Cozen Currents: The Political Fiction of the Debt Ceiling

“The battle over the debt ceiling is not really about controlling the country’s fiscal trajectory; it’s about controlling the political narrative.”
— Howard Schweitzer, CEO, Cozen O’Connor Public Strategies

The Cozen Lens

• While the two sides remain far apart ideologically on a debt ceiling compromise, there is plenty of creativity that can be used to close the gap so both sides can claim a political victory.
• Despite their differences, attendees at the G7 Summit portrayed a unified front on a range of issues, including China, support for Ukraine, and regulation of artificial intelligence.
• A hearing last week illustrated that the consensus on stablecoins attained last Congress has been slowly dissolving as both sides develop their own regulatory schemes.

Solving the Debt Ceiling Puzzle

The Debt Ceiling Rubik’s Cube. Raising the debt ceiling can be easy, but when there’s a Republican Congress and a Democratic president, it has proven to be politically fraught.

• The two parties are far apart ideologically, but any increase in the debt ceiling has to pass a Republican-controlled House, and Democratic-controlled Senate, and be signed by a Democratic president. Both sides need to feel like they walk away with a win.
• House Speaker Kevin McCarthy (R-CA) is insistent on spending cuts for FY24. But to bring enough Republican votes along, he can’t upset defense and national security hawks. So he can’t cut defense, veterans’ affairs, or homeland security. That leaves a bigger chunk of other non-defense funds to cut in order to reduce overall FY24 discretionary spending.
• President Biden won’t get the support of most Democrats for deep cuts in these non-defense programs while leaving other spending un-hit. They are still adhering to the parity principle of changes in defense and non-defense spending. The White House last week proposed a freeze in FY24 defense and non-defense spending, which was rejected by Republicans.
• Discretionary spending is not the only issue. Other divides include work requirements, rescinding unobligated Covid-19 aid, permitting reform, and the longevity of a debt ceiling increase.

The Debt Ceiling Deal Creativity. If the will is there to get a deal, never underestimate the creativity of policymakers to find a way to get to yes.

• Negotiators could double-count spending cuts. McCarthy said some $60 billion in Covid-19 rescissions could count towards FY24 spending cuts.
• Negotiators could cap spending short and count budget spending long. Freezing spending for a year or two would score as saving more than $1 trillion over a 10-year budget baseline, even if future spending increases.
• Negotiators could include “work requirements” in name only. Democrats won’t support Medicaid work requirements, but there may be some piecemeal changes to existing work requirements in other programs that would give Republicans a messaging win on a top policy priority.
• Negotiators could find a way to raise the debt ceiling past the 2024 elections without a direct vote on a long-term increase. The House could “divide the question” on a debt ceiling package to separate the vote on raising the debt ceiling and the fiscal concessions. Similar to the 2011 debt ceiling deal, they could also create a temporary mechanism for the president to raise the debt ceiling on his own, subject to two-thirds congressional disapproval.

Allied Unity at the G7 Summit

The Red Elephant in the Room. Even though China was not an attendee at last week’s G7 Summit in Japan, there was a sense of omnipresence given the focus on coordinating policy toward Beijing.

• The goal for all participants was to display a unified front toward China and minimize the visibility of the differences. President Biden’s actions over recent months have made clear that the US is in favor of a more hawkish approach than most of its allies, but there is an understanding that it cannot alienate these partners or its efforts to compete with China will be less effective, which was reflected in the language of the joint statement with respect to China.
• One of the White House’s goals for the G7 Summit was to build support for its anticipated executive order on outbound investment. In a win for the US, the joint statement on economic resilience and economic security mentioned this as a tool that “could be important.” While far from a full-throated endorsement, this seems to imply that the Biden administration may have achieved this goal.

Support for Ukraine Increases. Russia’s ongoing war in Ukraine was another priority for leaders at the summit, which was only reinforced by an appearance from Ukrainian President Volodymyr Zelenskyy.

