September 4, 2013

Friedman: ‘Twin Threats’ of Government Shutdown, Debt Default Could Roil Markets

Andy Friedman says a wild September may be in store if Congress ignores the debt limit crisis

Andy Friedman of The Washington Update. Andy Friedman of The Washington Update.

While a government shutdown is “quite unlikely,” the “twin threats” of a government shutdown and debt default that Congress must tackle when it returns next week could “roil the markets,” particularly if the government does indeed shut down or lawmakers agree only to push that deadline back a few months.

So says analyst Andy Friedman of The Washington Update in his latest white paper, released Wednesday. A “volatile September” may well be in store, he says, if Congress fails to deal with the looming debt limit crisis.

The last debt limit crisis, in August 2011, “produced a difficult month for the markets (in what was otherwise a strong year),” Friedman says. But perhaps this time will be different, he says, and today’s markets have developed “’Washington crisis fatigue.’” After all, he continues, the sequestration spending cuts “did not thwart the market run-up this spring.”

But Friedman predicts that “Congress will not allow the United States government to default on its national debt.”

However, the negotiations should be heated. As it stands now, Congress only has enough funds to keep the government operating through Sept. 30. If Congress fails to appropriate additional funds during September, the federal government will shut down Oct. 1.

As Friedman notes, House Speaker John Boehner, R-Ohio, has said he will propose stopgap legislation without conditions that would fund the federal government for a few more months at 2013 levels. If Congress adopts such a resolution, the funding deadline will be pushed later into the year.

But a second, and what Friedman calls “a more important,” deadline looms: the U.S. government has once again hit its borrowing limit.

“Congress had authorized the federal government to borrow only through May 18, 2013,” Friedman says. “Since that date, the government has continued to operate using current tax receipts and funds in accounts set aside for future expenses. But, according to the Treasury Department, by mid-October the government will need to borrow additional funds to pay its bills, including interest on its outstanding debt.” Either Congress will have to raise the debt limit or the U.S., unable to borrow to pay interest, will default on the national debt.

Heading into the negotiations, Republicans, Friedman says, are calling for increases in defense spending and cuts in domestic spending (primarily social programs) and entitlement spending — primarily Social Security and Medicare. However, congressional Democrats have refused to accept any changes to entitlements.

But President Barack Obama has “taken a somewhat more lenient stance, indicating that he might accept some cutbacks in entitlements if the Republicans agree to new taxes on affluent families.”

In that regard, the president has proposed a number of tax changes he wants to see enacted, including taxing municipal bond interest, limiting the amount individuals may accumulate in tax-preferred retirement accounts, and reversing recent expansions of the estate and gift tax exemptions, Friedman says. However, “none of these proposals is likely to get through Congress.”

As to cuts in Social Security, Republicans want to change the rate of growth of Social Security benefits. Under current law, Social Security benefits increase each year based on the consumer price index (CPI). “The Republicans seek to replace CPI with ‘chained CPI,’” Friedman explains, which “acknowledges that when the price of an item gets too high, people do not simply pay that higher price, they substitute something cheaper.” Chained CPI, he says, “does not grow as quickly as conventional CPI. Thus, using chained CPI would slow the rate of growth of Social Security payments.”

According to recent data released by the Social Security Administration — whose trust fund reported positive cash flow last year — Social Security paid benefits to about 61.9 million people in 2012, and provided at least half the income for 64% of the aged beneficiaries in 2011.

Republicans also are calling for affluent recipients to pay more for Medicare coverage.

Some congressional Republicans are also suggesting “they will refuse to vote for any bill that funds Obamacare along with the rest of the government,” Friedman says. “The party’s leaders, however, have shown a disinclination to follow that route for fear of a blowback against the party.”

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Check out Congress Girds for Another Debt Fight as Deficit Shrinks on ThinkAdvisor.

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