The US Debt Ceiling Theater Is Back: Think The Issue Is On Autopilot? Think Again

As Zero Hedge reported first, the US is once again, in just 5 short months (see chart), back at the debt ceiling, with just $25 million in new debt issuance dry powder, or in other words, no space of more debt absent resorting to the same "technique" last seen in late July when the Treasury plundered from government retirement accounts in order to accommodate new debt, such as yesterday's issuance of 3 Year bonds, and today's 10 Year bonds. And as The Hill reported yesterday, Obama is expected to request that Congress allow the incremental and final $1.2 trillion debt expansion (of the $2.1 trillion total) within a few days. So it is all on autopilot right? Wrong. As Bank of America explains below, it is very likely that the US will not have a debt ceiling hike for at least a few weeks, meaning that while a debt hike will ultimately come, it will very soon be all the song in dance, potentially overtaking the GOP drama, coupled with the pillaging of government retirement accounts yet again and likely leading to more rating agency action as the US debt fiasco is once again brought front and center. And the last thing the market needs is to experience the August 2011 collapse which brought it to 2011 lows and sent it gyrating for 400 DJIA points daily, in essence breaking the market as noted previously. And the worst news is that even with $1.2 trillion in new debt capacity, the total amount is guaranteed to not last through 2013, and should tax withholdings dip as trends are already indicating on adverse year over year comps, the $1.2 trillion in new debt may be exhausted as soon as September, which at this point may be the only thing that derails an Obama reelection if indeed he is running against "Wall Street."

First, here is why the debt ceiling is called the debt target:

Bank of America explains why the "debt ceiling dance" is back.

An issue that will not go quietly

Just when the debt ceiling controversy seemed like last year’s news, it’s back. At the start of the year, the gap between the current debt outstanding and the debt limit narrowed to less than $100 billion. Under the terms of the August 2011 deal, that condition allows President Obama to request an increase in the debt ceiling. However, as we discuss in detail below, the President has delayed the request to allow a convoluted “debt ceiling dance” required under current budget law. As a result, the Treasury is preparing to take similar “extraordinary” steps as last year to  avoid hitting the ceiling. We expect a $1.2 trillion increase to become law in the end, but only after some noisy political theater — all of which should further add to the uncertainty emanating from Washington DC this year.

How it’s all supposed to go down

The Budget Control Act (BCA) of 2011, enacted last August, authorized two prior debt limit increases totaling $0.9 trillion, raising the ceiling to nearly $15.2 trillion. As of December 31, 2011, actual debt outstanding was less than $0.014 trillion below this limit — well within the $0.1 trillion (or $100 billion) threshold to allow the President to request an increase. (Since the quantities involved are so large, expressing everything as trillions helps to keep relative sizes in context.)

The process spelled out in the BCA for raising the debt ceiling goes like this:

  • Once the Treasury informs the President that the outstanding federal debt is closing in on the limit, he can request an increase from Congress.
  • Congress can then reject that request by majority vote in each house.
  • The President can respond with a veto to maintain the increase.
  • At that point, Congress can try to override the veto, which requires a two-thirds majority vote in both houses.

An inconvenient calendar

The wrinkle to these plans is that, according to the BCA, once the President makes the request to raise the debt ceiling, Congress has 15 days to hold a vote to reject it. If it fails to do so, the debt ceiling increase would occur regardless. However, the House is not back in session until January 17, while the Senate returns on January 23. Recall that the whole design of the BCA was to allow members — mostly Republicans — to symbolically vote “no” on the debt ceiling increase while allowing it to (eventually) pass and avoid a default. Thus, the President agreed to postpone his request not for economic or budgetary reasons, but to allow these legislative machinations to occur.

Back in the real world

In the meantime, the federal government must deal with the real consequences of fast approaching the debt ceiling (Chart 1). The Treasury is preparing to once again adopt so-called “extraordinary measures” to keep the government from running out of “headroom” on the debt ceiling. These basically involve temporarily halting issuance of non-marketable securities, such as for various government trust funds, to allow more marketable debt to be issued in order to pay for ongoing programs. Similar tactics were used not just last year, but also in 1996 and 2002 though 2004. These actions are likely to be just temporary band-aids until the debt ceiling is actually raised.

Securing the no votes

The unwieldy structure of the BCA is the result of a compromise agreement among disparate policy factions – it hardly represents optimal fiscal policy. This condition of at least dollar-for-dollar future deficit reduction in exchange for increasing the debt ceiling was one key component to get Republican support for the BCA. Another was to grant both houses of Congress a vote on the proposed debt ceiling increase. This allows members to be on-record of voting against it. Last week, Republican Senator Marco Rubio (Florida) released a letter highly critical of President Obama’s handling of the issue and promising to vote against the increase. Political consultants suggest that most Republicans will vote against the President’s request — once Congress is back in session.

It also means that we will probably go several weeks before another $1.2 trillion increase in the debt ceiling is adopted, mostly likely because the process will take time to play out. That said, we see no scenario in which the debt ceiling is not raised, or in which there is any meaningful risk of default. We suspect that the opposition may die in the Senate, given that Democrats still have a majority. There is no expectation that either the House or the Senate will be able to muster enough votes for a veto override. But, in the meantime, the rhetoric should be just as heated as last summer’s debt ceiling debate.

It’s the process, stupid

It is worth remembering that the amount of outstanding debt is determined directly by current and past budget deficits, so no amount of future promised deficit reduction will change the near-term need to raise the debt limit. That fact, unfortunately, is likely to be completely lost in the current debate. Indeed, the convoluted process required to raise the debt ceiling is just another example that little substantive is likely to be accomplished in Washington DC this election year — it is designed for political showmanship, not for difficult but needed bipartisan forward progress on the long-term budget.

Thus, a better solution than freezing the debt limit would seem to be to reform the budget process so that changes to the debt ceiling must be passed along with spending and revenue decisions — as part of the budgeting process, and within the appropriation bills. In that way, politicians would be held accountable for budgetary choices that increase debt issuance when they are made. Unfortunately, this approach has been tried before, and Congress found ways to circumvent its own self-imposed rules. Thus, we are likely to revisit this debate on a regular basis, including in early 2013, after the new Congress convenes. This marathon dance still has a long way to go.