Geithner Cries WolfWhat If the U.S. Treasury Defaults?
The U.S. Congress has a little less than two months to raise the $14.3 trillion debt ceiling or possibly default on its debt. Treasury Secretary Timothy Geithner says not allowing the Treasury to raise the debt limit would be "catastrophic" for the economy.
Geithner is crying wolf according to Chris Whalen, a banking industry analyst and co-founder of Institutional Risk Analytics. Whalen argues Congress should vote against raising the debt ceiling unless they agree to major spending cuts. "Congress has the right to say 'no' and the people of the United States have a right to say 'no' we don't want to issue more debt," he tells Aaron Task in the accompanying clip.
Whalen first made his thoughts known about the debt ceiling in a Reuters opinion piece Why Congress should vote no on raising the debt ceiling published in April.
"My view is that Congress should vote down any debt ceiling measure unless President Obama agrees to sign the balanced budget amendment. Even if Secretary Geithner has to run the US government on cash, like the good people of Iceland and Ireland today, it will be a good thing for America's political debate to default — at least for a few weeks. Then people will know that the once unthinkable is very possible."
At the time, Whalen's comments were viewed as radical, and some say still are. However, in recent weeks, he seems to be gaining more support from some of Wall Street's heavy hitters. For example, in a recent interview with the Wall Street Journal hedge fund billionaire Stanley Druckenmiller echoed some of Whalen's rhetoric.
No one knows what will happen if the Congress does not raise the debt limit or if there's even a good chance of it happening, but Whalen is holding out hope: "If we don't have consequences in politics then we end up with what we've seen in the last 30 years, which is a permanent political class."
The WSJ article referenced above is What If the U.S. Treasury Defaults?
One of the world's most successful money managers, the lanky, sandy-haired Mr. Druckenmiller is so concerned about the government's ability to pay for its future obligations that he's willing to accept a temporary delay in the interest payments he's owed on his U.S. Treasury bonds—if the result is a Washington deal to restrain runaway entitlement costs.The Upside and Downside
"I think technical default would be horrible," he says from the 24th floor of his midtown Manhattan office, "but I don't think it's going to be the end of the world. It's not going to be catastrophic. What's going to be catastrophic is if we don't solve the real problem," meaning Washington's spending addiction.
Widely credited with orchestrating Mr. Soros's successful shorting of the British pound in 1992, Mr. Druckenmiller also built his own fund, Duquesne Capital, into a $12 billion titan. He announced plans last year to close the fund and now reports, "I have no clients." He is still managing his own money, which Forbes magazine recently estimated at $2.5 billion.
Whatever the correct figure is, it would be significantly larger if Mr. Druckenmiller hadn't given away so much of his wealth. The online magazine Slate reported last year that Mr. Druckenmiller and his wife gave away more money in 2009—over $700 million—than anyone else in the country. Over the last two decades, he has been the largest benefactor of the Harlem Children's Zone, a community service organization featured in the movie, "Waiting for 'Superman.'"
In a May 2 letter to House Speaker John Boehner, Mr. Geithner warned of "a catastrophic economic impact" and said, "Default would cause a financial crisis potentially more severe than the crisis from which we are only now starting to recover."
In a Monday speech at the New York Economic Club, Mr. Boehner fired back, saying that "It's true that allowing America to default would be irresponsible. But it would be more irresponsible to raise the debt ceiling without simultaneously taking dramatic steps to reduce spending and reform the budget process."
So the moment couldn't be better to consult Mr. Druckenmiller, who almost never gives interviews but is willing to speak up now because he thinks that fears about using the debt-limit as a bargaining chip for spending cuts are overblown—and misunderstand the bond market. "The Treasury borrowing committee letter speaks about catastrophic financial crises, comparing it to Fannie and Freddie. That's not what we're talking about here," he says.
He contemplates the possibilities for bond investors if a drawn-out negotiation in Washington creates a short-term problem in servicing the debt but ultimately reduces spending:
"Here are your two options: piece of paper number one—let's just call it a 10-year Treasury. So I own this piece of paper. I get an income stream obviously over 10 years . . . and one of my interest payments is going to be delayed, I don't know, six days, eight days, 15 days, but I know I'm going to get it. There's not a doubt in my mind that it's not going to pay, but it's going to be delayed. But in exchange for that, let's suppose I know I'm going to get massive cuts in entitlements and the government is going to get their house in order so my payments seven, eight, nine, 10 years out are much more assured," he says.
To suggest there is "No Downside" is a bit inaccurate. A better way of phrasing the setup is there is "no NET downside" to not increasing the ceiling without significant budget cuts.
The downside is a temporary default. Interest rates may go up if that happens. Some parties maybe harmed in the process. Thus, the downside is a temporary delay in payments and the small mess that might entail.
The upside is a potential permanent reduction in US spending. From my perspective, that is a massive upside potential, for a bit of short-term downside.
Risk of Greek-Style "Solution"
It should be crystal clear that Congress and the administration need to do something about budget deficits before the market imposes a "Greek-Style" solution on the US.
I mentioned that possibility in my recent Yahoo Finance video appearance: Debt Ceiling Discussion on Daily Ticker with Mish, Aaron Task, Henry Blodget: Will the Bond Market Eventually Force Congressional Hands?
How You Can Help
Please pick up the phone, call your Congressional representatives, and insist on "Major" budget reductions now "Not in the Future", before agreeing to hike the debt ceiling.
Here is the Online Directory for the 112th Congress
It is time Congress call Geithner's and the President's bluff.
The way to make that happen is to insist your representatives recognize something must be done NOW, not 10-years from now about the budget crisis.
Mike "Mish" Shedlock
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