Debt Talks Survived Breakdowns With Geithner Set to Calm Markets

U.S. Treasury Secretary Timothy Geithner
Timothy Geithner, U.S. treasury secretary. Photographer: Andrew Harrer/Bloomberg

In the Oval Office two days before a threatened debt default, President Barack Obama and his advisers confronted a question they’d been striving to avoid: what should Treasury Secretary Timothy Geithner say, and when, to calm financial markets if a tentative agreement imploded?

Obama had just hung up with Republican House Speaker John Boehner on July 31 and learned they were at another impasse. This time it was over defense spending cuts, and Boehner wasn’t sure he could get enough Republican votes to pass the plan.

It was the third time in as many weeks that the talks stood on the brink of collapse, according to Democratic and Republican officials who gave accounts of the discussions on condition of anonymity. After discussing a potential Geithner message to the markets, Obama called Boehner at 8:15 p.m. to learn where things stood and the speaker interrupted him to offer congratulations.

They had a deal.

The president’s surprise television appearance later that night announcing an agreement to slice $2.4 trillion in deficit spending and lift the $14.3 debt ceiling by $2.1 trillion to avert an Aug. 2 default ended a showdown that brought the ideological differences between the parties into stark relief and the nation to the cusp of a financial calamity.

Managing Divides

It tested the leadership and mettle of Obama’s two-year-old presidency and Boehner’s eight-month-old speakership. They each had to manage divides within their parties. Boehner had to build credibility with his Tea Party freshmen, who resisted compromise, while Obama had to bring along a caucus reshaped by the loss of centrist Democrats in the 2010 midterms. Neither emerged unscathed politically as partisan activists on both sides voiced frustration with the final package.

Ultimately, the stalemate was resolved after the more seasoned, bipartisan Senate leadership fully engaged. Senate Minority Leader Mitch McConnell, a Kentucky Republican, launched the final chapter of negotiations with a reassuring signal to the markets, a proposal to give Obama unilateral authority to lift the debt ceiling if a larger agreement fell apart.

Throughout the process, the markets avoided tumult. Yields on benchmark 10-year Treasury notes fluctuated between 3.18 percent and 2.72 percent during the past two months. That compares with an average of 4.03 percent since 2001.

The path toward the final agreement began with the collapse of the private negotiations between Obama and Boehner over a broader deal that would have included changes in entitlements and the tax code.

‘Left at the Altar’

On July 22, with no warning to Obama or his staff, Boehner announced the end of their negotiations, leaving Obama to complain publicly of being “left at the altar.”

According to Boehner, after agreeing to consider at least $800 billion in new revenue, Obama suddenly pushed for about $400 billion more after a bipartisan Senate deal was unveiled with more sources of revenue.

On July 23, Obama summoned Boehner, McConnell and Democratic Senate Majority Leader Harry Reid of Nevada and House Minority Leader Nancy Pelosi of California to the White House for a meeting in which he urged the congressional leaders to find a resolution to avoid a default that could harm the economy and diminish investor confidence in the U.S. for decades, according to Democratic officials familiar with the talks.

Meeting at Capitol

Later, the four congressional leaders met in Boehner’s Capitol office suite and began discussing a possible compromise. They weighed a two-step process that would cut spending and boost the debt limit slightly less, followed by creation of a bipartisan congressional committee to enact further deficit reductions as a condition tied to future debt ceiling increases.

The concept had enough support that they ran it by the White House, said officials in both parties, and Obama raised a red flag. He objected to tying the debt-limit extension to future deficit reduction; he wanted enough borrowing authority to last through the November 2012 election.

Negotiations continued through the weekend, and it became clear that Boehner would fall short of his own goal of having a plan to present to rank-and-file Republicans by the afternoon of July 24 -- a development that sent Asian shares and U.S. equity futures and Treasuries falling while gold rose to a record high amid concerns of a default.

Boehner’s Plan

On July 25, Boehner presented a plan to his caucus that he said would cut deficit spending by almost $3 trillion and raise the debt ceiling by a similar amount in two phases. The second instalment would be conditioned on $1.8 trillion in cuts and a vote on that would come in early 2012, a direct challenge to Obama’s demand that the debt ceiling increase extend to 2013.

Obama responded with a prime-time television address from the East Room of the White House, in which he accused Republicans of playing a “dangerous game we’ve never played before” with the debt ceiling and urged Americans to pressure Congress to compromise by calling their representatives.

Boehner, in a televised rebuttal from Capitol Hill, accused the president of seeking “a blank check” to continue government spending that is “sapping the drive of our people.”

The public responded by jamming Capitol Hill telephone lines. Many wanted Washington reach a compromise, while others urged House members to hold firm, according to aides and lawmakers.

On July 26, Boehner and his leadership team urged the caucus to rally behind his proposal and to give him maximum negotiation leverage in the final negotiations, according to Republican officials.

CBO Setback

Boehner suffered a setback when the Congressional Budget Office released an analysis showing the spending cuts it contained were smaller than advertised -- $850 billion rather than $1.2 trillion over a decade.

Fiscally conservative and Tea Party-allied groups and lawmakers were in revolt, complaining it wouldn’t do enough to rein in the debt, particularly because it lacked language advancing a balanced budget amendment to the U.S. Constitution.

Boehner was forced to retreat and rewrite the proposal, inserting a provision that made action on the balanced budget amendment a prerequisite for a debt ceiling increase. It passed the House 218-210 on a party-line vote on July 29.

Within hours, the Senate scuttled it on a vote of 59-41. That same night, Obama picked up the phone and called Boehner, asking him what would come next and suggesting they meet. The following day, the House defeated Reid’s alternative debt-ceiling plan and Biden phoned McConnell, kicking negotiations into high gear, according to Democratic and Republican officials.

‘Fully Engaged’

“We are now fully engaged, the speaker and I, with the one person in America out of 307 billion people who can sign a bill into law,” McConnell told reporters. “I’m confident and optimistic that we’re going to get an agreement in the very near future and resolve this crisis in the best interests of the American people.”

As the competing votes unfolded in the House and Senate, Reid was in private talks with the White House on an enforcement mechanism, or trigger, that could guarantee the deficit reductions Republicans wanted, without conditioning the increase in the debt ceiling on those savings.

For days, Reid, McConnell, Boehner, Pelosi and White House aides went through about 50 versions of the so-called trigger, according to Democratic officials familiar with the talks. As they settled on a plan to force $1.2 trillion in automatic spending cuts if a proposed 12-member, bipartisan committee failed to make a final recommendation, a new problem emerged.

Defense Cuts

On July 30, Obama, Reid and Pelosi accepted the fact that they couldn’t force new revenue into the package and decided instead to protect domestic programs by ensuring some cuts would hit the Defense Department, according to Democratic officials.

Biden informed McConnell and Boehner that the automatic cuts must break 50-50 between defense and non-defense cuts and that his position was non-negotiable. Obama told them the same thing the next morning. That evening, the Republicans pushed back, arguing the proposal would lead to unacceptably deep spending reductions in defense, according to Democratic and Republican officials.

The next day, Boehner informed the president that the agreement was vulnerable to collapse.

McConnell then reached back to an idea floated during Biden’s deficit-reduction negotiations with a bipartisan group of senators in the spring. He proposed switching the breakdown to a 50-50 split between security and non-security programs, which would provide some protection to the Pentagon by cutting more from such programs as foreign aid or homeland security, the officials said.

The House voted 269-161 to pass the plan yesterday. The Senate is poised to follow suit today, clearing the way for Obama’s signature in the last hours before the government defaults.

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