Thursday, October 17, 2013

Debt Ceiling Default 101 by Rob Ellsworth

My friend Rob Ellsworth, a Georgetown University graduate and former congressional staffer who co-founded the Majority Group, a bipartisan lobbying firm in Washington, D.C., wrote the following compelling essay about how anti-American the Tea Party truly is:

After shutting the government down for weeks, laying off 800,000 Americans, and putting the U.S. at risk of becoming the first major western democracy to default on its obligations since Nazi Germany in 1933, the Tea Party essentially achieved nothing other than looking foolish, putting every American's personal and business finances at risk, and jeopardizing our country's stature in the world. The irony of all this? (1) They scored no major policy victories in this fragile agreement (if this agreement even passes) and they even failed at a feeble attempt to take away their own Congressional staff's employer contribution on health insurance (which by the way, is no different than what private companies offer employees and it is most certainly not a "special exemption" from Obamacare; I digress...) and (2) The real costs of a manufactured government default to score conservative ideological purity points would not only exceed the costs of "Obamacare" on our economy (by any estimate - see below), they could also make Nancy Pelosi Speaker of the House again. So good goin' Tea Party! The Nation and the rest of the Republican Party must be grateful to you for "sticking to your principles!"

To sensible Americans (and I would mostly argue to moderate, business-minded Republicans who need to take their party back), before you vote for any of these "Freedom Fighters" and "Liberty Crusaders" again, here's what the debt ceiling default they've exposed our country to would actually mean to YOU:
  • You could see a spike in interest rates on credit cards, student loans, mortgages, and autos. Usually a rise in interest rates signals a growing economy. But when interest rates rise because the market is pricing in credit risk (due to an inept Congress playing chicken with reality) that comes right out of your pockets.
  • You could see the purchasing power of the dollar shrink dramatically, making the cost of virtually all goods and services explode (from milk and bread to gasoline and damn near everything else).
  • You could see a delay on tax refunds, social security payments, veterans' benefit payments, and military salaries.
  • You could see the stock market plummet if this deal falls apart; an initial hit by the end of this week and if nothing is resolved over the next two weeks when the Treasury actually can’t make interest payments, you will see an immediate collapse that makes the 2008 financial meltdown look tame. I agree with Warren Buffett's assessment: "this is a political Weapon of Mass Destruction" (but I know most Republicans don't think the 4th richest man in the world has enough "capitalist" street cred for their taste).
  • You could see a default on Treasury securities that would cause a margin call and subsequent credit freeze (If you think it’s hard to get a mortgage or Refi now? Just wait!)
  • You could see the U.S.A., the country with the deepest and most liquid financial markets on earth lose its key attribute: an ability to capture “flight to safety” investment dollars from global investors and institutions (these aren't just rich people, think: pensions and retirement funds). America would be unnecessarily ceding its hard-earned reputation as the safest place on earth to park one’s money. Not because of our inability to meet obligations (we can), but because our Congress is completely ignorant to basic finance. This is totally self-inflicted and unnecessary, regardless of our need to restructure and reduce our short term and long term debt obligations. And to be clear, I truly support doing a "Go Big" long term debt plan, but not under these absurd conditions. An extreme sect of Republicans has chosen the riskiest and wildly most expensive way to deal with our fiscal predicament. In the short term, a fragile economy needs more investment from the public sector, especially with interest rates near zero. By not investing now in transportation and infrastructure, we'll pay almost twice as much in interest down the road. We can solve this short term problem by finding trillions in long term savings through balanced tax and entitlement reforms done over time. It's common sense and it will relieve the need to have these silly debt ceiling fights every couple of months. In fairness, the President needs to lead on this front. He hasn't. And he doesn't deserve an out simply because Republicans are worse. 
  • You could see costly outcomes regarding an enormous outstanding pool of Treasury bonds and bills. Short-term government bills are used to grease the wheels for many financial transactions and provide a benchmark from which other assets are priced. If the value of that debt was suddenly drawn into question, markets could quickly seize up. Again — good luck getting a personal or small business loan. Imagine 2008-09 on steroids. This is not "good for business," I promise.
  • You could see the government have to balance its budget overnight. This sounds like a fiscal conservative's dream, but it is impossible because pulling that much money out of the economy too quickly would choke economic growth faster than you can imagine. Goldman Sachs estimates it would lop 4% off of GDP, strain foreign relations, wallop the stock market and destroy credibility we have left with investors. This must be done over time.
  • You could see the increase in U.S. interest rates increase the percentage of government revenues applied to debt servicing instead of being reinvested in any number of domestic priorities that create jobs and increase tax receipts. Again — totally self-inflicted wound.
Is any of this fiscally conservative?

Is any of this patriotic?

Hell No. (I'll answer the rhetorical questions for you.)

Unless Congress lifts the nation's self-imposed debt ceiling, the Treasury will have less than $30 billion cash on hand tomorrow which will be wiped out quickly. According to the Bipartisan Policy Center, the Treasury will owe a $6 billion debt interest payment on October 31, $43 billion in Social Security and Medicare payments on November 1 and $29 billion in interest due on November 15.

Some say, "No problem, the Treasury still brings in enough cash per year and per month to pay interest on the debt." But this misses the point that day-to-day cash flow is all that matters. And there are plenty of days when the Treasury takes in far less than $10 billion in tax revenue. With reserves dried up and faced with an interest payment in excess of daily revenue, our country could be forced to default if barred from borrowing more. This has little to do with deficits and lots to do with day-to-day cash-flow mechanics. Even immensely profitable companies utilize debt to bridge short-term cash-flow gaps.

The global financial system is built on credit. That's just the way it is. And credit needs collateral. Lenders prefer safe collateral, and Treasuries are considered the gold-standard, "risk-free" asset. They are basically the cornerstone of the global financial system. At least $2.8 trillion in Treasuries act as collateral in short-term lending markets.

Finally, this would all be silly if it wasn't serious. Hopefully the net positive of this is a final wake up call for moderate, business-minded Republicans to take their party back from the fringe. Mainstream Republicans expected the Tea Party to drive them to the country club and wait outside. Now the Tea Party has hijacked the Board and the social calendar. It's time for moderates in both parties, most importantly out in the country, to rise above this and reach a sensible long term deal and move on.

The author with that other Beltway insider

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