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Danger Of Default: Three Bad Right-Wing Arguments

President Obama went to St. John’s Church on Lafayette Square on Sunday for the first time since Easter. No doubt to seek divine intervention. The way things are going, that’s what it might take to conclude a deal by the end of this week that will not only raise the debt ceiling but also will not freak out the markets. The problem is that there is a sizable faction within the Republican Party that doesn’t think all the hair-on-fire warnings from the Obama administration are real.

Some argue that the nation’s credit card needs to be ripped up or that Washington cannot be given another blank check to spend, spend, spend. So a national default is what’s needed to snap some fiscal discipline into the federal government. Some argue that a short-term default wouldn’t be so bad, that there’s plenty of money for the nation to meet its obligations to bondholders and as long as they are taken care of everything would be okay. Some argue that there’s no way they go along with an increase in the debt limit without a balanced-budget amendment. And some are making all three arguments in one form or another.

Folks, all three arguments are a recipe for disaster. You better pray something gets worked out.

The debt ceiling. Raising the debt ceiling is not — I repeat, IS NOT — like giving Washington a blank check or adding more to the national credit card. Increasing the legal limit the federal government can borrow allows it to pay for things it has already bought. In short, the money’s been spent. For the United States to not meet its obligations for the first time in its history would destroy the full faith and credit of this nation and could irreparably damage our economy and financial standing in the world.

Prioritization. A default by the United States would force the Treasury to rob Peter to pay Paul. And it’ll be ugly. Meeting obligations to holders of U.S. treasuries is one thing. It’s paying all the other bills that will come due in August that will send the American people into apoplexy.

The federal government will have $306 billion in bills (including $29 billion in interest on Treasury securities) in August and only $172 billion in its wallet to pay them. The remaining $134 billion will have to come by denying checks to seniors, active-duty military, federal workers, etc. Such prioritization has been called unworkable by the Obama administration. And the Wall Street Journal reported Thursday that a Standard & Poor’s official told Senate Democrats that failure of the United States to pay any of its bills on time could lead to a loss of the nation’s precious AAA bond rating. This comes despite an intense lobbying by the Obama administration to persuade the bond rating agencies not to issue threats against the nation’s creditworthiness.

Balanced-budget amendment. This week the House will vote on the Cut, Cap, Balance Act.Cutting and capping budgets is a matter of political debate. But given that there are two weeks before the nation runs out of cash to pay all of its bills, requiring passage of a contentious balanced-budget amendment before raising the national debt limit is lunacy. A Post editorial on Thursday made the rational argument for why this perennial “solution” for fiscal promiscuity is a bad idea.

The constitutional cure, while superficially tempting, would be worse than the underlying disease. A balanced-budget amendment would deprive policymakers of the flexibility they need to address national security and economic emergencies. It would revise the Constitution in a way that would give dangerous power to a congressional minority.

This bad policy prescription won’t pass the Senate. But many Tea Partiers in the House won’t vote for a debt-ceiling increase without it. Combine them with the Tea Partiers who signed pledges not to raise the debt ceiling under any circumstances, and you have the makings of a willful fiscal train wreck.

The full faith and credit of the United States, a precious asset that took more than two centuries to build, is seriously at risk. To whatever prayer Obama might have said at St. John’s related to the wrangling over a debt-ceiling deal, may I add, “Lord, hear his prayer.”

By: Jonathan Capehart, The Washington Post, July 17, 2011

July 19, 2011 Posted by | Budget, Congress, Conservatives, Constitution, Consumers, Debt Ceiling, Deficits, Economic Recovery, Economy, GOP, Government, Government Shut Down, Ideologues, Ideology, Middle East, Politics, President Obama, Public, Republicans, Right Wing, Senate, Seniors, Tea Party | , , , , , , , , , , | Leave a comment

How Default Would Harm Homeowners, Cities, Businesses And Everyone Else

It’s easy to understand why the government will have more trouble borrowing if it fails to pay its debts, or even has a difficult time paying its debts. It’s a bit harder to see why ordinary Americans, the city of Pittsburgh, hospitals in Iowa, and medium-sized corporations will have more trouble borrowing. But they will. And their trouble borrowing is the main channels through which a default, or even something too close to it for the market’s comfort, could deal a body blow to the economy.

