Fiscal Pitfalls Hinge on Gridlocked Congress

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Published September 24, 2012

| FOXBusiness

The debt ceiling and the fiscal cliff: Both elements of the political third rail – especially in an election season in which Mitt Romney and Barack Obama face a brutal battle to the finish line. But the nation’s looming fiscal crisis has voters paying attention – and the Fed clamoring for Congress to act.

Federal Reserve Chairman Ben Bernanke ratcheted up his calls on Congress to avert the fiscal cliff:, a combination of tax increases and spending cuts scheduled to kick in at the beginning of 2013. In a press conference recently, he said specifically, “(The Fed) can’t solve this problem ourselves.” He warned, “If the fiscal cliff isn’t addressed, I don’t think our tools are strong enough to offset the effects of a fiscal shock. It’s really important for the fiscal policymakers to work together to find a solution for that."

But are the chairman’s words falling on deaf ears in Washington?

The Senate passed a $1.047 trillion, six-month stop gap bill in a late-night vote this weekend in yet another last-minute move to keep the government running. Though the stopgap measure delays the seemingly ever-present threat of government shutdown in the short term, it does nothing to chip away at the mounting U.S. debt and increasing government spending. And it’s a tool Congress continues to deploy rather than dealing with the issue by passing appropriations bills that would fund the government properly.

The Office of Management and Budget released a report last week presenting the possible consequences and impact of sequestration -- automatic spending cuts that are part of the fiscal cliff. In that report, the OMB issued this dire warning.

“…the report leaves no question that the sequestration would be deeply destructive to national security, domestic investments, and core government functions. …sequestration would undermine investments vital to economic growth."

Unfortunately, the nation’s fiscal woes have become a pawn in the election game for Congress. Neither chamber plans to take action to avoid the fiscal cliff until after November 6. Even then, though, it’s impossible to say whether the new Congress will take action or suffer the same fate the deficit reduction super committee faced when it was unable to agree on a viable plan, placing the nation on the fast track to sequestration. 

Douglas Holtz-Eakin, president of the American Action Forum, explains what all of these what-ifs mean for the nation in the long run.

“I think Congress and the president are well aware of two big things. One is the end of the year fiscal cliff, tax increase and budget cuts that have us headed for a recession. Politically, they can’t make progress,” he said, “The second big problem is the debt and they know it’s a problem. They weren’t able to find a solution last year, but now they’ll have to. The truth is, they don’t have a choice; ratings agencies are going to downgrade us if we don’t.”

Indeed, it seems the threat of a credit downgrade is an ever-present cloud of gloom hanging over Washington, adding to the mounting pressure of a gridlocked Congress failing to act. Last year during a similar debt debacle about whether to raise the debt ceiling, Standard & Poor’s lowered its outlook on the U.S. from AAA to a AA+. The downgrade sent shockwaves through financial markets across the world since the U.S. is one of the safe haven assets of the world. This time around, it’s Moody’s turn to call for action. The credit service in a report this month it plans to lower its gleaming AAA rating for the U.S. if lawmakers can’t get the nation’s fiscal house in order. On Tuesday, the company released a statement outlining two potential scenarios for Congress.

1) Do nothing, forcing the nation go over the fiscal cliff and face:
        -Higher taxes
        -Lower spending
        -Another recession in 2013
        -An unemployment rate of 9.2% beyond 2013
        -No more action from the Federal Reserve because interest rates 
        are already too low
        -Moody’s cites a 15% probability of this scenario.

2) Take some action, avoiding the fiscal cliff and face:
        -No changes to taxes or spending levels
        -An improved U.S. economy in 2013
        -No progress to long-term fiscal sustainability
        -Credit services likely to downgrade U.S Treasury debt and federally 
         supported institutions
        -An unemployment rate remaining above 6%
        -Moody’s cites a 30% probability of this scenario.

A fix for the national economy is not as simple as just passing a budget, or reducing government spending. And the risk is potential to seriously destabilize an economy that is already at a tipping point. If more than one credit ratings service decides to downgrade its outlook on the U.S., it not only spells trouble for lawmakers, but financial markets as well. In its report, Moody’s warns what follows multiple downgrades would be a very different scene than when S&P took action. That’s because money-markets funds and other investment tools hold only the highest quality bonds. 

But the report adds, “Even without any action by the ratings agencies, a failure to make progress toward fiscal sustainability would signal that policymakers will not act until the budget is out of control and the nation is in a serious financial crisis.”

Holtz Eakin takes that one step further, describing what the bigger picture would look like in the absence of some kind of Congressional action.

“It would be an unambiguously bad event in the financial markets,” Holtz-Eakin said. “We’ve seen turbulence in the past and Main Street’s unimmune. We’d have bad equity market performance, bond yields would go up, credit channels would be depressed. It would send us into another recession.”

Still, no matter how you slice it, it seems the future of the economy all comes down to politics.  

“How we solve the long-running problem is affected by the election,” Holtz-Eakin said. “The president is committed to raising taxes on rich people, funding changes to Medicare and expanding Medicaid. Republicans are for tax reform, getting rates down, Medicare and Medicaid reforms to make those come under budgetary control.  It’s a different set of priorities.”

Holtz-Eakin said all hope is not lost, though, if the U.S. suffers a downgrade, and that the nation is “100% capable of taking care of its fiscal problems.” The one large caveat, however, is first setting aside the  nation’s political problems -- it’s only then that lawmakers will get to work on implementing a real solution to the financial crisis. 

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