Obama Girds for Next Struggle With Republicans Over Raising Debt Limit

The struggle last week to avert a government shutdown may be little more than the warm-up for a much bigger battle in coming months over raising the debt limit.

The U.S. government is projected to slam into the $14.3 trillion legal cap on government borrowing sometime this spring. As the price of their vote to allow the government to go further into debt, congressional Republicans are demanding far deeper cuts than the $38 billion they got last week in the deal to fund the government for the last six months of the 2011 fiscal year.

Failing to raise the debt ceiling would have much more dire consequences than a shutdown, with Treasury Secretary Timothy Geithner predicting last week that it would “call into question the willingness of the government of the United States to meet its obligations,” and “shake the basic foundations of the entire global financial system.”

That is why Republicans see the vote as their best chance this year to force President Barack Obama to accept dramatic reductions in the federal budget, this time perhaps measured in trillions, rather than billions.

“I can tell you this: There will not be an increase in the debt limit without something really, really big attached to it,” House Speaker John Boehner, an Ohio Republican, said at an April 9 fundraiser in Connecticut.

Obama Plan

The Obama administration, which omitted plans for tackling the long-term deficit from its budget plan released just eight weeks ago, is now reversing course, promising to outline a plan this week for putting the government’s books in order. The president will address the nation April 13, an administration official said yesterday.

Obama will propose changes in Medicare and Medicaid as well as taxes and perhaps additional defense spending cuts, senior adviser David Plouffe said in interviews as he made the rounds of Sunday morning television talk shows in the wake of the fight over the funding for the remainder of this fiscal year.

The president will “lay out his approach this week in terms of the scale of debt reduction he thinks the country needs so we can grow economically and win the future, a balanced approach,” Plouffe said on Fox News Sunday. Obama, he said, will use a “scalpel, not a machete.”

Lawmakers can’t avoid raising the debt limit by simply cutting spending, Geithner warned last week in a letter to lawmakers. With the public debt growing by an average of $125 billion per month, Congress would have to cut $700 billion from this year alone, which would mean, for example, eliminating all discretionary spending.

‘Massive Shock’

Cutting that much, that soon would be a “massive shock” to the economy, Mark Zandi, chief economist at Moody’s Analytics Inc. in West Chester, Pennsylvania, said in an interview. “I don’t think there would be any question” that would tip the economy back into recession.

Lawmakers won’t have much time to work out an agreement. The government will hit the debt cap by May 16, according to the Treasury Department. After that, the government will be able use a number of accounting moves and other steps to stave off default, Treasury said, though by around July 8, it will be out of options.

Failing to raise the cap would reverberate throughout the economy, pushing up borrowing costs for the government as well as individuals and businesses, the administration says.

‘National-Security Interests’

Congress needs to raise the limit to maintain vital services and avoid “questions about our ability to defend our national security interests,” Geithner said in his letter to lawmakers. The U.S. would face sharply higher interest rates and would have to stop or delay payments to the military, retirees and others, he said.

“Default would cause a financial crisis potentially more severe than the crisis from which we are only now starting to recover,” he said.

JPMorgan Chase & Co. (JPM) Chief Executive Officer Jamie Dimon said March 30 that companies, insurance funds and investors would lose access to markets if the U.S. appears to be headed toward a default related to its debt limit.

“If the United States actually defaults on our debt it would be catastrophic,” Dimon, 55, said at a U.S. Chamber of Commerce event in Washington.

Tea Party Promises

Votes to raise the debt limit are always difficult for lawmakers because their support for such measures makes it easy for their opponents to paint them as profligate spenders in campaign commercials. This year’s vote promises to be especially tricky with scores of Tea Party-backed freshmen, elected on promises to slash spending, who backed Boehner’s compromise last week on the promise that the debt limit would give them an opportunity to make a much bigger dent in the $1.4 trillion deficit.

What’s more, while neither the administration nor lawmakers have said by how much they would like to raise the cap, it will probably need to be increased by more than $1 trillion to accommodate borrowing through next year’s elections, which may leave some lawmakers with sticker shock.

Senator Charles Schumer of New York, the chamber’s third- ranking Democrat, warned yesterday against a repeat of last week’s brinksmanship over spending.

“Boehner had to keep these negotiations going until the last minute to show the Tea Party people he was doing everything he could,” Schumer said yesterday on CBS’s ‘Face the Nation.’ “You cannot do that with the debt ceiling -- that is playing with fire because if the markets believe we are not going to pay our debts, it could be a formula for recession.”

Bond Yields

For now, financial markets are giving lawmakers room to act. Bond yields are lower than when the government was running a budget surplus a decade ago even as Treasury Department data show that the amount of marketable debt outstanding has risen to $9.13 trillion from $4.34 trillion in mid-2007.

The benchmark 10-year Treasury note yield was at 3.58 percent on April 8, below the average of 7 percent since 1980.

Similarly, derivatives tied to government debt show investors’ perceptions of America’s creditworthiness are improving. Credit-default swaps on Treasuries stood 41.12 basis points as of late April 8 in New York, according to data provider CMA Datavision. The swaps are down from this year’s high of 51.5 basis points on Jan. 27 and last year’s high of 59.7 in February.

Borrowing Costs

Low borrowing costs mean the U.S. is spending less to service its debt as a percentage of gross domestic product. Interest expense fell to 2.7 percent of GDP in fiscal 2010 from 3.8 percent in 2001, when the U.S. had a budget surplus, according to data compiled by Bloomberg.

Still, interest payments on the federal debt will more than quadruple in the next decade, with projected costs topping the Pentagon’s 2017 budget of $622 billion, according to the Congressional Budget Office.

Though Republicans aren’t saying yet what exactly they will demand for their debt-limit votes, a number have begun offering ideas. All 47 Senate Republicans have endorsed a balanced budget amendment to the Constitution. House Republicans, meanwhile, are slated to vote this week on Budget Committee Chairman Paul Ryan’s plan to cut $6 trillion over the next decade, a proposal he’s said offers a menu of possible items to attach to a debt- limit hike. His plan also calls for tax cuts while the administration has proposed more than $1 trillion in tax increases.

Senate Minority Leader Mitch McConnell, a Kentucky Republican, laid down his marker April 8, after Congress narrowly avoided a government shutdown.

“In order to raise the debt ceiling, we need to do something significant about the debt,” he said. “My definition of significant is that the markets view it as significant, the American people view it as significant and foreign countries view it as significant.”

To contact the reporters on this story: Brian Faler in Washington at bfaler@bloomberg.net

To contact the editor responsible for this story: Mark Silva at msilva34@bloomberg.net

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