A town hall of sorts was under way last week inside New York City’s Harvard Club, the prestigious university’s wood-paneled, velvet-draped Manhattan outpost. Treasury Secretary Timothy Geithner had just delivered a short speech outlining the Obama administration’s approach to deficit reduction and the need for Congress to raise the federal government’s debt ceiling before it risks a default on August 2. In the question-and-answer session, the microphone reached Christian Oberbeck, a merchant banker in a gray business suit and yellow tie.
“Just a quick question, but, assuming a deal is reached at midnight on August 1—”
Geithner looked pained and cut him off.
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“It has to be before that. Let me stop you there,” he said. “If you leave people in doubt, then they’ll start to act in a way that protects them if we don’t act. That itself has the same basic dynamics of default. More modest, initially, but we can’t wait for that. It would be irresponsible.”
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At an event later that night before a similar group, someone asked the Treasury secretary when the “real deadline” for raising the debt limit would arrive. Geithner answered that the punishment for inaction could come without warning, so “why would you want to experiment?”
Those kinds of exchanges underscore the difference in worldviews between Washington and Wall Street on the debt limit now driving the country’s broader fiscal-policy debate. Wall Streeters generally agree with Geithner that it would be a disaster if Congress failed to raise the debt ceiling and triggered an epic default. That, most agree, would freeze lending, torpedo the stock market, and very possibly usher in double-dip recession.
But few on Wall Street are losing sleep over that risk, because most are absolutely certain that Congress won’t let it happen. And some executives are actually urging Republicans to play brinkmanship, arguing that it’s the best way to force a real agreement on deficit reduction.
Treasury Secretary Timothy Geithner pleaded with Wall Streeters at the Harvard Club to take the debt ceiling seriously.
In effect, the financial community holds two contradictory beliefs about what Washington can do: One is that political leaders are either too inept or too partisan to make serious fiscal decisions; the other is that lawmakers are certain to do the right thing on the debt ceiling because they fully understand the consequences. It’s possible that the Wall Streeters are right on both counts, but it’s not a sure bet.
As a result of this outlook, financial lobbyists in Washington have been largely silent on the topic. Instead, they are focusing more on regulatory issues than on fiscal ones. Markets reveal almost no agitation among investors over short- or long-term Treasury securities, and borrowing costs remain at almost historic lows. The interest rate for one-year Treasury bills is barely one-quarter of 1 percent. That’s not what you might expect at a time when top administration officials use words like “Armageddon” and “catastrophic” to highlight the urgency of raising the debt limit. The complacency comes out in countless conversations.
“I’ve got a lot of confidence in the [House] speaker,” one financial executive told National Journal, referring to Republican John Boehner of Ohio. “I think he’s done a masterful job, and I’m going to leave the deal particulars to him and the House leadership team.” That confidence seems to ignore the skepticism that many Republicans express about the need to even raise the debt ceiling. It also ignores the dissatisfaction among conservative freshman Republican members about their party’s leadership and their willingness to rebel when they think their leaders have gone soft.
At the same time, the scorn toward the Capitol is widespread. “I don’t think there is a credible solution in Washington,” said Oberbeck, a leveraged buyout specialist, shortly after the Geithner event. Despite that, he was confident that Congress would, in fact, raise the ceiling. “In the restructuring businesses, the best deals have a little distress. A little bit of distress is just what America needs.”
But what if distress becomes disaster?
On September 29, 2008, Treasury Secretary Henry Paulson Jr. and Federal Reserve Board Chairman Ben Bernanke were stricken. They had warned Congress that failing to pass the Troubled Asset Relief Program would prevent them from saving the financial system and deal a coup de grace to already reeling markets. But the Republican leadership failed to deliver their caucus’s votes, and the bill failed in the House. At the time, most policymakers in Washington were speechless; on Wall Street, traders knew what to say: “Sell.” U.S. stock markets experienced their worst plunge since the Black Monday crash in 1987, wiping out $1.2 trillion in value. The bill passed on a second attempt days later.
All that drama replayed last week on a movie screen in the Time Warner Center, towering over the southeast corner of New York City’s Central Park. There, an audience of journalists and financiers gathered for a special screening of Too Big to Fail, the HBO movie about the financial crisis. Geithner, who figures largely in the film because of his tenure as president of the New York Federal Reserve Bank, once again took questions. This time, he was asked what the sequel to the film—the next financial crisis—might look like. Not missing a chance to press his case, Geithner responded that his biggest worry was the next two months until the debt deadline.
Although some Wall Street analysts are bracing for political turbulence, even they are still betting on a happy outcome.
“I don’t think there’s a totally unreasonable chance that they don’t pass it on August 2, and we have sort of a TARP-like vote,” Priya Misra, Bank of America’s chief U.S. rates strategist, said the next day. “It’s not passed the first time round, and that results in a big market reaction, and then ultimately it does get passed.”
The TARP comparison, however, also highlights the new political and economic challenge. It would be difficult to regain investors’ confidence and erase the economic losses if markets panic during the unexpected failure of a debt-ceiling vote—lobbyists and financial analysts all expect symbolic failed votes that then pave the way to a final resolution. But politicians who experienced the controversial TARP vote, and many new members who won their seats campaigning against “bailouts,” are leery of supporting any bill on the basis of disaster warnings purveyed by Geithner, Bernanke, and Wall Street.
A growing number of Republicans are questioning whether reaching the debt limit would be so bad. Without more borrowing to service the debt and to cover operating expenses, government spending would have to be cut by $125 billion each month. It’s a huge gap, and closing it would take essential services off the table. Bond markets, bankers say, would react the same way to a government that can’t pay Social Security checks or defense contractors as it would to a business that couldn’t pay its rent: unkindly.
