Monday, July 25, 2011

Nothing to Smile about in DC.

So the circus in Washington has made me decide to restart my blog.

So I've been following the debt ceiling talks very closely and I have just finished reading the transcripts of the television addresses of Obama and Boehner.

Where we are is this: the Democrats and the Republicans are miles apart and are not even negotiating. Instead they are trading barbs on twitter and blaming each other on national television. From the legislative perspective each party is crafting a separate bill in the chamber in which it has a majority and attempt to brute force it through the other chamber. This is very much a non-trivial matter. The Republicans might filibuster the Democratic bill in the Senate which would mean that they can't even get it to the House. This would give the GOP the advantage in that their bill might be the only game in town which would put additional pressure on the Senate and Obama to pass it. In my opinion, the bills are substantially different and are both primarily motivated by the political interests of their authors and are an attempt to frame the opposite party as unreasonable rather than to try to compromise.

The House bill recognizes the failure of the GOP to make progress on trimming the deficit and seeks to buy more time. Their bill contains a $1 trillion increase in the debt ceiling matched with the $1 trillion in spending cuts that were the least controversial in the recently failed negotiations. This is paired with a requirement to appoint a commission which will be tasked with finding another $1.6 trillion in cuts to both discretionary and entitlement programs as well as revenue increases through reform of the tax code. Only once the additional $1.6 spending cuts have been identified will the government raise the debt ceiling an additional $1.6 trillion. Some kind of deal would have to be reached relatively shortly because the government will blow through the $1 trillion borrowing limit in less than a year.

The plan of the Democratic Senators is to raise the debt ceiling by a full $2.6 trillion by pairing it with $2.6 trillion in spending cuts and no revenue increases. The Reid plan draws all of the $2.6 in spending reductions from discretionary programs and does not envision any changes to Social Security and Medicare. Of the $2.6 trillion $1 trillion is from the wind down of the wars in Afghanistan and Iraq and $400 billion is from “interest savings” though it is not at all clear to me how it possible for the government to save $400 billion by altering the term structure and interest rate profile of the debt especially considering that interest rates are pretty close to their theoretical minimum today and, given inflation, you could argue that they are in fact negative. Thus interest expense has nowhere to go but up. I don't think this really bothered the Reid staffers who put it together because they were primarily interested in getting to the $2.6 trillion number as fast as they can.

Both of these plans are ingeniously designed to make the other party look as though it is reneging on its original commitment. The Republican plan is actually the policy that Obama partially implemented earlier in the year when he appointed a commission to study the deficit. The trouble with that was that Obama then dissolved the commission without implementing any of its suggestions, or proposing any deficit reduction legislation whatsoever. Instead he left it to the House Republicans, a decision he almost certainly regrets. The Republicans will claim that they are just implementing Obama's original policy but with a hard deadline connected to the debt ceiling. The Democratic plan optically looks like what the Republicans asked for originally: $2.6 trillion in spending cuts with no revenue increases. Of course $1 trillion of those cuts come from reductions in defense expenditures which are already not projected to occur and $400 billion is in interest savings which will, as a practical matter be virtually impossible to capture. So the headline number of $2.6 trillion contains $1.4 trillion is in cuts that are not really cuts so in terms of actual effect its much closer to the current $1 trillion plan the GOP has put forward.

So basically both parties are offering to trim around $1 trillion in spending over ten years. The main difference is the timing of the next debt ceiling increase, the Republicans want it before the next election and the Democrats want it after the next election. It is pretty simple to understand why. Many of the Republican Congressmen elected in 2010 were given a mandate to cut spending. If they want to win reelection in 2012 they need to show that they have done this. It is obvious that the current impasse will not produce meaningful spending cuts so they need another chance to produce an agreement before the 2012 elections. The Democrats of course do not want this to become a major issue during the presidential election because what will be happening then is that Obama will not only be squaring off against the Republicans in Congress but also against Republican Presidential candidates who will all have strong opinions on what should be done with the debt ceiling but with no responsibility for actually doing anything. This would weaken him both as a candidate and as a negotiator, a position he will certainly seek to avoid.

So this is where we find ourselves with less around a week to go until the deficit ceiling needs to be raised. Two parties framing legislation designed to favor them in 2012 and, in the event that they fail to pass the legislation they each have the ability to claim that the other side reneged on its original strategy for narrowing the deficit. Meanwhile the government continues to borrow $3.8 billion dollars a day and the debt ceiling approaches.


Bernhard A S said...


good to have the blog back!

Anonymous said...

Welcome back!! Insightful as always. Troy.

Anonymous said...

Great commentary.

Any wisdom from the latest move at DIFC and ENBD in Dubai?

Anonymous said...

Something is not clear to me after reading your latest posting.. Are you suggesting that a delay of debt ceiling increase until after election is negative for republican congressmen but, positve for the republican presidential candidate?


Ken said...

No, it's negative for the GOP as a whole because it takes a major campaign issue off the table. More directly a great many GOP House freshmen will not be able to say they have carried out their mandate to trim the deficit because most of the Reid proposal is cuts that are already imagined in the current projections and therefore will do nothing to limit the growth of the debt.

Anonymous said...

FYI, the word on the street (wall street, that is) is that there will be an agreement by the deadline and Moody's will not downgrade. Also, none of the desks are hedged for the fact that the US will default. This explains why the markets don't seem to care. Clearly this is the opposite of what you believe is happening, ie. negotiations are ongoing to reach a deal by the deadline...

Ken said...

I agree that its not likely the desks are hedged and it is possible that the negotiations are ongoing and may yet reach an agreement. It is curious though that so much political capital is being expended on corralling the GOP members in the house in order to get the Boehner bill to the floor and voted on. I really don't think Cantor would have gone to the wall this morning pushing his guys to back it if he thought there was some other deal on the horizon.

Anonymous said...

very glad to see the blog is going again!