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If you make a quick scan of the headlines, which is the way a lot of people interact with the news, you’d see numerous reports stressing that Senate leaders had made “progress” in the “let’s try not to crash into the debt ceiling” talks and were hopeful of getting a deal done. Stock markets took cheer from these reports.
We feel compelled to mention one matter: getting a debt ceiling/end the shutdown pact of some sort is merely a precursor to the hoped for performance of The Persecution and Assassination of What is Left of the American Middle Class, as Performed by the Inmates of the Beltway under the Direction of Barack Obama (more commonly described as the Grand Bargain or Great Betrayal).
It is also important to recognize that even though the messaging was positive, anyone who has an eye on the calendar knows that things have to go close to without a hitch for bills to get through the Senate and House in time to avert putting the Treasury in the position of having to make do with existing cash flow until the debt ceiling is lifted. Mind you, only really serious pessimists doubt that the debt ceiling will be raised, and likely well before the real crunch time of October 31-November 1. And even then that does not a default on Treasury bonds; one analyst argues the drop dead date for Treasuries is November 15 (personally, I think there is no way an Administration so close heavily populated with acolytes of Bob Rubin would ever let that happen. Expect the Fed to invoke its unusual and exigent circumstances powers in the unlikely event that things go on that long).
But it’s also critical to recognize that the sanguine reaction of equity markets represents the reactions of a particularly happy-go-lucky bunch that has had the Greenspan and Bernanke put protecting their backs for a very long time. Fixed income investors are a much more sober and quant-y bunch, and with good reason. As Goldman’s senior partner in the 1970s, Gus Levy, remarked, “In bonds, you eat like a bird and you shit like an elephant.” In other words, the upside is modest and the downside is considerable.
Credit markets get much less reporting than equity markets; in part, it’s because they have long been dominated by institutional investors, in part, because the markets are over the counter, and hence less transparent than exchange traded stocks. And they are just less sexy from a news standpoint; most bonds are fungible. Investors buy them on their credit risks and specific attributes, while stocks are story paper.
And those dour fixed income investors have been quietly preparing for possible nasty outcomes even as the US stock market has stayed comfortably within its recent trading range. One indicator: one month Libor is lower than comparable Treasuries. Remember that the mere effort to get out of the way of bad possible outcomes can produce serious dislocations. Fixed income markets were closed Monday due to the commercial bank holiday. We’ll have a much better reading on the sentiment of the investors who matter over the course of the day. Remember Jim Carville’s saying: “I used to think if there was reincarnation, I wanted to come back as the President or the Pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everyone.”
Today, the New York Times is in particularly fine form, and its lead story on the debt negotiations is the best one-stop shopping on the status of the talks. Here’s the outline of the deal under discussion:
Negotiators talked into the evening as senators from both parties coalesced around a plan that would lift the debt limit through Feb. 7, pass a resolution to finance the government through Jan. 15 and conclude formal discussions on a long-term tax and spending plan no later than Dec. 13, according to one Senate aide briefed on the plan.
But keep in mind that the two Senators hashing out a possible deal, Harry Reid and Mitch McConnell, can’t make any binding commitments. They have to go back to their principals. One can assume that Reid is not too far out ahead of what Obama might accept. That is not a given on the Republican side, as the Times warns:
But while both Senator Mitch McConnell of Kentucky, the Republican leader, and Senator Harry Reid of Nevada, the Democratic leader, praised the progress that was made in the Senate, it was already clear that the most conservative members of the House were not going to go along quietly with a plan that does not accomplish their goal from the outset of this two-week-old crisis: dismantling the president’s health care law.
“We’ve got a name for it in the House: it’s called the Senate surrender caucus,” said Representative Tim Huelskamp, Republican of Kansas. “Anybody who would vote for that in the House as Republican would virtually guarantee a primary challenger.”
Now in fact, this Representative talk is bluster. Based on the public statements of Republican representatives, Democrats are highly confident that 19 to 21 Republicans in the House would go along with Democrats, which is enough to secure the passage of a clean continuing resolution and debt ceiling relief. But Boehner has clearly all this time felt the need to win some additional Republicans over before calling for a vote. Boehner has further, in the eyes of Democrats, dealt with Democrats in bad faith before. As Karen Tumulty wrote in the Washington Post:
Right up until the final days before the fiscal year ended Sept. 30, Obama and Democratic leaders believed that House Speaker John A. Boehner (R-Ohio) would find a way to avert a government shutdown by passing a stopgap spending bill.
Boehner, they thought, had assured them as much over the summer. That was when Reid agreed, with the White House’s assent, to set spending levels in the short-term funding bill at sequestration levels, rather than the higher amount that liberals and many in the House were hoping to see.
Translation: Boehner asked for concessions from Senate Democrats, Reid and Obama reluctantly agreed (and other reports indicate that Reid had to push hard to secure the cooperation he needed from fellow Senators), then Boehner said he couldn’t deliver on what he proposed and asked for more. That sort of retrading does not go over well in negotiations.
Even thought the Treasuries are not at immediate risk of default if the October 17 date comes and the deal is not finalized (and remember, that can happen simply due to procedural issues even if Obama and Boehner sign off on an outline agreed by Reid and McConnell), there can still be plenty of disruption and collateral damage if the deal is not looking like it will be in hand either by or very shortly after October 17. The Times explains:
Officials in several states said a default would mean unprecedented but unknown consequences to federal programs that are administered by the states, like Medicaid and food stamps. They also said that a market collapse could undermine state pension plans. And higher interest rates from a default on federal bonds could make short-term borrowing more difficult and costly for states…At the same time, asset managers and banks began taking steps to be ready if the Treasury Department is unable to pay back its short-term debt on time. And world leaders expressed concern about the impact on their countries…
Wall Street sentiment may be in evidence even before a vote, when the Treasury Department sells new 13- and 26-week bonds. If investors are hesitant to buy them, it could set a negative tone for the day, as was the case after an auction last Tuesday. George Goncalves, a Treasury strategist at Nomura Securities, said investors might not immediately panic if all signs were pointing toward a positive vote.
So while the magnitude of the possible damage means it looks unlikely that the Tea Party can cow Boehner into delaying a vote. But the timing is still getting very tight even if Reid and McConnell sign off on terms early today. And any delay past the 17th won’t just fray nerves, it will further damage America’s already falling standing in the rest of the world.