Debate over U.S. debt limit is going down to the wire

USATODAY.com feature

In just seven weeks, America could run out of borrowed money.

Exactly one month ago, the Treasury Department began issuing IOUs rather than bonds to some government pension funds. That allowed for continued auctions of so-called "risk-free" Treasury bonds until Aug. 2.

Unless Congress acts by then, the world's richest nation — unable to borrow $4 billion a day to pay its bills — would risk default.

Or would it?

To hear Treasury Secretary Timothy Geithner tell it, interest rates would spike, stock and home values would sink, savings and investment would dry up, jobs would disappear, businesses would fail, and everything from tax refunds to troops' salaries would go unpaid.

Federal Reserve Chairman Ben Bernanke says it would lead to "severe disruptions" in financial markets, lower credit ratings and damage to the dollar and Treasury securities.

The centrist Democratic think tank Third Way claims the gyrations in labor, financial and stock markets would cost 642,500 jobs, add $19,175 to every mortgage in process and lop $8,816 from the typical 401(k) account.

Others say the doomsday scenarios are hogwash.

Sen. Pat Toomey, R-Pa., says it would take a simple law laying out who gets paid first when the government no longer can borrow 41 cents of each dollar it spends. As long as bond holders collect interest on time, he says, there would be no default — just "sudden, drastic spending cuts" such as furloughing federal workers or delaying welfare payments.

Virtually no one expects this to happen, but the White House and Congress haven't yet found a way to avoid it.

During the past six months, Washington has faced partisan showdowns over tax cuts, then spending cuts.

Now comes the need to increase the government's $14.3 trillion debt limit — the amount of money it can owe creditors ranging from China to the Social Security Trust Fund. The ceiling was reached May 16, and only action by a reluctant Congress can raise it.

The federal government relies on borrowed money like a fish needs water. Threaten to take it away, and you risk a global crisis with economic, political, diplomatic and even moral implications.

What happens if America can't pay its bills?

"Nobody knows what would happen, but why in the world would you want to try to find out?" says David Walker, the former U.S. comptroller general now heading the fiscal watchdog group Comeback America Initiative.

"At least we experimented with nuclear bombs before we dropped one."

In the past half-century, Congress has acted 78 times to raise, extend or revise the debt limit — the amount of money the government can borrow to repay bond holders. The red ink has risen 49 times under Republican presidents, 29 times under Democrats. It's gone up 10 times since 2001.

Lawmakers often find ways to make the vote less damaging politically. Since 1980, the House has "deemed" a higher debt limit 15 times when passing a budget resolution, without spelling it out in the legislation.

In 1985, Congress attached a system of automatic spending cuts that would apply when the deficit exceeded annual targets. It lessened the blow for skittish lawmakers, only to be cast aside when the cuts proved too stringent.

This time is different.

The House must take a stand, because of a change in its rules. And not since the postwar years after World War II has the debt been so damaging — nearly the size of the entire $15 trillion economy. That has Republicans calling for spending cuts at least equal in size to any increase in the debt limit.

Says former Democratic congressman John Tanner of Tennessee: "The debt ceiling issue is a live-fire exercise."

Both parties share the blame

How did we get $14,300,000,000,000 into debt?

For three decades after World War II, the nation's debt grew only incrementally, fueled mostly by interest costs. In 1981, the debt was still less than $1 trillion, and just one-third the size of the economy — manageable by any standard.

The Obama administration has taken to citing Ronald Reagan's promotion of debt ceiling increases as proof that it's not just a Democrat's desire. Indeed, it was Reagan's defense buildup and tax cuts, along with a major recession, that helped triple the debt on his watch, to nearly $3 trillion — half the size of the economy at that time.

George H.W. Bush oversaw an increase to more than $4 trillion, nearly two-thirds the size of the flagging economy then. From a deficit-fighting standpoint, even that was a victory, fueled by Bush's reluctant agreement to raise taxes in 1990 — a decision that helped make him a one-term president.

Four years of economic boom at the end of Bill Clinton's administration produced historic budget surpluses and reduced the debt as a percentage of the economy to 56%. But the accumulated interest costs still caused the debt to rise to $5.7 trillion.

From there, it took off.

George W. Bush's tax cuts, wars in Afghanistan and Iraq, and expansion of Medicare to include prescription drugs were deficit-financed, sending the debt past $10 trillion.

