The tension is building in the budget talks as the calendar closes in

on the August 2 drop-dead date. According to Treasury Secretary

Geithner, this is the date where the government would no longer have the

money to pay its bills and a default on the debt would be looming.

As many have noted, including me, a default on the debt would be an

absolute disaster for the financial system. We would see the same sort

of freeze-up of lending as we did after the collapse of Lehman in

September of 2008, although this time would almost certainly be much

worse.

With US government debt no longer the rock-solid pillar of the world

financial system, banks would instantly lose much of their capital. They

would not only have to write-down the value of government debt, but also

all the assets backed by the government, like mortgage-backed securities issued by Fannie Mae and Freddie Mac.

This would almost certainly push the major banks into insolvency. JP

Morgan, Citigroup, Goldman Sachs and the rest would suddenly be back in

the welfare line. And any rescue would almost certainly not restore them

to their former strength and profitability like the last one did. If the

government defaulted on its debt, Wall Street would take a shellacking

and it would never again be the centre of world finance.

This is why we knew all along that the Republicans in Congress were not

serious about their threats over allowing the government to default.

While these people might be happy to kick poor people in the face, to

take hard-earned wages and benefits away from working people, and to

shove retirees out onto the street, the Republican congressional

leadership is not about to cross Wall Street. After all, who pays for

the campaigns?

This meant that the Republicans were always going to fold if President

Obama didn't cave. The only question was when and how.

Republican senate Leader Mitch McConnell gave us the answer to this

question on Tuesday when he proposed a convoluted scheme that would

essentially allow President Obama to unilaterally raise the debt

ceiling.

The price is that Obama would have to propose a set of budget

cuts, totaling $700bn over ten years (at 1.6% of spending),

to congress three times over the next year and half. These spending cut

packages would have to be given a straight up or down vote.

While President Obama may hold out and insist on some further Wall

Street-sponsored crawling by the Republicans in Congress, this deal

looks like it should be enough fun. Senator McConnell's plan lets Obama

put any cuts on the table that he wants. In keeping with the spirit of

this proposal, the cuts in round one could be composed entirely of

spending in McConnell's home state of Kentucky.

If more cuts are needed to reach the $700bn target, he can also

propose gutting spending for Ohio, the home state of Speaker John

Boehner. In later rounds he can include cuts for Virginia, the home

state of the Republicans' firebrand minority leader Eric Cantor. It will

be interesting to see the Republicans vote on these proposed cuts.

Of course this is silly, but the whole debate over the debt ceiling was

silly. If congress wants to cut spending then the way to do that is to

send the president smaller spending bills. They can do that any day of

the week.

The idea that Republicans in congress were going to force big cuts in

the country's most important programs – social security, medicare, and

medicaid – by taking Wall Street hostage with the debt ceiling is

absurd. It was only necessary for President Obama to call their bluff.

The bottom line is that the debt ceiling is a gun pointed first and

foremost at Wall Street's head. And, there is no way on earth that Wall

Street is going to let the Republicans pull the trigger.