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Miles Mogulescu Headshot

Is an 8-48 Hour Default the Least Bad Option?

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I realize that this is going to be extremely controversial but with great trepidation, I'm beginning to come to the conclusion that allowing the August 2nd deadline go by without legislation passed by Congress and signed by the president to raise the debt ceiling (with severe spending cuts included in such legislation) may be the least bad option left on the table.

The likely result is that a fast and furious decline in financial markets would rapidly force Congress to pass a clean debt ceiling hike -- with no mandatory cuts to domestic spending or Social Security/Medicare/Medicaid and no "Super Congress" committees to force these cuts later -- all of which would hurt the middle class and slow economic growth by reducing demand.

The immediate market response to not increasing the debt ceiling on time would be a mini-market crash, similar to what happened when Congress first refused to pass TARP in fall 2008 when the Dow declined a record 800 points in a day which resulted in prompt Congressional action.

Beginning at midnight on August 3rd, Asian and European markets would start to crash. When American markets open on August 3rd, the Dow is likely to be down 400-500 points and keep sinking at the rate of about 100 points an hour, interest rates on US government bonds would likely spike by at least 100 basis points a day, and the value of the dollar would tank. With world financial markets crashing and credit markets starting to freeze, within 8 to 48 hours, Congress would have no choice but to pass and send to the President a clean debt ceiling increase through 2012.

Bills raising the debt ceiling traditionally take only one sentence:

"Subsection (b) of section 3101 of title 31, United
States Code, is amended by striking the dollar amount
contained therein and inserting ['$14,794,000,000,000']."

It could be passed by the House and the Senate and signed by the president in about an hour, once they see the markets starting to tank. The markets would almost certainly rally in response. (Lawrence O'Donnell has been arguing on MSNBC that Congress would pass a clean debt ceiling at the last minute before the August 2nd deadline when it became clear that no bipartisan compromise on deficit reduction was achievable. It's now looking like the Obama and the Congressional leadership may have miscalculated the power of Tea Party Republicans and Grover Norquist-types to block any last minute bill to avoid a temporary default and it may take a few hours or days of markets collapsing after August 2 to force Congress to pass a debt ceiling hike. How ironic--It may take the forces of the market to compel these true believers in markets to do what's necessary to save the markets.)

The deficit reduction plans now put on the table by President Obama, Harry Reid, and John Boehner may produce worse economic results than an 8-48 hour default, even if they could pass Congress and be signed by the President. They would sap demand from a depressed economy, extend the recession, and prevent job growth.

• The "grand bargain" that Obama again appealed for in his Monday evening speech to the nation was already DOA when Boehner ended talks on Friday night. As Obama himself admitted, it was already highly tilted in the Republican direction with $800 billion-$1.4 trillion in revenue increases to $3 trillion in spending cuts, plus cuts to Social Security and Medicare. It has no chance of passing both houses of Congress so Obama's plea for this unbalanced "balanced" approach was little more than campaign rhetoric.

• Boehner's current proposal of "cut, cap and balance" is also DOA, particularly after the CBO rated it as not cutting as much as promised. With Tea Party defections, even if revised it might not even pass the House and has no chance of passing the Senate. If it were enacted, the cut part would reduce spending so deeply as to plunge the economy back into recession, the cap part would force massive cuts to Social Security/Medicare/Medicaid in the near future, and the balance part would permanently imbed Tea Party ideology into the US Constitution and make it impossible for future leaders to respond to future economic downturns.

• The Reid proposal is essentially a cave-in to the all cuts/no revenue plan that was being discussed between Joe Biden and the Republican leadership before Eric Cantor walked out of the talks two weeks ago. It doesn't pretend to have even a minor balance between cuts and revenue increases. While Reid hasn't been specific about where he would find $1.2 trillion in cuts (in addition to $1.7 trillion in "savings" from already-planned reductions to the war efforts in Iraq and Afghanistan), there's no way he can find that amount of cuts without major reductions to programs the middle class relies on like student loans, education, public health, community health centers, financial regulation, etc. The proposed Congressional commission would be weighted to providing cover in the near future to cut Social Security/Medicare/Medicaid, and to reduce tax rates on the wealthy and corporations to the lowest levels since the 1920's while eliminating deductions like the home owner and health insurance deductions which benefit many middle class taxpayers. The result would also be to aggravate the economic downturn by reducing demand. Nevertheless, if Congress is going to arrive at a "compromise" before August 2, it's likely to be based upon some version of the Reid all cuts/no new revenues plan -- that is if Republicans are actually capable of accepting Democrats' near total surrender and saying "yes" to their own victory.

Given these dismal alternatives, an 8-48 hour default -- followed by a clean debt ceiling increase -- might not only be less damaging to the economy and job creation than any of the budget-cutting proposals currently on the table in Congress. It would likely potty train Congress for a decade to come to never again make a debt ceiling increase a hostage for other policy changes like debt reduction, tax increases, or cuts to Medicare/Medicaid/and Social Security, out of fear that doing so would again tank the financial markets.

I come to this conclusion with great trepidation. I have no desire to talk like a liberal version of a Tea Partier who claims defaults don't matter. Even a default of a few hours or days would be a bad thing. But given the truly catastrophic alternatives currently on the table, it may be the least bad alternative if, as is all but certain, an immediate market crash then forces Congress to quickly pass a clean debt increase bill.

It would end up where Obama first started 6 months ago, with a clean debt ceiling increase not burdened by recessionary cuts. Obama and Democrats would then have the opportunity, if they choose to take it, to pivot away from the debt ceiling to job creation and stop spouting Republican talking points about how cutting spending will grow the economy.

It should never have come to this but, alas, perhaps it has.