Serial Brinkmanship

Seems everyone was applauding, even the American financial markets. Positive Congressional smoke signals emerged late yesterday afternoon, as Democratic Senate Majority Leader Harry Reid and Minority Leader Mitch McConnell took to the Senate floor to announce the result of four days of talks. Equity and bond markets, anticipating an agreement to re-open the federal government and once again raise the debt limit - for the 46th time just since the Carter presidency in the 1970's, from $0.7 trillion then to the current ceiling of $16.7 trillion - had been rallying for days. They jumped again yesterday on the news of an agreement.

But yesterday's euphoria seems to have evaporated this morning, as it has become clear that the bi-partisan resolution, signed into law by the President, is no solution. It merely re-sets the ticking clock, and not for very long, pushing forward budget decisions and borrowing limits to, respectively, January and early February next year.

Long-term reforms to tax policy and entitlement spending (Medicare, Medicaid and Social Security) are what America needs, implemented within a multi-year framework in which annual federal budgets move from deficit to surplus, and the stock of outstanding public debt declines, at least as a proportion of GDP. Through its impact on confidence, such a fiscal "Grand Bargain" at this point would revitalize growth and spur employment to an extent no amount of further monetary easing could possibly replicate. The Federal Reserve's incoming chairman, Janet Yellen, knows this, as do political leaders on both sides of the spectrum. But the antipathy between Republicans and Democrats, and within the Republican party itself, makes such a fundamental deal difficult to fathom. Instead, judging especially by the experience of the past two years, we are likely to get more blunt, inappropriate fiscal measures (think "sequester")  that damage growth in the short-term while ignoring structural change.

As part of yesterday's agreement, politicians have also agreed to come together and write a budget plan for the next ten years by December 13th. (Here's a suggestion: dust off the latest Simpson-Bowles plan, and implement it.) The effort began in earnest this morning, with House Budget Committee Chairman Paul Ryan meeting over breakfast with his Senate counterparts, in a process, known as a budget conference, that aims to reconcile separate budget documents passed earlier this year by the House and Senate. These documents are hugely different from one another.

We're all holding our breath.

Another Sovereign Debt Crisis

Detroit isn't legally bankrupt yet. U.S. Bankruptcy Judge Steven Rhodes will make the crucial call on whether the city of Detroit is officially eligible for Chapter 9 bankruptcy protection after a series of court hearings starting today. Lots of novel legal arguments from lawyers for claimants to the city's meager reserves will be heard. None is likely to prevail - “if there’s ever a city that needed Chapter 9, it’s Detroit,” said Kenneth Schneider, a Detroit bankruptcy attorney not directly involved in the case. Judge Rhodes is widely expected to agree, in a legal ruling, by the end of this month.

Other government authorities in America, at many levels, are watching closely. One of those is the Commonwealth of Puerto Rico. (This is a Caribbean island that, politically, elects a bicameral legislature and Governor, but as a territory of the United States is subject to US Congressional legislation pertaining to many fundamental aspects of Puerto Rican life.) The Commonwealth's issue today is, like so many other public entities, its debt - $70 billion in an economy valued at just over $100 billion, with an unemployment rate of 14%, and still in recession. From the day that Detroit filed for Chapter 9 in July, municipal-bond investors, who had gorged on Puerto Rico debt (given its triple-exempt status from federal, state and local taxes), have been selling, driving yields on the Commonwealth's bonds as high as 10%. (As a perspective, Greek 10-year bonds are currently yielding 8.4%.)

So of course a crisis in Puerto Rico has been reached. Government officials are meeting today with investors in an attempt to avert at least a credit downgrade by S&P and Moody's, at worst a collapse of investor confidence in the Commonwealth's ability to repay - and hence default.

Companies whose business is to insure municipal bonds - specifically MBIA and Assured Guaranty, who, together, are holding some $11 billion of Puerto Rican bond insurance and are also exposed to Detroit's bonds - are also under S&P's scrutiny. If these companies' credit risks are downgraded, then the issue of systemic risk throughout the municipal bond market becomes front and center. Hardly what America needs as its federal government faces the consequences of its own spending profligacy and political dysfunction.

The First of Several Sentencings

Former Mayor of Detroit Kwame Kilpatrick, convicted last March on 24 of  a 38-charge felony indictment including conspiracy, corruption and racketeering, was sentenced today in Detroit by District Judge Nancy Edmunds to serve what prosecutors asked - 28 years in federal prison.  

The sentence - which under guidelines could have been life - is equal to the highest ever given in a public corruption case. (As perspective, consider that the most recent poster child for public corruption, former Governor of Illinois, Rod Blagojevich, received 14 years in prison in 2011 on 17 charges, including that he tried to sell or trade an appointment to the US Senate seat once held by President Obama.) Mr. Kilpatrick, present today in the Detroit court, without his wife and children, made a final plea to the sentencing judge in which he asked for a "fair" sentence, while accepting responsibility, but showing little remorse. He said he "really, really, really messed up", was sorry, and wanted "the city to heal..to prosper..to be great in the end" like it was when he oversaw the 2006 Super Bowl in the city. Describing his family, he talked about his father, Bernard Kilpatrick (recently convicted on one of four counts of conspiracy and facing prison), as a good man - "typical Detroit north end guy" - who is the reason "I'm a great dad".

