The danger of the ‘default deniers’ – a financial apocalypse

Posted by AzBlueMeanie:

The Tea-Publican "default deniers" are truly a dangerous crowd because they are too ignorant to understand that they are playing with the fire of default that can have catastrophic consequences. Matthew Yglesias explains it for them. Four Reasons Debt Ceiling Breach Means Default:

A new idea is taking hold among House Republicans that perhaps breaching
the debt ceiling isn't such a terrible idea after all. One form this
takes is the patently absurd remarks of Rep. Ted Yoho (R-Fla.) who muses
that "I think, personally, it would bring stability to the world
markets." If you think that's right, you might wonder why the Chinese
government is warning that "the clock is ticking" and politicians need to stop screwing around
.

The more sophisticated view comes from the likes of Rep. Justin Amash (R-Mich.) who's concocted an idea about how we could avoid default even while breaching the debt ceiling:

"There's always revenue coming into the Treasury, certainly
enough revenue to pay interest," said Rep. Justin Amash, R-Mich.
"Democrats have a different definition of 'default' than what we
understand it to be. What I hear from them is, 'If you're not paying
everything on time that's a default.' And that's not the traditionally
understood definition."

This is what's known among debt ceiling junkies as "payment
prioritization"
—you use cash on hand to keep paying interest and rolling
over the principal on the national debt, while letting Medicare
reimbursements or salaries for FBI agents slide. Here are four problems
with the idea, according to the Treasury Department:

1. It's illegal: Treasury
is not authorized to unilaterally decide to pay certain bills and not
others. If it were, the constitutional order would completely collapse.
Obama could just not cut the checks for farm subsidies or missile
defense programs he opposes. Then in a few years President Ted Cruz
could refuse to pay SNAP benefits.

2. It's also impossible:
Because payment prioritization is illegal, Treasury's payment system is
not designed to allow prioritization to happen. Cardiff Garcia has an in-depth roundup of coverage of this angle, but the best simple explanation comes from the Treasury inspector general, who explains that on a technical level,
the systems "are designed to make each payment in the order it comes
due." Of course systems could always be changed. But look at all the
problems Health and Human Services is having in getting the Affordable
Care Act computer systems to work. They can't just whip up an entirely
new computer system in the next two weeks. (And, of course, given the
government shutdown, it would be illegal for them to hire someone to
try.)

3. The timing doesn't work:
Over a given year, the Treasury certainly collects more in taxes than
it pays in interest. But that's not necessarily true on any given day.
Most days the Treasury doesn't pay any interest. Then on some days large
interest bills come due. To prioritize interest payments, you would
need to not pay certain bills the Treasury does have enough cash on hand
to pay in order to stockpile money for future interest payments. That
further exacerbates problem Nos. 1 and 2.

4. Prioritization doesn't solve the problem:
Even if all these problems could be waived away, you're not really
solving the underlying problem. Yes, bondholders would still get their
money. But nobody in the future could seriously treat U.S. government
debt as a risk-free information-insensitive asset. It would become just
another speculative play whose odds of working out would depend on your
assessment of the ups and downs of American politics. Making the
interest payments would somewhat mitigate the ensuing financial crisis,
but would by no means eliminate it.

Stepping back a little, I'd also note that House Republicans can't
have it both ways here. Either the debt ceiling is a major leverage
point to extract concessions from the president, or else it's no big
deal. If it's no big deal, there's no leverage.

Paul Krugman writes in Default Deniers:

You knew this would happen, didn’t you? As we close in on the debt
limit, with Obama insistent that he will not give in to hostage-taking,
there is a growing chorus of voices on the right insisting that the
whole debt limit thing is scare tactics from the administration, and
that hitting the limit will be no big deal.

And the truth is that there is some real uncertainty about exactly what happens if we hit the ceiling. … What sane people should be emphasizing is that in addition to the risk
of financial disruption, there’s the certainty of huge pain from
spending cuts and a crippling hit to economic growth.

So, who are the default deniers? Actually, they come in three varieties.

The lower denial says that it’s all a conspiracy — that any pain
Americans feel will be because Obama wants them to feel pain. Dave
Weigel has a good rundown on this attitude.

The higher denial involves asserting that the government can
prioritize
, so as to avoid a default on interest payments, that this
would avoid damage to the financial system, and that this means that
everything will be OK. This is what you’re hearing, for example, from
erstwhile respectable Republican economists, who have (surprise!) mostly
fallen in line as the crisis looms. The crucial point here is that even
if they’re right about interest payments — which is unclear — the
government will (a) still go into default on obligations to vendors,
Social Security recipients, and so on (b) be forced into spending cuts
so large as to guarantee a recession if the standoff lasts any length of
time.

Finally, there’s the special form of default denial coming from the deficit scolds. I noted yesterday that they cheered on the 2011 debt confrontation; they’re not quite so rah-rah this time, but as Matthew Yglesias notes, they’re still endorsing hostage tactics. From Fix the Debt:

Instead of engaging in dangerous and self-destructive
political brinksmanship, our elected leaders should use this moment as
an opportunity take steps to improve our fiscal condition. We urge
lawmakers to stop focusing on issues unrelated to bringing down our
dangerously high debt levels and instead pursue a fiscally responsible
agenda that avoids default and puts in place a plan to bring down the
debt as a share of the economy.

Yep, they’re still fantasizing about a grand bargain, and are
endorsing hostage tactics over the debt ceiling because they believe it
can make their fantasy reality. It’s kind of awesome. Everyone else is, I
think, aware that Democrats will never accept a grand bargain without
revenues and Republicans will never accept one with revenues; this
latter point comes, in turn, from the reality that Republicans don’t
care about the debt and never did, they only pretended to as an excuse
to slash social insurance programs. Yet the folks at Fix the Debt
imagine that somehow the debt crisis — the crisis many Republicans are
insisting is no big deal — can push everyone into the sacred Grand
Bargain. Oh, and that all this can happen in the next 10 days or so.

Given all the forms of debt denial, I really wonder about the
confidence many people still have that there will be an 11th-hour
resolution.

Bloomberg News warns that A U.S. Default Seen as Catastrophe Dwarfing Lehman’s Fall:

NukeFailure by the world’s largest borrower to pay its debt — unprecedented
in modern history
— will devastate stock markets from Brazil to
Zurich, halt a $5 trillion lending mechanism for investors who rely on
Treasuries, blow up borrowing costs for billions of people and
companies, ravage the dollar and throw the U.S. and world economies into
a recession that probably would become a depression. Among the dozens
of money managers, economists, bankers, traders and former government
officials interviewed for this story, few view a U.S. default as
anything but a financial apocalypse.

The $12 trillion of outstanding government debt is 23 times the $517
billion Lehman owed when it filed for bankruptcy on Sept. 15, 2008. As
politicians butt heads over raising the debt ceiling, executives from
Berkshire Hathaway Inc.’s Warren Buffett to Goldman Sachs Group Inc.’s Lloyd C. Blankfein have warned that going over the edge would be catastrophic.

“If it were to occur — and it’s a big if — one would expect a series
of legal triggers, potentially transmitting the default to many other
markets,” said Mohamed El-Erian, chief executive officer of Pacific
Investment Management Co., the world’s largest fixed-income manager.
“All this would add to the headwinds facing economic growth. It would
also undermine the role of the U.S. in the world economy.”

Continue reading A U.S. Default Seen as Catastrophe Dwarfing Lehman’s Fall.

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