Goldman Ruminates On The Facility On Further Entrenching America With An Untenable Debt Load
Goldman's Alec Phillips discusses the topic of the imminent increase in the Federal debt limit from $12.1 trillion (to $13 trillion, $1 quadrillion?). Alec pokes amusing holes in both the worthlessness of Congress as a monetary policy check, saying that the Congress will of course approve the debt increase "as it always eventually does." What is also curious is the assumption that due to Democratic control of the entire political decision-making process, Phillips sees no risk to a debt limit increase this time unlike 1995 when Clinton was unable to promptly push a cap raise.
Normally the debt limit is simply a political headache for the
majority party in Congress, which must force its members to take a
politically unpopular vote while the minority party votes against it. But
it has been mostly irrelevant for market participants, since despite a
lengthy political debate, Congress always increases it in the end. The
one exception to this came in the winter of 1995, when President
Clinton and the Republican Congress deadlocked over increasing the
limit, effectively shutting the government down for three weeks in
December 1995 and January 1996.
Will this issue be used by Republicans to garner more populist support ahead of mid-term elections and ultimately ahead of the next presidential election? The answer is a resounding yes, especially with debt issues becoming much more of a mainstream concern these days. Even Goldman acknowledges this point:
The debt limit vote often focuses the nation’s attention, albeit briefly, on the amount of outstanding US obligations.
Perhaps this time the nation's attention will be focused a little less briefly on this most critical issue for the longevity of American capitalism/China non-vassal state status.
Lastly, and most notably, is Goldman's dismissive approach to what the general public will get out of any debt ceiling debate:
One should not read too much into the rhetoric that is likely to
come out of the upcoming debate over the debt limit, since much of it
will be meant for public consumption but will have little bearing on
other policy debates that follow.
We beg to differ. Public consumption is becoming a very prevalent issue these days. Perhaps Mr. Phillips should call up Goldman's PR department to see prima facie just the what the impacts of a shift in popular sentiment can do to either policy or, in his case, a firm's perception among the broad populace.
We would like to remind readers of Zero Hedge's petition to freeze the debt ceiling, which has been signed by nearly 2,000 of our readers, and which will be distributed to appropriate members of Congress shortly.
Full Goldman note below (highlights ours)
Raising the Federal Debt Limit: It's Never Easy
Within the next two months, the Treasury is likely to run up against the limit on publicly held debt. This will require Congress to raise the limit, which currently stands at $12.1 trillion, and is likely to involve a contentious debate over fiscal policy.
We expect Congress to approve a debt limit increase, as it always eventually does. However, the process may be more consequential than usual. First, the steps the Treasury may use to delay hitting the limit involve programs of some importance to the market, such as winding down the Treasury’s Supplementary Financing Program (SFP). In addition, the debate itself may be foreshadow what looks likely to be a more significant debate over fiscal policy next year, and will highlight the tension between the necessity of additional stimulus and the eventual need for fiscal restraint.
Raising the Federal Debt Limit: It’s Never Easy
Within the next two months, the Treasury is likely to run up against the statutory limit on publicly held debt. While we expect Congress to approve a debt limit increase, as it always eventually does, the debate over the debt limit may receive more attention than past debates given the significant fiscal deterioration witnessed over the last year and the importance of fiscal policy to the economic outlook over the next few years.
The debt limit will be breached before year end. On August 7, Treasury requested that Congress increase the $12.1 trillion statutory limit on public debt. At the time, the Treasury projected it would hit the limit at some point around the middle of this month. Since then, it appears that recent budget improvement and the creative management of federal finances may stave off the need for an increase for at least another month.
When the Treasury reports the budget results for September later this week, it looks likely to show a deficit for the month that is close to the $31 billion that the Congressional Budget Office estimated recently in its monthly budget review. October and November tend to be fairly substantial deficit months for the federal budget; spending doesn’t change much but revenues tend to be 15% to 25% lower than the average month, due to an absence of important tax filing deadlines in October or November. As a result, it seems likely that the deficit will grow by $150 billion or slightly more in October and again in November. With just over $300 billion in room left under the $12.1 trillion debt ceiling, this would put the breach at some point around the end of November, not counting any measures are taken to forestall hitting the cap.
The working assumption on Capitol Hill appears to be that the limit will need to be increased at some point in November, and congressional leaders are anticipating action at some point next month. That said, if lawmakers can identify measures to push the debate over this contentious issue into December, they may delay a vote, in part so that the healthcare debate can be concluded before this issue is taken up.
