By: Maxwell Reale, Managing Director

January 29, 2023

Welcome to the daftest debate in Congress: will the United States government be allowed to pay its existing debt obligations by borrowing money?

We are in an era of political brinksmanship and sound bites, where proving one’s mettle with primary voters means running an adversarial campaign against the other side—particularly in the House where these trends have been exacerbated by gerrymandering. This means a precarious US economy faces a prolonged debate on how to raise the debt ceiling before a fast-approaching default deadline catalyzes agreement amongst members of Congress, potentially undermining the existing faith in US government counterparty faith and credibility. Such a scenario generates needless economic angst as negotiators delay the inevitability of their elected responsibilities. Let’s call these the dumb—and overwhelmingly most likely—paths to resolution.

As we see it, this road to a dramatic early summer raising of the debt ceiling could play out in four ways, from least likely to most likely:

1. Democrats Cave: Though Speaker McCarthy has not staked out an official ask of Democrats in exchange for raising the debt ceiling, the expected ask is a reduction in discretionary spending to FY22 levels. On its face, the deal would entail reducing current defense spending levels by almost 10%—which we doubt has sufficient support among Republicans to pass. Or it means reducing non-defense, non-veterans spending by about 20%—a non-starter for Democrats. Without sufficient member-level support, this deal is not feasible even if Democrats caved and met Speaker McCarthy at his initial ask.
   
2. Speaker McCarthy Caves: By starting his negotiations without a clear proposition that could pass with sufficient Republican support in the House, McCarthy cannot win without compromise or surrender. The latter would require bringing a debt ceiling increase to the House floor absent any spending limitations, costing McCarthy his Speakership and sending the House into another chaotic leadership battle.
   
3. Democrats and McCarthy Find Common Ground: With surrendering equal to a political death sentence for McCarthy, he will likely need to find a compromise the majority of Republicans, all moderate Democrats, and President Biden can live with. This trade-off would likely need to include some preservation of defense spending levels, a promise to freeze FY23 non-defense, non-veterans spending levels, and a series of bipartisan and bicameral committees to address long-term entitlement reform. We view this as a possible outcome but not the most likely as we doubt this bargain would garner sufficient support from Republicans, resulting in either failure on the House floor and/or McCarthy losing his Speakership.
   
4. Moderate Republicans and Democrats Circumvent the Biden-McCarthy Stalemate: Let’s call this the “break glass in case of emergency” option, and it’s the most likely option given the dim prospects of the other possible, non-default scenarios. However, bypassing McCarthy and bringing a debt ceiling deal to the House floor would require a complicated and timely legislative maneuver known as a discharge petition. Given the requisite number of days to move discharge petition to the House floor—a process that would take about six weeks if everything goes smoothly—this option limits Congress’ ability to address the debt ceiling quickly if the Treasury prematurely exhausts its expected liquidity.

While the odds of a US government default are the highest since 2011, the overwhelmingly most likely outcome is Congress reaching a deal to raise the debt limit, averting a default. Nevertheless, there are alternatives where Congress fails to reach an agreement or a complacent Congress is unprepared to react if the US Treasury exhausts its liquidity before the current deadline of early June. These two options represent the dumber possible outcomes of months-long debt ceiling deliberations.

Facing the risk of default and lacking congressional authority to issue new debt would present the Biden Administration with a limited number of Constitutional—and to this point, purely academic—options for staving off default. In the coming months, Capstone will be analyzing both the process and potential of these administrative options, as well as political posturing by Democrats and Republicans as the Biden-McCarthy talks continue.

Conversely, Congress could reach a solution sooner and without drama, which would require Speaker McCarthy or Democrats to capitulate—a politically costly move absent the risk of a near-term default. While a quick and responsible resolution is preferable for markets, corporations, voters, and the global economy, Capstone fears the rhetoric and deal-making environment involved this time may be too dumb. Let’s all just hope they don’t act any dumber.