If you thought a banking crisis would be a moment of clarity for the debt ceiling in Washington, D.C., think again. It has only reinforced the divide on both sides of the aisle.
But just as the market reaction to the bank runs on Silicon Valley Bank and Signature Bank was a catalyst for broader policy action, there are potential moments in the debt ceiling negotiations that could provoke its own response.
Bank Contagion Pushed Policymakers To Act
As banking regulators testify before Congress about the banking crisis, their testimonies show how they viewed a contagion spreading over the weekend of March 11-12 that demanded a swift response.
The rapid bank runs of SVB and Signature Bank within 48 hours was creating knock-on effects for depositors at other small- and mid-sized banks. Investor doubt was growing that would make it harder for other banks to raise sufficient capital and quell bank runs. Numerous uninsured depositors were businesses that could struggle to make payroll and pay suppliers. Broader distress would reduce lending and lead to weaker economic performance.
The view among regulators was that pursuing traditional “least-cost” resolutions to failed banks would be insufficient. Other action was necessary.
Concerns about moral hazard went out the window when contagion was on the horizon. The FDIC and Fed Board voted unanimously, with approval of Treasury Secretary Yellen (who consulted with President Biden), to make a “system risk exception” in the resolution of SVB and Signature Bank.
This allowed the FDIC to fully guarantee the uninsured deposits of both failed banks. In addition, the Fed triggered its Section 13(3) “unusual and exigent circumstances” authority to establish the Bank Term Funding Program. whereby it is providing loans for one year at par value to banks for eligible collateral despite any current mark to market discounts.
Regulators today are saying the banking system is “sound.” This is not 2008 and the actions taken in a moment of crisis were critical in ebbing the tide of bank runs and broader contagion. Time will tell if this is true or not, but regulators are signaling to markets that they are keeping a watchful eye and are ready to deploy the tools they have used over the last couple of weeks moving forward.
The X Date And Market Could Change Debt Ceiling Dynamics
If bank runs on a few mid-sized banks can have a systemic impact on the entire financial system, risking the full faith and credit of the United States and the Treasury market could be even worse.
To be sure, appointed regulators have a different set of priorities than elected lawmakers. How they respond to a crisis is different. Regulators from Yellen to Federal Reserve Board Chair Jerome Powell have made known that they are can’t and/or won’t prevent a default with action from Congress to raise the debt ceiling.
But a market reaction can get the attention of lawmakers, just as it did in previous crises like the Great Financial Crisis in 2008 and the Covid-19 pandemic in 2020. “Fiscal principles” can often take a back seat to a market crash.
Right now, the specter of a federal default remains theoretical. There’s still a range of estimates for the X date, or when the Treasury can no longer pay all its obligations. The Congressional Budget Office has an X date range between July and September. Additionally, there is a flight to short-term Treasurys as concerns remain over the banking system, masking any nervousness over default risk.
That could soon change. There will be greater clarity from tax season in April and the new revenue available to pay obligations. With a more definitive X date, it could get the attention of lawmakers but also markets concerned about the impact of a default.
For Now, The Banking Crisis Does Little To Break Debt Ceiling Impasse
Without a true crisis mentality on the debt ceiling, lawmakers aren’t budging on their current positions.
House Speaker Kevin McCarthy (R-Calif.) wrote a letter to President Joe Biden imploring him to come to the negotiating table to find a path forward on raising the debt ceiling. There have been no debt ceiling talks since the two met at the White House in the beginning of February.
In response, Biden wrote a letter McCarthy asking him to release his own budget proposal, just as the president did earlier in March, before they meet again. House Republicans are nowhere close to releasing a budget (if they ever even release one). The White House position remains that there should be a clean increase in the debt ceiling, with any action on deficit reduction done separately.
When the two leading figures responsible for raising the debt ceiling are sending public letters attacking each other, that is never a good sign of the state of negotiations.
The last few weeks have only reinforced the dynamics from both sides. Republicans are blaming the banking crisis on a broader fiscal crisis. “Why are we having a banking crisis? Because government spent too much and created inflation,” McCarthy told reporters last week. “Should we do exactly what the president is saying, just lift the debt ceiling and create more inflation and more banking problems? I mean, this should be a wake-up call to everybody.”
Democrats are pointing to the banking crisis and saying it’s exactly why Congress shouldn’t mess around with lifting the debt ceiling. “Instead of calling for calm, House Republicans are sowing chaos by threatening a default at a time when banks need stability,” Senate Majority Leader Chuck Schumer (D-N.Y.) said on the Senate floor last week. “The right answer is for Republicans in the House to stop saber-rattling, drop the hostage-taking and brinkmanship and work together, work in a bipartisan way, to extend the debt ceiling without strings attached.”
There’s no breaking of ranks on either side of the aisle from the respective leadership positions. Senate Minority Whip John Thune (R-S.D.) last week said GOP senators remain behind McCarthy. Senator Jon Tester (D-Mont.), who faces a challenging re-election in a Republican state, told CNN, “I don’t think we should be negotiating on the debt ceiling.
Things publicly remain at an impasse. At a Punchbowl News event, House Financial Services Committee Chair Patrick McHenry (R-N.C.), a trusted McCarthy adviser and leading Republican responding to the banking crisis, said, “I’ve never been more pessimistic about where we stand with the debt ceiling. And we’ve been in some bad situations before and I’ve been a part of leadership for some very bad situations.”
Despite the impasse, that doesn’t mean events aren’t developing that will eventually lead to action on the debt ceiling.
The Onus Is On House Republicans To Show They Can Act
After Biden released his FY 2024 budget proposal and a banking crisis roiled markets, the onus is on McCarthy to show, not just tell, what Republicans actually can deliver in high-stakes fiscal negotiations.
It’s an important signal of McCarthy’s relative strength in negotiations if he can deliver 218 House votes on certain policy markers. It’s not just an important signal to Biden but also to Senate Republicans and moderate House Republicans who may have a bigger role to play if the speaker can’t deliver the votes.
To that end, McCarthy’s letter to Biden had some ideas to reduce the debt. This included reducing non-defense discretionary spending to “pre-inflationary levels,” capping the growth of discretionary spending to 1% as Senator Joe Manchin (D-W.Va.) proposed, reclaiming unspent pandemic aid, and strengthening welfare work requirements for able-bodied adult without dependents. McCarthy also included some non-fiscal measures, like passing legislation on energy independence and securing the border.
Some of the measures are being developed in separate legislation. Republicans are looking to pass H.R. 1, The Lower Energy Costs Act, that promotes domestic energy production and permitting reform among other energy-related items. A plurality of conservative House Republicans say “energy independence” is their most important policy priority for the debt ceiling. If Republicans can pass this in the House, it could embolden McCarthy to include it in debt ceiling negotiations.
Republicans are also discussing a $130 billion reduction for FY 2024 spending in budget talks and strengthening work requirements on mandatory programs like SNAP benefits in talks over the Farm Bill.
Most of these potential Republican asks are non-starters for Democrats. The White House vowed to veto H.R. 1. Democrats have coordinated attacks on potential Republican spending cuts.
But non-starters for Democrats may still be negotiating starters if it shows McCarthy can deliver the votes on something for raising the debt ceiling.
If he fails to deliver the votes, then talks about using a discharge petition and Senate Republican-led negotiations will ramp up.
In the horizon is an X date and a market reaction that may make banking regulators blush at what crisis could unfold if the debt ceiling isn’t raised in time.