Obama holds talks today to thrash out deal on federal debt

Banks tell politicians to stop playing chicken with markets as Treasury deadline approaches
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The Independent Online

The world's biggest banks are warning US politicians not to play chicken with the financial markets, and quickly agree to a deal that raises the limit on the amount the federal government can borrow.

The latest lobbying effort comes as members of both political parties said they were still far apart on the specifics of a debt-reduction package that the Republicans have made a condition of raising the debt ceiling.

President Barack Obama has convened a new round of talks at the White House this evening, but the signs are that agreement on a comprehensive package of spending cuts and tax rises is still some way off.

Meanwhile, the US Treasury has calculated that it will run out of money to meet the federal government's planned expenditures, including interest on its $4.3 trillion debts, by 2 August.

Lobbyists for banks which are the largest players in the US debt markets are understood to have contacted individual members of Congress to impress on them the financial chaos that could ensue if the US threatens to default.

And in recent days, the banking industry's main lobby group, the Financial Services Roundtable, sent an open letter to political leaders, drafted jointly with lobbyists for manufacturers and the US Chambers of Commerce.

"A great nation, like a great company, has to be relied upon to pay its debts when they become due," it says. "This is a Main Street not Wall Street issue. Treasury securities influence the cost of financing not just for companies but more importantly for mortgages, auto loans, credit cards and student debt. A default would risk both disarray in those markets and a host of unintended consequences.

"The debt ceiling trigger does offer a needed catalyst for serious negotiations on budget discipline but avoiding even a technical default is essential. This is a risk our country must not take."

US Treasuries are treated across global financial markets as the ultimate risk-free asset. They are used as collateral in incalculable numbers of financial transactions, and form the bedrock of investment portfolios by pension managers who may be forced to sell them if they are judged to have gone into default.

Congress votes annually on the federal government's budget, the tax and spending plans for the current fiscal year, which for each year since 2002 has implied a deficit and therefore additional government borrowing. It votes separately, however, on the so-called "debt ceiling", the legal limit on the amount the federal government can borrow.

Republicans refused to vote to raise the current $14.3 trillion debt ceiling again unless there was also a new tax and spending deal to reduce future deficits. With economists arguing that the US debt will hit unsustainable levels by the end of the decade, the Obama administration, too, saw the opportunity to introduce a long-term rebalancing of the federal budget.

But the debate has been rancorous, with the Republican leadership until recently ruling out any tax rises, including the elimination of any tax breaks. Only last week the Democrats agreed to discuss cuts to social security and medical benefits for the poor and the elderly.

And in an attempt to get as broad a deal as possible, Mr Obama said he would veto a short-term extension of the debt ceiling that only put off tough choices until nearer the presidential election next year.

That makes 2 August a "hard deadline" for a complicated political negotiation with no guarantee of success, but financial markets believe a deal will be done. There was strong demand for short-term government debt in a Treasury auction last week, and interest rates on Treasuries remain subdued.

The absence of concern in the financial markets, however, has the perverse result of making it harder to persuade some Congressmen that going to the brink of default – or even defaulting on one or more interest payments – could have serious consequences. According to one possible strategy sketched out by participants in the talks, a bill could be put before Congress without a clear majority in support, in order to trigger a violent market reaction when it is rejected.

As happened when the Wall Street bail-out plan was first rejected by the House of Representatives in 2008, that would concentrate minds on reaching a compromise quickly afterwards.