Deal reached to avoid US debt default

by editor | 1st August 2011 7:20 am

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President Obama and congressional leaders agree to lift the ceiling on US borrowing, just two days before a deadline
Republicans and Democrats in the US congress have reached an 11th-hour agreement with President Barack Obama to raise the limit on US borrowing and prevent an unprecedented US debt default.
Just two days before a deadline to lift the US debt ceiling, the White House and both Republican and Democratic leaders in congress said the compromise would cut about $2.4tn from the deficit over the next 10 years.
Now that congressional leaders have sealed a deal, both the senate and House of Representatives are expected to vote on Monday and in principle a bill could be on Obama’s desk by the end of the day.

While the senate is likely to give its approval, the agreement’s fate may be less certain in the House.

If approved, the compromise would presumably preserve America’s sterling credit rating, reassure investors in financial markets across the globe and possibly reverse the losses that spread across Wall Street in recent days as the threat of a default grew.

After weeks of impasse and with the final outcome hinging on support from reluctant legislators, Obama pressured both sides to follow up on the accord reached behind closed doors.

“The leaders of both parties in both chambers have reached an agreement that will reduce the deficit and avoid default – a default that would have had a devastating effect on our economy,” Obama said at the White House.

“I want to urge members of both parties to do the right thing and support this deal with your votes over the next few days.”

Two-step process

The plan – which boosted global financial markets — involved a two-step process for reducing the US deficit.

The first phase calls for about $900bn in spending cuts over the next decade and the next $1.5tn in savings must be found by a special congressional committee. Congress must act by December 2011, under the deal.

Republicans had insisted on deep spending cuts before they would consider raising the $14.3tn limit on US borrowing, turning a normally routine legislative matter into a dangerous game of brinkmanship.

Resolution of the debt-ceiling impasse could ease the immediate crisis, which has threatened global economic
consequences, but broad repercussions will still be felt for years to come.

While the deal means the US is unlikely to default, it is far from certain whether the plan goes far enough in reducing the deficit to appease credit ratings agency S&P, which has threatened to strip America of its prize AAA rating.

Despite that, markets showed signs of relief after becoming unnerved in recent days.

The Japanese stock index rose 1.8 per cent, US stock futures built on earlier gains and the US dollar rose
modestly against the yen and the Swiss franc. Gold fell more than one per cent, indicating investors had begun to shift out of safe havens.

“For the rally to be durable, markets will need more than this down payment agreement,” Mohamed El-Erian, co-chief investment officer at PIMCO, the world’s biggest bond fund, said.

“They will look to a more coherent fiscal reform to emerge from the second step and, more generally, for additional measures to remove structural impediments to growth and jobs.”

Selling the deal

A key provision of the deal was originally conceived as part of a “fallback” plan in case all else failed.

It would grant Obama the authority – and the blame – to raise the debt ceiling in three steps while allowing
Republicans to avoid explicitly approving each increase.

Congress would get a chance to register their disapproval on two of these, but would not be able to block them unless they muster a two-thirds vote in both the House and the senate – an unlikely prospect.

Congressional leaders will now have to gauge whether they have the votes to pass the deal – which has sharp spending cuts and no new taxes – in the senate and the House.

In the House, the political calculus is complicated by the entrenched opposition of some members affiliated with the conservative Tea Party movement.

John Boehner, the House speaker, who will face opposition from those conservatives in his ranks, told Republicans he backed the accord but that it was not the “greatest deal in the world”.

A senior House Republican, Jack Kingston, predicted the deal would pass with broad Republican support, though significant Democratic votes will be needed to guarantee passage.

Harry Reid, the senate Democratic leader, said: “I am relieved to say that leaders from both parties have come together for the sake of our economy to reach a historic, bipartisan compromise.”

Nancy Pelosi, a Democratic senator considered crucial to delivering enough Democratic votes to offset Republican defections, offered a muted reaction.

However, congressional insiders expect her to use her political clout with liberals to help Obama push it through.

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