Beware the debt ceiling vote

The debt ceiling talks, for weeks now, have been going on behind closed doors. The negotiations have been conducted by a tiny group of legislative leaders and President Obama's top aides.
All the while, the countdown to Aug. 2, when the government will no longer be able to pay all its bills, has marched closer.

Any proposal will still have to be put into legislative language, scored by the Congressional Budget Office and vetted by rank-and-file lawmakers whose votes will decide its fate.

Even after the principal negotiators announce a deal, the rest of Congress will have to be convinced to go along. The closer to D-Day Washington gets, the messier it will be.

Witness what happened on Sept. 29, 2008, when the House at first rejected the $700 billion bank bailout bill.

Weeks earlier, Fannie Mae and Freddie Mac had been placed into conservatorship by the Treasury Department. Lehman Brothers had filed for bankruptcy. AIG Corp, the world's biggest insurer, had been bailed out by the Federal Reserve.

After all that, the Senate passed the bill. And then, as markets watched, the measure was voted down in the House -- a defeat that shocked investors and congressional leaders on both sides of the aisle.

Debt ceiling: What happens if Congress doesn't raise it?

Following the vote, the Dow slumped 778 points, in the biggest single-day point loss ever.
A few days later, the House reversed course and passed a modified version of the bill. Some 58 members switched their votes.

Why was the process so hard? A principal reason is that it was rushed.

Lawmakers who voted against the bill warned that "being stampeded" into a decision would be a serious mistake.

"Wall Street is so hungry for the $700 billion they can taste it. To get it they need to ... create panic, block alternatives and herd the cattle. We ask Congress not to rush," California Democrat

Rep. Brad Sherman said before the vote.

"I am voting against this today because it's not the best bill. It's the quickest bill," Rep. Marilyn Musgrave, Republican of Colorado, told the New York Times. "Taxpayers for generations will pay for our haste and there is no guarantee that they will ever see the benefits."

Norman Ornstein, a resident scholar at the American Enterprise Institute, said lawmakers now face a similar situation, but this time around, "It's worse."

Lawmakers aren't going to have a lot of time to consider their options. And all the negotiations are happening behind closed doors, limiting the involvement of rank-and-file members.

"With TARP, it wasn't clear that another day or two wouldn't make a big difference," Ornstein said. "If you take two to three days messing around with this, you end up with what could be a profound and very long lasting impact."

The White House has already warned that time is running short, saying that a deal needs to be completed in the next couple days in order to give Congress time to pass a bill.

Alabama Republican Sen. Jeff Sessions has voiced concern about the timeline, saying there is a "very real risk that no text will be available until the last minute" and that a bare minimum of seven days is needed to review legislation.

How Washington screwed up the budget

"The real endgame here is not August 2," Ornstein said. "It takes time to put any agreement into legislative language and get it scored. It sure as hell doesn't look to me like we are urgently moving to make sure that happens."

And like 2008, not everyone is dealing with the same set of facts. At that time, every high-ranking government official from then-President Bush on down was warning of dire consequences if TARP faltered in the House.

That moved a few members into the "yes" column, but not all.

"We're on the cusp of a complete catastrophic credit meltdown. There is no liquidity in the market," Rep. Sue Myrick, a North Carolina Republican, said in a statement before the vote. "We are out of time. Either you believe that fact, or you don't. I do."

Right now, despite warnings from Treasury Secretary Tim Geithner, President Obama, Federal Reserve Chairman Ben Bernanke and even House Speaker John Boehner, a number of Republicans remain so-called debt ceiling deniers.

"You've got enough people out there, way too many people, who aren't going to be convinced until Armageddon actually happens," Ornstein said.

Greece Get $17 billion Bailout Package

The European Union approved the disbursement of it's last $17 billion tranche of bailout funding Saturday, putting Greece's debt crisis at bay -- for now.

With the last part of the $156 billion bailout package in place, the struggling nation will be able to keep functioning for a little while longer. The disbursement, which will be made by July 15, follows the Greek Parliament's approval of new austerity measures.

This latest piece is the fifth tranche of a bailout that was approved by members of the European Union last year.

"The Greek authorities provided a strong commitment to adhere to the agreed fiscal adjustment path, and to the growth-enhancing structural reform agenda, which are essential components of our strategy to restore fiscal sustainability and safeguard financial stability," ministers said in a statement Saturday.

European officials will now work on a second proposed bailout.

The bailout is a highly contentious subject in Greece. As the Greek Parliament voted in favor of the funding on June 28, thousands of protesters descended on Athens and clashed with riot police. Tear gas choked the streets as protesters and police pounded each other with clubs and firebombs.

Greece: Back from the brink - for now

However, the bailout won't take care of the nation's long-term budget problems, according to Mark Blyth, an economics professor at Brown University in Providence, R.I.

