S&P, the Debt Limit, and Political Risk

By :: April 21st, 2011

So it has come to this: The biggest short-term risk of the U.S. defaulting on its sovereign debt is not that big spenders will have their way. Rather, it is that a relative handful of self-styled fiscal conservatives succeed in throwing the country into financial crisis by refusing to raise the nation’s debt limit.

It is curious that Standard & Poor’s well-publicized threat to downgrade U.S. debt if a budget deal is not reached by 2012 never quite got around to recognizing this far more urgent problem (more on S&P in a minute). But notwithstanding the rating agency’s silence, the coming game of debt limit chicken will obsess Washington through at least June. I suspect this ridiculous squabble will further delay, and not enhance, any serious deficit debate.

Make no mistake: the debt limit battle is about nothing more than naked politics. President Obama tours the country raising campaign funds and ripping Republicans for their fiscal irresponsibility. GOP uber-strategist Karl Rove lays out a plan for Republicans to  “win” the debt limit fight. And, of course, congressional GOP leaders declared months ago that their top priority is defeating Obama in 2012. Fiscal prudence (as opposed to spending cuts) may be somewhere on their shopping list, but it is surely not at the top.

And finally, there is the American public. Firm in their belief that deficits are too high, Americans are equally firm in their insistence that their favorite federal programs remain untouched and that only rich people pay higher taxes. Oh, and they also overwhelmingly oppose increasing the debt limit.

Nonetheless, and not to put too fine a point on it, any lawmaker who voted for the budget deal that funds the remainder of this fiscal year or who opposed the measure because it cut spending by too much ought to be impeached if he does not also vote to increase the debt limit. That politician has voted for a budget that will result in about $3.7 trillion in spending and about $2.2 trillion in revenues. In other words, that pol has voted to add $1.5 trillion to the debt (or at least that fraction of $1.5 trillion necessary to get the government through the remainder of the budget year). Having voted to run up the bill, it is utterly irresponsible to prohibit the government from borrowing the money to pay it.

More importantly, there is no fiscal plan now on the table that would balance the 2012 budget, and thus stop adding to the debt. There is no such plan for 2013, or, for that matter, for 2020. The House-passed budget resolution, for instance, would add $1 trillion to the national debt next year and $6 trillion over the coming decade. Obama would add even more. This money must be borrowed. There literally is no alternative. But that can’t happen without first increasing the debt limit.

As dozens of new lawmakers are beginning to learn, governing is tough stuff. It is certainly harder than pandering to voters who firmly believe the budget can be balanced by eliminating foreign aid and government waste.

S&P says there is a one-in-three chance it will downgrade U.S. debt if Washington can’t figure out how to fix its fiscal problems in two years. The bond market barely noticed—perhaps remembering the stellar job S&P did in rating mortgage securities during the housing bubble.

S&P described the nation’s fiscal problem as almost entirely political, and not based on economic fundamentals. In this, at least, it is correct though it hardly deserves credit for the insight. It is painfully obvious that the public doesn’t want to lose government programs or pay higher taxes. And in that environment, politicians much prefer jockeying for political advantage than doing the dirty and likely unappreciated work of seriously addressing the deficit. Thus, we face the prospect of months of irresponsible but politically fruitful pandering over the debt bill.

Until Mr. Market begins demanding higher interest rates, there will be no serious fiscal progress—not now and not in 2012, S&Ps concerns notwithstanding.