State Debt: Washington's Next Budget Headache?

Congress may have finally approved the FY11 budget this week, but the next battles have already begun. The deficit debate awaits a proposed centrist compromise from the Gang of Six, both parties are firing salvos over the debt ceiling vote and the forgotten issue of state and local debt could soon become Washington’s next worry. As Capitol Hill takes a breather from the budget battles, here’s an overview of the unresolved debates and still-mounting spending skirmishes.

Fiscal Year 2011 Funded at Last: The Senate joined the House late this week in passing the seventh and apparently final version of the FY11 appropriations bills, in the form of a Continuing Resolution.  House Minority Whip Steny Hoyer was able to provide sufficient Democratic votes for Speaker John Boehner to compensate for the loss of 59 members of the Republican caucus.  At least now agency and program managers in the federal government have guidance on how to run their departments and what their budgets will be.  Some experts estimate that between the emergency funding in the bill and the costs of the five delays caused by five CRs, the final bill actually added to the FY11 deficit.  One can be reasonably sure that this result was far from what the bulk of the GOP caucus intended when this entire adventure began.  In some sense, it reminds one of World War I—bloody, interminable, hand-to-hand combat day after day without any tactical nor strategic gain for either side.

Gang of Six Needs to Move: Frustrations mount among Senators as both the House and President Obama have joined the budget fray full scale.  The “Gang of Six” has yet to release a comprehensive FY12 budget plan nor a longer term outline similar to that House Budget Committee Chairman Paul Ryan and Obama have produced.  Appointment of Sens. Dan Inouye and Max Baucus by Majority Leader Harry Reid to represent the Senate in the budget talks proposed by the President must be viewed as a deliberate slight of Senate Budget Committee Chairman Kent Conrad and other Democratic members of the Gang of Six.  Most observers believe that Reid’s appointment of Inouye, Chairman of Appropriations, and Baucus, Chairman of Finance, makes a comprehensive and detailed legislative outcome less likely.  What the Gang of Six does now remains uncertain, although hints have emerged recently that the group will reveal a full-scale plan when the two-week Easter Recess ends.

The Debt Ceiling Approaches: Media hysteria, focused so breathlessly on a “government shutdown” as the CR debate lingered, can now attach itself to the question of how Congress will pass an increase in the federal debt ceiling.  The present limit is $14.29 trillion.  Treasury Secretary Geithner estimates that ceiling will be breached no later than July, even using every trick in Treasury’s book.  Thus, President Obama called for his three-party budget negotiations and set an end of June deadline for reaching an agreement on a long-term blueprint to get the projected national debt under control.  No one with any experience in this town believes that even the best-intentioned negotiators could reach agreement and produce implementing legislation in such a short time, but the President was well-served by setting a deadline, especially one that he knows cannot be met.  Despite what conventional wisdom holds, we believe that President Obama will be on the offensive on the debt ceiling increase vote and that the public burden lies squarely on the House Republican leadership.  The President will continue to call for quick action on a “clean” debt bill (one without any amendments attached), knowing full well that it will never happen.

Treasury’s Good Luck Continues: If deficits are so bad, why are American interest rates so low?  That question arises whenever deficit hawks warn about soaring debt and the inevitability of higher interest rates.  The answer, of course, lies in present global economic and military realities.  The European debt crisis proves more expensive and more extensive than first projected.  North African instability continues, with Iran involving itself at every opportunity to cause turmoil.  Japan’s earthquake/tsunami tragedy raises economic uncertainty not only in the world’s third largest economy but throughout the developed world’s economies.  Economists warn of a persistence of the slowdown in America’s economy in the just-concluded first quarter.  And, Fed Chair Ben Bernanke remains a buyer of last resort of American debt issuance.  Under such unique circumstances, which put a premium on safety and liquidity, global investors rush to buy United States debt as a temporary refuge from this global chaos.  So Treasury’s good luck continues—as long as the world remains unstable and investors rush to risk quality and perceived safety, American interest rates will remain low.  However, this unusual situation will end; when and how remains unknowable.  But when safety becomes a lesser priority among investors, and greed/risk take over again, then America will have to pay high interest to investors to sell its debt.  That could cause “interesting” consequences.

Meanwhile, the States Plod Along: Lost in the media’s focus on the federal debt, the worsening condition of state and local finances occupies the back pages.  Interviews with professional municipal bond managers reveal less fear than headlines suggest.  Most professionals believe that some states will face serious debt problems within 3-5 years, but most dismiss predictions of thousands of defaults costing tens of billions of dollars as vastly over-stated.  No one predicts the future with great accuracy, but even if only California, Illinois, and Pennsylvania come to the federal government seeking some sort of “bail out,” bond markets will quake.  Taking a larger view, one is struck by the fact that debt is migrating up the governmental food chain.  Cities ask for state help, states ask for union and other spending concessions, ratings agencies watch warily, and, ultimately everyone looks to the federal government.  Even individuals who cannot pay the debt on their homes, have turned to state and federal programs for help.  This migration of debt will reach some sort of federal policy decision-point before the end of the decade—but the feds will have no money to help.

Finally, the Public Remains Fed Up: Poll data from a wide variety of sources shows that Americans still believe by overwhelming margins that the country is going in the wrong direction.  The President’s approval ratings remain below 50 per cent, Congress’ approval barely nudges 30 per cent, and joblessness continues to unnerve almost everyone.  As foreclosures continue relentlessly, and good jobs remain scarce, almost no politician in a competitive situation should assume an easy race in 2012.  Those pundits who confidently predict an Obama win or loss, or Republican takeover of the Senate, or Democratic gains in the House, engage in pure speculation.  In turbulent national and international conditions, where exogenous events govern public confidence levels, prediction is almost less than an art—it is mythic.

Congress Begins Its Two-Week Easter Recess: As Will Rogers is reported to have said, Congress is out of session, so the nation is temporarily safe.  Old Will would have loved to be alive and commenting these days.

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