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Obama Fights Republicans on Debt as Investors Seek Growth

By Mike Dorning
January 04, 2013 5:04 PM EST 262 Comments
Obama Catastrophe With Congress Looms as Investors Show No Alarm
Obama Catastrophe With Congress Looms as Investors Show No Alarm

Fresh from a budget fight so raw that the Republican speaker of the U.S. House cursed the Democratic leader of the Senate outside the Oval Office, President Barack Obama and Congress are heading for an even bigger confrontation over raising the nation’s debt limit.

U.S. Treasury bond investors -- who most directly bear the risk of a government default -- aren’t alarmed. In a sign of the disconnect between Washington and Wall Street, investors remain confident the two sides will compromise rather than inflict what Obama called “catastrophic” consequences. Yields on long-term U.S. debt are near record lows.

“It’s ugly in Washington, and getting uglier,” said Matthew Duch, a fund manager in Bethesda, Maryland, for Calvert Investments, which oversees more than $12 billion in assets. “But that is just resulting in even lower rates as the market is much more concerned about growth than if the U.S. will be able to pay their bills.”

That hasn’t stopped Republicans and the president from moving toward a clash, with House leaders vowing to exact deep spending cuts in exchange for raising the borrowing ceiling and Obama saying he won’t negotiate on the debt. The U.S. Treasury is bumping up against its legal borrowing limit.

“Heretofore, they’ve been playing with a cherry bomb in economic terms,” said Steve Bell, a former Republican Senate budget aide. “When they start playing with the debt ceiling in February, they are starting to play with C-4,” he said, referring to the powerful plastic explosive material.

Investor Reaction

When partisan gridlock last brought the government to the brink of default in August 2011, the stock market fell and Standard & Poor’s cut the nation’s credit rating. After House Speaker John Boehner, an Ohio Republican, withdrew from negotiations on July 22, 2011, the S&P 500 Stock Index fell more than 16 percent in the next 11 trading days.

Bond investors were unrattled. Yields on 10-year U.S. Treasury notes declined from 2.96 percent on July 22 to 2.56 percent on Aug. 5, 2011, the day of the S&P downgrade. Yields continued to drop, reaching 1.72 percent on Sept. 22 of that year.

Ten-year note yields declined today one basis point, or 0.01 percentage point, to 1.90 percent at 4:21 p.m. New York time, according to Bloomberg Bond Trader data. The U.S. unemployment rate in December was higher than forecast, boosting speculation the Federal Reserve’s stimulus efforts may not end anytime soon.

‘Not Worried’

“The market is not worried about default,” said Zach Pandl, an interest-rate strategist in Minneapolis at Columbia Management Investment Advisers LLC, which oversees $340 billion.

“In the U.S., the debt level is lower than comparable countries, growth is higher and we have a unblemished track record in the U.S. of debt repayment, all of which has helped calm investor concerns,” he said. “The process is messy, but the outcome is always acceptable.”

The budget deal that Obama and lawmakers struck this week averted the so-called fiscal cliff of income-tax increases on most Americans and delayed automatic spending cuts until March 1. So while Obama has pledged not to negotiate over the debt limit, that timing raises the possibility that talks to address the automatic cuts would also include the debt ceiling.

Treasury Secretary Timothy F. Geithner, a key figure in Obama’s response to the recession and the 2011 debt-limit talks, plans to leave the administration at the end of January, even if the president and Republicans haven’t reached an agreement on the debt ceiling, said two people familiar with the matter.

Tax-Spending Split

The two sides start far apart.

House Republican leaders have said they will demand a dollar in spending cuts for every dollar that the federal debt limit is increased. House Republicans plan to discuss strategy at a retreat in Williamsburg, Virginia, later this month.

In contrast to the Republican focus on spending cuts, Obama said on Dec. 31 that any deficit reduction to block scheduled spending cuts would have to be “balanced” to also contain more tax revenue.

The administration believes the composition of deficit savings included in the tax deal to pay for a two-month delay in the automatic spending cuts sets the template for any future deal, according to a White House official, who requested anonymity. The $24 billion in savings was split evenly between new revenue and spending reductions, half of which came from defense.

The U.S. reached its $16.4 trillion legal debt limit on Dec. 31, and the Treasury Department began using extraordinary measures to finance the government. It will exhaust that avenue as early as mid-February, the Congressional Budget Office says.

