“It would be inexcusable for us to not be able to take care of last year’s business.” —President Barack Obama, April 2011
"The fact that we are here today to debate raising America's debt limit is a sign of leadership failure. Leadership means that 'the buck stops here.' Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better. I there intend to oppose the effort to increase America's debt limit." --then Senator Barack Obama, March 2006.
The budget brawl is not just D.C. dysfunction in high definition, a very tardy fight over a budget for a fiscal year that is already half done.
It also bodes ill for what many believe is the far more important fight: the brinksmanship over raising the U.S. debt ceiling.
Failure to raise the debt ceiling will ding the U.S. government's Triple-A rating, which helps give the dollar its reserve status.
Which is why the U.S. Treasury is expected to once again deploy the same gimmicks it used in past debt ceiling fights in 1985, 1995-1996, 2002, and 2003, to give itself breathing room, says the Congressional Research Service [CRS]. That includes raiding Social Security and federal workers' civil service pension funds. Treasury redeemed bonds in these plans for cash, helping to blow out their unfunded liabilities.
And the cavalier money management continued when in 2009 Treasury, according to the CRS, raided a $200 billion Wall Street bailout fund launched at the Federal Reserve in 2008, in order to avoid a debt ceiling fight.
The debt ceiling will be reached sometime between now and May 31, 2011. The debt subject to this limit is projected to reach $15.03 trillion at the end of fiscal 2011, says the Congressional Research Service.
Credit rating analysts charged with monitoring the U.S. government's Triple-A credit rating have every reason to be sharpening their knives. Look for more chatter that the U.S. will lose its Triple-A status, which it has held since 1917.
The debt ceiling has been lifted 66 times since 1962, when it reached $300 billion, says the Office of Management and Budget. A gridlocked government under Republican President George H.W. Bush and a Democratic Congress hiked the ceiling, then to a quaint $3.12 trillion, with less than a day to spare.
This is D.C. political theater at its most neurotic.
What Happens in a Debt Ceiling Impasse
A debt ceiling fight doesn't mean default. A default only occurs if the government fails to pay principal or interest on the debt. Treasury instead can redeem certain bonds, including those in government pension plans (see below).
But how much is needed for the rest of 2011?
The Congressional Research Service [CRS] says: “Under current estimates, the federal government will have to issue an additional $738 billion in debt above the current statutory limit to finance obligations for the remainder of fiscal 2011.”
If the debt limit is not raised, “and Treasury is no longer able to issue federal debt, the federal government would have to eliminate all spending on discretionary programs, cut nearly 70% of outlays for mandatory programs, increase revenue collection by nearly two-thirds, or take some combination of those actions in the second half of fiscal year 2011 (April through September 30, 2011) in order to avoid increasing the debt limit,” the Congressional Research Service says.
Treasury’s Government Pension Raids
If you have any shred of doubt that Social Security is really not a lock box, watch what Treasury has done during prior debt ceiling fights, notably in 1985, under then President Ronald Reagan. The president wanted to make sure retirees were paid their Social Security benefits.
So Treasury raised much-needed cash by redeeming bonds held in government pension plans, and delayed funding these plans by shoving off into the future bond auctions, "so as to meet the federal government’s other obligations,” like paying interest on U.S. Treasury debt and, ironically, to pay Social Security paychecks themselves, the CRS says.
In the1985 debt ceiling fight, the Treasury redeemed "earlier than usual fund securities" in Social Security, the Civil Service Retirement and Disability trust fund, and several smaller trust funds, CRS says.
And it also essentially stopped funding these government retirement plans, too, in order to preserve cash.
Specifically, Treasury delayed public auctions of government debt, and delayed issuing new short-term government securities to the Civil Service Retirement and Disability Trust Fund, the Social Security Trust Funds, and several smaller trust funds.
The Treasury made similar moves during the debt ceiling impasses in 2002 and 2003, and during the government shutdown under the Clinton Administration in 1995 and 1996, CRS says, with some restrictions on the use of the Social Security fund.
The Clinton Debt Ceiling Fight
The debt ceiling fight did not trigger the government shutdown in 1996--failure to enact appropriations bills did so.
Back then, Republicans fought with the Clinton Administration over the deficit, with then House Republican Leader Dick Armey demanding cuts such as abolishing the Commerce Dept. in exchange for hiking the debt ceiling.
But watch how Treasury finessed the debt ceiling problem in order to pay Social Security benefits in the 1996 fight. It simply said in the interim, new Treasury debt to cover Social Security payments, presto change-o, would not count against the debt limit.
“In March1996, Congress authorized the Treasury to issue securities to the public in the amount needed to make the March 1996 benefit payments and specified that, on a temporary basis, those securities would not count against the debt limit,” CRS notes.
That move came after then President Bill Clinton warned that, because the debt ceiling had not been raised, the government might be late in issuing Social Security checks. That scared Congress into passing a somewhat small increase in the debt ceiling, just to make these payments.
Congress Got Mad—Sort Of
Treasury’s use of government pension funds got Congress mad. In 1996, says CRS, Congress passed a bill to increase the debt limit noting its anger, but it didn’t do anything to stop Treasury’s raids.
The bill merely codified a warning, which basically said“Congress’s understanding that the Secretary of the Treasury and other federal officials are not authorized to use Social Security and Medicare funds for debt management purposes, except when necessary to provide for the payment of benefits or administrative expenses of the programs,” CRS says.
Treasury Raids Once Again
Since warnings don't stick, Treasury once again raided the trust funds from April to June of 2002, and from February to May 2003. “Treasury again took actions to avoid reaching the debt limit, including utilizing certain trust fund assets and suspending the sale of securities to certain trust funds,” CRS says.
