventually emerge, the difficulty of reaching an agreement may leave a lasting impression on investor sentiment, some traders fear…. A worry in the markets is that only a short-term deal will be struck, with a promise to revisit the issue later.

Is that the worry? Perhaps just a quick temporary fix – a patch – just won’t do. Heck, every few weeks Microsoft sends out another batch of security patches for Windows and Office – again and again and again, month after month, year after year. That doesn’t exactly give you warm fuzzy feelings about their products. The temporary fix for the debt limit is kind of like that, but the day before both congressional Republicans and Democrats, reluctantly, had said that they want an extension of the debt ceiling only through the end of next year – as Steve Benen explains, for purely political reasons – there is no actual economic justification for this. So Wall Street reacted, perhaps afraid the Republicans, and the exasperated Democrats, will get their way, and like Microsoft, just keep issuing patches. That might be what was stunting market performance.

But Senator Bob Corker, a quite conservative Tennessee Republican, said the Boehner plan was all wrong, and wrong on this very matter:

In particular, Corker warned that extending the debt ceiling for only six months, as Boehner has proposed, would still risk the nation’s credit rating, and leave lawmakers facing another ugly half a year.

“I know the president has been concerned, candidly, about a short-term extension,” Corker said. “In fairness, I think the business community around our country would be concerned about a long short-term extension.” …

“To even set up a process that’s short of that doesn’t make any sense to me,” Corker said, referring to the size and duration of a deal. “It’s kind of like, you’ve got to be kidding me. We’ve got to go through the aggravation of the next six months working towards an aspirational goal that we all know doesn’t solve the credit rating issue.”

Steve Benen is appalled – the Democrats want one extension, not two, and Wall Street wants one extension, not two, and the Republican line as recently as last month was one extension, not two. And now there’s Corker, being all logical. So Benen asks the obvious question:

Can Boehner and McConnell offer any kind of coherent defense for wanting to put us through this now and again six months from now? How on earth would that benefit anyone?

Well, it would be a fresh chance to make Obama look bad. That was always the idea. And Andrew Leonard adds a new twist to this:

On the Laura Ingraham radio show Wednesday, House Speaker John Boehner acknowledged that “a lot” of Republican House members “believe that if we get past August the second and we have enough chaos, we could force the Senate and the White House to accept a balanced budget amendment.”

Boehner then said that he disagreed with that theory. In his view, “the closer we get to August the second, frankly, the less leverage we have vis a vis our colleagues in the Senate and the White House.” But the damage was done. As the news of his comments spread through social networks, the Dow Jones Industrial Average began to fall sharply. It closed down 198 points.

Okay, Leonard admits there might be no cause and effect here – there have been all sorts of negative economic data – but there might be. And of course others argue that it’s the Democrats’ fault, like CNBC’s loopy Larry Kudlow arguing that Harry Reid’s attack on the Boehner plan was what really drove the markets down – anytime someone says something mean about a Republican everyone sells, or something. But Leonard holds that the markets actually have good reason to be nervous:

The normal way Congress works on a big, controversial piece of legislation is to patch together a last-second compromise after months of huffing and puffing. Reid and Boehner call each other nasty names, and then cut a deal. On the surface, the current deadlock is a perfect setup for just such a denouement.

But that doesn’t seem to be what’s going on now, and Leonard cites the political scientist Jonathan Bernstein:

The truth is that Boehner’s plan is a totally legitimate, if many months late, opening offer. But if he’s presenting it to his conference as a done deal – if he’s arguing that if only they vote for this, the Democrats are sure to fold and accept it – then he’s just not telling them the truth. I’m not sure I agree with those who say that Boehner’s plan is very similar to Harry Reid’s proposal, but I do agree that it’s not hard at all to picture a compromise between them. However, it’s just not true that the Senate will vote for Boehner; indeed, as of now it looks as if Boehner won’t get a single Senate Democrat while losing four or more Senate Republicans. Reid might have 50 votes for his own plan, but probably doesn’t have 60. So the two plans, after the votes are taken, are headed for another round of deal-making – which, of course, is how this stuff is supposed to go.

But Leonard says not this time:

What we’ve just witnessed in the last 48 hours is a conservative rebellion in the House that forced Boehner to rewrite his plan and seek deeper, quicker cuts. The new plan looks likely to pass in Thursday’s vote, but anyone watching must appreciate that the Tea Party has just demonstrated its power to push Boehner to the right.

