The Debt Ceiling, the Fed, Obama's Risky Strategy, and Related Thoughts

-- Posted by Neil H. Buchanan

Yesterday, here on Dorf on Law, I promised that today's post would present my view that the Federal Reserve must inevitably be the savior that prevents a default, should the Republicans' refuse to increase the debt ceiling.  Before making that argument, however, I will offer three short comments on related issues.

First, in his op-ed in today's NYT, Paul Krugman essentially adopts the "choosing from among nothing but bad choices" framework that Professor Dorf and I have been advocating (literally for years, but most recently in yesterday's post).  He links to a Washington Post WonkBlog piece that carefully describes our work and that quotes extensively from an interview with Professor Dorf earlier this week.  This framework, of course, would be especially likely to make sense to Krugman, because he always uses his economics training to analyze real-world tradeoffs, not abstract fantasies.  In any case, it is good to see that the conversation is turning away from the idea that there is no other choice for the President but to default.

Second, Krugman starts to make a point that I have been thinking about for awhile.  He notes that, during the 2007-09 crisis, "Wall Street was bailed out but distressed workers and homeowners got little or nothing."  If we now "prioritize" paying bondholders, in the way that many of the true believers in the Republican Party insist that we can and should, "[w]e would, once again, be signaling that the financial industry gets special treatment because it can threaten to shut down the economy if it doesn’t."  Quite so, but the larger point is, I think, more significant (and even, in its way, poignant).

The Tea Party's origins are deeply based on the idea that "bailouts" and special treatment are wrong, wrong, wrong.  An early Tea Party upset, when arch-conservative Republican Senator Robert Bennett lost his Party's nomination in Utah to now-Senator Mike Lee, was accompanied by frenzied Tea Party activists in the convention hall, angrily chanting, "TARP!  TARP!  TARP!!"  TARP (the Troubled-Assets Relief Program) was the core bailout provision that enraged and mobilized the right-wing populist base.  Once again, therefore, we are seeing that the big money guys are using the "rubes," who actually thought that there was a way to prevent Wall Street from getting special treatment.

Third, most of the debt ceiling debate is obviously about framing the issues.  Republicans want people to believe that refusing to raise the debt ceiling is about controlling debt, whereas Democrats say correctly that the debt ceiling prevents the government from paying its already-existing debts.  Among all the different ways that I have heard people try to make this point, my father-in-law came up with my favorite: "My wife and I have decided not to pay our electric bill this month, because we don't want to raise our debt ceiling."

(On a different topic, Jon Stewart offered a similarly clarifying analogy last night regarding Republicans' claims that everyone has access to health care through free emergency rooms: "Don't say that we don't need Food Stamps because we already have dine-n-dash."  Brilliant.)

In any case, I argued yesterday in my Verdict column and here on Dorf on Law that the best of the bad choices, when we reach the drop-dead date for the debt ceiling, would be for the Fed to step in and buy the additional bonds that the President would have to issue in order to avoid default.  Because of the possibility of a "failed bond sale" (which, I continue to believe, is a very low-probability event, but not impossible), the Fed could decide that its fundamental duty to protect the global financial system requires it to step in and buy the new debt that would be needed to finance Congress's spending laws.

I have recently come to believe that this is not just what the Fed might do, or even that it should do, but that the Fed must buy those bonds.  The problem is simply a matter of timing.  Whenever the drop-dead date is reached, the President is committed to forcing Republicans to back down.  If they stand firm, and the clock hits 11:59:59 pm, then it will be simply impossible to carry out the public bond sale that would be necessary to avoid default.  (That, by the way, is also true of the super-coupon bonds that I described in yesterday's post.)

At that point, there really are only two possibilities: the President follows Buchanan-Dorf by getting the Fed to buy the bonds, or there is a default.  I do not see how the Fed can allow the latter to occur.

This shows just how dangerous is the President's stare-them-down strategy.  Many liberals have said to me recently, "But don't you think that the President has to pretend that he's not aware of your argument, to keep up the pressure on Republicans?"  And they are surely right.  Once the President decided on his current strategy, it required him to maintain his poker face, which further requires him to deny that there are any other possible routes.

Last week, I argued that the President still has the last word on this, because at midnight, he is the one who has to choose whether or not to default.  Or, as I was quoted in The Wall Street Journal earlier this week: "The Obama people are committed to not blinking. If Republicans don’t blink either, then the last mover in this drama is the president. He can float some bonds or default on the obligations, but he’s the one who has to make that tragic choice."  That is still true, but the problem is that floating bonds takes time.  That is why the Fed will have to act.

All of which lends further support to the argument that the President should have announced as early as possible that the debt ceiling is a dead letter.  The best recent date would have been March 31 of this year, right after Congress passed the continuing resolution that kept the government running through September 30.  Announcing then that he would always choose more debt rather than allowing a default would have given everyone time to freak out, a few news cycles to pass with newspapers filled with conflicting opinions over his strategy, Republicans vowing impeachment, and so on.  Most importantly, the President would have time to make the point, over and over, that all of his options were bad, and that he was choosing the least bad among them.

By the time the debt ceiling was reached, the financial markets would have had time to assess how to respond to a bond sale, and the mechanics could have been in place.  It would still be white-knuckle time, but it would be in some ways old news.  Even if Obama had been impeached by the House, the Senate could have acquitted him in a matter of minutes.  I am not saying this lightly, but I am saying that the reason many people reject the Buchanan-Dorf analysis is that it is unfamiliar, and thus seems like something that the public would not accept.  Had the Administration decided to go that route, however, they could have taken advantage of the summer months to make the argument seem not just familiar, but obviously true (which it is).

Instead, they decided that there is political advantage to a strategy that fundamentally guarantees a last-minute standoff.  That might work out, with either the Republicans blinking or the Fed stepping in, but it was unnecessary and incredibly risky.