If the government missed a bond payment, both Standard & Poor’s and Moody’s bond-ratings agencies would downgrade U.S. debt from Triple-A, the highest rating, to “selective default,” and economic disaster would likely result. A ratings cut would automatically send Treasury yields sharply higher, in part because institutional investors are routinely required to restrict their holdings of bonds not rated Triple-A. Interest rates for corporate bonds, mortgages, and most other loans, which are all benchmarked against Treasury rates, would shoot up too. If investors truly began to panic, the fallout would be much worse.
Some remain skeptical, however. Investor Stanley Druckenmiller, in a much-discussed interview in The Wall Street Journal, argued recently that a default might be helpful in resolving long-term budget challenges. That echoed the claims by some Republican lawmakers. “By defaulting on the debt, in the short and long term, it could benefit us to go through a period of crisis that forces politicians to make decisions,” Rep. Devin Nunes, R-Calif., told Politico earlier this month.
Arguments like those alarm many economists and financial analysts.
“We’re shifting from the main issue: ‘Let’s pass the debt ceiling, let’s get a longer-term sustainable budget plan in place,’ ” worried Bank of America’s Misra. “It’s moving now to, ‘What are the ways we cannot pass the debt ceiling and avoid a default?’ Or: ‘Is actually a default good?’ The market implications of a missed payment on Treasury obligation are immense. I completely take the other side of Mr. Druckenmiller’s point.”
A financial-sector lobbyist, who declined to be identified, agreed: “You can’t go to the last minute with this; markets are already nervous.”
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If they recognize that the consequences are largely in their own hands, why are those on Wall Street doing so little to urge Congress to act? They’re taking, in their own parlance, a huge position: The financial sector hopes that Republican demands for spending cuts will kick-start a debate over deficit reduction—their larger concern—without actually getting to the point of chaos.
“It would be insanity if we don’t lift the debt ceiling, and it would be shooting ourselves if we were not to do so,” said one financial executive of the Republican strategy. “But at the same time, there’s admiration for their direction of putting our nation on a better fiscal course.” Oberbeck put it even more bluntly: “I hope Republicans have the guts to push them to the brink.”
Playing chicken over the debt ceiling is some-thing the villain of Wall Street might have savored.
Brinksmanship, though, might mean different things on Wall Street and in Washington. The flirtation with a government shutdown this spring revealed that the capital’s policymakers, and particularly Boehner, could indeed hold out for a last-minute deal and live to tell the tale. But many rank-and-file Republicans saw that deal as a sellout—the legislation was advertised as cutting $38.5 billion in a year, but the Congressional Budget Office later estimated that it would reduce spending less than $25 billion over 10 years. Now, in the next round of brinkmanship, many of those lawmakers are determined to hold their leaders to even tougher positions.
Wall Street’s confidence about the debt ceiling extends to its lack of specific lobbying on the issue. In fact, the financial industry has mobilized far more lobbyists and spent millions of dollars more to tamp down one of the most narrow provisions of the Dodd-Frank law—the Durbin amendment, which calls for strict new limits on the “swipe fees” that banks charge retailers for processing debit-card purchases.
In part, the lack of lobbying on the debt ceiling reflects a pragmatic consideration by financial executives. Given that Wall Street is still extremely unpopular in the public mind, lobbyists say, a public campaign by the financial industry to raise the debt ceiling could backfire politically. As a result, Wall Streeters are deferring to the U.S. Chamber of Commerce and other business groups with more Main Street credibility.
When financial-sector representatives do talk to members of Congress about the debt ceiling, they focus on the consequences of failure, not how to avoid it. The consensus among their in-house economists is that a realistic deficit-reduction package will have to include revenue increases as well as spending cuts. That’s not an argument that Wall Street lobbyists are making, however.
“We are not being prescriptive about that all; we’re staying totally far away from that,” the executive said. “In our visits with members, we’re just educating [them] on the economic consequences of default on the debt.”
As the July congressional recess draws closer, the financial industry may need to be more specific. Although the industry’s overriding assumption is that Boehner will be able to bring his caucus around to a deal, those prospects will decline if rank-and-file Republicans become even more dubious about the financial dangers of failure. House GOP leaders, facing heavy internal rebellion against their last budget deal, needed large numbers of Democratic votes this spring to avert a government shutdown. Industry lobbyists now estimate that as many as 70 Democratic votes will be needed to pass a debt-ceiling increase, suggesting that more than a third of the Republican caucus might vote against an increase. Democrats, however, have their own internal divisions, and many liberals will be reluctant to vote for a deal they perceive as too focused on spending cuts.
Some veteran lobbyists and Hill staffers say that the debt-limit fight has actually delayed, rather than hastened, progress on what Wall Street sees as a much larger problem: the United States’ unsustainable long-term deficit path. While many agree that the solution is an everything-on-the-table, comprehensive deal, the artificial timeline imposed by the debt-ceiling debate has focused policymakers on finding a soft fiscal framework to give cover for votes, rather than a solution to the problem.
“This is really not a strength of the U.S. budget process,” explained Nikola Swann, the primary Standard & Poor’s analyst for U.S. sovereign debt. “It might be impossible to find another country that puts this kind of constraint on its government: two separate votes that are quite divided in time, one on the budget that creates the need to borrow, and second, on the ability to borrow.”
In the end, the most common reason that Wall Streeters give for betting on an increase in the debt ceiling is that Congress has done so 78 times in the last 50 years. “The track record is, it’s always been raised before,” Swann said. But if past performance is the main reason for believing in future results—like, say, a hundred-year trend of rising U.S. home prices—then perhaps Americans should be more worried than the financial pros are.
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This article appears in the May 28, 2011, edition of National Journal Magazine.