The recession and Obama's economic stimulus package in 2009 sent it higher still. And in December, Obama agreed to extend the Bush tax cuts through 2012.

Today the debt isn't just a problem because of its size. Nearly half of the $9.7 trillion "public" debt — as opposed to the $4.6 trillion held by the Social Security trust fund and other government accounts — is owned by foreign investors. Nearly half of that $4.5 trillion can be traced to two countries, China and Japan.

Perhaps the biggest problem is the burden of the debt itself: $225 billion in interest costs, projected to grow to nearly $800 billion in 10 years. That money doesn't buy a thing.

Because of those rising interest costs and a growing, aging population, even the deficit-reduction plans floated by Republicans, the White House and various outside groups wouldn't stop the debt from growing.

The most draconian — House Republicans' plan to slash $4.4 trillion from the deficit in the next decade, then transform Medicare into a voucher-like program — projects a $16.2 trillion debt next year. By 2021, even with all the cuts, it would be $23 trillion.

"This problem," says Sen. Mark Warner, D-Va., a leader of a bipartisan Senate effort to control the debt, "just gets exponentially worse."

Republicans are in the drivers seat

For now, the nation's ability to borrow money is the big problem.

The Treasury Department makes about 1 billion payments a year, 80 million a month. Without borrowing authority, some payments couldn't be made.

Obama and Senate Democratic leader Harry Reid control two-thirds of the negotiations, but Republican House Speaker John Boehner is in the driver's seat.

He's demanding that federal spending be trimmed by more than the debt ceiling is raised — perhaps $2 trillion or more, if the ceiling is to be raised enough to get past the 2012 elections.

Republicans are insisting that entitlement programs such as Medicare and Medicaid be included in the cuts, but that tax increases be left out.

Obama wants to target tax breaks enjoyed by oil companies and others, and he's pushing for a "debt cap" aimed at locking in the savings over five years by forcing automatic reductions if needed.

House Majority Leader Eric Cantor, R-Va., says more than $1 trillion in spending cuts already has been identified by GOP and Democratic negotiators meeting regularly with Vice President Biden. Some of the proposals cited by both sides include reducing farm subsidies, overhauling the federal pension system and capping non-security spending for several years.

As Aug. 2 nears, it becomes less likely that a deal to raise the debt limit can get through Congress in time. That means a short-term extension would be needed to avoid default.

The deadlocked debate has spooked financial markets and all three major financial ratings agencies. Pimco, the world's largest bond investor, unloaded its U.S. government debt in March.

"It's a very dangerous game of roulette that we're playing right now," says Neel Kashkari, Pimco's managing director.

Standard & Poor's put the government on notice in April that its triple-A rating was in jeopardy. Moody's Investors Service warned this month of a similar downgrade. Fitch Ratings says Treasury bonds could be rated as "junk" by August.

Among the world's nearly 20 AAA-rated nations, "the U.S. really is the only one that has not yet adopted a serious plan to reverse the upward path of the debt," says Steven Hess, senior credit officer at Moody's.

Default clocks and payment plans

That failure has at least some lawmakers preparing for default — something Congressional Budget Office director Douglas Elmendorf calls "a dangerous gamble."

One school of thought: It would never happen. The Treasury Department would find some way to extend the clock. Geithner's Aug. 2 deadline isn't real.

Geithner counters that as soon as the nation failed to pay any of its bills on time — from salaries and contracts to tax refunds — "the world would recognize it as a first-ever failure by the United States to meet its commitments."

As the deadline gets closer, raising the specter of 'default clocks' on cable television for all the world to see, some lawmakers have introduced legislation that would determine who gets paid and who doesn't.

Toomey has proposed that principal and interest owed to bond holders take priority. Sen. David Vitter, R-La., wants Social Security benefits given the same priority. Rep. Marlin Stutzman, R-Ind., would add military spending to the mix.

What actually would happen in the event Congress doesn't raise the debt limit is unclear.

Would federal workers be laid off, and would they be rehired and paid later? Would Social Security benefits be delayed? Would federal "prompt payment" rules require the government to pay interest on late payments?

The whole mess could be avoided if Democrats and Republicans agree to work together — something Senate GOP leader Mitch McConnell says would prevent either side from gaining political advantage.

"We can do something important for the country together, and this is the opportunity," he says. "That is the importance of this debt ceiling moment."