On Wednesday, Moody’s warned that it was putting the U.S. government credit rating on review for a downgrade. But they didn’t stop there. Another 7,000 debt products that are “directly linked to the U.S. government or are otherwise vulnerable to sovereign risk” were also put on review for a possible downgrade. That’s about $130 billion worth of debt. If America tumbles, so do they. But Moody’s still wasn’t done. An unknown amount of “indirectly linked” debt is also getting reviewed.

If America’s credit rating falls, it’s taking a lot more than just Treasury securities with it. It’s going to take the whole credit market with it. Which, as you’ll remember, is exactly how the subprime housing sector took the economy down in 2008.

The first to fall will be “directly linked” debt. These are bonds that rely on payments from the federal government. Naomi Richman, a managing director in Moody’s Public Finance division, puts it bluntly: “There are certain kinds of municipal bonds that are directly reliant on Treasury paying or some other direct payment,” she says. “If those bonds don’t receive their payment, they have no other source of revenue.” So down they go.

Then there’s the “indirectly linked” debt. That’s debt from state government, local governments, hospitals, universities and other institutions that rely, in some way or another, on payments from the federal government. If Medicaid stops paying its bills, all the hospitals that rely on Medicaid’s payments become less creditworthy. If we stop funding Pell grants, then all the universities that enroll students who pay using financial aid become less creditworthy. And since the federal government passes one-fifth of its revenues through to the states, and the states pass those revenues through to cities, if the federal government stops paying its bills, all states and all cities are suddenly in worse financial shape, which will make it harder for them to get loans.

And then there’s everything else. Mortgages. Credit cards. Loans that businesses take out to expand. Much of the debt in the American economy, and in fact globally, is “benchmarked” to Treasury debt. When your bank quotes you a mortgage rate, the calculation begins with the rate on 10-year treasuries and then adds premiums for various types of risk specific to you and your area on top of that. “There’s a whole credit structure,” says Pete Davis, president of Davis Capital Investment Ideas. “Think of it as roads and bridges, but it’s finance, it’s all connected, and it’s all on top of treasuries. Your CD at a bank, your credit card interest rates, your car loans, your mortgages — that’s all built on Treasury rates. So when you shake the basis of it, everything on top of it shakes, too.”

The 2008 economic crisis wasn’t started by a nuclear bomb detonating in New York, or a campaign to sabotage the country’s factories, or a plague that struck our able-bodied young males. Rather, investors bought a lot of debt based on subprime mortgages. They performed some tricky financial wizardry that they thought made the debt low-risk. They found out they were wrong. And then, because the players in the financial system no longer knew how much money anyone had, the credit markets froze and the economy crashed.

Now imagine that happening, not with the housing market, but with the government of the United States of America. The cornerstone of the global financial economy is the idea that Treasuries are risk-free. If they’re not, then like in the financial crisis, no one knows how much money anyone who holds treasuries has. But they also don’t know how much money anyone who depends on the federal government — be they businesses or individuals — holds.

This is how a default gets into the rest of the economy: It takes everything the financial markets thought they could know and rely on and upends it. It then shuts off credit, or makes it prohibitively expensive, for nearly every participant in the economy, from states and cities to hospitals and universities to homebuyers and credit-card applicants. That, in turn, freezes all of their activity, which destabilizes everyone who relies on them, which then destabilizes financial markets further, and so on.

It was one thing to have forgotten that this sort of thing could happen in 2006, when America hadn’t seen it for 70 years. But we just went through it. And if we go through it again, the Federal Reserve, which has pushed interest rates as low as they can go, and Congress, which has vastly expanded the deficit, have a lot less ammunition left for a response.

Are we likely to get to that point? No, of course not. But between here and there are worlds where the economy doesn’t crash, but because the federal government panics the market, interest rates rise and the economy slows. In a recovery this weak, that would be a disaster. And it would be entirely of our own making.

