While Europe stubbornly refuses to get off the pedestal of daily "risk On-Off" headline news disinformation, the time has come to shift our attention to the epic misnomer which is the US supercommittee, or the unelected sub-branch of the legislative body which is supposed to find $1.2 trillion in cuts to enact the debt ceiling hike that Obama passed in August so that America can spend itself into the drunken sailor coma. Incidentally, the country has already issued $700 billion in debt since then, and by the end of the week, total US debt will be just shy of $15.1 trillion. So at least the "benefit" of the debt ceiling, pardon, debt target hike has been implemented, if not any of the mandated budget cuts that are supposed to offset this. Unfortunately, they won't, because as the attached supercommittee trading cards created by JPM's Michael Cembalest demonstrate, as well as the associated Q&A from Goldman explaining all one needs to know about the supercommittee, hell has a better chance of freezing over than these 6 republicans and 6 democrats coming to some agreement.
From JP Morgan:
Are markets too focused on Prime Ministers and not enough on Economics? US super-committee trading cards
To get a sense for who is on the committee, we hereby introduce Super Committee trading cards. On each card, the color scheme is a proxy for each member’s ideological voting record as compiled by the University of Georgia in their extensive database dating back to the first Congress in March 1789. A Political Ideology Indicator (PII) score of -1 indicates the most liberal voting pattern, while +1 is the most conservative1. As you can see, Max Baucus (D-Mon) is the closest thing to a “moderate” on the committee, with moderate defined by +/- 0.2. The rest are closer to the ideological wings of their respective parties, lessening the chance of a “rogue move to the middle”, against the wishes of their respective congressional sponsors (e.g., the party leaders in the House and Senate). While the Super Committee only needs a simple majority to make a recommendation to Congress, it is unlikely that any member would cross party lines alone. This ideological make-up is admittedly representative of the Congress and electorate at large, but still, if the purpose of the Committee was compromise, couldn’t they have opted for members that were closer to the middle? So far, the only thing Super about this committee is the level of its polarization and lack of progress.
And to complete the picture, here is a comprehensive Q&A answering any and all supercommittee related questions from Goldman Sachs.
Q: What is the super committee?
A: 12 members of Congress who must decide on at least $1.2 trillion in deficit reduction. The super committee is made up of six Republicans and six Democrats from the House and Senate. It was established by the Budget Control Act (BCA), the legislation that raised the statutory debt limit in early August. If a simple majority of the super committee members vote for a legislative package, it will be forwarded to the House and Senate, to be considered with no changes or delay possible.
Q: What happens if the super committee cannot reach an agreement?
A: Automatic spending cuts kick in for 2013, but a downgrade seems unlikely. If the super committee reaches its November 23 deadline without any agreement, the process concludes. While this would be far from ideal and could weigh on sentiment, the practical near-term repercussions seem limited. There would be no near term fiscal consequences, but automatic spending cuts would take effect from January 2013. At this point there is little reason to believe that either S&P or Moody's would downgrade solely based on a failure to agree. Both rating agencies have indicated that while a stalemate in the super committee would be negative, they expect $1.2 trillion in planned deficit reduction to materialize through automatic cuts if not through the super committee, so their fiscal outlook should remain unchanged.
Q: Can the deadline be extended?
A: Yes, but this does not seem very likely. In theory, if super committee members are unable to reach an agreement by November 23 but feel that one will be reached soon, they postpone the deadline for a few weeks. However, this seems unlikely for two reasons. First, in order to effectively provide more time for negotiations, it would take more than a political agreement; legislation to the delay the deadline would need to become law. This could be attached to the upcoming "continuing resolution" to fund government operations (current funding expires November 18) or the super committee could pass an extension. Even if technically possible, senior members of both parties have indicated that an extension is unlikely, and in any case it is not clear that an extension would have sufficient support to pass the House and Senate even if one were desired.
Q: How will the outcome of the super committee change the medium-term deficit outlook?