The debt limit was increased at a breathtaking rate back then. It jumped in June 2002 from $5.95 trillion to $6.4 trillion, and again on May 27, 2003 from $6.4 trillion to $7.38 trillion, CRS notes.
Treasury Raids a 2008 Bailout Fund
“Treasury used another tool in 2009 to cope with the debt limit without declaring a debt issuance suspension period,” CRS says. “Specifically, Treasury used a program that was originally established as an alternative method for the Federal Reserve (Fed) to increase its assistance to the financial sector during the financial downturn, the Supplementary Financing Program (SFP), which was announced on September 17, 2008.”
CRS explains: “Under the SFP, Treasury temporarily auctioned more new securities than were needed to finance government operations and deposited the proceeds at the Fed. Since January 2009, the Treasury has generally held $200 billion at the Fed under this program.”
Treasury dipped into this fund, just in case of a debt ceiling stand-off, CRS notes.
Bernanke and Moody’s Warn
While the current shutdown fight has almost no bearing on the country's Triple-A rating, the inability to cleanly reach a compromise has set the tone for the current debt ceiling impasse.
Many of the same issues in the budget fight will come to the fore in the debt-ceiling fight, notably the need for deep cuts before Republicans get on board.
Federal Reserve Chairman Ben Bernanke has testified to Congress that not raising the debt limit could ultimately lead the nation to default on its debt with catastrophic implications for the financial system and the economy.
Mark Zandi, chief economist for Moody’s Analytics, has expressed similarstatements.
What Matters Most: Footing the Bill for Interest Costs
A downgrade will happen if the U.S. loses its ability to pay the interest costs on its ballooning debt, a cost which, standing alone, would make it the 30th largest economy in the world, by some estimates.
The danger zone is when interest costs surpass 20%.
The U.S. is fast approaching that danger zone.
The White House’s adjusted 2011 budget shows that net interest expense on the U.S. debt is set to triple to a record high of $554 billion in 2015, from $185 billion in 2010, according to the Obama administration’s adjusted 2011 budget. That 2015 interest expense is equivalent to just a little less than the economy of Thailand, and it’s about 22% of the federal take.
The Deficit Numbers
A debt ceiling fight is separate from a government shutdown, which the market did not respond to when the government shut the lights out in 1995 to 1996. The S&P went ho-hum, as it rose 1.3% in November 1995, and 0.06% in January 1996.
In its March 11, 2011 budget submission, the White House along with the Office of Management and Budget projected that the fiscal year 2011 budget deficit would total $1.65 trillion, versus a budget deficit that was just $161 billion in 2007. The $1.65 trillion includes spending on the wars in Afghanistan and Iraq.
What Congress Wrought
Already, from the time Calif. Democratic Rep. Nancy Pelosi became House speaker in January 2007 to when she gaveled out last year, the U.S. added $5.2 trillion to the national debt, a sum that is more than the economies of Germany and Russia combined. The $5.2 trillion includes spending on the wars in Afghanistan and Iraq.
The government is expected to run total annual budget deficits amounting to more than $4 trillion through the end of 2015. President Barack Obama's budget plan has projected a cumulative shortfall of $11 trillion through 2021.
Budget deficits are the annual difference between what the government takes in and what it spends. The federal deficit is the total deficit outstanding.
Under President Obama’s fiscal 2011 budget proposals, the federal deficit is projected to reach $26.2 trillion at the end of fiscal 2020, up from $15 trillion now, says the CRS.
Moreover, the debt may constrict the Federal Reserve’s ability to raise interest rates to ward off inflation.
The Treasury Dept. says interest costs will rise as Treasury bond yields rise. Which may inexorably happen given the worldwide bond glut. The worldwide flood of bonds needs to attract a finite pool of investors, and can only do so by tempting them with ever higher yields.
CBO Ratchets Up the Numbers
Meanwhile, the Congressional Budget Office has been quietly and steadily ratcheting up its spending estimates, which typically contradict what the Administration and Congress projects.
The CBO says the U.S. budget deficit in the first six months of fiscal 2011 amounted to $830 billion, $113 billion more versus the same period last year.
However, when President Obama took office in January 2009, the CBO estimated that, under then-current law, the federal government would run a budget deficit of $641 billion for the entire 2011 fiscal year, notes Fox News statistical analyst James Farrell.
Since Christ Was Born
The 111th Congress added more to the U.S. national debt than the first 100 U.S. Congresses combined. If you spent one million dollars every day from the day Christ was born to now, you still would not have spent one trillion dollars.
The U.S. government first enacted a debt ceiling in 1917, as part of a new Congressional bill that abolished the need for Congress to sign off on every debt issuance. It approved $8 billion over the $3 billion debt level in place before World War I. At war's end, the limit was $43 billion. At the end of World War II, the limit was $300 billion. President Ronald Reagan then approved in 1981 a debt ceiling limit that surpassed $1 trillion.
Watch the bond markets' reaction to this outsized spending. No country should hazard having the bond markets enacting its fiscal discipline for it. It can be swift, brutal and violent, its reaction can occur instantaneously, overnight.
That just happened to Portugal, after it rejected three austerity budgets and its bond yields spiked towards double digits. Greece's debt sports 13% yields.
Other Countries Cut and Prospered
The White House and Congressional Democrats like to fear monger that government spending cuts will wreck the economy.
But if government austerity really rang a death knell for any economy, than West Germany Japan never have recovered from World War II. Both cut spending and taxes, and recovered. Also, Canada, Finland, Sweden, and Belgium cut spending to win back their Triple-A ratings, which they lost after runaway entitlement spending.