By: Ezra Klein, The Washington Post, July 15, 2011

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July 17, 2011 Posted by | Banks, Budget, Businesses, Congress, Conservatives, Consumer Credit, Consumers, Debt Ceiling, Deficits, Democrats, Economic Recovery, Economy, Financial Institutions, GOP, Government, Government Shut Down, Ideologues, Ideology, Lawmakers, Medicaid, Middle Class, Politics, Public, Republicans, Right Wing, States | , , , , , , , , , , , , , , , , | Leave a comment

Debt Ceiling Warning: Inaction Would Double Interest Rates, Crash Market

Public efforts by both House Speaker John Boehner and President Obama to convince skeptical new Republican House members to add $2 trillion to the nation’s burdensome $14 trillion debt ceiling are being reinforced by dire warnings from business leaders that failing to OK the increase will lead to inflation, an immediate doubling of interest rates and a killer Wall Street crash.

“If they don’t increase the debt, there will be a huge impact on the economy,” a Wall Street executive told Whispers on background. “Interest rates would spike. S&P and Moody’s would downgrade U.S. debt, raising the price of borrowing, there would be a market sell-off, it would be a disaster.”

While Boehner, who yesterday called for a deal that would OK the debt ceiling increase in return for trillions of dollars in spending cuts, Wall Street lobbyists and banking and business leaders are meeting with several of the new Tea Party-backed House members who pledged to stop raising the ceiling to explain the impact of standing pat.

“A lot of freshmen are new to the issue,” said one of those meeting with the new members, some of whom signed pledges not to raise the debt ceiling no matter what.

Among the specifics the sources say they are telling the new members:

— Inflation could jump, though they aren’t giving any percentage growth.

— Interest rates could double if U.S. debt is downgraded. House loans, for example, that are now below 5 percent, could surge to 9-10 percent, killing any chance of fixing the housing slump or cutting the unemployment rate, now at 9 percent.

— The stock market could suffer a 10 percent drop, far more significant than the 778 point thrashing Wall Street took when the House rejected the government’s $700 billion bank bailout plan in September 2008.

“That market sell-off will look small compared to what we’ll see,” said a Wall Street executive.

So far, the campaign to turn the naysayers around is starting to work, say those involved. Helping is the expectations that the debt ceiling won’t actually be breached until August.

While there have been warnings that the vote must come sooner due to expectations that the cap will be breached this month, officials explained that Treasury can make several moves to postpone that until about August 2.

By: Paul Bedard, U. S. News and World Report, May 10, 2011

May 10, 2011 Posted by | Banks, Businesses, Congress, Conservatives, Debt Ceiling, Deficits, Economic Recovery, Economy, Financial Institutions, GOP, Government, Government Shut Down, Jobs, Lawmakers, Lobbyists, Politics, President Obama, Republicans, Right Wing, Tea Party, Unemployment, Wall Street | , , , , , , , , , | Leave a comment

Standard And Poor’s Attempt To Influence The Political Debate

In what appears to be an attempt to influence the political debate in Washington over federal government deficits, Standards & Poor’s rating firm downgraded U.S. debt to negative from stable. Yes, the raters who blessed virtually every toxic waste subprime security they saw with AAA ratings now see problems with sovereign government debt.

The best thing to do is to ignore the raters — as markets usually do when sovereign debt gets downgraded — but this time stock indexes fell, probably because of the uncertain prospects concerning government budgeting. After all, we barely avoided a government shutdown earlier this month, and with S&P. joining the fray who knows whether the government will continue to pay its bills?

Mind you, this has nothing to do with economics, government solvency or involuntary default. A sovereign government can always make payments as they come due by crediting bank accounts — something recognized by Chairman Ben Bernanke when he said the Fed spends by marking up the size of the reserve accounts of banks.
Similarly Chairman Alan Greenspan said that Social Security can never go broke because government can meet all its obligations by “creating money.”

Instead, sovereign government spending is constrained by budgeting procedure and by Congressionally imposed debt limits. In other words, by self-imposed constraints rather than by market constraints.

