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Conservative Strategists Warn GOP About Economic Risks Of Pushing Debt Ceiling Debate Too Far

Wall Street

First Posted: 04/22/11 08:25 PM ET Updated: 06/22/11 06:12 AM ET

Conservative strategists are warning that the GOP should not push the debt ceiling debate too close to the breaking point.

“If there is a vote on raising the debt ceiling and it fails, there will be a significant market reaction,” said Tony Fratto, a former Treasury and White House official in the Bush administration. “Investors already believe that Congress doesn’t understand the financial markets. A failure to raise the debt ceiling will confirm this to them."

If the markets get spooked, U.S. treasury bond yields will spike, driving up interest rates and increasing the price of borrowing money for everyone from the federal government to municipalities to consumers, Fratto warned. The cascading effects on the economy would be severe and long-lasting.

The negative market reaction would "come quickly,” Fratto said. “I think you can virtually guarantee that, and I hear it from everyone that I talk to in the markets, here and abroad.” He added, “I’m uncomfortable about the number of [Congress] members who don’t seem to understand that.”

But the market’s reaction to any debt vote will depend on what expectations are set by political actors in Washington, cautions Doug Holtz-Eakin, a former top adviser to Sen. John McCain’s (R-Ariz.) 2008 presidential campaign.

“If there was an up or down vote on the debt limit with nothing attached to it, that [investors] knew was not going to pass, I don’t think it would cause any trouble at all,” Holtz-Eakin said. “But if we get to July and it’s a deal that is perceived to be the deal and it fails -- yeah, I think they’ll freak.”

“Both sides are going to spend a lot of time setting expectations” for the markets and the voters, he said.

For Democratic leaders, the narrative is relatively straightforward: The ceiling should be raised promptly, and some limited spending cuts would be appropriate.

Republican leaders face a more delicate balancing act. They must get enough of their Congress members to vote for the debt ceiling increase at a time when most of their voters –- and especially those in the Tea Party -– oppose such a move.

"The one thing we want more than anything else out of the debate over the debt ceiling: No increase in the debt ceiling," said Mark Meckler, co-founder of the Tea Party Patriots.

Rep. Tim Griffin, a freshman Republican from Arkansas’s Second District, told The Huffington Post that the feedback he has heard this week from voters back home has been “mostly just opposition to raising” the debt ceiling.

Rep. Dennis Ross, another freshman Republican from Florida's Twelfth District, responded to a question from The Huffington Post on Twitter about what he was hearing from constituents: "Universally, across parties and socio-economic levels, hearing 'do not raise it.'"

All of this is supported by a poll from the Tea Party group FreedomWorks, which found that 69 percent of all voters oppose raising the debt ceiling.

While there is disagreement between Democrats and Republicans over when a default would occur if the government hit the debt ceiling, there is broad bipartisan agreement that such a scenario is undesirable and would likely have dire consequences for the economy and the nation.

So the task for House Speaker John Boehner (R-Ohio) and Senate Minority Leader Mitch McConnell (R-Ky.) will be to extract significant concessions from President Obama and Democrats in Congress that will not be rejected as a fig leaf by Tea Party activists. Judging from the Tea Party’s scathing reaction to the deal struck in the most recent fight over this year’s budget, that will be a difficult task.

There are three main components to any potential deal that Boehner and McConnell must address.

One is what kind of structural changes to spending can be enacted, such as spending caps for each year's budget. A second is how deeply spending will be cut in the budget for fiscal year 2012, which starts in October. And the third is how high the debt ceiling will be increased from its current $14.3 trillion level, and whether that will last beyond the 2012 election or not.

They must also deal with what are essentially two different Congressional Republican camps.

Many GOP lawmakers are in the conventional wisdom crowd, which says that the debt ceiling has to be raised no matter what. This subset wants to avoid scaring the markets, but they also think the united GOP bloc has substantial leverage and can extract significant spending cut concessions from Democrats.

The second Republican camp is the more hard line conservative group, which appears willing to press their case to the political and economic limit. They will not vote for a debt ceiling increase unless they receive significant concessions.

This hard-line group is led by Sen. Jim DeMint (R-S.C.). In his view, the only achievement worth the price of raising the debt ceiling is an amendment to the Constitution that would require the federal government to balance its budget every year. His constitutional amendment is supported by all 47 Republican senators and in a test vote in March. Eleven Democrats also gave DeMint's amendment their backing.

That's still far short of the the two-thirds majority needed in both the Senate and the House for a constitutional amendment. (Three fourths of the nation’s 50 state legislatures must also approve.)

But DeMint appears ready to go to the mat on this issue. He has promised to filibuster the debt ceiling increase, if the constitutional amendment is not included.

Anything less, DeMint sees as capitulation and failure.

“It’s balance or bust,” the Tea Party firebrand wrote in a fundraising email earlier this month. “Agreeing on the right policy is not enough to save our country. Republicans also have to be willing to fight to enact that policy, even if it means sacrificing their political careers,” he said.

Certainly some portion of the GOP will line up behind DeMint. Yet even the most conservative group in the House, the Republican Study Committee, has not yet coalesced around what they want out of the debt ceiling fight.

Republicans from both camps interviewed by HuffPost gave the balanced budget amendment virtually no chance of passing with a Democratic-controlled Senate and a Democratic president.

Conservative congressional analysts agree.

“It is going to be very difficult to get a two-thirds vote to pass a balanced budget amendment with so many big spending liberals in the Senate,” said Brian Darling, a senior fellow for government studies at the conservative Heritage Foundation. “The [amendment] has a good chance of passing in 2012 with a new Tea Party congress.”

To give themselves some breathing room, Republicans are inoculating themselves against falling into a situation similar to 2008, when many in the GOP feel they were bum rushed into passing the TARP bailout by dire warnings from the Bush administration.

The GOP vaccine is one half psychological and one half process-oriented. They argue that hitting the debt ceiling does not equal automatic default, because the Treasury Department can move money around and prioritize payments to ensure creditors continue to get paid for a time.

So when Treasury Secretary Tim Geithner’s May 16 deadline arrives and the $14.294 trillion red line is reached, don’t expect the GOP to appear too worried.

But the wild card in the debt ceiling fight is how the global credit markets will respond to what Congress does, and at what point there might be a negative reaction. If there is a chaotic spiral set off by a failed balanced budget amendment vote or some other development along the way, all bets might be off.

Or, conversely, there is a chance that the axiom "what’s good for Wall Street is good for Main Street" will fall on deaf ears, and then be put to the test.

This article originally stated incorrectly that two thirds of state legislatures are required to ratify an amendment to the Constitution. That has been corrected.

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