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By Yves Smith

This article by Yves Smith is cross-posted from Naked Capitalism.

Washington DC appears to be readying itself for a repeat of the TARP, namely, the passage of unpopular legislation to appease the Market Gods (and transfer even more income from ordinary Americans to the Masters of the Universe). It isn’t yet clear whether this drama will be played out via generating bona fide financial market upheaval or mere threat-mongering (the Treasury market seems pretty confident that well-trained Congresscritters will fall into line). But unlike the TARP, which was a classic example of well-placed interests finding opportunity in the midst of upheaval, this reprise is a far more calculated affair.

The latest episode of brinksmanship is the breakdown in talks between Obama and John Boehner Friday afternoon. Boehner claims Obama retraded the deal, asking for more tax increases; Obama, in an unusually incoherent press conference, says he bent over backwards and the Republicans just won’t be satisfied. Obama demanded talks resume on Saturday.

The presumed deadline for reaching the outline of a deal is Monday, given the need to finalize language. But that assumes that the shortfall hits August 2. Barclays and Normura reports claim that internal Treasury forecasts indicate the crunch probably does not start until the 9th or 10th.

Let’s review how we got here. Obama made it clear before he took office (hat tip reader Hugh) that he intended to go after Social Security and Medicare. As we discussed, shortly after he took office, Obama was privately reassuring conservatives that he’d curtail entitlements once the economy was on a better footing. Clearly, he’s been willing to settle for “better” being tantamount to “not in imminent danger of falling off a cliff.” And if you had any doubts, Obama made his intentions abundantly clear (to use that Nixonianism) by creating a Deficit Reduction Commission and staffing it with enemies of Social Security, former Clinton chief of staff Erskine Bowles and Senator Alan Simpson.

The second thing to keep in mind is that his deficit ceiling crisis is contrived. The Bush Administration bumped up against it multiple times and never used it as a basis for budgetary theatrics, even though it was also keen to cut Social Security. Obama could have taken action long ago, before the midterm elections, which were seen as putting the Democratic majority in the House at risk, to gain more headroom.

One also has to wonder at the position reached by respected Constitutional scholar Lawrence Tribe on the clearly worded 14th Amendment (““the validity of the public debt of the United States, authorized by law … shall not be questioned”) and the only Supreme Court decision on it, which clearly stated that Congress may not “alter or destroy” existing debt. That clearly includes issued Treasury bonds, and arguably includes existing Federal obligations.

The problem with his reading is that it’s based on an operational misunderstanding, that the government has to issue new debt to fund itself if tax revenues are insufficient. No one wants to admit that the bond issuance is a political constraint, and when Congress has already approved the expenditures and you have both the Constitution and related Supreme Court decisions stressing the importance of honoring existing Federal obligations, it’s hard to see why direct expenditures would be problematic if the alternative was a clear breach of these strictures. And even if you did subscribe to the Tribe/Obama view, other work-arounds have been broached, both the Ron Paul suggestion of canceling the $1.6 trillion of Treasuries held by the Fed, or the coin seignorage idea. Yet the Treasury pointedly fails to acknowledge that other options exist.

Consistent with the “let’s create a crisis” view is the talk of Armageddon coming from the officialdom. They’ve even hauled Hank Paulson out of the mothballs to give the concerns more weight. From the Financial Times:

The collapse in the talks came after Tim Geithner, US Treasury secretary, met top officials from the Federal Reserve as well as Hank Paulson, his predecessor, to step up preparations for a possible default on US debt, which could occur as early as August 2.

After Mr Geithner spoke on Friday with Ben Bernanke, Fed chairman, and Bill Dudley, president of the Federal Reserve Bank of New York, they issued a joint statement saying they had discussed the “implications for the US economy” of a default but were confident that the country’s borrowing limit would be lifted.

Mr Paulson, who earlier had breakfast with Mr Geithner, was blunt in his assessment of the dangers. “Failing to raise the debt ceiling would do irreparable harm to our credit standing, would undermine our ability to lead on global economic issues and would damage our economy,” said Mr Paulson, who dealt with the financial crisis. “The sense of urgency is clear.”…

Calls with Mr Dudley are also common but none of these discussions are normally publicised. Both the Treasury and the Fed have been reluctant to discuss any contingency plans in case of default.

