Monday, August 15, 2011


I’m ending my hiatus and getting back in the blogging saddle. I was traveling for a few weeks, and catching up for a few weeks. During my travels, I was fortunate to avoid the political drama (and media frenzy) surrounding the debt-ceiling debate. While catching up, I couldn’t avoid the media frenzy (or political drama).

We all know the ultimate outcome of the debate: an agreement to lift the debt ceiling by approximately $2 trillion in three steps, conditioned on "deficit savings" of a similar amount. A good summary of legislation (the "Budget Control Act of 2011") is available here.

The first two steps will increase the debt ceiling by approximately $900 billion. The third step will increase the debt ceiling by another $1.2-$1.5 trillion, depending on the outcome of budget negotiations within a Congressional fiscal-reform “SuperCommittee.” Democrats and Republicans will each appoint six members to the SuperCommittee, and the twelve members of Congress will negotiate a mix of spending cuts and revenue increases that are intended to exceed the amount of the debt-ceiling increase. If the SuperCommittee is unable to agree on a mix of cuts and revenue increases, automatic spending cuts will take effect.

The ratings agency S&P is not sanguine that the SuperCommittee will take credible steps towards “fiscal consolidation” in the existing political climate. On Friday, August 5, S&P downgraded the credit rating of U.S. Treasuries from AAA to AA+ (with a negative outlook). The Downgrade and other economic factors traumatized the financial markets last week. Ironically, investors dumped stocks in favor of U.S. Treasuries as a “safe haven” investment. Go figure.

Reactions to the Downgrade were mixed. The Obama administration challenged the credibility of the Downgrade, arguing that S&P’s assumptions were flawed. (An important factor motivating the Downgrade is the spectacularly polarized relationship between Democrats and Republicans, and the resulting dysfunction on Capitol Hill.) Conspiracy theorists speculated that S&P was attempting to establish its objectivity, and thus salvage its reputation in Europe, where it has begun losing market share after downgrades of European sovereigns.

The majority view ranged from indifference to resignation to mild optimism. For most political and market observers, the Downgrade was neither a surprise (S&P telegraphed it in mid-July), nor a harbinger of doom (as noted, investors fled to U.S. Treasuries after the downgrade). Most observers viewed the Downgrade as an official wake-up call.

In my view, the Downgrade was several years late. We’ve always known that entitlement spending was unsustainable in the long run; and the gap between projected revenues and expenditures has been exacerbated by the Great Recession. We collectively borrowed too much to fuel a decades-long binge on consumption and government transfer payments. The resulting economic bubble has burst with devastating consequences; the aging Baby Boom population will become an immense strain on federal and state budgets in the next decade; and our flabby industrial sector faces ruthless competition from emerging-market economies. We are facing the abyss, and our political leaders have been slow to acknowledge the severity of our fiscal imbalance. Everyone deserves a share of the blame: Democrats; Republicans; and a voting public that rewards incompetence with re-election.

Can the new SuperCommittee take baby steps towards fiscal sustainability? During the last year, two bipartisan committees produced serious recommendations to address our nation’s long-term fiscal imbalance (see here and here). I’m hopeful, although not optimistic, that the SuperCommittee will build upon some of those recommendations.

If I had to wager, I’d put my money on “politics as usual,” with Democrats (and many Republicans) opposing sensible entitlement reforms, and Republicans (and many Democrats) opposing sensible reforms to tax expenditures. The Obama administration ignored the recommendations of its own budget-reform committee, which speaks volumes about its commitment to tackle the fiscal crisis. More disturbingly, President Obama takes every opportunity to poison the well, by obsessing publicly over tax breaks to “millionaires and billionaires,” defining “millionaires and billionaires” as “households earning more than $250,000.” But that’s a post for another day.

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