- The Washington Times - Thursday, February 10, 2011

The White House is warning of financial Armageddon this spring if Congress fails to raise the Treasury’s $14.3 trillion debt ceiling, but many on Wall Street are skeptical that the looming spending clash will produce anything but riveting political theater.

Wall Street ratings agencies are not particularly worried that the U.S. Treasury will be forced into default, and some traders and investors say they are less concerned about the market impact of an extended partisan spending war than its potentially adverse effect on the economy and the nation’s social fabric.

Republicans, though far from united over what to do about the debt ceiling, nearly all want to couple the measure with some kind of major spending cuts or reforms.

Some freshman Republicans backed by the tea party say they will not vote for any increase in the debt ceiling at all, in a bid to force draconian, immediate spending cuts. Others are drafting a plan that would allow selective increases in the debt to finance Social Security payments, military spending and interest payments to Treasury’s bondholders.

A leading Senate conservative and tea party favorite, Sen. Jim DeMint of South Carolina, wants to attach a balanced-budget amendment to the Constitution on legislation that would increase the debt limit.

The proliferation of Republican plans to try to force major spending cuts and reforms as their price for raising the debt ceiling has prompted dire White House warnings that such plans risk forcing the Treasury into default and setting off financial turmoil in markets worldwide.

But to David Wyss, chief economist at Standard & Poor’s Corp., both sides are manufacturing an “artificial crisis.”

He expects the clash over the debt limit to be mostly “high-octane political theater” rather than a major market-moving event. But he said there’s a small chance the highly charged political atmosphere could produce a real blowup.

“It’s a political game of chicken — a way of making the other side flinch,” he said, adding that credit agencies take a dim view of what has become a ritual fight over the debt limit that occurs each time it is put before Congress.

“The problem with games of chicken, of course, is that there is always the risk that neither side flinches,” however “irresponsible” that might be since Congress already has approved the spending increases and tax cuts that caused the debt to rise, Mr. Wyss said.

The Treasury can employ a number of “exceptional measures” that would extend the deadline for passing a debt-ceiling increase by some estimates into July or August. Once the limit is reached, the government would either have to cut spending immediately or put off paying its debt obligations in a first-ever default on U.S. government securities.

“Default by the U.S. Treasury could cause significant and long-lasting financial and economic disruption,” Mr. Wyss said, but “we don’t believe there is a significant chance of this occurring, as implied by our ‘AAA’ U.S. sovereign credit rating and its stable outlook.”

Mr. Wyss added that “temporary delays in raising the debt ceiling will most likely have no effect because such delays have occurred many times before.”

Federal Reserve Chairman Ben S. Bernanke was not so nonchalant about the looming spending clash in an appearance before the House Budget Committee on Wednesday. He stressed the danger of letting Treasury’s borrowing authority lapse and sought to discourage Republicans from crossing that threshold.

“Failure to pay interest on the debt would create an enormous crisis in financial markets,” would raise the interest rates that Treasury pays for years to come, and would make reducing the deficit much harder because of the higher debt payments, he said. “We could have a seizing of the system that would be quite detrimental to the economy.”

Mr. Bernanke also was cool to the strategy championed by some Republicans to enable the Treasury to keep making debt payments and payments on a few politically favored programs while prohibiting borrowing for other spending programs. He said that plan would present “technical” difficulties that would have to be worked out, at a minimum.

Mr. Bernanke’s warnings about letting the debt ceiling lapse echoed Treasury Secretary Timothy F. Geithner’s prediction earlier this year of “catastrophic damage to the economy” that would be “potentially much more harmful than the effects of the financial crises of 2008 and 2009.”

On Wednesday, Mr. Geithner conceded that “there’s always a little political theater” over the debt legislation and expressed greater confidence that Congress “will act as it always has to meet its obligation.”

David Greenlaw, an economist with Morgan Stanley, said he expects only a “modest impact” on financial markets from a “major political battle” peaking in July and August, when the ceiling is close to being reached after Treasury exercises various stalling measures and accounting gimmicks to delay the crunch.

Mr. Greenlaw said no one can be sure how the political drama will play out.

House Speaker John A. Boehner, Ohio Republican, has said he will use the debt-ceiling resolution as a vehicle to try to force spending cuts. At other times, however, he has said that legislators will act like “adults” and raise Congress’ self-imposed debt ceiling when needed.

Among other things, “it’s not clear that his message is getting through to the rank and file,” Mr. Greenlaw said, noting that Rep. Michele Bachmann, Minnesota Republican, is leading the charge for the tea party in circulating a petition opposing any further hikes in the debt ceiling.

The tea party plans are reminiscent of a move by House Speaker Newt Gingrich in the GOP’s 1995-96 standoff with President Clinton, in which he declared that it was better to default on the debt than to not balance the budget. He relented after his stance became a political liability for the GOP.

The 1990s confrontation, which produced extended government shutdowns as well as threats of default, had “noticeable spillover effects on the bond and currency markets,” Mr. Greenlaw said.

“We expect to see an extended period of threats and counterthreats play out over the course of the spring and summer, leading to auction delays … and investor uncertainty,” Mr. Greenlaw said. The “showdown could rattle investor confidence” a bit.

But after much storming about, he predicted the debt ceiling would be raised and the confrontation would accomplish little in terms of forcing significant spending cuts or budget reforms.

The $50 billion to $100 billion of discretionary spending cuts demanded by House Republicans, for example, would do little to lower $1 trillion deficits for long, he said.

“What’s really needed from the standpoint of fiscal reform are long-term measures to reign in the deficit” such as the reforms in Social Security, Medicare and taxes recommended by President Obama’s deficit commission in December, he said.

That point was made by the Fed chairman and Mr. Wyss as well.

Robert Dugger, managing partner at Hanover investments, expects this year’s debt-limit confrontation to cause a few ripples in the markets. But he said it will mostly serve to highlight that the country is in a period of civil strife as it moves toward a period of budget austerity.

“Civil tension is rising,” he said. “Budgets contain the fabric of civil commitments that hold us together.”

Mr. Dugger thinks the drastic budget cuts being pushed by conservatives will bring out resistance from the left wing and result in strikes and labor stoppages as seen among New York City sanitation workers and government employees in Greece when confronted with draconian budget cuts last year.

• Patrice Hill can be reached at phill@washingtontimes.com.

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