Outlines of a Debt Ceiling Agreement Becoming Clearer

blr-editor | July 18, 2011 | Comments (0)

Things will look bleak for the U.S. without an agreement

As we move into the week before a possible U.S. economic implosion, the outlines of a debt ceiling agreement are becoming clearer. First though, is the fact that the talks between President Obama and Republican leaders in Congress have failed.

The failure of the talks stem partly from the insistence of the President that new revenues from taxes on the wealthy and tightening of corporate loopholes must be included in any agreement.

On the other side, Republican leaders in Congress, John Boehner and Eric Cantor have dug in their heels on new taxes, insisting that only steep cuts in programs like Medicare and Social Security provide the basis for any agreement.

Most understand that cuts are actually not required to raise the debt ceiling or the amount of money that the U.S. is statutorily allowed to borrow. Congress could pass a ‘clean’ increase inthe debt ceiling, but the influx of Tea Party freshmen intent on addressing the debt question and adamant on the issue of new taxes have partly led the crisis.

The new Congressmen have made it clear to the Republican leadership that compromise is out of the question on the matter of taxes.

Countdown to the Debt Ceiling Deadline – Who Will Blink First?

As the August 2 deadline approaches, other factors have come into play. The major one is that important business lobbies have begun to warn the Republican (and Democratic) side that downgrades of the US credit rating will surely follow a credit default, as well as a (likely) deep and punishing recession.

In addition, default would actually increase the cost of borrowing for the U.S. and add to the deficit. As the voices of the powerful business lobbies have grown louder, the ratings firms – Moody and Standard and Poor have added their own harsh warnings that default will definitely bring about downgrades of the US credit rating of AAA and what is now regarded as the safest haven for investments and savings in the world.

These warnings have been enough to convince the Republican side that they will receive most of the blame and punished at the next election if they shut down the government.

So Where do We Go From Here?

Enter Senator Mitch McConnell’s proposal. He has proposed to pass complex legislation essentially allowing the President to raise the debt limit – subject to veto-able legislation opposing it.

This way, he figures, the President and the Democrats will get blamed in 2012 for raising the nation’s credit limit. From the tenor of the debate thus far, one cannot escape the feeling that if the Republicans felt 100% sure the Democrats would receive blame for a new recession, they would completely block a debt ceiling raise.

Thus, even though symbolic legislation will be passed in the House this week by the Republicans – a “cut,cap, and balance” bill, it is an act in futility (due to the Democratic Senate majority) that will likely be followed by swift adoption of Senator McConnell’s proposal in the days before August 2.

This legislation also does not guarantee any spending cuts, which is where things might remain sticky with the ratings agencies. Why? Because if the credit limit is raised and few cuts and/or tax increases are enacted, the US remains a highly indebted nation, with its national debt close to 100% of GNP.

The next two weeks will be eventful. If things happen as stated here and quickly enough, there will probably be no early ratings drop by the agencies. If things proceed as stated, but with no significant spending cuts or tax increases passed, one or more agencies will cut the U.S.’s credit ratings within a few months.

Also, if events proceed too slowly for the stock markets, we may see savage drops in the market in the week leading up to August 2nd. Whatever happens, we will report it here. Hang on to your hats…and stocks.