Now as the article also indicated that Mr. Market has been singularly unconcerned; 10 year and 30 year bond yields fell slightly on Friday, but that was before the talks broke down. The release of concerned chatter among Geithner, Paulson, Bernanke, and Dudley, appears an effort to rev up the engines in case they feel they need to go into full out alarmist mode and rattle the markets to pressure Congress into acting.

But we can see how the endgame is already being scripted. Ezra Klein, the Democratic Party’s answer to Baghdad Bobis already telling us how this staged drama will play out. The messages in his piece tonight: Boehner allegedly doesn’t have the votes, and not having a deal (just like not passing the TARP) is The End of The World As We Know It (in his words, “disaster,” “unleash a market panic,”). So the only solution is for the Democrats to give in to this Republican non-negotiable posture and presumed market armageddon (which we indicated, might not be the calamity the DC punditocracy presumes it will be).

Ezra Klein: Telling it like it is, Baghdad-Bob style

But the average person loses out no matter what happens. Budget trimming in a weak economy will assure flagging growth or a contraction next year. If you have any doubts, debt to GDP ratios have worsened in the European countries that have put on the austerity hair shirt. Cutting Social Security and Medicare is not popular and not necessary (even Ron Paul, who favors extremely aggressive budget measures, pointedly avoided advocating cuts to Medicare and Social Security in an interview today; as we and many others have noted, Medicare is not a “Medicare” problem but a health care cost problem, which the Obama “reforms” will only make worse).

So it isn’t clear why Democrats should sign an Obama suicide pact. Market turbulence, of course, would hit big donors worse than ordinary voters, which is presumably why it should be avoided at all costs. Yet it was the Blue Dog corporate Democrats, and not the progressives, that took it in the chin in the midterms.

The fact that Obama is regularly being compared to Herbert Hoover and now Nixon should give him pause; it’s an indication that he is vulnerable. A bit of upheaval and discomfit to the moneyed classes might be the best thing that could happen to Obama in the very unlikely event Democratic Congressmen prove to be as difficult as their Republican counterparts. But I suspect he’ll get his way and perpetuate the now well honed practice of using crises, whether real or not, to transfer more income to the top of the food chain.

Yves Smith runs the brilliant financial blog Naked Capitalism, and she’s the author of ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism.

Would you like to know more? Click the cover and buy Yves’ book!


Add your own

  • 1. helplesscase  |  July 25th, 2011 at 12:03 pm

    The “Left” in this country needs to show a willingness to part with the Democrats. Otherwise, they’re just going to keep screwing you.

  • 2. DrunktankDan  |  July 25th, 2011 at 4:32 pm

    Damn, gettin Yves to crosspost for you lends some much needed ‘respectability’ to this most awesome of newspapers.

  • 3. ariot  |  July 25th, 2011 at 5:32 pm

    the paradox of nihilism gives me headaches, but I live with it.

  • 4. CensusLouie  |  July 25th, 2011 at 7:01 pm


    That’s the exact attitude too many people had in the 2000 election.

    How did that end up turning out?

  • 5. Zadig  |  July 25th, 2011 at 10:05 pm

    The Democratic power has betrayed the left and the rest of its traditional power base, but what will the left do once it leaves the Democratic party? Form its own political group? Take to the streets? I don’t know why third parties don’t work in the US, but they just don’t seem to: it’s a two-party country for the foreseeable future, and the energy needed to form another viable party seems better spent on remodeling the Democratic party into a leaner, meaner version, more in line with politicians like Sanders or Grayson.

    This not meant to be a rhetorical question; it also seems equally likely that the Democratic party will be thoroughly discredited by Obama’s tentative second term, and that starting fresh is the best idea. It is not a bad idea, but it is more of an uphill battle, and it seems like the left needs to sacrifice some of its purity to get shit done.

