At least some players in the world of High Finance are starting to ease up about the consequences of the United States defaulting on its debt. Until recently, the consensus had been that any default caused by Congress' failure to raise the debt ceiling would risk a calamitous panic, so the hike shouldn't be open to the politics of brinksmanship. But now that analysts listening into Washington are expecting a ceiling hike to coincide with long-term debt reduction measures, then, well, maybe a brief "technical default" of a "few days" would be worth it if Congress needs that time to strike a deal. Sounds easy! Let's do it. But maybe not? Because this all rests on a pretty thin reading of our irreparably broken political system.
Business Insider's Joe Weisenthal put together a roundup yesterday of these top analysts and investors who are now considering the once "unthinkable" option of temporary debt default as a workable trade-off for Wall Street's pet project of destroying the last vestiges of the welfare state. This explanation from Citigroup's Steve Englander yesterday is typical of the new attitude:
A breach of the credit ceiling is priced in neither fixed income nor FX markets to any significant degree now. Even two months ago there was a virtual consensus that a debt ceiling breach would be an unmitigated disaster for US asset markets. Confidence in Treasuries as the ultimate safe haven would be destroyed and there would very likely be spillovers into other asset markets. If investors or business were counting on using coupons or redemptions to meet obligations, there would also be the possibility of a series of business or investors defaults tied to delayed Treasury payments.
The revisionist view is that a breach of the debt ceiling would magnificently concentrate the minds of Congress and the Administration to reach a speedy deal on longer-term fiscal consolidation. In this view, if brinksmanship or even a few days delay in receiving a payment were the cost of long-term reform, it would be worth it. Longer-term attractiveness of Treasuries might even be enhanced if the deficit were put on a sustainable course.
This is a delightful pivot, if you're a Republican. As Reuters explains, "The Republicans' theory is that bondholders would accept a brief delay in interest payments if it meant Washington finally addressed its long-term fiscal problems, putting the country in a stronger position to meet its debt obligations later on," and now they're getting some loose support for that theory. It would just be a couple of days of default, that's all! Creditors would understand, and bondholders would sit on their hands instead of launching the great sell-off from Hell immediately.
But here's the thing about this "few days" business: If markets don't react with panic when the default deadline is reached — which is still an extremely questionable assertion! — then what extra incentive does that give Congress to reach the deal that it couldn't make before the deadline? There's no such thing as "a few days." Unless Congress reaches a deal soon and doesn't let it play out at the brink, then nothing will get done until signs of a market panic do start materializing. A few days of nothing changing will breed a few more days of nothing changing which will breed maybe a week of nothing changing, until, at some point, markets decide to change course and dump their bonds. That could escalate into a panic whenever it happens, and by the time Congress would recognize it and finally force itself to push through some sort of hike — probably a hasty deal without much long-term reform anyway, if it becomes an emergency — the damage could be uncontainable.
Here is what will need to happen if people keep insisting Congress attach long-term reforms to a ceiling hike: Republicans will have to agree to raise taxes on at least the top two marginal income tax brackets, and Democrats will have to agree to Medicare cuts. Republicans would get hell from their base for raising any tax, and they'd only consider it worth doing if the Democratic Senate and President agreed to make significant Medicare cuts in exchange. This would get Republicans out of the deep political hole that Rep. Paul Ryan's end-Medicare plan put them in and neutralize the Democrats' best attack for the 2012 elections. That's why Democrats really don't want to cut Medicare, but might consider it if it induces Republicans to raise taxes.
This is why we're in gridlock right now. And it doesn't make sense to suddenly think, oh, a teensy-weensy default wouldn't breed market panic if Congress just needed a few extra days to pass something. Because "the deal" of this sort can only be struck after markets panic. Why not just pass a clean hike, leave long-term reforms (that the American people supposedly want so badly) for the annual budget debates, and not cause a market panic instead? Nothing makes sense anymore.
[Images via AP]