Debt-ceiling drama
Is the debate much ado about nothing or a slow-moving train wreck?
Bottom Line
With Tax Day and the two-week Easter/Passover recess now behind it, Congress should begin to address the debt ceiling. The Treasury hit its previously approved limit of $31.4 trillion in January, and Secretary Janet Yellen has been employing “extraordinary measures” to meet the payment obligations on the federal government’s debts.
Depending on the pace of tax collection this week, Yellen can probably forestall default until the third quarter. According to our research friends at Goldman Sachs, however, collection through Tax Day has been weak, down an estimated 29% from a year ago. That likely will rise. Taxpayers who owe the government money generally don’t send in that check early. So it may be several more weeks before we have a clearer picture of total tax receipts. June 15 is a critical date, with quarterly tax payments and potentially huge inflows. If Treasury can remain solvent past June 15, then Yellen’s effective “X-date,” when defaults will begin, could shift into late July.
Game of chicken With the X date probably a few months away, expect political posturing between now and Labor Day, with both parties hoping the other blinks first. In our view, both sides are hoping to score points with independent voters ahead of the critical presidential election in 2024.
To be sure, both sides have valid points. President Biden and the Democrats are demanding a clean lift of the debt ceiling with no concessions. Strategically, the administration may be counting on continued internal disarray among Congressional Republicans. They seem to be channeling the old “four-corner-stall” that Dean Smith and the North Carolina basketball team perfected from the 1960s to the ’90s.
House Speaker Kevin McCarthy and the Republicans argue that the administration and the other side of the aisle have spent—or simply handed out—$5 trillion over the last two years with nothing to show for it other than the worst inflation at 9.1% in 40 years and a record total debt to GDP ratio of 123% at the end of last year.
Next steps Biden has refused to meet with McCarthy over the past two months, so the speaker is hoping to force the issue by preparing and passing Republican-backed legislation to address it as early as next week. Key elements may include:
- Claw back an estimated $200 billion in unused and unspent pandemic relief funds.
- Return nondefense discretionary spending to fiscal 2022 levels and implement 10-year spending caps with 1% annual growth.
- Repeal Biden’s signature 2022 Inflation Reduction Act (IRA), which spent $1.4 trillion on climate and healthcare programs, added 80,000 new IRS agents and increased corporate tax rates.
- Impose modest work requirements on some government benefit programs, such as food stamps.
- Prohibit Biden’s plan for student-debt cancellation, currently under Supreme Court review for constitutionality.
- Enact policies to tighten border security, expand traditional energy production, re-establish energy independence, lower energy prices, increase jobs and grow the economy.
$1.5 trillion If implemented, the Republicans are proposing to raise the debt limit by an estimated $1.5 trillion, which likely would kick the can to February or March 2024. That would mean we would be right back where we started, but in the middle of the presidential election season, with a searing spotlight on the issue of prudent fiscal policy spending. It’s unlikely that such a bill will pass in the Democratic-controlled Senate, so some compromise will be needed.
Entitlements commission The growth in entitlement spending on Social Security, Medicare and Medicaid is a significant longer-term budget problem, which ultimately must be addressed. But it’s a highly contentious and complicated issue, with no easy fix in sight. Rather than hold up the near-term lifting of the debt ceiling, Republicans are likely to propose the creation of a bipartisan committee to study the problem and propose solutions, much like the successful Greenspan Commission in 1981 and the Simpson-Bowles Commission in 2010. President Reagan implemented Greenspan’s suggestions, but President Obama chose not to implement Simpson-Bowles’ proposals.
Equity market sequel? While we fully expect the debt ceiling to be lifted successfully at some point, this ugly debate could easily drift into the July-September quarter, which is historically the most volatile for markets.
We’ve seen this horror movie before. Amid a stalemate in debt-ceiling negotiations between the Democratic White House and Congressional Republicans in August of 2011, the S&P 500 hit a 15% teeth-shattering air pocket. During the entire third quarter of that year, stocks plummeted 20% from peak to trough. Eventually, Obama and Congressional Republicans reached a compromise and the debt ceiling was successfully lifted. Stock prices rebounded 17% during the fourth quarter of 2011. We could be looking at a similar reboot in 2023.