What Just Happened


[ Photo: Flickr: maorix ]

I sense some confusion both on the left and the right about the fiscal deal that just passed the Senate and the House. Some people are asking: is it good or bad? Who won? The palpable consensus is that neither side is happy about it.

Because many have not followed the Fiscal Cliff crisis as closely as I have, especially over the holidays, let me summarize in simple terms.

First, some definitions:

Fiscal Cliff – an automatic end to Bush’s tax cuts passed in 2001-2003 and automatic cuts to the budget (aka “sequestration”).

Budget cuts (sequestration) – a deal that was reached as a result of the debt ceiling agreement between Rs and Ds in the summer of 2011. Includes cuts to social programs as well as big cuts to the defense budget.

Debt ceiling (or debt limit) – often confused with Fiscal Cliff. The debt ceiling is a borrowing limit that has been raised, no questions asked, for years to meet US spending obligations — until 2011, when the Republican Congress decided to make it a partisan issue and demand that Democrats make 1:1 budget cuts before raising it. We will hit the debt ceiling again in 2 months.

Deficit (or budget) hawks – people who think that reducing the deficit should be our utmost priority. In my experience, many budget hawks are more interested in spending cuts than in raising taxes.

What happened:

Technically, we went over the Fiscal Cliff at 12:01am on Jan 1, 2013. But we were in “free fall” only for 2 hours. At 2am, the Senate passed a bipartisan bill that raises taxes on roughly the top 2% (households making more than $450K and individuals making more than $400K), extends unemployment benefits, and spares the 98% from tax increases. It doesn’t address budget cuts, which were postponed until February.

If you remember the events of late summer of 2011, when markets plunged as Congress was at an impasse over the debt limit and US credit was downgraded, you’re in for a similar experience this coming February. As expected, Republicans (even though about 85 of them voted for the bill in the House) will make a big show about budget cuts, namely cuts to social programs like Medicare and Medicaid, and they will no doubt link it to an increase in debt limit. That is, Democrats will not get the debt limit raised unless they cut, 1 for 1, their favorite public programs. Democrats will be pushing for smaller cuts or for cuts in defense spending. From what I read on different political blogs right now, defense spending seems to be a more sacred cow than social programs. Will Democrats find the guts to cut it?

After the Fiscal Cliff deal is signed by Obama, he will forfeit the leverage he had on Dec 31st. Because Obama didn’t include the debt limit resolution in the bill (my major complaint about the deal), he essentially gave away the advantage on the issue to the deficit hawks. I think he had room to negotiate that provision into a deal. He could have just said: “Guys, I’m raising the cutoff for families from $250K to $450K and for this I’d like to make debt ceiling increase automatic.” He didn’t do it, and as such I consider this deal, although a move in the right direction, rather poorly negotiated.

While I have my own reservations about this deal, most people on the right simply hate it. Taxes were raised and no budget cuts were included  – a heresy! Even the acquisition of debt ceiling leverage did not placate them. Obama adamantly said yesterday that he will not play the debt ceiling game again,but the only tool he has against Republican intransigence (and hurt egos, bitterness and thirst for revenge) is rhetoric.

Obama’s trump card has been played.


  1. Alan says:


    While I agree that the partial deal is not sufficient at all, I think Obama has one powerful leverage card he can play: let the debt ceiling be hit and exceeded, let the fallout hit on financial markets, Treasury bonds, debt rating, etc. and then let the public react how they will. I would expect the public will indeed be outraged, frightened, and in a blaming mood – mostly towards Congress, and especially towards Republicans. Even though the Tea Party folks, Fox News, and the right will make much of the noise – and be very loud – many people will find them to be largely at fault. But, I also expect that Obama does not have the political will, courage, and poker-like backbone to go eyeball to eyeball(i.e., he’s not Bill Clinton facing Newt Gingrich).

    Thanks, as always for your sharp analysis.

  2. Lenny says:

    Katya — thanks for the incisive analysis! I think the deal made the best of a bad situation, and certainly the most troubling part of the deal is that it sets up another potential fiscal crisis in two months. But at least Obama kept his word on raising revenue by making the wealthiest pay a little more.

  3. Katya G says:

    Alan, this would be the worst thing that could happen. It’s like killing a hostage during a rescue operation. If US defaults, which is what exceeding the debt limit is, the repercussions around the world will be devastating. US will lose its credibility and its credit overnight. Treasuries will plunge driving interest rates to double digits. Because we won’t be able to borrow anymore, you can forget about the recovery. Obama simply can not let this happen.

  4. Allison Tupper says:

    But how long would a default last? a day? a couple of hours? I think we know enough about Obama not to expect him to try this. If he did, though, and if the Republicans believed him, wouldn’t they raise the debt ceiling at the last minute?

    Enough of fantasies. What can we do in the real world to keep Obama from agreeing to cuts in social programs, which would steepen the recession?

    • Andrew Solomon says:

      Allison, just a quick aside: I’m not sure that making certain changes to social programs, such as re-indexing Social Security payments, would actually have much effect on the economy in the near term. That’s not to say that it the right thing to do. But the real impact of those kinds of changes comes over a 10+ year period, when the slower growth of payments really starts to add up.

      Obviously, other changes to the safety net, like reducing unemployment payments or increasing payroll taxes, have a pretty big immediate (negative) economic impact.

  5. Katya G says:

    Allison, the way it works with sovereigns (countries, governments)is that one missed payment on its debt obligations automatically means default. Even if you come up with money the next day it won’t matter. It’s not like a mortgage payment that you can technically postpone.
    Last time Republicans raised it, but after much brinksmanship, market turmoil and squeezing agreement from Obama on mandatory budget cuts, which would be triggered on Jan 1st have they not been postponed until Feb.
    The only thing going for us this time is that Obama can say to them – we agreed on the cuts, pick and choose which ones you want and we can take it from there. Republicans, of course, know that they want cuts, but they adamantly refuse to say which ones.

    • Andrew Solomon says:

      Katya, you’re probably right that even a technical default would be a disaster. But it’s probably also true that policy makers, regulators, and market participants would do everything they could to disqualify any technical default as a “true” default in order not to trigger CDS and various other instruments and contract clauses. No one wants a “credit event.”

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