Some historical accounts of the Great Fire of Rome, which destroyed three of the city’s fourteen districts and damaged seven others, depict it as an urban redevelopment project gone bad. Emperor Nero allegedly torched the district where he wanted to build his Domus Aurea. Hence any lyre-playing was not a sign of imperial madness, but a badly-informed leader not knowing his plans had spun badly out of control.
President Obama’s plan at social and economic engineering, of rolling back core elements of the Great Deal out of a misguided effort to cut spending in a weak economy, is similarly blazing out of control. The debt ceiling crisis was meant to be a scare to provide an excuse for measures that are opposed by broad swathes of the public. Polls predictably show that voters want five contradictory things before noon: they are against cutting Social Security and care much more about more jobs than about less deficit, but yeah, they’d like that too if they can have it.
While members of the administration may dimly recognize what a firestorm they have unleashed, their crisis responses look to be no better than Nero’s. Obama has severely limited his options by playing up the rigidity of the debt limit. In the meantime, the Republicans are playing chicken and are looking very convincing by claiming the Tea Partiers had removed the steering wheel from the car. As John Kay warned in the Financial Times, this produced a toxic “bidding” dynamic:
The game theorist Martin Shubik invented an unpleasant economists’ party game called the dollar bill auction. The players agree to auction a dollar bill with one cent increments to the bids. As usual, the dollar goes to the highest bidder. The twist is that both the highest bidder and the second-highest bidder must pay.
You might start with a low bid – but offers will quickly rise towards a dollar. Soon the highest bid will be 99 cents with the underbidder at 98 cents. At that point, it pays the underbidder to offer a dollar. He will not now gain from the transaction, but that outcome is better than the loss of 98 cents. And now there is a sting in the tail. There is no reason why the bidding should stop at a dollar. The new underbidder stands to lose 99 cents. But if a bid of $1.01 is successful, he can reduce his loss to a single cent.
The underbidder always comes back. So the auction can continue until the resources of the players are exhausted. The game must end, but never well. There are reports that over $200 has been paid for a dollar in Shubik’s game.
In the DC version, neither the Democratic Senators nor the Republicans in the House want to be underbidders. And the Obama appears recklessly unwilling to circumvent the debt ceiling, since it would eliminate his leverage for pushing through entitlement cuts.
Yet as we’ve discussed, the outcomes the players have committed themselves to are either shooting the economy or bleeding it to death. A sudden curtailment of Federal spending, unless it was very brief, would assure a slowdown. And that’s before you get to wild cards of what might happen to the Treasury market. With Timmie in charge, an actual default seems unthinkable but not all investors will be willing to trust that, and it is not at all clear what would happen in the event of a downgrade. It has had remarkably little effect on Japan, but crisis psychology has kicked in. While I think worries on that front are exaggerated, even small changes will still have an impact. And utter failure of the Treasury or Fed to make any reassuring noises or discuss contingency plans is making rattled nerves much worse than they need to be.
Put it another way: you know things have gotten really bad when you realize having Larry Summers back in a position of authority would probably have led to less stupidity than what we are seeing now. As bad as many of his reflexes are, Obama’s and Geithner’s are even worse.
It has, late in the game, hit the point where Wall Street is imploring Team Obama and Congress to raise the debt ceiling. Obama has claims that his lawyers told him that he could not use the 14th Amendment to ignore the debt ceiling. But the few precedents suggest otherwise, and opinion is certain to be divided enough among authorities that the President could easily have found legal cover if he wanted to (the Administration has had no compunctions on taking aggressive positions on habeas corpus and a raft of other Constitutional issues).
Respected Constitutional scholar Lawrence Tribe, who had obligingly provided Obama with an ass-covering, not-convincingly-argued New York Times op ed against the viability of invoking the 14th Amendment, has effectively reversed himself since then, admitting that that both a court challenge and impeachment were highly unlikely. Yale constitutional scholar Jack Balkin wrote today (hat tip Arthur) of three additional routes the President could use to work around the debt ceiling. One is the coin seigniorage idea that has been discussed here and on other sites. Another is the “exploding option”:
The government can also raise money through sales: For example, it could sell the Federal Reserve an option to purchase government property for $2 trillion. The Fed would then credit the proceeds to the government’s checking account. Once Congress lifts the debt ceiling, the president could buy back the option for a dollar, or the option could simply expire in 90 days.
Balkin also argues for a third route, effectively, that the President can’t use the 14th Amendment casually, but could when circumstances became more extreme:
If the president reasonably believes that the public debt will be put in question… Section 4 [of the 14th Amendment] comes into play once again. His predicament is caused by the combination of statutes that authorize and limit what he can do: He must pay appropriated monies, but he may not print new currency and he may not float new debt. If this combination of contradictory commands would cause him to violate Section 4, then he has a constitutional duty to treat at least one of the laws as unconstitutional as applied to the current circumstances.
The increased urgency has also led to a change in stance in the Democratic hackocracy. Matt Yglesias, a reliable purveyor of party orthodoxy, pooh poohed the coin seigniorage idea two weeks ago. Today, Brad DeLong (who is generally a loyalist but not an official water-carrier) came out in favor of it based on the Balkin reading. Yglesias made a partial retreat and admitted that Balkin might be right but invoked the bogeyman of a debt downgrade.
But a related question is why is the Administration not doing a better (as in any) job of crisis preparation as a way of calming rattled nerves? Of course, part of the answer is that since this is a manufactured crisis, they really feel they need to keep the heat on and are locked into their current strategy. But a piece by Gillian Tett of the Financial Times lists five areas where the Fed and Treasury owe the public answers on what takes place if there is no debt deal before official finances become strained. I’m not in agreement with all the questions on her list. For instance, “What might the US government do to support the US money market funds if American debt is downgraded, or suffers a technical default?” Paul Volcker was vehemently opposed to the backstopping of money market funds in the crisis, and the assumption underlying Tett’s question assumes that these reserves are entitled to some sort of official protection. Money market fund managers have reportedly raised cash levels substantially in anticipation of redemptions; Treasury-only money market funds won’t dump Treasuries; AAA only funds would presumably in the event of a downgrade (other types of institutional investors are seeking waivers, but I think it would be a non-starter in a product branded as AAA). But her general point is valid: the authorities have been way too close mouthed given the worries they have whipped up. It is astonishing, for instance, that the false August 2 deadline is still widely reported in the media when it is now acknowledged that the real drop dead date is August 10.
We know that the end game is the Democrats will blink, but uncharacteristically, they haven’t done so yet. And enough Senators regard cuts to Social Security with no corresponding sacrifices from better heeled interests (from the military industrial complex to the rich) as fatal to their re-election chances so as to make bringing them to heel daunting in the limited time left.
It is hard to come up with words that are strong enough to describe what an appalling display of misguided ego, inept negotiating postures, bad policy thinking, and utter disregard for the public interest are on display in this fiasco. But as a friend of mine likes to say, “Things always look darkest before they go completely black.”