Returning to the debt negotiations for a moment. A fellow law blogger, Professor Jonah Gelbach, takes up the first question I asked in my earlier post on the negotiations — what happens if you take away the pressure of the debt ceiling altogether? It’s an important short post at PrawfsBlawg. His answer, based on looking at credit markets, is that solvency is not the issue:
On July 25, the day Anderson asked his question, the market was requiring Treasury to pay well less than 1 percent for a 3-year loan, 3.03 percent for a 10-year loan, and 4.31 percent for a 30-year loan.
Two points here. First, the financial markets already focus on the longer term question, because bond purchasers are choosing to lend over the long term.
And second, the markets aren’t worried about the government’s capacity to make good on long term loans. People with capital to invest are lending it to the U.S. Treasury at very low rates for very long periods of time. The notion that the U.S. government faces anything like a solvency crisis is wildly inconsistent with what financial markets are telling us. The real risks from the current political crisis are (i) the possibility of default on short-term debt,* and (ii) the huge negative shock to aggregate demand that would accompany switching to a de facto balanced-budget fiscal policy in the middle of a serious downturn.
I take the point, but still worry about confounding variables. E.g., where else do they go? It’s long term debt, of course, but there are many reasons why investors require these maturities, reasons that might lead them here even if they had substantial doubts.
In addition, going to Megan McArdle’s post on the seeming unconcern on Wall Street about either the long term or the short term prospect of no deal, I wonder if the bailout culture has somehow induced a sense on Wall Street that, when it comes to massive political-economic moves of this magnitude, there is always the possibility of a do-over and a reset.
Call it a “culture of mulligans.” The threatened consequences are too earthshaking to be the result of a mere artificial, merely human deadline; unless it is an actual, natural tsunami, these human-created deadlines can always be re-worked after the fact, without consequences. It’s not precisely moral hazard; it is an attitude that springs from the culture of Wall Street accustomed to bailouts after the fact. It receives them from government; why shouldn’t government receive them from government, after the fact, as well? Consequences that are supposedly horrendous and will really truly happen on schedule, just like the incoming asteroid on a collision course, actually are endlessly revisable. It’s as though they were all closet marxists who see the supposed natural and immutable order of things as merely the veil of ideology.
That’s in addition to the bankers’ expectation that in any case they would once again get bailed out — true moral hazard. On that view, a proper internalization of costs would mean that bankers would be well and truly screaming like crazy and indicating in pricing already their dismay with the situation. They’re not, because of a form of moral hazard that causes them to assume they’re insured against such events.
We should add the possibility that the bankers are not as smart as they, and we, continue to assume they are. The proposition that market players behave irrationally and en masse in situations that fundamentally turn on political considerations can’t exactly be ruled out of court these days. Wall Street and Washington operate now more than ever in their own space of politicized markets, and the usual rules of the price mechanism don’t necessarily tell you what you need to know. The fix is in, &tc.
Finally, there is the possibility — horror of horrors — that maybe the bankers actually share the Tea Party sense that there are worse things than a downgrade from the rating agencies or a declaration of default from a rating agency, and failing to address the long term solvency problem now is one of them. Why don’t the price signals suggest, as much as anything else, that Wall Street thinks:
(i) that the Tea Party view of the long run is correct,
(ii) moreover that the Tea Party view is likely to prevail politically now and beyond 2012, and
(iii) that it will restore health to the long term credit of the United States.
That’s a very long chain of premises, and they are called premises because our interest in them at this moment is not whether they are true or false, but the implications for the possible reasoning of bankers if they were true. I don’t think the price data as such rule this out as a possible explanation for why Wall Street seems sanguine. I’m not endorsing any substantive view here, nor am I suggesting that this is particularly likely as an explanation for current pricing — I’m just urging that there are many ways to read the bond price tea-leaves, and they might even include things as apparently unlikely as this string of premises all being true.
Consider what this suggests for the two political combatants, however, and not just Wall Street. On this view, the Tea Party and the Democrats share one belief, a procedural one — that a line must be drawn in the sand now, it can’t wait. Each of them says what Captain Picard says about the Borg at the beginning of First Contact — a line must be drawn here. But the line goes to a different issue for each of the players, even though each has unavoidable implications for the other. For the Democrats, it is the debt ceiling, and the implied question of liquidity; but for the Tea Party, it is the solvency issue that, in their estimation, otherwise never gets addressed and which is, at bottom, the real source of concern even over liquidity and for which reason liquidity is even at question.
They each have reasons for fighting to the death, here and now, but they are actually fighting over slightly different propositions. They grapple and struggle as though they were taking opposite sides in a debate — and in the “objective” sense, as we marxists like to say, they are. But each seen from its vantage point is in fact fighting over, and fighting for, a proposition that is distinct from the proposition disputed by the other side. The two sides are not fighting over perfect negations of each other, and that makes the issue both far more complicated, less likely to end in compromise, and difficult to game.
Where the bankers come down in all this I have no idea — but I am not persuaded that surface price signals are dispositive in a situation that is fundamentally political.
(PS. Please be civil in the comments — I won’t have time this week to go through and read them or weed things out. Look, after a quick glance and a couple of deletions, I’m closing comments here. Apologies to people with useful thoughts; I’m serious when I ask people to be civil.)