The Debt Limit and the Next Financial Crisis

In the latest phase of our endless budget brinksmanship, congressional Republicans will attempt to extract policy concessions in return for raising the debt limit (Republicans are not only demanding cuts to Social Security and Medicare—they are brazenly demanding that Democrats propose, and therefore own, these unpopular cuts).  The administration and key allies are claiming they will not negotiate over the debt limit.

At stake in this standoff is not just whether the federal government will default on its financial commitments (which is to say, whether Congress will absurdly prevent the government from paying the bills that Congress has legally obligated it to rack up) but also whether we will move one step further toward making these standoffs a customary part of the (mal)functioning of government.

In the context of some key changes made by the Dodd-Frank Act, this new normal on the debt ceiling has disquieting implications for how the federal government will respond when the next financial crisis hits.  Dodd-Frank doesn’t do much to prevent the next crisis from emerging, but it does change the way the government can respond.  At last year’s Minsky conference in New York (see Session 6), Morgan Ricks noted that a number of organizations that played a large role in the response to the financial meltdown (Fed, Treasury, FDIC) have seen their discretionary authority limited by Dodd-Frank.  Most notably, the Federal Reserve’s leeway under section 13(3) of the Federal Reserve Act has been curbed (13[3] allowed the Fed to lend, “under unusual and exigent circumstances,” to individuals, partnerships, and corporations at its own discretion; it was under this authority that most of the unconventional lending and asset purchases were carried out).

After Dodd-Frank, Ricks observed, we are now supposed to rely on the FDIC’s newly-created “Orderly Liquidation Authority” (OLA) to handle the collapse of a large multifunction financial institution.  The use of the OLA requires the approval of the Treasury Secretary and two-thirds of the both the Federal Reserve board and the FDIC board, but most importantly, funding for the OLA will come from the Treasury rather than the Federal Reserve.  Ricks pointed out that since the Treasury would have to issue debt to provide such funding (assuming platinum coins are off the table), this means that a future government rescue through the OLA may require that Congress lift the debt ceiling in the midst of a financial emergency.  You might say this adds a laudable element of accountability and transparency to any future crisis response.  But after watching Congress perform these past two years, how confident are you that this will end well?