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Get Ready for TARP 2.0

Posted: 23 Jul 2011 01:25 AM PDT

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) i 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 Bob, is 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).
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 upheaval, 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.