Goldman On The Various Deficit Reduction/Debt Ceiling Plans And Immediate Next Steps

Still confused by all the various plans offered by the two parties? That is to be expected: after all these change on a daily, if not hourly basis, which was great a week ago, but now with just 3 days until the absolutely latest deadline by which congressional legislation has to be enacted, which is this Thursday, some cohesion would have been good. Instead D.C. keeps pushing further apart with no chance of a compromise anywhere on the immediate horizon. And while it does provide daily TV opera, it does nothing to assuage fears that next week America may stop paying out its checks as soon as a week from today (the details of when Treasury runs out of cash are irrelevant: the absolutely drop dead date is August 15, but without the machinery in place to resume refunding well ahead of it, the market will have no choice but to begin discounting that fact). And while we know that S&P has now sided with the uber-fluffy Reid plan, which does nothing at all to address America's encroaching insolvency, the real question here, as in every other topic, is what does Goldman think. Because after all Goldman rules the world. Here is the answer.

From Goldman's Alec Phillips

Two plans, but still no clear outcome. At this point, neither of the proposals released today look likely to become law without further modification/negotiation.  The Senate’s plan looks unlikely to pass in the House, and it is not clear that it will gain the 60 votes needed to pass the Senate.  The House plan may not have enough Republican support to pass the House (several Republicans announced their opposition today), and Democrats in the House are unlikely to support it without modification.  The upshot is that neither bill appears to have enough support to pass both chambers of Congress, and at this point it isn’t clear that either of the bills can even pass their own respective chambers.  Thus further modifications may be necessary.

House Republican proposal: $3trn deficit reduction, $2.6trn debt limit increase, with both accomplished over two stages.  The structure is in line with reports over the weekend: a $1trn debt limit increase coupled with $1.2 trillion in savings over ten years from discretionary caps, which would be enforced with across the board spending caps if not met.  A second debt limit increase of $1.6trn would take effect only if the reforms proposed by a special fiscal committee are adopted. That committee would be charged with proposing deficit reduction of $1.8 trillion over ten years, with a deadline of November 23, and the recommendations would be subject to an up or down vote in the House or Senate (in other words, Congress must vote on the plan, with no procedural obstacles, but it could still reject the proposal if it chose to). The Democratic objection to the House proposal, which was reiterated by President Obama this evening, is that the need for a second debt limit debate would create additional uncertainty and would essentially be a replay of the current debate.

Senate Democratic proposal:  $2.7trn spending cut, $2.4trn debt limit increase, both in one stage.   The proposal envisions $2.7trn in spending cuts over ten years, but while some of the cuts would produce tangible savings, the bill would change the fiscal outlook less than the headline numbers imply.   Among the tangible savings: (1) $1.2trn from discretionary spending caps, similar to the House bill; (2) $100bn in cuts to non-healthcare mandatory spending $15bn from spectrum auctions; $10bn from agricultural subsidies; and unspecified savings from student loan changes.  The remainder comes mainly from capping funding for overseas military activity at $576bn over the next ten years. This would essentially codify what is already an expected outcome related to Iraq and Afghanistan, but would show up as roughly $1 trillion over ten years in savings compared with the CBO baseline. However, most realistic baselines such as the fiscal commission’s “plausible baseline,” CBO’s “alternate scenario,” as well as our own, already assume an eventual phase down of troops similar to what is proposed.  Like the House proposal, the bill envisions a special fiscal committee with instructions to report by November 23, and vote by December 23, 2011. The committee would be given a goal to reduce the deficit to 3% of GDP or less, but there would be no enforcement mechanism to enforce this outcome.

The President’s proposal: Still focused on a grand bargain.  Although neither the House nor the Senate’s approach involves revenues, and neither reduces the deficit by $4 trillion, the President mentioned once again that he would like to see both aspects this evening, while lending support to the Senate’s approach as a fallback.

Endgame:  A short-term increase, with another shot at deficit reduction later this year?  A two-stage process continues to look like the most likely agreement, since it is very difficult to generate savings of the magnitude being discussed without developing more complex policy reforms in a number of areas, including health programs and potentially tax policy, and those would take time. It is possible that negotiators could try to reduce the uncertainty around the second debt limit increase that the House plan would create, but in doing so an alternative enforcement mechanism for the commission process would need to be identified, which might create more controversy.

Timeline: Senate floor consideration has started, House moving forward for Wednesday vote.   The Senate began consideration today of a debt limit increase this afternoon. At this point the bill is unlikely to come up for a vote before Thursday. House leaders are expected to bring up their bill by Wednesday for a vote. There is a possibility of amendment to either proposal prior to those votes. Moreover, after each chamber passes its respective bill, it can be amended by the other chamber.  The stated deadline for enacting a debt limit extension is August 2.  Although the usual legislative timeline can take up to 8 days for House and Senate passage, if a deal is reached it can be expedited (as it was in April, when a deal to avert a shutdown was reached the evening of April 8th, and was enacted only a few hours later around midnight).   While there is a clear risk that legislative consideration goes past the August 2 deadline, a deal still seems more likely to be enacted just ahead of the deadline. In the less likely scenario that the deadline is missed, spending would be cut sharply but the lapse in borrowing authority would very likely be brief and would almost certainly be resolved prior to the August 15 Treasury coupon payment.