Will Reform Come From Government Shutdown? If So, That Would Be Wonderful. What Are The Odds?

David Malpass: The Bigger Battle Behind the Shutdown

A staggering $250 billion per month, 80% of spending, runs on autopilot without congressional control.

By DAVID MALPASS
The Wall Street Journal, October 10, 2013

At its core, the shutdown is part of a much bigger battle to restrain the federal government. It is spending $3.6 trillion per year without a budget, and its expenditures are expected to increase rapidly in the years ahead.

Meanwhile, the government has piled up $17 trillion in debt and $60 trillion more in unfunded spending promises. The Federal Reserve will borrow $1.1 trillion in 2013 alone to buy bonds—and it reserves the right to borrow unlimited amounts for future bond purchases without congressional or presidential permission.

These are crisis-level problems. Whether the government is open or closed, they are surely grounds for immediate talks between the president and Congress on ways to pare ineffective federal programs, restrain spending and reduce borrowing.

Ducking governance decisions year after year will leave the U.S. too weak to face global challenges. Big government has meant slow growth, painfully high youth and minority unemployment and falling median incomes—except in the Washington, D.C., area, which recent census data show is growing ever richer.

Under current law, the federal government and Federal Reserve are in a sharp upward trajectory in their power and the riskiness of their policies. Federal domination of the economy and financial markets is only increasing. The government shutdown reflects a Republican demand for permanent new checks and balances—to restrain a government that spends wildly without a budget, buys $1 trillion per year in overpriced bonds from an already-rich Wall Street, and micromanages federal medical care but exempts unions and Congress from the sting of regulations that affect others.

Washington’s panic prior to the budget sequester that took effect earlier this year gave a glimpse of the truth: Much federal spending can’t be justified. The government shutdown is giving more insight into the problem — a staggering $250 billion per month, 80% of spending, runs on autopilot without any congressional involvement or control. So much for the Constitution’s bedrock principle that “No Money shall be drawn from the Treasury, but in Consequence of Appropriations made by Law.”

To break the impasse, and to address the government’s disastrous finances, the president must lead the way. Mr. Obama has made clear that he will not change ObamaCare, but given the challenges the country faces, a blanket insistence on keeping the whole government unchanged isn’t defensible.

One good starting point for presidential leadership is the fraud-plagued federal disability programs that cost taxpayers $200 billion annually. There are innumerable other such programs, as well as roughly 200 independent federal agencies, many with little purpose and certainly not enough purpose to justify more debt.

To avoid future stalemates like the current one, making a legislative change is clearly imperative: The current debt-limit law, despite its name, operates to make the debt larger, not smaller. The law should be rewritten to mandate continuous spending restraint when debt exceeds the ceiling.

Fortunately, an actual default is a red herring. The president has sweeping powers through Treasury to continue paying the national. Mr. Obama alluded to this on Tuesday by listing the non-debt obligations that might be paid late, including government contractors, veterans and Social Security recipients (whose checks are due Nov. 1). In effect, the government would choose to pay them late and use newly arrived tax revenues to maintain debt payments.

Treasury Secretary Jack Lew’s weekend appearances on four major networks made the same point. He complained about Republicans extorting the president—then defined default as “choosing not to pay bills on time.”

The administration is frustrated that Wall Street is largely ignoring its talk of default, hence the president’s cautioning the stock and bond markets—on Tuesday afternoon, in the heart of the trading day—about the potential for catastrophe.

Democrats are hoping that the political consequences of a broader shutdown of government payments, what the president is calling an economic shutdown, will force House Republicans to allow a vote on a short-term extension of the debt limit.

Maybe so, but the president might have a tough time convincing House Democrats to vote for more debt with no reforms. The better course would be to agree on reforms now—there’s ample common ground—and put an end to the downward spiral in rhetoric.

Rather than discuss restraint, the administration has increasingly turned to the Federal Reserve as a crutch. The Fed is borrowing and spending $85 billion per month on bonds, and it claims the legal authority to increase its debt at will. Wall Street is intensely focused on supporting this profligacy and profiting from it. The Fed’s debt will reach $4 trillion at year-end, with at least $200 billion of it not counted properly in the national debt.

The Fed is choosing to buy long-term bonds with short-term debt. The result is a rapid shortening in the effective maturity of the national debt that benefits current politicians but puts taxpayers at risk. Like an adjustable-rate mortgage, the borrower, in this case the government, gets a lower interest rate now but will have to refinance at higher rates later.

Compounding the taxpayer risk, Treasury has scheduled a November launch of a new class of floating-rate debt that will compete with the Fed’s debt when interest rates begin to normalize. This leaves a huge portion of the national debt exposed to higher interest rates. And as Europe’s weak southern flank demonstrated in their 2010-12 crisis, financial markets treat floating-rate and short-term debt like blood in the water.

The president keeps telling the public that Republicans would, in effect, “burn down your house” if he doesn’t negotiate. Republicans should ignore the outrageous charges of extortion and blackmail coming from the other side and continue to seek positive change. The upside is clear: Growth, jobs, the dollar and financial markets would surge if the shutdown leads to restraint.

Mr. Malpass is president of Encima Global LLC. He served as deputy assistant Treasury secretary in the Reagan administration.