Opening Remarks

Washington Plays Chicken With the Debt


Suppose Congress fails to raise the national debt ceiling before the federal government reaches the current limit of $14.294 trillion, which is expected sometime around May 16. How bad would it be? Treasury Secretary Timothy F. Geithner, who is paid to worry about these things, says he has a few emergency measures at his disposal. Treasury could keep the government running for approximately two months—by borrowing money from the Civil Service Retirement and Disability Fund, for example, instead of from private investors.

By the beginning of August, however, the Treasury Dept. would be like a besieged homeowner deciding which bills to pay and which to put back in the drawer. The U.S. would begin defaulting on some Treasury notes and bonds as they came due, so creditors would demand higher interest rates on new bonds, as they have done for Greece and other heavily indebted nations. Some pension funds and insurance companies that are huge holders of Treasuries would have to dump them because they're prohibited from owning debt of institutions that are in default. The resulting panic would drive rates higher still—though no one can say precisely how high they'd go, since such a thing has never happened. "Threatening not to raise the debt ceiling is not just playing with fire," says Robert A. Brusca, chief economist at Fact and Opinion Economics, a New York consultancy. "It's playing with fire in a dynamite factory."

Destroying the full faith and credit of the United States of America is no small matter—which makes it all the more frightening that so many Americans want to see it happen. Forty-six percent of those surveyed in a Mar. 31-Apr. 4 Wall Street Journal/NBC News poll said they opposed raising the debt ceiling. The pollsters asked the question again after giving the two sides of the argument: Some say that if the ceiling isn't raised, bills, benefits, government salaries, and interest won't get paid. Others say raising the ceiling "will make it harder to get the government's financial house in order," increasing debt held by other countries and owed by future generations. After considering those two propositions, the public's opposition to raising the debt ceiling increased, to 62 percent.

This to-hell-with-it attitude is emboldening members of Congress who are preparing to force the debt-ceiling negotiations down to the last possible minute in hopes of extracting the maximum gain. House Majority Leader Eric Cantor (R-Va.) said on Apr. 12 it would be "irresponsible" to raise the debt ceiling without guaranteed limits on spending growth. Cantor may be gearing up for brinksmanship; others seem to invite a head-on collision. Senator Marco Rubio (R-Fla.) said in a Wall Street Journal op-ed on Mar. 30 that raising the debt ceiling would be "nothing more than putting off the tough decisions until after the next election. We cannot afford to continue waiting."

It's nauseating to witness such anti-debt posturing by some of the very lawmakers who created the debt in the first place by voting for spending hikes and tax cuts. President Barack Obama's hands aren't clean: He voted against raising the ceiling when he was a senator, because it was George W. Bush who had to do it that time.

Despite all this posturing, the debt ceiling plays a valuable role in the nation's political process. The limit that Congress imposes is a useful stand-in for the real ceiling—the one that will sooner or later be imposed by the nation's creditors. At some point they will get fed up with growing U.S. indebtedness and say, no more. No one knows how much deficit spending the U.S. can indulge in before reaching that iron ceiling, one that can't be raised by a simple vote of the House and Senate. Clearly we're still well below it. The world's investors are demonstrating their confidence in the creditworthiness of the U.S. by purchasing 10-year inflation-protected Treasury notes that yield just 0.8 percent a year. It's cheaper to finance debt now than it was during the budget-surplus years of the Clinton Administration. But bond vigilantes can turn vicious in a heartbeat—just ask the Greeks, who have seen their 10-year borrowing costs double to nearly 13 percent in the past year.

Ridiculous as it seems at times, the fight over raising the congressionally imposed debt ceiling gives the nation a foretaste of what running up against the real limit would be like. Enacting a debt ceiling, like standing on a gallows with one's head in a noose, concentrates the mind wonderfully. It's an artificial forcing mechanism. Compromises get made only when the U.S. walks right up to the edge of default. In the dysfunctional culture of Washington, the ceiling plays the role of a stern parent. The Japanese have a word for this: gaiatsu, meaning external pressure.

The problem is that in the absence of political leadership, the debt limit becomes a loose cannon instead of a lever. In a divisive political climate populated by ideologues, there's a real risk that the U.S. will default because of a stalemate by members who stand on principle to the very end. One combatant who has shown no appetite for compromise is Representative Paul C. Broun (R-Ga.), a conservative physician who voted against the Apr. 8 resolution to prevent a shutdown of the federal government because it didn't cut spending enough. Broun has repeatedly accused President Obama of attempting a "socialist takeover" of the nation.

There's never been a better time for cooler heads to step up and lead. The outlines of what needs to be done are obvious. First of all, don't be distracted by the current short-term budget deficit, which will largely disappear as the nation recovers from the deep 2007-09 recession. Drastic cuts now would slow that healing. The problem to focus on is the long-term budget gap, which is projected to grow at an alarming pace after 2020 mainly because of rising spending on entitlements, primarily Medicare and Medicaid, as the boomer generation ages and sickens. In the Congressional Budget Office's "alternative fiscal scenario"—which is actually the most likely course unless Washington gets serious about deficit reduction—the federal debt held by the public triples to 185 percent of gross domestic product by 2035 from 62 percent last year.