  • 6. derpotism  |  July 26th, 2011 at 5:38 am

    the reason a two party system dominates is because of the infrastructure- I mean yeah, also because a two party system represents the most number of people that can disagree with each other but also because a 3rd party would have to compete with the other two for party donations and social connections. Public financing of elections might actually let 3rd partiers to get in on those elections, but in a privately funded system you have to suck a LOT of dick to become important.
    also Obama will lose 2012 and the republicans will win, sending us even further into the shitter

  • 7. DeeboCools  |  July 26th, 2011 at 12:19 pm

    If they just focused on the dollars and stopped their “liberal social policy”(gun control and censorship) nonsense, I would support the democrats. Democrats like Sanders and Grayson should push a hardline anti-war(including drug war) progressive angle. I think a lot of people who currently don’t vote would jump on board

  • 8. adam  |  July 26th, 2011 at 12:29 pm

    What if we started with election reform? Like #6 said, public financing would even the playing field. So, instead of divesting the democratic party of its progressive base and losing out to the right in 2012, maybe we should vote dem, but fight to make campaign financing strictly within the public domain, then work out the logistics for a 3rd party.

    It’s a long-term goal, but this is a democracy, and shit takes forever to get anything done!

  • 9. CensusLouie  |  July 26th, 2011 at 2:43 pm

    How is Obama going to lose 2012? Does anyone honestly think that Mitt Romney is going to be the one to galvanize the Republican base? The Mormon thing alone will kill his chances.

    Honestly, the country just plain can’t afford another Republican administration. That party has been a rampant slash and burn plundering machine since 1980 and each incarnation pushes us closer to the shitter.

    The Democratic party may have its fair share of corruption and assholes, but there’s still enough of a difference between the two parties to matter.

  • 10. helplesscase  |  July 26th, 2011 at 5:21 pm

    # 4

    Yeah, he sucked and Obama sucks in many of the same ways. Enjoy your “shared sacrifice.”

  • 11. ☭ mouse ☭  |  July 26th, 2011 at 6:31 pm

    @4 fuck you censuslouie, fuck you. Nothing is going to get better until it gets much much worse …. Bachmann/Palin 2012!!!! WOO! Seriously, fuck the democrats, the Obama presidency should be all the proof you need. there is literally no point in voting for that party anymore.

  • 12. Space Cynic  |  July 26th, 2011 at 8:51 pm

    You very cleverly, yet incorrectly, move from the legal requirements of the 14th Amendment (regarding debt not being questioned) to somehow conflate that with “federal obligations” – which are NOT legally required to continue. Discretionary spending is just that – discretionary. So before the government *has* to raise the debt limit, they need to eliminate all those expenditures not required by law. This means they can also choose to trim or eliminate “entitlements” – which they should do as many of those ponzi schemes need to be taken out behind the woodshed and shot.

  • 13. Don  |  July 26th, 2011 at 9:55 pm

    All the hand-wringing here about the two-party system betrays a continued distracted focus. Nothing will change until campaign contributions are addressed in a legitimate way. That’s not going to happen if even those paying attention aren’t addressing it as the primary concern.

  • 14. Don  |  July 26th, 2011 at 10:03 pm

    @5 3rd parties don’t work in the US because the other two parties are old boy’s clubs that have local support platforms locked up.

  • 15. Dom  |  July 27th, 2011 at 3:23 am

    Looking at that Ezra Klein photo I’m reminded of:

    “He looks like a recombo DNA project aimed at tailoring people for high-speed burrowing.”
    – William Gibson, “Burning chrome”.

  • 16. helplesscase  |  July 27th, 2011 at 2:50 pm


    Lol’z. Entitlement programs are mandatory spending, dipshit. Furthermore, failure to raise the debt ceiling would cause a default on money that has already been appropriated and spent (in violation of the 14th Amendment most likely)–“discretionary” doesn’t mean “we can stop payment whenever we want.”

  • 17. Cum  |  July 28th, 2011 at 3:52 am

    I feel a snake flicking its tongue in my ear.

  • 18. pat  |  August 6th, 2011 at 11:52 am

    S&P downgrade….
    Who owns Standard & Poor? McGraw Hill.

    “President Bush has managed to keep his family’s nearly eighty-year relationship- with the McGraws alive and well – – a relationship that, according to THE NATION , began between the President’s grandfather, Prescott Bush, and James McGraw Jr., great uncle of current McGraw-Hill Chairman Harold McGraw, III in the 1930’s.”

    They think they are foolin’ us.

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