"This is simply giving them more breathing space, while they're kicking the can down the road," Blyth said, referring to the bailout. "They need to have enough money to cover the primary fiscal debt, and for keeping the lights on at the hospitals and military bases. Once they've got that, they're able to default without shutting down the country."

Blyth believes that a Greek default is inevitable. "Ultimately, there's no way the Greeks can pay back what they've borrowed," he said.

The debt-ridden nation has "heavy near-term financing requirements," according to S&P, with about $135 billion in government debt maturing between now and the end of 2013. An additional $82 billion is set to mature in 2014.

Still, the rest of Europe does not want Greece to default, because it would rupture the bond market and undermine the European banking system so severely that the repercussions could be felt on Wall Street.

Greek austerity: Cure or poison?

The French banking association and the German Finance Ministry, as well as German banks, have offered proposals to keep the Greeks from defaulting on $152 billion worth in bonds.
These proposals offer different variations on the same theme: rolling over Greek debt. As explained by Barclays (BCS), one of the options is to roll the debt into a 30-year bond, with at least 70% backed by private sector investors.

For the Greeks, there is one part of their future that is crystal clear: more austerity. In order to qualify for the final tranche of the bailout, the Greek Parliament had to agree to a new raft of austerity measures, in addition to the ones that were imposed on the Greek people last year. This is why people were rioting in the streets of Athens.

Since 2010, the Greeks have faced a myriad of austerity measures including pension cuts, a boost to the sales tax, excise taxes on fuel, cigarettes, alcohol and luxury goods, more stringent eligibility for disability benefits, and a hike in the retirement age to 65 from as low as 61.
On June 29 and 30, the Greek Parliament approved a new raft of austerity measures that included reducing the pay of public workers, increasing the attrition of public jobs and ramping up taxpayer compliance.

Tax dodging, in particular, is one of the most chronic fiscal problems in Greece. Many of the protesters in Athens blame rich tax evaders for their nation's troubles. The protesters -- particularly the young and unemployed -- believe they're being forced to shoulder an unfair burden to get their country out of hock.

The pain of Greece's crisis

Marko Mrsnik, the lead analyst in the recent Standard & Poor's downgrade of Greece, blames the austerity measures for exacerbating the shoddy job market. The unemployment rate has soared to 16.2%, compared to 11.6% in March 2010, he said.

The contradiction of the austerity measures is that they're harming the economy even as they're keeping it afloat, according to Jurgen Odenius, a strategist for Prudential Fixed Income.

Fed set to buy $300B more Treasuries

QE2 is just about done. But the Federal Reserve will still be buying massive amounts of long-term Treasuries.

In fact, the Fed's purchases over the next year will likely be at least $300 billion. That's half the size of QE2 -- even if QE3 never takes place.

While the Fed's efforts to pump about $600 billion of new cash into the economy over the last eight months comes to an end this week, the program, known as quantitative easing or QE2 for short, was not the only way the central bank was an active buyer of Treasuries.

Since last August, the Fed purchased $250 billion in long-term Treasuries in addition to the QE2 purchases. That's because it was reinvesting the principal from other securities that matured.

Assuming the Fed keeps reinvesting, as it said it would earlier this month, it will continue to be a very big buyer of bonds in the months to come.

"We still see the Fed being a major buyer of Treasuries, and giving the market some support," said Kim Rupert, managing director of fixed income for Action Economics.

But those purchases may not push yields, which move in the opposite direction of their price, lower for that much longer.

Rupert said she expects bond yields to rise even with the Fed's continued purchases. She said some investors who bought Treasuries recently in a flight to quality will unwind those positions. If the economic outlook improves later in the year, that could also lift interest rates.

The additional Fed purchases will have an impact though. Rupert said it should "slow the updraft in yields in a measurable way."

The Fed still has more than $1 trillion in mortgage-backed securities, debt issued by government-sponsored firms Fannie Mae and Freddie Mac and other long-term bonds on its balance sheet.

While not all of this debt is set to mature in the next few months, the Fed still has a lot at its disposal to roll over into new bond purchases.

Of course the Fed could decide to stop reinvesting the principal of maturing securities. But that could almost have the same effect of actually raising interest rates. It would take significant amounts of cash out of the economy.

Even though some Fed policymakers are worried about the impact the bond buying has had on the dollar and inflation, the Fed does not seem ready to remove all its stimulus just yet. After all, the central bank did just issue a gloomier forecast for growth and unemployment through the end of 2012.

"Most of us can agree the economy is not going gangbusters and it's not a self-sustaining recovery yet," said David Coard, director of fixed income sales and trading for The Williams Capital Group. "For the foreseeable future, the Fed will have to maintain an accommodative stance. It's the only game in town."