A DEFAULT IS NOT ENOUGH TO FIX AMERICA´S FISCAL PROBLEMS / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( A MUST READ)

A default deal is not enough to fix America’s fiscal problems

Steven Rattner


July 5, 2011

Like a video game in which the combatants periodically ascend to a higher, more intense level, the budget talks in Washington have ratcheted up, with Barack Obama now engaged in direct talks with Republican leaders. And while the initial goal of an agreement by July 2nd has been missed, the president has successfully bullied the Senate into cancelling its Independence Day recess and returning to Washington today, allowing negotiations to resume early this week.


As the equanimity in financial markets is signalling, some deal to avoid default will probably be cobbled together; the consequences for America and for the world of failing are just too great.


But even if the talks succeed, the outcome will do far less to address America’s fiscal problem than was hoped when the formal discussions were launched under vice-president Joe Biden’s leadership in April.


Back then, the goal was to achieve at least $4,000bn of deficit reduction over the coming decade, consistent with the proposals of the National Commission on Fiscal Responsibility and Reform, better known as the Bowles-Simpson Commission.


The recommendations of that bipartisan, blue ribbon panel – an unprecedented package of spending reductions and new tax revenue – garnered considerable press attention and little support from the Obama administration or the Republican leadership. An even more ambitious budget proposal, from the Republican chair of the House budget committee, Paul Ryan, received similar treatment.


Now, with each passing week, expectations of the outcome of the Biden talks have steadily reduced and the $4,000bn goal seems ludicrously out of reach. Smoke signals emerging from the surprising silence surrounding the talks suggest that the two sides have “soft circled” about $1,000bn of spending reductions, while remaining deadlocked over the inclusion of new revenues.


Absurdly, Mr Obama’s modest suggestion of eliminating a bunch of tax subsidies for corporations and wealthy individuals has been met by howls of opposition from Tea Party Republicans, insisting that nothing that looks or smells like a tax increase would be acceptable.


This is all both dispiriting and ridiculous. Even under Bowles-Simpson, Washington’s debt would still rise from $9,000bn in 2010 to $15,100bn in 2020. The Republican opposition to new revenues is not only wrong on policy grounds, it is also irresponsible.


The numbers simply don’t work without tax increases. Similarly, while Democrats have shown modestly more flexibility toward cuts in Medicare, their accommodation stops well short of the surgery that is needed in both health care entitlements and Social Security.


A disproportionate amount of the coverage of the budget talks has focused on the messiness of the American process. The problem is not the process, the problem is the outcome. All the sound and fury would be more amusing if it signified something.

Alas, it appears to signal only that America’s fiscal challenges remain just as daunting as they were before the last months of political theatre. The coming presidential election augurs poorly for major reform before 2013. The first job of the new president will be to lead the country to a more responsible place.

The writer is is an American financier and a former head of the US government taskforce that oversaw the federal bailout of Chrysler and General Motors.


Response by Sebastian Mallaby


Republicans are playing with fire as they flirt with not raising the debt ceiling



Steve Rattner rightly sums up the frustrating US budget negotiations – frustrating not just because they are so torturous but because they are unlikely to deliver serious deficit reduction. Yet he omits the most bizarre aspect of this drama: the idea, popular among some Republicans, that it would be fine not to raise the federal debt ceiling and leave the government’s borrowing authority to expire.


If the do-nothing caucus gets its way, the federal government will have two options when the national debt hits its permitted ceiling next month. Either it can cut spending in order to get by with no further borrowing, or it can default on its debt-service obligations and use the savings to keep financing government programmes. To some Republicans, perhaps, the first option sounds like a Reaganite triumph – a case of “starving the beast” of public spending – while the second option might sound like just retribution for the evil money lenders who engineered the financial crisis. But the truth is that both spending cuts and default lead directly to mayhem.


If the government went for the starve-the-beast option, the sudden contraction in public spending would send the economy off a cliff. The federal budget deficit is running at around 9.3 per cent of gross domestic product. Balancing the budget implies taking a huge slice of total demand off the table at a time when growth is already weak. If the prospect of a deep recession does not worry the deficit hawks, perhaps they should remind themselves that a sharp contraction in output implies an increase in debt to GDP.


If the government went for the default option, the consequences could be even more extreme. Investment portfolios all over the world are constructed on the assumption that US treasuries are the risk-free benchmark; other financial assets are priced in relation to them. But if risk-free becomes risky, portfolio managers will lose their moorings. Where will they turn for a reliable store of value? They can not buy renminbi bonds and there are not enough German euro bonds. Will they bid gold up to even sillier levels than it has reached already? The confusion and panic could make the aftermath of the Lehman Brothers bankruptcy look like a picnic.


In today’s Financial Times, Gideon Rachman draws attention to the similarities between the debt traumas in the United States and Europe. But one hair-raising contrast is surely worth noting. In Europe, policymakers are bending over backward to finesse their way out of a Greek default, even though Greece is a marginal player in the international financial system. In Washington, meanwhile, some members of Congress appear alarmingly unalarmed about the prospect of a US default, even though the US is the issuer of the world’s dominant reserve currency.


The writer is an FT contributing editor and a director of the Maurice R Greenberg Center for Geoeconomic Studies at the Council on Foreign Relations. He is the author of ‘More Money Than God‘.