• Although the participants opted against a near total ban on exports to Russia, they still agreed to expand limits on strategic goods. The revised sanctions will target more goods that support Russia’s war effort, such as industrial machinery and tools, and other key sectors, such as manufacturing, construction, transportation, and business services. One of the goals will be to close existing loopholes and improve enforcement, with a particular eye on third world countries through which Russia is importing banned goods.
• In their statement on Ukraine, the G7 leaders vowed to continue their support. Notably, Biden said that the US would now join efforts to train Ukrainian pilots on modern fighter aircraft, including F-16s. In addition, Biden has signaled he will not block the export of F-16s to Ukraine by US allies. The White House has been hesitant to provide F-16s to avoid escalating the war, but with other countries increasing their efforts, the Biden administration was under pressure to act.

Tech Talk. Geopolitics was not the only topic of discussion, as participants also looked to ways to jointly address questions around strategic technologies.

• At the top of the agenda was work to create a regulatory framework for artificial intelligence. While not on the initial topic list, the technology’s explosion into the mainstream made it an unavoidable issue for the leaders. Few specifics came from these initial talks, but with the spotlight as bright as ever, look for the collaboration to become more specific in the coming months.
• Also, a focus was on efforts to continue collaboration to reduce reliance on China for critical minerals. The US and Australia announced a new partnership toward this end and talks continue between the US and EU to reach a critical minerals agreement allowing more EU-manufactured cars to qualify for electric vehicle tax credits under the Inflation Reduction Act.

House Financial Services Committee Squabbles Over Crypto

Trying to Put the “Stable” in Stablecoin. Last Congress, the bipartisan leaders of the House Financial Services Committee developed a foundation for stablecoin legislation. Now Republicans have released a proposal that Democrats say was made without their input.

• The original kernel of the bipartisan proposal — that stablecoins must hold dollar-for-dollar reserves — remains intact. This is meant to address the possibility of a collapse like that of FTX in November. Many fear stablecoin failures, intrinsically tied to US currency values, could spread a contagion of instability and some argue it contributed to the banking crisis.
• The major point of clash in this bill is that Republicans would have stablecoin issuers only register with state-level regulators, not the Fed, though the Fed retains ultimate enforcement authority. The GOP has a long history of emphasizing federalism and points to the New York Department of Financial Services as a positive example in this area. Democrats worry that market rules will only be as strong as the weakest regulator, creating a race to the bottom.
• The draft bill would also settle a hot topic by definitively declaring stablecoins commodities, not securities. Each is overseen by different congressional committees, federal agencies, and statutes. The Securities and Exchange Commission has cracked down on stablecoins this year for not registering as securities.

The Democrats’ Counter. Ranking Member Maxine Waters (D-CA) has responded by putting forward her own version of legislation containing classic Democratic priorities.

• Democrats want the Federal Reserve to have the power to deny stablecoin issuers registration, even if they are approved at the state level. This is similar to the current regime over state-chartered banks. This proposal would also strike direct access to the Fed for non-bank stablecoin issuers.
• Consumer protection is emphasized. Digital wallets holding customer assets would have to be separated from crypto exchanges. The commingling of accounts was a source of scandal revealed by FTX’s bankruptcy.
• This bill would also place a two-year moratorium on “endogenously collateralized stablecoins,” otherwise known as algorithmic stablecoins. This ban was in the consensus draft but is now gone from the Republican side. Last year, algorithmic stablecoin LUNA failed, causing a $45 billion plunge in market capitalization.

Trying to Keep the Pieces Together. Republicans are more optimistic than Democrats are at the moment about a way forward. A deal seems out of reach, at least in the near term.

• On the plus side, several possible sticking points are out of the way. Both sides have come to a definition of “stablecoin.” The committee is focused and motivated to create a framework for the market to operate; Rep. Dusty Johnson (R-SD) declared, “we know this issue is ripe.”
• On the other hand, Waters says the GOP bill was made without consultation: “I think we’re starting from scratch.” “I would argue that we are further behind now than we were in the 117th Congress,” commented committee member Rep. Ritchie Torres (D-NY). Even if everybody agrees something must be done, the devil is always in the details.
• Gaining bipartisan consensus in not just one, but two narrowly divided chambers will be difficult, especially with the debt ceiling currently stealing all the oxygen in the room. The breakdown in trust and willingness to go it alone on the House side suggests a deal is at least several months away and there has been no real attention to the issue yet in the Senate.

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