Constitutional Crisis: Not a Debt Crisis, But a Crisis Nonetheless

Includes: DIA, QQQ, SPY
by: Tertiary Finance

The Constitution of the United States

Amendment XIV

Section 4.
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.

The ongoing crisis in Washington is casting a pall over the financial markets, to say nothing of putting the workings of Washington, DC, at an inconceivable new low. The debate over how, or if, to raise our debt ceiling and avoid an August default grinds on. The viewpoints of both extremes would be laughable if the stakes were not so high: one side wants to tax the wealthy, the other to simply cut spending. Then there are members of congress, notably associated with the Tea Party, who claim a default would not be a very significant event anyway. And starting a presidential election cycle certainly hasn't helped matters. Welcome to the new Millenium; your government is run by 10th graders.

Both sides have to give, period. Our problems are too intractable to simply cut spending or tax the wealthy. We need a workable and credible deficit reduction plan if we want the world to keep lending us money, or at least not call it back, as we continue our manifest destiny of over consumption.

We are scheduled to spend $307 Billion in August versus receipts of $172 Billion. The largest components of our projected $135 Billion deficit include: $80.9 Billion on Social Security and Medicare/Medicaid, $72.9 Billion on Govt Agency Expenses, $31.7 Billion on Defense, and $29.0 Billion on Interest on Treasury securities. Everything else including Federal salaries is comparitively minor.

Their are myriad pathways depicting how this crisis could turn out, most of them quite negative, but we don't have to raise the debt ceiling. Our President, for his gifts and flaws, is a constitutional scholar. He could order the Treasury to raise more debt and then face a suit, or even impeachment proceedings from the House of Representatives. Were this to occur we could avoid a technical default but still face very adverse consequences.

The Ratings Agencies would likely downgrade the U.S. Government anyway, because we had not explicitly come up with a deficit reduction plan at 96.3% U.S. Public Gross Debt to GDP. This would likely cause an immediate jump in interest rates across the curve. Meanwhile, many holders of our debt would likely be looking for other places to put their money, though that process would take some time to play out.

Banks and other financial institutions around the world could suddenly see massive balance sheet impairments from falling treasury and spread bond prices. Correspondingly, the cost of capital would suddenly jump for every public or non public entity, on this planet anyway. Money market funds could yet again enter a period of turmoil, as many of these assets are in government paper. This gets very complicated but, in essence, entities of all kinds including individuals could suffer losses on their cash deposits. Credit would correspondingly dry up and this could tip us back into a recession-- which is pretty close to where most of the domestic economy is right now anyway.

On the plus side, I suppose, we could witness even more political theater as the House took up impeachment proceedings against the President. MSNBC and FOX both win there.

But that is more for people who enjoy watching the arguments of 10th graders.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.