The Treasury has already taken measures to avoid hitting the ceiling, and more are likely. The Treasury carefully manages cash balances when it approaches the debt ceiling, and often resorts to temporary measures when Congress fails to act in a timely manner. This time, the Treasury may be forced to undertake some familiar measures, but may also use some new tools at its disposal it has not had in the past:
1. Supplementary financing program (SFP): The Treasury created the SFP in September 2008 in order to help the Federal Reserve drain reserves from the banking system created by the Fed’s lending programs. As of October 7, the SFP accounted for $130 billion in Treasury securities outstanding, down from $200 billion in mid-September, and a peak of $559 billion in November 2008. The SFP balance is now declining at a rate of $35 billion per week, and the Treasury has stated its intention to draw it down to a $15 billion balance
2. Cash management bills. The Treasury may rely slightly more heavily on short term cash management bills (CMBs)—these normally carry a maturities of just a few days but more recently have been longer—to more closely manage the amount of debt under the limit. CMBs count toward the debt limit just like longer maturity Treasuries, but allow for slightly greater flexibility as the limit approaches.
3. State and Local Government Series Securities (SLUGS): The amount outstanding of these securities, which allow state and local governments to invest funds with the federal government, has declined by roughly $80 billion since peaking at over $300 billion in 2007. A temporary halt to SLUGS issuance is normally one of the first things the Treasury does when it approaches the debt ceiling, but will be a less important factor this time around given the run-down.
4. The “G Fund” and other trust funds: There are several government trust funds that are invested in Treasury securities: the “G Fund” of the federal employee’s retirement plan, which is invested in government securities (hence the “G” designation) and the civil service retirement fund are most often affected when the debt limit approaches. The most common step taken is to stop reinvestment of fund proceeds in Treasury securities until after the debt limit has been raised. This can create tens of billions in additional room under the limit. (The last time this was done, in 2006, the Treasury estimated it freed up around $60 billion in borrowing capacity).
5. The Exchange Stabilization Fund (ESF): The Treasury’s ESF holds roughly $50 billion, and can be used for a broad range of purposes; it was most recently used for the guarantee of money market mutual funds, which expired in September. This fund has been tapped in the past when a breach of the debt limit was imminent, but the Treasury is apt to pursue other measures before the ESF.
6. Financial assets: The Treasury holds $165 billion in Fannie and Freddie mortgage backed securities (MBS) and $134 billion in bank preferred shares acquired under its Capital Purchase Program (CPP). While a sale of either of these is very unlikely, the Treasury may halt purchases of MBS, which must be financed through Treasury issuance. These purchases have already declined from around $20bn per month earlier this year to around $6bn per month currently, so halting the program would create only a small amount of room.
The debt limit debate will be more consequential than usual. Normally the debt limit is simply a political headache for the majority party in Congress, which must force its members to take a politically unpopular vote while the minority party votes against it. But it has been mostly irrelevant for market participants, since despite a lengthy political debate, Congress always increases it in the end. The one exception to this came in the winter of 1995, when President Clinton and the Republican Congress deadlocked over increasing the limit, effectively shutting the government down for three weeks in December 1995 and January 1996. While we don’t envision this occurring again—if nothing else, the fact that the president’s party controls large majorities in Congress should minimize this risk—the debate does seem likely to be more consequential than usual, for three reasons:
1. Heightened public concern about the US fiscal position. The debt limit vote often focuses the nation’s attention, albeit briefly, on the amount of outstanding US obligations. While the burgeoning federal debt is certainly not new, the amount of public attention likely to be paid to the fiscal situation may increase. This is reflected, for example, in opinion polls that indicate that the share of the public that sees the budget deficit as the top policy concern is approaching levels last seen in the early 1990’s, when fiscal policy became a central election issue.
2. Increased reliance on federal programs. Financial markets have come to rely on the government’s balance sheet more over the last year than at any time in recent history, so a disruption here would be unwelcome. In particular, the need to wind down the Treasury’s SFP may raise a perception problem for the Fed, as bank reserves and the monetary base will increase absent other actions. The debt limit also poses challenges for the FDIC, which may need to borrow now that it has nearly depleted its deposit insurance fund in order to cover the cost of several recent bank failures . However, while these issues present minor policy challenges, it is difficult to see any of them creating significant problems.
3. Signaling effect for future fiscal policy. One should not read too much into the rhetoric that is likely to come out of the upcoming debate over the debt limit, since much of it will be meant for public consumption but will have little bearing on other policy debates that follow. That said, coming on the heels of probable enactment of health reform legislation, which may have important fiscal consequences, it is entirely plausible that the debt limit debate late this year will set the stage for a political campaign season in 2010 with focus on tension between the ultimate need for fiscal tightening and what may still be a need for more fiscal stimulus in the short term. Moreover, an increase in the debt limit—along with enactment of health reform—is likely to be an important prerequisite any further fiscal stimulus. Until it occurs, the only action likely to be taken on stimulus is extension of extra unemployment benefits and related measures, as we outlined in a daily last week (see “The Prospects for Additional Stimulus and Its Potential Effects,” US Daily, October 8, 2009).