Government needs to be concerned about pressures on inflation and the exchange rate should its spending become excessive. And it should avoid “crowding out” private initiative by moving too many resources to our public sector. However, with high unemployment and idle plant and equipment, no one can reasonably argue that these dangers are imminent.

Strangely enough, the ratings agencies recognized long ago that sovereign currency-issuing governments do not really face solvency constraints. A decade ago Moody’s downgraded Japan to Aaa3, generating a sharp reaction from the government. The raters back-tracked and said they were not rating ability to pay, but rather the prospects for inflation and currency depreciation. After 10 more years of running deficits, Japan’s debt-to-gross-domestic-product ratio is 200 percent, it borrows at nearly zero interest rates, it makes every payment that comes due, its yen remains strong and deflation reigns.

While I certainly hope we do not repeat Japan’s economic experience of the past two decades, I think the impact of downgrades by raters of U.S. sovereign debt will have a similar impact here: zip.

By: L. Randall Wray, The New York Times, April 18, 2011

April 19, 2011 Posted by | Bankruptcy, Banks, Congress, Debt Ceiling, Debt Crisis, Deficits, Economic Recovery, Economy, Federal Budget, Financial Institutions, Financial Reform, Government, Government Shut Down, Ideology, Politics, Social Security, Standard and Poor's | , , , , , , , , , , , | Leave a comment

Standard And Poor’s Is The Broker Who Lost All Your Money: There Is No Real Risk Of Default

What does Standard & Poor’s action lowering the U.S. outlook to “negative” mean? What are the likely ramifications of the U.S. deficit and debt? I do not want to conflate two completely different issues, so let’s take each in turn.

First, I have stopped paying any attention to anything that S&P says or does. Its performance over the past decade has revealed it to be incompetent and corrupt – it sold its AAA ratings to the highest bidder. It is the broker who lost all your money, the girlfriend who cheated on you, the partner who stole from you. Since the portfolios we run never rely on its judgment or analysis, we simply do not care what it says about credit ratings.

But big bond managers like Bill Gross of Pimco do matter – he invests hundreds of billions of dollars. We pay close attention when smart managers like him announce they are out of the Treasury market, which he did last month.

Many people misunderstand the U.S. deficit. First, it is stimulative to both the economy and the markets. Look at what happened under Reagan and Obama and most of Bush II – the economy recovered from recession and the markets rose along with the deficit.

Second, Social Security is fine. Sure, the retirement age will go higher, there will be means testing, and the income cutoff for contributions ($106,000) will likely double. But it will remain solvent. Medicare is much trickier, as the United States pays two times what most countries pay for health care but gets lesser care.

The current debate about deficits looks like more politics. Look at the voting records of those posturing about the debt. The “deficit peacocks” voted for new entitlements (the prescription drug benefit — Medicare Part D), went along with a trillion-dollar war of choice in Iraq, and supported (for the first time in U.S. history) a major tax cut during wartime. I find it hard to take their deficit noise as a bona fide fiscal concern.

After Standard & Poor’s missed the greatest collapse in history – indeed, they helped create it by rating junk mortgage backed securities Triple AAA – they are now over-compensating. As I mentioned on The Big Picture, there is an old Wall Street joke about analysts: “You don’t need them in a Bull Market, and you don’t want them in a Bear Market.” That especially seems apt with regard to S&P.

The deficit has been with us for a long time. Since investors are continuing to lend money to Uncle Sam at exceedingly low rates, there does not appear to be any real fear of a default. That is what matters most to bond buyers — and it’s why I never care what S&P thinks on this.

By: Barry Ritholtz, The New York Times, April 18, 2011

April 19, 2011 Posted by | Congress, Consumers, Debt Ceiling, Debt Crisis, Economic Recovery, Economy, Federal Budget, Financial Institutions, Financial Reform, Government, Government Shut Down, Lawmakers, Medicare, Politics, Social Security, Standard and Poor's, Wall Street | , , , , , , , , , , | Leave a comment

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