On the Debt Limit, its Significance, Constitutionality, and Avenues to Navigate.

Commentary on the Debt Ceiling, view on the duties and position of the two parties, debt's constitutional angle, and a long term wish that the debt ceiling permanently retires.

The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void. - Section IV, 14th Amendment.

https://www.fox43.com/.../521-ada2b119-0c3b-498e-9ad3...

First, the reality is that, even in the event the United States does default, it will likely be in the form of missing days' worth of Medicare / Social Security payments (that counts as a technical default as far as credit markets go). If and when we default, the market reaction will be so swift and severe lawmakers and Biden will sprint toward compromise to get an emergency deal done. They will lose their current confidence in not budging or refusing to compromise very quickly when the stock market drops 7% in a few hours, the bond market goes into spasm, and Biden's White House is inundated with angry and frantic phone calls from world leaders from all over the globe, not to mention his largest corporate donors. The same goes for GOP leadership; corporate lobbyists and powerful donors will unload on McCarthy and his team if this threat becomes real. It will be ugly. That said, the damage will likely be quickly reversed when a deal is done, potentially making this a good opportunity to buy bonds and stocks on weakness. Most realistically, a panic deal will be a clean, short-term raise to buy more negotiating time. Fortunately, the reality is that the US is still.. well, the US, and if we quickly remedy a breach, it's unlikely that the "default" will be treated by the global market as a genuine default, the type that stems from structural issues. Therefore we won't see a massive, permanent rerating of government debt, and therefore most commercial debt, several hundred basis points (100 basis points = 1%) points higher (US debt is the reference rate, if US debt rerates 175bp higher, you can expect to see that reflected in corporate /municipal bonds as well).

I can't believe I'm saying this, and I don't like this fact, but the Democrats arguing for Biden to lift the limit via the 14th amendment could actually be correct in that the power is there to do that, and I somewhat support them going down that road if not to end the debt limit as a legislative device permanently.. 14A makes it clear that a default on US debt is unconstitutional. A large portion of our new debt issuance is to pay interest on past debt, so essentially, we have to borrow more money to make good on past debt. To me, this means there is a constitutional argument to be had that due to our debt obligations that were permitted by past sessions of Congress (and for expenses appropriated and allocated by Congress), the US needs to continue accessing the debt marketplace in the form of new treasury issuance - which I *think* gives the executive branch the constitutional right to issue more debt beyond any arbitrary limit. Furthermore, Congress decides how to appropriate/allocate money; once they have done that, their duty with the strings of the purse is complete. From that point on, the actual financing of those spending decisions rests with the executive branch.

The 14th is clear: the US has a constitutional duty to honor its debt, given that debt is largely issued to pay off past debt and pay for spending already approved by Congress. A strong case can be made that the limit itself is unconstitutional. If Congress wants to limit or reverse spending decisions, it should pass a bill. Refusing to honor past made obligations and commitments, as well as paralyzing the federal government's capacity to issue debt in order to pay off existing debt (yes, the US government is essentially running a Ponzi scheme if you think about it..), seems to be at odds with the Constitution (at the very least, in spirit). The founders would not be ok with arbitrarily halting obligations or restricting the executive branch's ability to access the debt market after spending has been approved or past debt is due for refinancing. I believe they intended for a system in which Congress could pass legislation that appropriates and allocates funding, at which point their duty to manage the nation's purse has been met. The new debt is not for new spending projects; it’s simply to pay for past approved spending and to honor obligations tied to past debt issuance that Congress authorized.

I don't know, mixed feelings. Biden has been out of control with spending, and it's time we get back to a pre covid budget deficit size. To some degree, I'm glad Republicans have something to work with to force a concession, and given the circumstances, I do think Biden needs to make concessions as the obligation and capacity to honor debt rest in his hands as the chief executive - and that must be done no matter the cost to the president's personal spending agenda. But that said, I have always hated the debt limit. It's literally like giving a financial nuclear bomb to uninformed, unsophisticated parties and expecting them to negotiate the issue in brinksmanship and never accidentally setting it off. I hope at some point when Congress and WH are aligned/have supermajorities, this dumb device is permanently eliminated.

