Thursday, April 28, 2011

The Debt Ceiling Facts And Falsehoods

According to my research, since 1962, the U.S. has reached its debt ceiling 74 times, about once every eight months. Every time, the ceiling has been raised with little notice outside Washington and little, if any, change in the trajectory of government spending. But when opposing parties have held the White House and Congress, the process has always resembled a Kabuki dance. What should be a debate becomes an exercise in scoring political points.

In one such exercise in 2006, congressional Democrats criticized the Bush deficits and publicly refused to raise the ceiling, yet they had every intention of doing so. Almost daily their leadership called Bush administration officials to ensure they knew when the ceiling would be breached, so they could strike a deal before reaching the limit.

The difference today is that—in the wake of news like Standard & Poor's revising its outlook for the U.S. to "negative" and Pimco shedding U.S. Treasurys—the world is watching. Observers around the globe can expect to hear many old myths:

• The Treasury is certain that there will be wrenching dislocations in the capital markets if the ceiling is not raised. In fact, there is no secret Treasury analysis suggesting the world will collapse. Because we've always raised the ceiling, we simply don't know the consequences of not doing so. Four times the ceiling has been reached, remaining in place for months while Congress found consensus, and there was no disruption to the capital markets.

The real disruption would result from the sudden drop in federal spending and its significant impact on economic activity. But that would be partly offset by a stronger dollar, a healthier balance sheet, and the removal of the uncertainty which clouds our markets today. Near-term economic dislocation might be the painful medicine necessary for long-term health.

• The Treasury will raid pension funds to avoid exceeding the debt ceiling.When the ceiling is reached but not exceeded, the Treasury has lawful tools to free up borrowing capacity and prolong the time until the ceiling's technical breaching. The Treasury correctly calls the tools "extraordinary" since they are out of the ordinary course of business, but in reality they are neither extreme nor dangerous.

Still, if Treasury deploys these tools, expect Democrats to claim that Republican intransigence is forcing the administration to take drastic measures. Such demagoguery can yield political fruit because Treasury's tools include postponing transfers of U.S. Treasurys that would otherwise go to pension funds such as the Civil Service Retirement and Disability Fund.

But Treasury would be required to restore these funds upon any budget agreement: No retiree will lose a penny by virtue of the Treasury's technical use of its time-tested tools.

• The government will default on Treasury obligations if the ceiling is not raised. It is critical that we not default, but we don't have to. Hitting the ceiling means that we can spend only what we collect in taxes. According to the Congressional Budget Office, tax revenues for 2011 will be around $2.2 trillion, with net interest on the debt costing $225 billion. We can afford that interest and therefore not default. Also, Congress could pass legislation requiring the government to honor interest payments before any other expense, thereby avoiding a technical default.

Not raising the current ceiling would please our creditors who, like all lenders, care simply that they be paid timely interest and principal. Leaving the ceiling in place and restricting further debt would, in the long run, make that more likely.

But the reality is that the debt ceiling will be raised once again. By law, Congress must pick a specific number, which will be the subject of intense negotiation behind the scenes. Those negotiations will also determine the timing of the next debt ceiling debate. If past is prologue, that could be during the election year of 2012.