Sometime in February, I began to think that Pres. Biden wanted a showdown with the Republicans over the debt ceiling. Now, I am sure of it. Even as the accolades role in congratulating the White House on the success of the negotiations and the terms of the settlement, the genius of their negotiating strategy is being underappreciated. So, here is what I think went down.
1. The failure to raise the debt ceiling last fall was not a mistake, it was a calculation.
Last fall, Pres. Biden was facing two challenges: the debt ceiling and the 2024 budget. He also wanted to advance the long-standing project of sidelining the Freedom caucus. The question Pres. Biden’s team faced was whether they could use a showdown over the debt ceiling to ease negotiations over the budget while also weakening the hold of the Freedom caucus over Speaker McCarthy. Answer: yes and yes.
2. Pres. Biden’s talk of using the 14th Amendment to avoid default was a head fake.
The 14th Amendment route was always problematic and Pres. Biden was not shy about saying as much. It would require the Treasury to sell bonds that the market knew might be voided by the Supreme Court.
So why talk about the 14th Amendment strategy and its weaknesses? Pres. Biden needed the Freedom caucus to believe that the threat of default was real.
3. The 14th Amendment was never the Biden Administration’s plan to avoid default.
Pres. Biden had another much simpler much more clearly legal option than the 14th Amendment and less gimmicky than the platinum coin strategy. Here is how it would work.
There are many ways of structuring debt. The most common structure used by the Treasury is the “balloon” type. The Treasury only pays interest until the note matures, at which point the Treasury repays the principle. However, with a “conventional” loan, each payment includes interest and principle. So, when the note matures, the outstanding principle is zero.
The Second Liberty Bond Act of 1917 only regulates the “balloon” type structure. There is no limit on debt with the “conventional” structure. A second relevant feature of the 1917 Act is that the debt ceiling applies to the total outstanding face value of the debt outside the Treasury.
So, it would have been a very simple task for the Treasury to print up some “conventional” bonds and swap them for “balloon” bonds currently being held at the Federal Reserve. Once the “balloon” bonds are back in the Treasury they no longer count against the debt ceiling. Problem solved with no gimmicks and nothing scary or difficult to understand for the bond markets.
4. We were never in danger of defaulting on the debt and Speaker McCarthy knew it.
Pres. Biden had multiple channels to avoid default and he made very clear that default was not going to happen. As a consequence, the Republicans may have tried to take the debt ceiling hostage, but their guns were loaded with blanks. Speaker McCarthy must have realized as much, given the way he negotiated.
5. Pres. Biden’s claim that he wanted a clean debt ceiling bill was a head fake.
With the debt ceiling hostage deactivated, Pres. Biden then turned to use the debt ceiling negotiations to advance his other two objectives: the 2024 budget and marginalizing the Freedom caucus. Enter Sec. Yellen, raising the alarm about impending doom. Why? To create the illusion of a negotiating deadline and force a budget settlement.
6. Deactivating the threat of default flipped the power value of joining debt ceiling and budget negotiations from the Republicans to the Democrats.
When the threat of default is real, Republicans can extract budget concessions from Democrats simply because Democrats care more than Republicans about protecting the full faith and credit of the United States. If the threat of default is illusory, its only effect is to impose an end date on negotiations. Since the deadline was only perceived as real by the Freedom caucus (and the press), they were the only ones affected by Sec. Yellen’s default date.
With the default date fast approaching at the end of May, Pres. Biden had more bargaining leverage over the budget than he could ever have had in August. The threat of default is a grave one to Democrats. But Republicans are not immune. Crashing the global economy would not wear well on them either.
Some members of the Freedom caucus were in fact skeptical of the June 1 default date and suspected they were being stampeded. They started asking to see Sec. Yellen’s “math.”
This line of reasoning also explains why many members of the Freedom caucus think the budget deal Speaker McCarthy negotiated is worse than a clean debt ceiling increase would have been. They realized too late that the power value of linking the debt ceiling and budget negotiations had shifted against them.
This Biden guy … he’s good at politics.