“How To Dismantle A Fiscal Bomb”

bomb missile

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BofA’s Ethan Harris had a great note out today with the title How To Dismantle A Fiscal Bomb on the subject of the debt ceiling, and the intensifying game of chicken being played by both sides.Here’s how Harris breaks down the possible outcomes:

Stuck in a moment you can’t get out of  
Specifically, we see the following possible outcomes of the current political posturing between the two sides during this summer:

Cliff hanger (high likelihood, say 60%):
Push up close to the August deadline, then agree to modest up-front cuts and extend the debt ceiling until after the 2012 Presidential election;

Wile E. Coyote (less likely, say 30%):
Same as above, except the agreement isn’t reached until a week or two after the deadline, and there is a TARP-like moment of market panic;

Summer breeze (least likely, say 10%):
Agree to a sensible multi-year plan that takes a good chunk out of future deficit  projections, but leaving the Medicare debate until after the elections.

Harris is disturbed at this notion that hitting the Aug 2 “drop dead” date would be no big deal:

We are particularly concerned by the growing belief that hitting the August drop- dead date would be no big deal. We see no advantage to possibly putting at risk the central role of the dollar and the US Treasury market in global capital markets. In our view, attempting to prioritise interest payments is fraught with logistical and legal challenges, and would necessitate politically unpopular and potentially
economically crippling budget cuts that would likely push the US into recession and drag down the stock market. We believe a series of limited debt ceiling increases would likely have the same adverse consequences, just in slow motion. There is no substitute for serious bi-partisan negotiation and action.

Here’s the good news. Congress is due to go on vacation six days after the August 2 deadline. As he puts it, nothing concentrates the minds of politicians better than a vacation, and so his baseline scenario is an 11th hour save.