You can read about it here, if you’re so inclined. It’s a big messy compromise with massive cuts and a two-stage debt ceiling hike and a cost-cutting super panel and triggers for huge spending cuts and a balanced budget amendment to the US Constitution. (I’m actually not sure that a deal that is to the right of the Republicans’ initial bargaining position can be considered a compromise but apparently this is the only thing that both party leaderships could agree on.)
As far as I can tell, there are some really serious problems with this deal from a policy perspective:
- The budget cut triggers. If the super panel’s recommendations weren’t adopted in the spring, then this compromise would trigger massive spending cuts to defense, Medicare, and other big-ticket nondiscretionary areas. This is intended to guarantee Congress would consider the panel’s recommendations seriously. Unfortunately, this basically never works; historically Congress passes new laws to get around politically unpopular cuts. So this attempt to foist the deficit issue off on a distant and separate panel would almost certainly be just as unsuccessful as every other deficit-fighting panel that the US Congress has created in the last few decades.
- The balanced budget amendment. If Congress didn’t adopt all the super panel recommendations, they’d have to send a balanced budget amendment to the states for ratification. You’d probably think this has no chance of passing, as it would absolutely devastate the American federal government’s ability to fight wars or recessions or natural disasters, but 74% of American adults polled last week supported such an amendment. That’s a higher proportion than basically any other policy proposal - so this is actually something that states would likely consider and debate, and some would ratify, and it’s something that would be a big part of political discourse in 2012 campaigning. This would be massively suboptimal.
- The US Treasury credit rating. This new deal might not be sufficient to prevent a downgrade of US credit by the big credit rating agencies. Specifically, since the deal (not including the panel recommendations) doesn’t raise revenue and doesn’t cut entitlement spending, and the process for raising the debt ceiling hasn’t changed, it’s relatively likely that at least S&P will downgrade the reliability of US government debt - because bondholders won’t be guaranteed that this exact same thing won’t happen again in the future. This would raise government borrowing costs by around $100 billion a year.
Despite all these problems, I’m going to say the odds that this passes are about 80%, because the alternative is seriously suboptimal. The most likely failure point would be in the House, where the Tea Party types are going to vote against anything and leftist Democrats probably won’t want to be on record supporting this proposal. A filibuster in the Senate is possible, I guess, although that would be really effing malicious. (Or a personal hold, although I’m not sure if that would even be respected in this situation.)
If this passes, I’m guessing markets will gain a couple hundred points right away, and then (as real economists have noted) the US will see a sharp slowdown in growth and rise in unemployment as the cuts are implemented. Most likely the panel’s recommendations will be somehow circumvented in the spring, and then things will go back to the status quo until the next debt ceiling fight.
If this doesn’t pass then the debt ceiling doesn’t get raised in time and the US Treasury runs out of cash. From there, things would go really poorly. I’m not sure if it would be like TARP, where Congress votes for something really unpopular in the face of market panic - there might need to be more negotiations, and I’m really not sure what that would look like in the context of government shutdown.
The official requested anonymity because no announcement has been made. The Treasury has said about $90 billion in debt matures on Aug. 4 and more than $30 billion in interest comes due Aug. 15. Overall, more than $500 billion matures in August.
Here’s confirmation that bondholders get first dibs on whatever money the US Treasury has left when they start running out after 2 August.
This sounds seriously suboptimal for, I don’t know, government employees or pension recipients or anyone else hoping to get their cheques - and it is. But if the US Treasury didn’t make those debt payments, then they’d be totally effed when they wanted to borrow money again once the debt ceiling was raised, since investors would have lost a lot of trust. And remember, constant borrowing is absolutely essential to keep the current system running smoothly (hence all the fuss about the debt ceiling). So this was really pretty inevitable.
A decision by ratings agencies to downgrade US Treasury debt from AAA - that is, for ratings agencies to formally announce that US Treasury debt was no longer totally ubersafe from the risk of missed payments - would have an almost-automatic knock-on effect to the ratings of state and municipal debt. This is because the federal government implicitly guarantees states and municipalities; investors are pretty sure that if states or big cities started to default, the federal government would step in with some sort of emergency rescue. Obviously, if the federal government can’t be trusted to make its own payments, then there’s absolutely no hope that they’re going to bail out lower-level government at the same time.
Specifically, the states most at risk are Maryland, New Mexico, South Carolina, Tennessee and Virginia, which all currently have AAA ratings but would likely lose them if the federal government was downgraded. All of these states have quite a bit of debt, and also Maryland and Virginia host a whole lot of federal government offices which can look forward to some exciting and unpredictable shutdowns if this debt ceiling thing becomes an issue. Other states could have troubles too because they depend on transfers from the federal government.
So that’s kind of exciting, right? Borrowing costs go up for basically everyone in the event of a downgrade, if investors react the way they usually do. JP Morgan puts the cost at $100 billion per year in higher interest payments. This is absolutely not what a country already faltering economically needs right now.
So there won’t be any panic yet. Actually, I’m thinking there won’t be any steep market selloff unless one of the following (relatively unlikely) events happen:
- Ratings downgrade. All three big ratings agencies have warned this could happen, especially if the US government keeps racking up huge deficits and then having a tantrum every time they need to raise the debt ceiling. I think it’s rather unlikely that they’ll actually do it, though, as ratings agencies tend to be super conservative about changing ratings.
- Selloff by central banks. If they no longer trust US Treasury (or if for some reason China thinks it’s strategically beneficial to trigger a massive selloff) then they could start reducing their holdings. Central banks are super risk averse. But this is very unlikely as there is no good alternative - there’s nothing as big as the US Treasury bond market, and eurozone countries have problems too because the banking sector there is so risky. (Not sure how the Chinese government thinks though.)
- Missing the deadline. This is the really obvious one. Everyone’s been counting down to 2 August as the ultimate deadline, even though this was a too-conservative estimate by the Treasury. If that deadline passes, investors might realize “oh hey these people seriously don’t give an eff about the economy” and react accordingly, even before payments get missed. This seems like the most likely risk, although I don’t know if Congress is filled with sufficiently irrational and/or horrible people to let this happen.
So we can probably relax and enjoy the spectacle for the rest of the week. Probably?