Against the constitutional option, cont’d

at 10:51 AM ET, 06/30/2011

Jonathan Chait and David Dayen both think that the breakdown of debt-ceiling negotiations strengthens the case for the Obama administration to attempt the “constitutional option,” in which they simply declare the debt limit unconstitutional and hope the Supreme Court agrees. I disagree.

As I understand it, the case against taking the debt ceiling all the way to the edge is risk aversion. No one is worried that the American government doesn’t have the financial capacity to pay its debts. Any default would be temporary, and the result of political jockeying. But what would potentially devastate the markets is a process that suggests they’ve misunderstood the strength of the American political system, that suggests we can’t reliably do easy, obvious things like paying our bills and thus won’t be able to do harder, more challenging things like fixing our health-care system. And that’s when the market begins wondering if we really will be able to cover our debts later, and that’s when they begin charging us higher borrowing rates and diversifying into other currencies.

To Chait and Dayen, that’s the case for the constitutional option: If it works, there’s no longer a risk that the debt ceiling will cave in. To me, it’s the case against it. There’s every reason to believe that the markets expect, and have even priced in, a typical political tussle over the debt ceiling. Frustrating as it may be, what we’re seeing right now is politics-as-usual, and markets tend to take a benign view of Washington’s constant dramas. In 1995, Congress and the president gridlocked over not just the debt ceiling, but also the appropriations bills, yet bond rates barely budged. Now, if the standoff hadn’t eventually been resolved, the market would’ve panicked. But it was resolved. And that further taught the market to ignore these periodic eruptions of Beltway hysteria. When the time comes, the American government always pays its debts.

But that confidence is, I suspect, largely dependent on this debt-ceiling fight looking pretty much like past debt-ceiling fights. So long as bond traders are calling their political fixers and hearing reassuring things about how they’ve seen this before and this is just how Washington works and there’s no way that Boehner and Obama won’t come to a deal before Social Security checks stop going out, they’ll give us time to work it out. What we don’t want them to do is call their political fixers and, after a long silence, hear, “No. I’ve never seen anything this before. I don’t know how this is going to play out.”

And that’s what they’d hear if we went to a constitutional showdown. How do you price the probability that Anthony Kennedy votes with the liberals rather than the conservatives? How do you judge whether the Supreme Court will care more about Section Four of the 14th Amendment, where it says that “the validity of the public debt of the United States ... shall not be questioned” or Article I, Section 8, Clause 2, which says only Congress can “borrow money on the credit of the United States”? How do you predict the aftermath of the Obama administration losing its case after trying to end-run Congress? What does it say about future efforts between the two parties to work together on reducing the deficit?

I don’t know how you price all that into your trading strategy, and nor does anyone else. That’s why it’s so dangerous. Yes, the first round of debt-ceiling negotiations failed, but we always knew that was likely to happen. Now we’re moving to a fairly predictable second round. Bond rates aren’t spiking. The market hasn’t been caught by surprise and forced to dramatically reassess its confidence that this will ultimately be resolved. Now’s not the time to overturn the chess board.

 
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