By Terry Connelly
It’s hurricane season, and we have a perfect storm brewing for our financial markets, with its very own political cone of uncertainty.
First, Congress returns from recess Monday, September 9, to consider whether to put the government's operations on hold on October 1 because it no longer has an operating budget. Current Federal budgetary authority to spend, Sequester and all, expires at that time (although the Sequester plan nominally carries forward for another nine years).
Democrats want to pare down the Sequester for fiscal 2014, and make up the difference with targeted spending cuts and tax increases. Republicans want to continue the Sequester and make other cuts as well.
Obamacare at issue
Second, some Republicans also want to cut all Federal funding to implement Obamacare, as a price for agreeing to any budgetary plan at all; i.e., they are willing to shut down the government on October 1 unless Obamacare is cut from any spending authority going forward. Even if Democrats and Republicans could find some “continuing resolution” compromise on the issues between them outlined above on the mix of spending and taxes, these Republicans would hold out for elimination of Obamacare. They realize the Senate Democrats would not initially go along but believe ultimately Obama will blink, as he did in the 2011 debt ceiling crisis, when he agreed to the doomsday Sequester device as a way to satisfy Republican calls for budget cuts equal to any increase in the ceiling.
Republican leadership certainly favors repealing Obamacare, having taken 40 fruitless votes to do so already. However, they fear the linkage of defunding it to a government shutdown. Speaker Boehner has let it be known he would like to buy time with some sort of continuing resolution to allow time to maneuver later in the fall when the debt ceiling issue is expected to come up again – maybe around Thanksgiving.
But then the other shoe drops. Turns out the government will run out of room to do its routine borrowing to finance its Congressionally-agreed deficit under its current budget just one month after Congress reconvenes.
It would be a misleading oversimplification to say that our national credit limit kicks in October 15. But because our national revenues from budgeted taxes and fees come in “lumpy” over the course of a fiscal year, we need to borrow operating funds to cover our not-so-lumpy bills as they come due, just like ordinary corporations.
Congress has already agreed that we must pay each of those bills, including Social Security, military pensions, Medicare, and principle and interest of U.S. Treasury securities, but has added a spurious debt ceiling law that purports to deny the government access to credit markets beyond a fixed amount that has no actual relationship to the debts we have incurred. Any corporate board of directors that imposed such a restraint on its executive officers would be successfully sued for malfeasance. But we’re stuck with this preposterous financial lunacy as a nation because it’s the law.
Aside from misinterpreting a section of its authority to mint currency to produce a $2 trillion dollar coin (let’s call it the “Krugman”), there is little the executive can do if the debt ceiling is reached other than what you or I would in our own financial dealings: prioritize our creditors and use whatever current revenues we have. Some in the House want to legislate that prioritization in advance, but that would be trying to make sense of insanity.
So Republican leadership plans to duck a government shutdown but kick the Obamacare issue over to late-year “leverage” on the debt ceiling issue. They’ll do this on the same theory that Obama will surely cave again as he did in the 2011 fiasco so as not to be the president who presides over the first U.S. default on its “full faith and credit.” But the president has drawn a red line against negotiating again on the debt ceiling extension.
So the U.S. financial markets could face both a government shutdown and a debt ceiling expiration just two weeks apart. And the Fed also has its own moment of truth the week of September 15 as well, as it decides whether to begin dialing back its purchases of mortgage-backed securities and Treasury bonds because the economy has been growing enough of late to survive a gradual, tapered withdrawal of such unconventional stimulus. Putting aside recent mixed-to-poor economic data, especially on the pace of housing recovery, can the Fed risk starting to taper in the face of a fiscal collapse like a shutdown and default at the same time, weeks before its next meeting?
While the events relating to Syria have spurred a modest flight to safety in U.S. government debt, those trading waters are bound to be roiled in the coming weeks by the gathering clouds of shutdown and default. The Fed has the first chance to help avoid a market meltdown by postponing its tapering decision until the fiscal “hurricane watch” is lifted. Congress and the President have a chance to make the storm blow over by negotiating a budget deal (which would be consistent with Obama’s red line on direct debt ceiling negotiations) that satisfies enough Republicans to lift the debt ceiling separately.
Past experience with the TARP legislation that saved the U.S. banking system and the “fiscal cliff” resolution just months ago shows that Congress doesn’t act these days until it feels the harshest winds – in this case, a stock market meltdown out of frustration with the lawmakers’ willingness to tempt fate by seeing what a few days of shutdown and default actually are like.
Cash is looking real good for now.
Terry Connelly is an economic expert and dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco. Terry holds a law degree from NYU School of Law and his professional history includes positions with Ernst & Young Australia, the Queensland University of Technology Graduate School of Business, New York law firm Cravath, Swaine & Moore, global chief of staff at Salomon Brothers investment banking firm and global head of investment banking at Cowen & Company. In conjunction with Golden Gate University President Dan Angel, Terry co-authored Riptide: The New Normal In Higher Education.