Fixing health-care entitlements will require a combination of less generosity and greater efficiency. It's crazy that Medicare devotes about 28 percent of its budget to recipients' final year of life and is moving to pay for costly cancer drugs like the $93,000-a-year Provenge. Second, taxes on the well-off will have to go up. Simply letting the Bush tax cuts expire for all brackets as scheduled at the end of 2012 would eliminate about 40 percent of the projected 20-year budget gap.

Egged on by anti-tax Tea Party activists, House Republican leaders forfeited their chance to lead on debt reduction—their plan would put the entire burden of adjustment on spending. House Budget Committee Chairman Paul D. Ryan (R-Wis.) would reduce the 10-year deficit by $4 trillion through deep cuts, including shifting rising medical costs onto the shoulders of Medicare and Medicaid beneficiaries. The wealthiest taxpayers would benefit from a cut in the top rate to 25 percent, from 35 percent, combined with the elimination of loopholes.

Obama, sensing a political opening, trashed the Ryan plan in a speech at George Washington University on Apr. 13 in which he offered a ringing defense of the social safety net. Obama presented his own plan to cut spending by $4 trillion, over 12 years instead of Ryan's 10. He chose not to mention raising the debt ceiling, perhaps mindful that the public hates the idea. But he did propose his own budget-enforcement gimmick—a "debt fail-safe" that would force Congress to negotiate further cuts if debt reduction is not on track by 2014. While light on specifics, Obama defended Medicare and Medicaid and opposed big cuts in clean energy, education, and transportation. He claimed that Ryan was proposing a trillion dollars in new tax cuts for the wealthy. In his one applause line of the afternoon, Obama declared, "That's not right, and it's not going to happen as long as I'm President." In fact, Ryan's plan would mostly just extend the Bush cuts.

This sort of inside-the-Beltway brawl makes for good television, but it isn't going to get us anywhere by May 16. What the country needs is a centrist compromise that responsible leaders from both parties can sign onto, even if with a grimace. Just such a plan is in the works from the so-called Gang of Six, a group of three Democratic and three Republican senators who want to put the government on a firmer footing without letting the pyromaniacs blow up the dynamite factory.

The unofficial leaders of the Gang of Six are Democratic Senator Mark Warner of Virginia and Republican Senator Saxby Chambliss of Georgia. The other four members sat on the bipartisan Simpson-Bowles commission on deficit reduction that Obama appointed last year: Democrats Dick Durbin of Illinois and Kent Conrad of North Dakota, the chairman of the Senate Budget Committee, and Republicans Tom Coburn of Oklahoma and Mike Crapo of Idaho.

"Gang" is the customary Washington term for such ad hoc legislative groups, and it's an apt one, since gang members have each other's backs and keep each other's secrets. This bipartisan six has been leak-proof despite intense curiosity about the plan, which the senators are planning to announce in May after Congress returns from recess. The assumption in Washington is that their blueprint will not be too far from the Simpson-Bowles commission report released last Dec. 1. The commission called for sharply curtailing the growth in Medicare and Medicaid, but by decreasing the rate of health-care spending growth rather than pushing costs off onto beneficiaries. It also advocated shrinking or eliminating the home-mortgage interest deduction and the charitable-giving deduction, among other unpopular ideas. In a bow to anti-tax conservatives, it proposed reducing tax rates to ease the pain for rich taxpayers from reduced deductions.

To win Republican support, the Gang of Six will need to distance itself from Obama. That won't be easy, because the President appointed the bipartisan Simpson-Bowles commission and cited its work in his Apr. 13 speech. The gang might have had an easier sales job if Obama had chosen to maintain his low profile a little while longer.

Given the intense pressure from both left and right, the Gang of Six will need to be even more courageous than the commission that spawned it. Gang members haven't forgotten where they came from. Durbin, one of the Senate's most consistently liberal members and an Obama ally, expressed serious misgivings when he voted for the Simpson-Bowles report: "To use an analogy only a senator would make, I don't view this as a vote on final passage of a bill," he wrote. "I view this as a vote on a Motion to Proceed to begin debate on the floor. If this were final legislation before the Congress, I'd vote No." In terms of putting the national interest first, Durbin is miles ahead of Senate Finance Committee Chairman Max Baucus—not a gang member—who belonged to the commission but voted against its report in a three-page message that mentioned Montana seven times and fretted that the commission plan "would raise rates for hydroelectric power in Western Montana." No prize for guessing what state he represents.

Vin Weber, a Republican who served as a congressman from Minnesota from 1981 to 1993, is impressed by the cohesion of the politically diverse Gang of Six. "They are serious," says Weber, now chief lobbyist at Clark & Weinstock. "They are working to expand from the Gang of Six to maybe the Gang of 20 or the Gang of 30, a bipartisan group that could be critically important."

The federal budget is on an unsustainable path, and the two political parties are still miles apart on how to set it right. Grandstanding may be the order of the day, but hope is not lost. The forcing mechanism of the debt ceiling, combined with the leadership of the Gang of Six, just might begin to put the U.S. on a better course—if, that is, the politicians have the good sense not to send the nation into default.

Coy_190
Coy is Bloomberg Businessweek's economics editor. His Twitter handle is @petercoy.

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