July 25, 2011, 9:09 pm
Debt Drama Blocks
Out Big Picture on Credit
As Washington continues to debate a debt
deal, the Obama administration has been preparing the country for the worst,
with officials essentially saying the sky is about to fall.
But so far, oddly enough, nothing has
happened. Despite warnings that a deal would need to be brokered by Sunday
night before the Asian markets opened, stocks merely stumbled on Monday — the
type of weakness usually associated with soft corporate earnings instead of an
Wall Street’s blasé response presents a
serious challenge for the administration. The government has been ringing the
alarm bells of an impending catastrophe to add urgency to its efforts to get
Republicans to hash out a compromise.
President Obama, in his address on Monday
night, again warned of dire consequences if a deal is not reached.
“We would risk sparking a deep economic
crisis, this one caused almost entirely by Washington,” he said.
While the sky indeed may fall if the sides
cannot compromise, the fact that the market has been calm has served only to
deepen the resistance to a deal. People who perhaps should be worried don’t
seem to be, and worse, appear to have stopped listening to the warnings.
How did it come to this?
The administration may have made a strategic
mistake in warning too soon that the market would react negatively. It
ultimately undercuts the government’s negotiating position because the doomsday
scenario has not played out, even though the deadline is fast approaching.
“They have lost all credibility,” said Neil
M. Barofsky, the former special inspector general for the Troubled Asset Relief
Program. “It’s so typical of the way Treasury and the
Fed treat everything — it is always to warn that Armageddon is coming.”
The Treasury secretary, Timothy F. Geithner, is
among those who may have miscalculated.
He has consistently held out Aug. 2 as the
cutoff date for lawmakers to reach a compromise. After that, Mr. Geithner has
said the government might not be able to continue sending out Social Security checks or Medicare payments.
“On Aug. 2, we’re left running on fumes,” he told the CBS program “Face the Nation.”
He told me back in May that he was expecting
to reach a deal by mid-July, way ahead of the final deadline. “Why would you
want to experiment? In July, you’d want this done.”
But increasingly, the market seems to believe
it was a false deadline. Some economists have said the government would have
enough cash on hand to continue making payments for several days at least. The
administration could also decide how to prioritize payments. The government,
for instance, could opt to pay interest on Treasuries and put off other bills.
In other words, the United States has some
“The Aug. 2 deadline is not as hard as
indicated by Secretary Geithner,” said Mohamed El-Erian, the chief executive of
Pimco, the large bond manager.
It doesn’t help the government’s case that
investors believe the debate over the debt ceiling amounts to
political posturing. Wall Street is counting on lawmakers to work out a deal,
albeit at the last minute — a big reason the markets remain sanguine.
“The markets believe the political parties
will reach a compromise agreement to avert a default,” Mr. El-Erian said,
especially considering that they may have a bit more time on the doomsday
Investors have good reason to ignore the
drama. In years past, politicians have rubber-stamped an increase in the debt
ceiling with little discussion or dissent. Since 1962, Congress has voted to
increase the limit 74 times, according to the Congressional Research Service, a
division of the Library of Congress. It
happened 17 times under President Ronald Reagan and four
times during the Clinton administration.
But investors may have been lulled into a
false sense of security and, as a result, they may have missed the bigger
Whether lawmakers reach an agreement about
the debt ceiling may be beside the point. Republicans and Democrats are likely
to comprise at some eventual date.
The question is how rating agencies will view
the country’s creditworthiness, even if a deal is reached.
To some extent, that’s why lawmakers are
wrangling over whether to pursue a stop-gap measure for the next couple of
months versus a long-term plan. Standard & Poor’s
threatened that it would cut the United States rating if lawmakers didn’t come
up with a “credible” solution.
“What I think is underappreciated until now
is a possible outcome whereby the debt ceiling is increased, debt default is
avoided, but one of the rating agencies feels compelled to downgrade America’s
AAA because of insufficient agreement on medium-term fiscal reform,” Mr.
If the country were to lose its vaunted
rating, the federal government, companies, homeowners and innumerable others
would see their costs skyrocket — a situation that would certainly send the
markets into a downward spiral.