The clock is ticking on the prospects for a government shutdown and, even worse, a technical default on U.S. obligations -- and investors seem almost blasé about it. The Standard & Poor's 500 Index is down barely 1% since reaching its all-time high last Wednesday, after the Federal Open Market Committee declined to taper its $85-billion monthly bond purchases.
Meanwhile, since Labor Day, the yield on the 10-Year Treasury Note has dropped from nearly 3% to 2.65%. September may be a record month for investment-grade corporate bond issuance. And the CBOE Volatility Index (VIX) has barely budged. And every day, we move closer to a government shutdown or debt default, with far knottier politics than we had during the debt-ceiling fiasco of summer 2011, after which the U.S. lost its AAA-rating from Standard & Poor's.
"The complacency on this issue is alarming," Chris Krueger, Washington analyst for Guggenheim Partners, told me earlier this week. "Clearly with Washington policy, everybody's been focusing on the Fed and the taper," he said, and are only now looking at the prospects of shutdown or default -- and aren't worrying too much about it.
"Our growing concern is that everyone is far too complacent that just because there has been a deal in all the prior fiscal cliff fights that there has to be a deal in this debt-ceiling fight," he wrote in a note to clients. "There is no evidence to suggest that the debt-ceiling will be raised in time." Krueger clearly thinks the debt-ceiling fight is the more dangerous one, but avoiding a government shutdown may not be a slam dunk, either. Here's why.
In recent years, Congress has passed continuing resolutions (CR) instead of formal budgets to fund the government. The latest runs out on Oct. 1, which is when fiscal year 2014 begins. Without that funding, the government would begin shutting down. But some Tea Party-backed senators, like Ted Cruz (R-Texas) and Mike Lee (R-Utah) have pushed to tie passage of the CR or extension of the debt limit to cutting off funds for Obamacare. The House of Representatives defunded Obamacare in its CR, which the Democratic-controlled Senate is now taking up.
But the Senate bill would likely include funding for Obamacare, and it could pass by Saturday. That would give the House a short time to either cave to the Senate's budget or vote it down, setting the stage for a government shutdown. Krueger puts the chances of a government shutdown at 40%. If the government does shut down, federal employees may be furloughed, and national parks and museums could close, although air traffic controllers and border patrol officers would likely remain on duty.
Default Is Another Story
But it may not be a catastrophe. The market did little during the full and partial shutdowns from November 1995 through January 1996. Default is another story. Raising the debt-limit used to be routine, because it meant paying for programs Congress already had authorized. But it became a political weapon back in 2011, when House Republicans insisted any increase in the debt-limit be paid for by spending cuts. They succeeded: The debt-ceiling battle led to spending cuts of around $2 trillion over a decade, including the dreaded sequester (automatic spending cuts), which took effect this year.
This time, Republicans are tying the debt-limit extension to defunding Obamacare, and other pet causes, rather than spending cuts. President Obama has said repeatedly that the debt-ceiling is non-negotiable. His Treasury Secretary, Jack Lew, says it needs to be extended by October 17. The Congressional Budget Office had said the money would run out by Halloween. Trick or treat, everybody!
Problem is, on the budget, "there's at least an exit strategy. At least the House and the Senate are trading legislation," said Kruger. Not so for the debt-ceiling. No talks are going on, and the president briefly called House Speaker John Boehner (R-Ohio) last Friday to reiterate he won't negotiate. House Republicans, worried about primary challenges in their safe GOP districts, have dug in as well.
"The exit strategy for the debt ceiling is that one side will blink," said Krueger. "Both sides are in their foxholes." The likelihood that the president will give in on this is "as close to zero as you can get in Washington," said Krueger. "The president doesn't have to run for re-election." Unfortunately, everyone else does.
And the stakes of a technical default couldn't be higher. "It's something that could jar the entire global financial system, [which] is based on the premise that Treasuries are a riskless asset and you're calling that into question…," he said. During 2011's crisis, the S&P plunged 17%. I don't think it will be as bad this time, because Congress will likely kick-the-can down the road on both issues until late in the year, when we go through this mess again in an endless loop of fiscal cliffs.
Krueger puts the odds of a technical default at 40%. And the 60% chance it won't happen? "The other 60% is based on blind faith that they're not that stupid," he said. When it comes to Washington D.C., that's not a bet I'm willing to take.