A: Only modestly, if at all. The super committee process presents an important opportunity to reduce the longer term imbalance between the expected growth in entitlement programs and the revenues used to finance them and other government spending. However, a "grand bargain" to resolve this imbalance appears to be a low probability this year. Instead, the politically realistic outcomes range from no agreement to a deal reaching $1.2 trillion in deficit reduction over 10 years. While $1.2 trillion represents a meaningful amount of deficit reduction, it is important to keep in mind that the same amount of deficit reduction would occur even if the super committee deadlocked and automatic spending cuts took effect. So while a great deal of attention is being paid to the super committee, it is unlikely that deficit projections will change substantially following their agreement. That said, Congress is less likely to reverse any of the deficit reduction measures agreed to by the super committee than it is to reverse the automatic spending cuts in event of super committee stalemate, so all things equal a super committee agreement of $1.2 trillion probably implies a slightly lower deficit level over the next decade than if the automatic spending cuts were to take effect.
Q: So why is it important for the super committee to reach agreement?
A: It will decide how the deficit is reduced, it might extend expiring stimulus, and it signals whether the political process is functioning. At the most basic level, the super committee process is important to market participants because it provides a signal as to how successful future fiscal consolidation efforts might be. Indeed, our impression in speaking to clients is that many are more focused on whether the super committee is able to reach a deal at all than they are on the specifics of the agreement that is reached. If the process ends without any political agreement and no legislative product, we would expect markets to become more pessimistic regarding post-election progress on the broader structural fiscal issues that Congress must eventually address. On a more practical level, although the super committee may not affect the overall amount of deficit reduction--it seems unlikely that deficit reduction of more than $1.2 trillion will be enacted through this process--super committee success or failure will still decide whether the planned deficit reduction occurs through across the board spending cuts (if there is no agreement) or a mix of more targeted tax and spending policies (if a deal is reached). This distinction will be relevant particularly for industries with significant government exposure, like defense and health care. A final reason the super committee is being closely watched is that the legislation it passes is likely to be a vehicle for other priorities; extensions of the payroll tax cut and emergency unemployment compensation are on the table, as is folding a highway bill or farm bill into the package.
Q: How will the super committee affect the fiscal impulse in 2012?
A: It should have a minimal effect. The Budget Control Act (BCA) capped congressional appropriations, which is estimated to reduce discretionary spending in FY2012 by $25bn (slightly more on a calendar year basis). This amount is already included in our forecast. The super committee does not seem likely to change this by more than a few billion dollars. Policies outlined in the Biden-Cantor talks earlier this year would have reduced spending by another $25bn in FY2012; the Bowles-Simpson recommendations related to health and other mandatory spending--these are the most likely areas for super committee savings--would have reduced the deficit by only $6bn in FY2012. The President's proposal to the super committee, excluding his jobs package, would have essentially no effect in 2012. Assuming that the super committee is looking at the same sorts of policies these previous proposals envisioned, it is unlikely that the agreement would have a substantial effect on the deficit in 2012.
Q: What is the consensus expectation?
A: Market participants seem pessimistic. Our sense from client conversations is that most market participants expect either no agreement to be reached or a half-deal. Public opinion polling also shows a pessimistic view among the public, with only 24 percent of voters expecting an agreement. 32% of economists polled in the November Blue Chip financial survey expected a super committee agreement to become law. Our sense is that most market participants who do expect an agreement expect it to be a fairly modest one, potentially reaching only halfway to the committee's $1.2 trillion target. This is similar to the view we have had for the last couple of months (see for instance "The Fiscal 'Super Committee': An Agreement Is More Likely than Not," US Daily, September 28, 2011).
Q: How does our view differ from consensus?
A: We are slightly more optimistic than the apparent consensus view. While there is certainly a chance that the talks dissolve without agreement, it seems much more likely that the public pressure on super committee members and congressional leaders would lead them to salvage at least a bare minimum agreement rather than walk away empty-handed. While we do not believe a "grand bargain" is likely due to the longstanding disagreements between the parties on tax and entitlement issues, reaching the $1.2 trillion target does appear (just barely) possible without agreement on those broader issues. This would probably require an agreement to include some new tax revenues in the package, super committee discussions over the last few days imply that the probability of limiting some tax preferences has increased slightly, though new tax revenues still look likely to make up only a small part of whatever deal is reached. The most likely scenario in our view appears to be an agreement that involves specific policy changes reaching slightly more than halfway to the $1.2 trillion target, with most or all of the remainder made up through automatic spending cuts and potentially a modest amount of creative budget accounting.