Bitter Climate

Negotiations over raising the limit will play out in a bitter political climate. Some Republicans complain that Obama’s insistence on increasing tax rates for the wealthy rather than reverting to a more flexible position he took in 2011 amounts to using his re-election victory to bully them.

Several also grumbled about a campaign-style event the president hosted at the White House on Dec. 31 criticizing Republicans during a delicate moment of the tax talks.

“I just listened to the president, and my heart’s still pounding,” Senator Bob Corker, a Tennessee Republican, said on the Senate floor. “I am very disappointed to hear what the president just had to say in front of a pep rally, something very unbecoming of where we are at this moment.”

Emotions ran so high during the latest round of talks that at one point Boehner told Senate Majority Leader Harry Reid, a Nevada Democrat, to “Go F--- Yourself,” according to two people familiar with the conversation, which took place just steps from the Oval Office.

‘Serious Mistake’

Frustration also boiled over as House Republicans left a conference meeting on Jan. 1 at which they were presented with the deal the party’s Senate leaders negotiated with the White House. “On Nov. 6,” the day Obama was re-elected, “the American people made a serious mistake,” Representative Trent Franks, an Arizona Republican, said in an interview.

Obama wasn’t only re-elected, he became the first president in more than five decades to win at least 51 percent of the vote twice, which not even Ronald Reagan achieved in the 1980s. Democrats in November expanded their majority by two votes in the Senate and, while Republicans maintained a majority in the House, Democratic House candidates nationwide won 1 million more votes than Republican contenders.

Obama Emboldened

The tax deal signed on Jan. 2 by Obama, which raised rates on annual income above $450,000 for couples, produced a split in the House Republican leadership. Boehner and Budget Committee Chairman Paul Ryan of Wisconsin voted for the bill. Majority Leader Eric Cantor of Virginia and Whip Kevin McCarthy of California, the party’s No. 2 and 3 leaders in the chamber, voted against it.

Lining up against the Republican leadership is an emboldened president, who appeared before the television cameras at the White House Jan. 1 to draw a line against accepting any conditions for an increase in the debt limit.

“I will not have another debate with this Congress over whether or not they should pay the bills that they’ve already racked up through the laws that they passed,” Obama said. “We can’t not pay bills that we’ve already incurred.”

That sparked anger among some House Republicans.

“If the president thinks that he’s not going to negotiate he’d better think again,” said Oklahoma Representative Tom Cole, according to NBC News. “He’s president of the United States. He’s not emperor of the planet.”

Political Risk

Senator Michael Bennet, a Colorado Democrat, said he’s worried about the possibility of a debt default because of a standoff between congressional Republicans and the White House.

“We were downgraded because of concern of the political risk that the two parties couldn’t work together,” Bennet said in an interview with Bloomberg Television’s Peter Cook for the program “Capitol Gains” airing Jan. 6. “There still isn’t evidence that we can do that.”

The next chapter in the skirmishing over the nation’s finances plays out during a phase of the political calendar that gives Obama unusual access to the power of the presidential bully pulpit, with his inauguration for a second term and State of the Union address in the coming weeks.

The administration is considering how to make the best use of the opportunities, the White House official said. Obama is likely to repeat tactics he used to mobilize public opinion in the fight over tax rates, including a social media campaign and campaign-style appearances outside Washington, the official said.

Different Position

Patrick Griffin, who was White House congressional lobbying chief for Democratic President Bill Clinton, said the debt limit “is not the leverage that Republicans think it will be.”

Obama “is completely in a different position” than during the 2011 debt talks, Griffin said.

The president has a fresh political mandate from his re- election. And corporate leaders anxious to avert the economic disruption of a debt default have taken a more prominent role in pressing for compromise, Griffin said.

Obama also has gained more public credibility on the deficit, in part because he has spent more time speaking out about wanting to bring down government debt, Griffin said. A Bloomberg National Poll conducted Dec. 7-10 found 40 percent public approval of Obama’s handling of the deficit versus 32 percent in June 2011, at the start of the last debt-limit talks.

Congressional Republicans have now twice backed off threats to stand fast in the face of a financial crisis, agreeing to the debt-limit increase in August 2011 and reaching a deal to avert the tax increase on Jan. 1.

“Republicans conceded they did not want to create a crisis on the fiscal cliff,” Griffin said. “Why would they want to turn around and create an even bigger crisis on the debt limit?”

To contact the reporter on this story: Mike Dorning in Washington at mdorning@bloomberg.net

To contact the editor responsible for this story: Steven Komarow at skomarow1@bloomberg.net

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