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Posted at 03:30 PM ET, 07/19/2011

Danger of default: McConnell-Reid vs. Gang of Six


The reemergence of the Gang of Six (GO6) and the backing of President Obama today is a glimmer of hope that the willful insanity over the debt ceiling will give way to a credible plan that puts the United States on a credible fiscal path. It would cut $3.7 trillion in spending over 10 years, reform entitlements and add additional revenue. Everything the bond rating agencies want and the nation needs. But in case an agreement can’t be reached on the GO6 plan, Obama also called on Congress to keep pushing ahead on the dreaded McConnell-Reid deal.

My fingers are crossed are that GO6 does indeed win the day.

McConnell-Reid is one big legislative bad choice. If the measure doesn’t pass, the full faith and credit of the United States would be destroyed, and a world of hurt would be unleashed on the American people. If it does pass, the U.S. avoids default, but the prospect of a devastating downgrade to AA by S&P would skyrocket. This is why I argued that what we’re seeing is Washington moving fast to make a train wreck of its own creation less bad.

When Senate Minority Leader Mitch McConnell (R-Ky.) last week announced a plan to raise the debt ceiling, I slammed it as his “Plan C(haos).” But his diabolical plan has changed and now includes Senate Majority Leader Harry Reid (D-Nev.). The bipartisan effort is laudable, but late and might not stop fiscal calamity. That’s because it doesn’t come close to doing what the bond ratings agencies want to avert an unprecedented downgrade of the credit rating of the United States.

In an exclusive interview with Fox Business Network yesterday, Nikola Swann of Standard & Poor’s spelled out the specifics of what his agency would want to see.

We need to see bipartisan agreement on fiscal consolidation plan that would be multi-year and large enough to stabilize the net government debt to GDP ratio. We believe that would have to be in the order of $4 trillion. A plan that is agreed to by both parties; making the proposition that it could survive a change of administration credible.

Before Moody’s announcement yesterday that the U.S. should do away with the debt ceiling altogether, the outfit warned last week that if the nation’s AAA bond rating were maintained it would be slapped with a negative outlook if certain conditions weren’t met.

However, the outlook assigned at that time to the government bond rating would very likely be changed to negative at the conclusion of the review unless substantial and credible agreement is achieved on a budget that includes long-term deficit reduction. To retain a stable outlook, such an agreement should include a deficit trajectory that leads to stabilization and then decline in the ratios of federal government debt to GDP and debt to revenue beginning within the next few years.

The McConnell-Reid plan would allow President Obama to raise the debt ceiling three separate times for a total $2.5 trillion increase. A “motion of disapproval” would be voted on each time. It would cut $1.5 trillion in spending over the next 10 years. There would be no provision for revenue. A bipartisan commission would be formed to come up with additional ways to reduce the deficit that would include cuts and maybe tax revenue. As you can see, McConnell-Reid is woefully inadequate effort.

“McConnell-Reid plan would be a very mediocre plan that would probably not meet the test of the S&P and they would downgrade us,” Joe Carson, director of global economic research AllianceBernstein Investments told me yesterday. “So I think what Congress is doing is doing enough to get the markets through the Aug. 2 deadline. But they are not looking at the long-run negative consequences of their actions and that’s the worst thing you can do.” Carson noted, “Even though this avoids default, I don’t think it is a positive outcome and shows a lack of leadership in Washington because they can’t agree on anything....Even though some people in Washington think this is a positive development, it really has a lot of negative economic consequences tied to it because of the uncertainty factor.” Uncertainty over deficit trajectory and tax laws, to be specific.

Carson’s assumption is that McConnell-Reid will pass. But that’s debatable. Some Republicans don’t want to raise the debt ceiling at all. Some Republicans won’t think the cuts are deep enough or that they’ll happen at all. And Democrats won’t be thrilled by the lack of revenue generation. It’s a legislative dud that does nothing to safeguard the nation’s economic well-being. The plan from the Gang of Six does. With 50 Senators on board and Sen. Tom Coburn (R-Okla.) back at the table, not only could the U.S. lift its debt ceiling and start down a more sustainable economic path, but it also could do it without sacrificing its AAA credit rating.

By  |  03:30 PM ET, 07/19/2011

 
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