Q: What is the super committee's deficit reduction goal, $1.2 trillion or $1.5 trillion?
A: $1.2 trillion is the key number. To avoid any automatic spending cuts from taking effect, the super committee must agree to at least $1.2 trillion in deficit reduction, which would probably mean just under $1 trillion in spending cuts or tax increases, and $200bn in interest savings. If the super committee goes beyond that minimum, the statutory debt limit is raised by a commensurate amount until total deficit reduction reaches $1.5 trillion. Thus, it is possible for the debt limit to rise from $16.394 trillion under a small super committee agreement to $16.694 trillion under a large deal. Although both numbers are seen as targets, most of the focus is on reaching the $1.2 trillion in savings needed to avoid automatic spending cuts.
Q: What is a spending "sequester" and how does it work?
A: Spending cuts known as a "sequester" are set to take effect automatically on January 2, 2013, unless the super committee legislation reaches its target. If the super committee achieves no savings, "sequestration" would total $1.2 trillion through 2021 including interest savings, or just under $1 trillion in actual spending cuts excluding interest. For every dollar the super committee reduces the deficit, the sequester is reduced by a dollar, so that if the super committee reaches its minimum goal of $1.2 trillion in deficit reduction, no automatic spending cuts would take place. Half of the spending cut under the sequester would come from defense and the other half from domestic programs. The distribution among domestic programs depends on the amount of the automatic cuts. For instance, under full sequestration of $1.2 trillion, about $125bn or so would be cut from Medicare payments to health care providers, and nearly $300bn would come from domestic appropriations. The remainder would come from the few segments of the "mandatory" budget that do not affect seniors, the disabled, or low income (this leaves education subsidies, agriculture, and health subsidies under the new health law, and a few other smaller categories). If the super committee agreed to half of its deficit reduction target, the Medicare cuts under the sequester would remain roughly the same, but other cuts would fall proportionately.
Q: If the super committee does not address the payroll tax cut and unemployment insurance, could they still be extended?
A: Yes, but expiration would become much less likely. It is possible for Congress to address the expiring payroll tax cut and/or unemployment benefits outside of the super committee. After all, Congress deals with expiring provisions all the time, and typically just wraps extensions into year-end legislation. However, addressing these issues would be much harder outside of the super committee. The main reason is that Congress is under pressure to offset any new stimulus, and it would be very difficult to find the $160bn in deficit reduction necessary to offset the cost of a one year payroll tax cut and unemployment benefit extension. A second factor might simply be time; the super committee bill will not be considered by Congress until at least early December, so any attempt after that to extend the expiring provisions would occur only a few weeks before expiration. Our forecast assumes extension of the payroll tax cut but not of emergency unemployment benefits, though we see the latter as a close call.
Q: What are the key dates to watch for?
A: The next two weeks will be critical. On November 18, the current "continuing resolution" (CR) that provides funding for government operations expires. Another CR is likely to be enacted around that time, and we do not see much risk of a shutdown, as had looked possible around similar such expirations earlier this year. By November 23, the super committee must vote on final legislative language that has been estimated by the Congressional Budget Office. Failure to vote by this date eliminates the procedural protections for the super committee's proposal provided for under the Budget Control Act. Assuming that the super committee meets this deadline, Congress has another month, until December 23, to pass the proposal in both chambers of Congress. However, there is a good chance that congressional leaders will want to expedite that process, so the final vote could take place by mid-December.
Q: When must the super committee reach agreement, and when do the details become public?
A: Probably only a few days before November 23. Although the Congressional Budget Office (CBO) has indicated that it would like two weeks to consider the budget effects of the super committee's proposal, most of the items that seem likely to be included have been under consideration for a while, and many have already been estimated by CBO. Drafting the formal legislation could take a few days and could overlap with the deficit reduction estimation process. This implies that an agreement reached as late as November 20 would still allow the super committee to meet its deadline. An official announcement of the details might not take place until even closer to November 23.