There's more to come in the Kilpatrick saga. His co-defendant and contractor friend Bobby Ferguson will be sentenced tomorrow on his 9 convictions; his father faces sentencing on October 17; Derrick Miller (Kwame's right-hand man, who testified against him) will be sentenced to possibly 10 years in prison; Victor Mercado (former head of the water department who also cut a deal with prosecutors) is facing 18 months in prison.

The tragedy here is not Mr. Kilpatrick's capacity for self-deception - however grand that is. It is that, though the city of Detroit's financial woes were decades in the making, Mr. Kilpatrick, with his charisma and broad political mandate, could have made the admittedly tough decisions needed during his regime to restore at least a breath of life to the city. Instead he chose to establish a criminal enterprise within city hall to enrich himself and his friends. He left an already vulnerable Detroit near death. His legacy is today's extraordinarily difficult process of municipal bankruptcy.

No More Negotiating

It's not just President Obama that has said no to negotiating.  

Since July 3, when the Egyptian army abruptly ended the country's experiment with an Islamist government led by Mohamed Morsi, negotiations with the International Monetary Fund (IMF) over a $4.8 billion loan, ongoing since the January 2011 Arab Spring revolution, have ceased. Egyptian officials have cited the Fund's apparent reluctance to provide formal recognition of General Abdel Fattah al-Sisi's new, "interim" government. In protest, the government has even taken the unusual step of announcing a reduction in its level of representation to the Fund's annual meetings, which begin this weekend, to mere diplomatic staff, instead of its finance minister and central bank governor. In an effort to avert this, IMF Managing Director Christine Lagarde issued a statement today noting that the Fund "is strongly committed to supporting the people of Egypt during this difficult transition,...and we are committed to working with the current authorities".

Even with the Fund's apparent change of heart, however, IMF officials are not likely to be invited to return to Cairo anytime soon. There are two reasons: first, as with previous Egyptian governments since the overthrow of President Mubarak in 2011, the current military government, faced with persistent civil unrest, is hardly receptive to imposing IMF-inspired reforms, such as lifting fuel subsidies and raising taxes, needed to reign in a budget deficit now equivalent to 14% of GDP. Such austerity measures would surely trigger even further public protests, yet without them, the Fund's position is that their lending would provide nothing more than very short-term relief.

But, more importantly, Egypt's current government is not concerned with pursuing IMF financing at this point because it has found another source that appears not only more generous - but less insistent on conditionality. Financing pledges of at least $12 billion from several GCC countries , notably Saudi Arabia, the United Arab Emirates and Kuwait, have poured into Egypt since the removal of President Morsi and the crackdown on the Muslim Brotherhood. The motivation here is purely political - the Gulf countries, like Egypt's military, view the Brotherhood, a transnational organization present throughout the Middle East, as a clear threat to their political stability, and as such, are aggressively stepping in to ensure the survival not only of the Egyptian economy, but the current government as well, at least until new Egyptian elections next year.

GCC financing is on such a scale that Egyptian authorities seem little bothered by America's decision yesterday to suspend the delivery of large-scale military systems and some cash assistance. They have even been able to cobble together a fiscal stimulus package of some $3.2 billion, aimed at supporting growth and creating jobs. But the package contains no mention of the difficult, long-overdue fundamental economic reforms identified by the IMF. An effective fix of the Egyptian economy, it seems, will have to wait.   

Deadlock and Leadership

So, we have this - yet another manifestation of political deadlock in Washington.

So-called federal discretionary spending, which unlike mandatory spending, must be authorized every year, has been halted, because Congress cannot - or will not - pass another continuing resolution. In essence, "non-essential" government functions have been shut down, and nearly a million government employees have been sent home. In a classic example of performance art, Republicans in Congress say no more discretionary spending until Washington's latest entitlement program - the Affordable Care Act - is stopped or at least modified; Democrats, on the other hand, say the Act is already the law of the land (since 2010), and in any case has nothing to do with the procedural matter of passing another continuing resolution. President Obama, who has repeatedly stated that he will not negotiate over the matter of paying for spending already authorized, attempted to break the deadlock in a White House meeting last night with Congressional leaders. He failed, as he refused to negotiate.      

Even worse can be expected in the next two weeks. The US public debt ceiling was once again reached last May, at $16.7 trillion, and after some shifting of spending by the Treasury between federal government departments over the past few months, Treasury Secretary Lew says it will be ultimately breached by October 17. If it isn't raised by Congress, default on some of the government's obligations - be they interest payments, or one or another of its entitlement programs - would be the result within a matter of weeks. Regular readers of this blog will recall that a similar display of Congressional incompetence in late 2011 (resolved at the last moment by the "Sequester" agreement)  led to the first-ever S&P credit downgrade of US government debt. So, although the current shutdown is annoying and disrupting, the impending battle over raising the debt ceiling is, indeed, serious.

Political deadlock is, of course, nothing new in Washington. But in earlier instances, it revolved around rather more significant issues than continuing resolutions or even debt ceilings. And, invariably, it was broken by Presidential leadership. Thus, for example, in 1862, President Lincoln issued his Emancipation Proclamation, freeing slaves, in a political environment characterized by not just a contentious Congress, but by an entire country split in two. Similarly, President Johnson, who under tragic circumstances inherited not just the presidency but also political deadlock from the Kennedy administration, nonetheless managed to use his office, almost miraculously, to finally achieve the passage of the 1964 Civil Rights Act - in an extremely hostile Congress.  

If today's impasse is not to persist, such leadership is needed again. The difficulty is that the current crop of Washington leaders - President Obama, Speaker Boehner and Senate Majority Leader Reid - are showing no signs of leading.