So what are the odds that these folks are going to be willing to suck it up and do the traditional thing and cut a compromise deal that moves to the left at the last minute?

Low. Very low. Abysmally low.

So Boehner was just telling the truth to Laura Ingraham:

The obvious conclusion to draw from today’s events is that the only thing capable of changing minds is chaos. At that point, the pressure on John Boehner to put together a coalition of Democrats and not-Tea Party Republicans who will vote for a compromise that can pass the Senate will be intense. But if he gives in to that pressure, he seems virtually certain to face a leadership challenge that could result in the end of his speakership.

This is not looking good, and Kevin Drum sees that too:

If the United States defaults on its debt, its credit rating will be downgraded catastrophically by every ratings agency. That’s not going to happen because the United States isn’t going to default, but Standard & Poor’s has warned that it might downgrade U.S. debt regardless. Even if there’s no default, says S&P, it might take action if Congress fails to credibly cut the long-term deficit by $4 trillion.

So how worried should we be about this?

And he cites Time’s Massimo Calabresi:

S&P is an outlier among the top three ratings agencies: Moody’s and Fitch say they won’t even consider a downgrade unless there’s a danger of an actual default.

Well that’s cheery. There are money-market and mutual funds, and some pension funds, not able to hold Treasuries without an AAA rating – that’s the rule to keep the money safe – so we may be safe. There may be no mass-dump of treasury notes to send the whole world into economic chaos. But Drum thinks this through:

So even if S&P follows through on its threat – and frankly, I suspect it’s just a bluff – it probably won’t have any immediate effect on the market for U.S. bonds. Pension funds won’t have to engage in a massive sell-off, state and local bonds will be fine, and life will go on.

In other words, the threat of actual default is nil, and the threat of downgrade is pretty close to nil too. This goes a long way toward explaining why bond markets aren’t panicking over the debt ceiling fight.

The real danger, of course, is different: shutting down the government for any extended period would likely have a disastrous effect on our still weak economy. Unfortunately, keeping the government operating at the cost of passing the deficit deals currently on the table would probably also be pretty disastrous.

We are, for no good reason, deliberately setting our economy on fire. It’s insane. Nero may have fiddled while Rome burned, but at least he didn’t set the fire himself.

And for a wonky explanation of disastrous, see Ezra Klein:

Boehner 2.0 got scored by the Congressional Budget Office today, and the results aren’t as different from Boehner 1.0 as you might think. The spending cuts jumped from $850 billion to $915 billion. Bigger, but not that much bigger. The real change is in the timing: the original bill had only $5 billion in spending cuts next year. Like Reid’s bill, this version has more than $20 billion.

Remember that these spending cuts aren’t alone. Unless future legislation changes this, they’re alongside the expiration of the $160 billion payroll tax cut and the $60 billion in expanded unemployment insurance that the administration negotiated in the 2010 tax deal. So that means the economy – which is very weak right now – is losing something in the neighborhood of $250 billion in federal support.

And Klein says that really does matter, quite a lot:

Earlier today, Suzy Khimm quoted the International Monetary Fund saying “a fiscal consolidation equal to 1 percent of GDP typically reduces GDP by about 0.5 percent within two years and raises the unemployment rate by about 0.3 percentage points.” There’s reason to believe that in a weak global economy, the effect will actually be worse than that. But let’s say it isn’t. Projected GDP in 2012 is about $15.8 trillion. So a $250 billion cut is about 1.5 percent of 2012′s projected GDP. So whether we pass Reid or Boehner’s plan, we’re looking at a drag on growth of more than 0.5 percent of GDP and a drag on employment of more than 0.3 percent.

This is not good for the recovery.

Rome will burn, because we set it on fire. But in Slate, Annie Lowrey argues we won’t really have a default, we’ll have something much weirder and more chaotic:

Yes, something awful and weird will happen in early August, but it isn’t going to be default. The Treasury will need to issue more bonds to make promised payments to the country’s creditors, senior citizens, federal employees, and so on. Without that extra cash, the federal government will need to miss 40 to 45 percent of its payments, according to calculations by the Bipartisan Policy Center. But that is not default. Default is too tidy a term for it. The chaos that might hit after Aug. 2 has no precedent, and therefore no name.

