Monday, August 1, 2011

Debt Ceiling Deal

It now looks like we have a deal on the U.S. debt ceiling.  While the deal hasn't yet passed, it seems very likely that it will for two reasons.  I don't think Obama, Reid, Boehner and McConnell would be endorsing it unless they already had a pretty good sense of the vote.  More fundamentally, prior bills failed because one party or the other was 100% against them so all the yes votes had to come from the other side.  Even if Tea Party Republicans vote no on this compromise the bill can still pass since some number of Democrats in the House will vote in favor.

I usually blog about one specific idea, but today's post is going to move about a bit as there are a number of really interesting things to discuss about the negotiation and the deal, so I'm going to move around between them.

Agreement at the Last Minute

As has been widely noted, this negotiation came down to the wire.  This is very common and is seen not only in negotiations but in complex auctions as well.  Until the deadline (or final round) approaches, a lot of activity is kept on hold.  There are some good reasons for this and some bad ones but recognizing it is important when we consider our own negotiations, especially those in which we have some control over process.

There is some research that suggests that a willingness to wait to the last second helps capture value.  In one study of negotiation exercises conducted between Americans and Israelis, for example, the Israelis captured more value and the main factor seemed to be their comfort in waiting.  The downside is that reducing the amount of constructive negotiation time and keeping cards close to one's vest are both harmful to value creation.  As we've discussed, in many deals the potential to do well by increasing the size of the pie outweighs incremental gains in one's share of the original pie.  Negotiators should consider how much value creation potential they see, and if it's high they should consider working against the "deadline" phenomenon.

The greater the amount of brinkmanship involved (and this deal had a lot), the more likely it is that real progress waits until the last moment possible.  Trust and a mutual commitment to value creation are essential if major progress is to be made throughout a negotiation.

Deal within a Deal

The current deal accomplishes a modest amount of deficit reduction now and empowers a 12-person group (nicknamed the Super Congress) to propose further deficit reductions.  If it fails to do so, or if those reductions are blocked by Congress (difficult, but theoretically not impossible) then further spending cuts are automatically triggered, divided between defense and domestic programs.  Thus, the main consequences of this deal are not fully known at this time and will depend on which members are chosen for the committee.

The Wall Street Journal notes this and says
While the "trigger" includes no revenue increases, the committee itself could agree to raise taxes to meet the $1.2 trillion deficit reduction target. This means GOP leaders Mitch McConnell and John Boehner have to be especially careful in their choice of appointees. No one from the Senate Gang of Six, who proposed tax increases, need apply. The GOP choices should start with Arizona Senator Jon Kyl and House Budget Chairman Paul Ryan, adding four others who will follow their lead.
We don't know, however, whether the membership of the Super Congress has already been agreed.  Nor is it clear that Boehner and McConnell would choose six hard-liners.  The whole purpose of creating the Super Congress is to make it more likely that politically difficult deficit reduction decisions will be taken, both by reducing the number of people who need to reach agreement and by providing political cover to members of Congress who might otherwise have trouble supporting it.  Republicans were able to hold firm on tax increases in the initial agreement but at the cost of being seen as unreasonable according to many polls.  Continuing to hold that hard line carries real political risk, so the Super Congress may be a "golden bridge" (to borrow terminology from William Ury) that lets them compromise on some tax increases.  From the perspective of internal politics it's also likely that Republican leaders don't want to give too much power to the element of their party that was the least tractable.

Deliberately Creating a Bad BATNA

Agreeing on substantial deficit reductions won't happen easily, since each party wants them to happen in different ways.  The initial agreement happened largely because Republicans created a bad BATNA for both sides by threatening to block an increase in the debt ceiling.  The current deal takes a less drastic approach by saying that unless an agreement can be reached the cuts (or shortfall in the event that a partial agreement is reached) will be triggered automatically.  Since half of the cuts would come from Defense and half from domestic programs, it's hoped that members from each party would find a compromise preferable.

Most observers are summarizing this as a situation where Republicans would hate half the cuts (to defense) while Democrats would hate the other half (to domestic programs) but I think there's something more subtle at work.  Creating a mutually painful BATNA works when the negotiation in question has the potential for value creation, i.e. it's easily possible to create deals that are better for both parties than their BATNA.  Electoral politics is very nearly zero-sum.  Thus, from a political perspective, it's hard to see how any particular outcome is damaging to both sides.

I suspect that this structure really aims at creating political cover for, and applying political pressure on, individual members.  A reluctant Congressperson can say, "This proposal isn't perfect but it's what the Committee has agreed on and the alternative means failing to support our troops in the field and cutting medical support to the most needy."  Alternately, any block that attempts to prevent a proposal from being enacted (e.g. because it includes some tax increases) is in a more vulnerable position than when the consequences of no deal being reached are vague or theoretical.

As Always, the Fine Print Matters...and sometimes it's Dominant

The agreement calls for deficit reductions...but from what?  The current CBO baseline (which is what the triggers are based on) seems both obvious and neutral but it includes an assumption that is politically volatile: that the Bush tax cuts will expire in 2013, adding $3.5 trillion in revenues.

This is huge.  Republicans have long insisted that the Bush tax cuts should be made permanent and Obama and most Democrats have supported making them permanent for those making less than $200,000 per year.  Either proposal would mean a bigger change to the CBO baseline than the entire targeted level of reductions.

The WSJ editorial argues that this is such a large increase that the Super Congress is unlikely to consider any further increases, but this is pretty simplistic analysis.  The Super Congress is likely to want to ignore the Bush tax cuts altogether in its proposal, since any change would make their task monumentally more difficult, and their timeline theoretically makes ignoring the cuts easy.  Obama, however, can use his threat to veto a later extension of the cuts to pressure Republicans to accept some tax increases as part of their overall deficit reduction recommendation.  Obama has some real leverage here, as the cuts expire after the 2012 election, giving Republicans limited recourse against a veto threat.  It's entirely possible that a two-prong agreement will be reached, with some tax increases being part of the Super Committee's recommendation in exchange for concessions on the Bush tax cuts.

More fundamentally, it means that this deal should be seen as just one salvo in an ongoing struggle.  A small agreement has been reached with a medium-sized negotiation scheduled through November but a larger issue remains very much on the table and barely discussed in the context of the current deal.  Regardless of where you fall on the political spectrum, we continue to live in interesting times.


  1. The main problem is that in early 2013 the Republicans will just threaten to block the debt limit increase again. You have to say no sometime. I think Obama is planning to wait until the economy gets better. Bad news, that ain't happening.

  2. Breathing room is still useful. I think Democrats were caught off guard by the tactic this time but won't be next time (or at least shouldn't). As for Obama waiting on the economy, I think you're right...and unfortunately this isn't the only are where his strategy is to buy time. 2013 is also when the "sold" toxic assets are likely to come back to us, since the buyers can use their put options.

  3. How could anyone be caught off guard? We've known this would happen since December (at least).

  4. I would love to see an update to this post, given that the exact same situation is brewing again now in the middle of 2012...