I think it's a ridiculous concept to begin with.. that a country with a nearly unlimited capacity to borrow and full ability to honor that debt (nevermind the fact that it controls its own currency and has the ability to print as much of it as needed to honor obligations) is thrown into a near-crisis situation every year and a half or so when the parties are split between Congress and the White House. It should be pretty simple: Congress should either not approve spending or pass legislation to reverse previous spending bills. I feel this way regardless of the party in control of the White House. Again, the bottom line is that we need to issue debt to honor past made commitments - such as social security payments - as well as service previously issued debt. It's the honoring of past debt commitments by way of issuing new debt to do so that makes the 14th Amendment case stick.

I've spent a lot of time in finance as an active market participant, and I believe I have good familiarity with debt markets, public markets more broadly, ramifications of debt issuing/debt default, and, importantly, a comprehensive grasp on the outsized role US treasuries play in both domestic and foreign markets. They really are at the heart of the modern financial system. To break them by way of not raising the level of some archaic device like this debt ceiling is absolutely crazy. The parties involved - Biden, McCarthy, Congress, etc. - clearly don't fully understand the ramifications of breaking the treasury market. These lifetime politicians and even some of the people meant to be expert advisors but who have never operated outside of government policy are just clueless about financial markets and the credit-driven, US debt-anchored global financial system more broadly..

It is hard to overstate just how big of a deal it is to break the financial system to mess with the treasury market and creditworthiness more broadly. It will cause structurally higher borrowing costs as this now realized the risk of US default due to political BS must be priced into the market (and I think that's going to happen regardless of a deal in time or no deal, I fully expect a credit downgrade/comment from the rating agencies in the coming days/weeks). It rattles business confidence and stability in corporate treasury activity (investing cash into short/medium-term assets with yield). It undermines US leadership/power over international markets (just another hit to our reserve currency standing..). I could go on at length about what the ramifications would be immediate to longer term, but I'll summarize that it's really bad, with lots of chaos and potentially severely broken markets.

More interesting than the 14th Amendment would be extraordinary Fed US debt purchases and remittance to the Treasury, or the treasury outright using its ability to print money (now done via the Fed through the open market committee adding zeroes to its buying power) to retire/expunge outstanding debt. They could go out to the marketplace and bid up every treasury on offer, then essentially retire the debt and remit the balance back to the Treasury Department, lowering outstanding debt and giving the treasury the capacity to issue new debt.

Another route that could be taken is the Fed's ability to create a financing window for the treasury to access. Those funds could then be used to cover expenses as they arise until a limit raise is sorted out. Even further, the Fed could do a discount window with the treasury itself, where the treasury posts some form of collateral with minimal value (maybe an IOU of sorts that don't constitute new public debt), and the Fed would lend against that collateral at a massively inflated valuation, flooding the treasury in new cash to cover immediate obligations.

These Federal Reserve scenarios are unlikely, but if it hits the fan and we do trigger a default, it is guaranteed the Federal Reserve will try and do something. It depends on how creative and willing Jerome Powell is to push the legal limit. In summary, this is a very real threat to economic performance. Missing debt payments will trigger many knock-on effects, paralyze business investment, potentially break more small/regional banks, cause chaos in global markets, and assuredly lead to a significant sell-off in the stock market. The debt limit is a dumb device that needs to be removed - the debt limit has been increased 70+ times over the last 50 years. By way of past precedent (up until this go around), the debt ceiling plays a pretty pure symbolic role. Biden does need to make concessions, it's his game to lose, but Republicans need to be within the bounds of reason in their requests. Get a small win and punt this financial weapon of mass destruction for a year or more.

Biden's spending has been outrageous, COVID is long behind us at this point, and budgets are still bursting at the seams, and deficits are well over 1 trillion / year, despite no longer being in an emergency environment. To cool inflation and get back on track, we need the federal budget and total government spending to revert back to 2019 levels, where the deficit was a (relatively) mild $900 billion. Will post more as we approach June 1st and potentially trigger a default.