And she gets specific about this no-name event:

On Aug. 2 or soon after, Treasury will “exhaust its borrowing authority.” That does not mean that we “hit the debt ceiling.” We hit the ceiling back in May, and since then the country has not been able to issue new debt, only to roll over maturing bonds. “Exhaust its borrowing authority” means that Treasury will no longer be able to fudge the country’s finances enough to keep all payments going out on time.

Yes, the country could default – we could stop paying interest or principal to our bondholders – but Lowrey says the likelihood of that happening is nil:

Doing so could trigger panic in the financial markets and force higher borrowing costs throughout the global economy. “Default with a downgrade is a game changer,” warns Tim Ryan, the head of the Securities Industry and Financial Markets Association, “with dire consequences for money funds, capital markets and banking systems broadly. It will be a systemic event in its own right.” The Treasury Department will not admit outright that bondholders will get prioritized over, say, Social Security recipients. But they will.

They have to, for the sake of worldwide stability. But avoiding default, because of the simple math, is not that good a thing:

That means it will be soldiers, doctors, federal employees, and government contractors who will see their payments delayed. There is no real term of art for this scenario, at least not yet. But the wonks have taken to calling it “selective default,” “payments prioritization,” or “delinquency.”

It will be something like a government shutdown. But during a shutdown, mandatory spending payments – such as Social Security checks and Medicare reimbursements – keep going out. That will not necessarily happen in the event of “selective default,” or “delinquency,” or “debtpocalypse,” or what have you. And though shutdowns always come with a degree of uncertainty, they are hardly unprecedented in Washington. The White House and Treasury have a tested playbook for a shutdown. They do not have one for the debtpocalypse.

She prefers “payments prioritization” as the best term, as it gets to the heart, or heartlessness, of the matter:

Treasury is going to need to decide who gets paid and who doesn’t – making temple-rubbing, flinty-faced, increasingly bedraggled Timothy Geithner the most economically powerful person in the country until Congress resolves this.

The choices would be difficult. In August, the United States could use its cash receipts to make its interest payments ($29 billion) and pay Social Security benefits ($49.2 billion), Medicare and Medicaid ($50 billion), defense contractors ($31.7 billion), and unemployment insurance ($12.8 billion) – all considered of vital importance.

But that would leave about half of the bills unpaid. Federal employees, from the zookeepers to the prosecutors to the prison guards, would have to make do without their salaries. There would be no transfers for food stamps, housing programs, the IRS, the EPA, or the troops either. The Bipartisan Policy Center notes that “the reality would be chaotic.” The results would be unfair. Treasury would be picking “winners and losers.”

Do we want that? The Tea Party folks say none of that will happen. There’s plenty of money to go around. There just is. They somehow know it. And math is so boring, and liberal.

But the figures are clear, and Lowrey notes, so are the possible secondary effects of this sort-of-default-but-not-really event:

The major ratings agencies would downgrade U.S. sovereign debt, possibly raising the country’s borrowing costs permanently. (Politico reports that’s what the White House is really worried about.) Some money-market and mutual funds would not be able to hold Treasuries without an AAA rating, meaning the specter of plummeting bond values and a credit crunch. Even if the bond market stayed relatively calm, investors might dump U.S. stocks and other investments, hoarding cash instead. Nobody really knows what would happen.

The risk is of something far worse than a recession. It’s a no-name catastrophe. And the uncertainty is excruciating. But it’s all great fun. And these guys say what we need in this economy is to remove uncertainty. Go figure.

So the markets are dropping, day after day, significantly, but not yet catastrophically. And we wait. Rome is on fire. Nero is tuning up. What happens next?

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About Alan

The editor is a former systems manager for a large California-based HMO, and a former senior systems manager for Northrop, Hughes-Raytheon, Computer Sciences Corporation, Perot Systems and other such organizations. One position was managing the financial and payroll systems for a large hospital chain. And somewhere in there was a two-year stint in Canada running the systems shop at a General Motors locomotive factory - in London, Ontario. That explains Canadian matters scattered through these pages. Otherwise, think large-scale HR, payroll, financial and manufacturing systems. A résumé is available if you wish. The editor has a graduate degree in Eighteenth-Century British Literature from Duke University where he was a National Woodrow Wilson Fellow, and taught English and music in upstate New York in the seventies, and then in the early eighties moved to California and left teaching. The editor currently resides in Hollywood California, a block north of the Sunset Strip.
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