Budget Games

The tension is building in the budget talks as the calendar closes in on the Aug. 2 drop-dead date. According to Treasury Secretary Geithner, this is the date where the government would no longer have the money to pay its bills and a default on the debt would be looming.

As many have noted, including me, a default on the debt would be an absolute disaster for the financial system. We would see the same sort of freeze up of lending as we did after the collapse of Lehman in September of 2008; although this time would almost certainly be much worse.

With U.S. government debt no longer the rock-solid pillar of the world financial system, banks would instantly lose much of their capital. They would not only have to write-down the value of government debt, but also all the assets backed by the government, like Fannie Mae- and Freddie Mac-issued mortgage-backed securities.

This would almost certainly push the major banks into insolvency. J.P. Morgan, Citigroup, Goldman Sachs and the rest would suddenly be back in the welfare line. And any rescue would almost certainly not restore them to their former strength and profitability like the last one did. If the government defaulted on its debt, Wall Street would take a shellacking and it would never again be the center of world finance.

This is why we knew all along that the Republicans in Congress were not serious about their threats over allowing the government to default. While these people might be happy to kick poor people in the face, to take hard-earned wages and benefits away from working people, and to shove retirees out onto the street, the Republican congressional leadership is not about to cross Wall Street. After all, who pays for the campaigns?

This meant that the Republicans were always going to fold if President Obama didn’t cave. The only question was when and how.

Republican Senate Leader Mitch McConnell gave us the answer to this question on Tuesday when he proposed a convoluted scheme that would essentially allow President Obama to unilaterally raise the debt ceiling. The price is that Obama would have to propose a set of budget cuts, totaling $700 billion over 10 years (at 1.6 percent of spending), to Congress three times over the next year and half. These spending cut packages would have to be given a straight up or down vote.

While President Obama may hold out and insist on some further Wall Street-sponsored crawling by the Republicans in Congress, this deal looks like it should be enough fun. Senator McConnell’s plan lets Obama put any cuts on the table that he wants. In keeping with the spirit of this proposal, the cuts in Round One could be composed entirely of spending in Mr. McConnell’s home state of Kentucky.

If more cuts are needed to reach the $700 billion target, he can also propose gutting spending for Ohio, the home state of Speaker John Boehner. In later rounds he can include cuts for Virginia, the home state of the Republicans’ firebrand minority leader Eric Cantor. It will be interesting to see the Republicans vote on these proposed cuts.

Of course this is silly, but the whole debate over the debt ceiling was silly. If Congress wants to cut spending then the way to do that is to send the president smaller spending bills. They can do that any day of the week.

The idea that Republicans in Congress were going to force big cuts in the country’s most important programs ? Social Security, Medicare and Medicaid ? by taking Wall Street hostage with the debt ceiling is absurd. It was only necessary for President Obama to call their bluff.

The bottom line is that the debt ceiling is a gun pointed first and foremost at Wall Street’s head. And, there is no way on earth that Wall Street is going to let the Republicans pull the trigger.

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of Plunder and Blunder: The Rise and Fall of the Bubble Economy and False Profits: Recoverying From the Bubble Economy.

This column was originally published by The Guardian.


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Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.

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