Financial Times (London)

May 10, 2002, Friday London Edition 1

SECTION: US & CANADA; Pg. 6

US debt limit turns into political football again: Despite entreaties, Congress has resisted quick action to raise the ceiling by Dollars 750bn, writes Deborah McGregor

By DEBORAH MCGREGOR

Paul O'Neill has a reputation for speaking bluntly and this week was no exception as the US Treasury secretary urged Congress to hurry up and extend the government's authority to borrow or risk an unprecedented default.

"If we run into the debt limit ceiling, that's really bad," said Mr O'Neill in a breakfast meeting with Republicans on Capitol Hill.

Normally, increasing the amount the nation can borrow is a routine matter. But this year, election-year politics and tumbling federal tax revenues have conspired to transform the debt limit into a political football. "It's a great vehicle for political blackmail," says Leon Panetta, who was former President Bill Clinton's chief of staff during the last big debt limit showdown in 1995.

Despite repeated entreaties - including from President George W. Bush - Congress has resisted quick action on legislation to raise the debt limit by Dollars 750bn. If Congress fails to act, the Treasury Department has said that it will bump up against the current Dollars 5,950bn ceiling by the middle of this month and run out of ways to avoid breaching it by the end of June.

Conservative House Republicans are reluctant to approve an increase, angry at the return to budget deficits and anxious to underscore their view that more cuts in federal spending are needed. The Democrats, who control the Senate, see it as an opportunity to drive home their argument that the massive Bush tax cut helped push the nation to the edge of fiscal instability.

If the government were to miss payments on debt coming due, it would be technically in default on the national debt - something that has never happened in the nation's history.

Mr O'Neill had been counting on the customary surge of April income tax revenues following the annual tax-filing deadline to buy time. But tax revenues have run far below expectations, complicating the Treasury's juggling act and fueling expectations of higherthan-forecast deficits.

The current showdown is not unprecedented but it is clearly a high-stakes game. Mr O'Neill finds himself in a dilemma faced by two previous treasury secretaries: James Baker during Ronald Reagan's presidency in 1985 and Robert Rubin under Bill Clinton in 1995.

Mr Baker performed some fancy footwork to avoid default when Republican senators Phil Gramm, Warren Rudman and Democrat Ernest Hollings tried to use a debt limit extension as leverage to force through radical new changes in budget law.

A decade later, the limit became a weapon in the hands of Newt Gingrich and his conservative band of revolutionary House Republicans as they tried to force Mr Clinton to embrace unprecedented changes in the structure of federal spending. They ultimately failed but not before they had driven the nation to the edge of a potentially disastrous default.

The Republican strategy then was to include an increase in the debt limit in a broad budget bill containing a vast array of tax and spending provisions.

In November 1995, Mr Rubin was left with little choice but to implement new and creative ways to avoid default. He created Dollars 61.3bn in additional borrowing authority by "disinvesting" two retirement funds managed by the government for civil service employees.

He essentially substituted a non-interest-paying IOU for some of the government-issued securities the funds previously held.

In fact, it was little more than an ingenious bookkeeping change. As a result, Dollars 61.3bn in outstanding bonds disappeared from the government's balance sheet, permitting the Treasury immediately to borrow billions in the public bond markets. Mr Rubin assured federal pensioners that whenever the debt limit was permanently increased, the retirement funds would be reinvested in interest-bearing bonds and that lost interest would be paid.

That, in fact, is what later happened. It was all a clever bit of manoeuvring that allowed Mr Rubin to sidestep the trap Republicans had set for him. Alice Rivlin, Mr Clinton's budget director, was appalled. She warned that even flirting with default could badly roil financial markets and branded Mr Gingrich's tactics "irresponsible". Today, Mr O'Neill can hardly go around publicly labelling House Republicans "irresponsible" - much as he might like to - since many of Mr Gingrich's old allies are the ones blocking House action.

But he has adopted several of Mr Rubin's techniques - to the point where many in Congress simply do not believe the Treasury when it says a crisis point will soon be reached.

"Congress and the markets have been conditioned by past debt limit showdowns to believe that there really is no great risk of default - that Treasury will always find a way around it," says John Youngdahl, a senior economist with Goldman Sachs.

But Mr O'Neill appears to be taking no chances. "It's a question of how close to the cliff we're going to run before we do what we know we need to do," he said.

Unfortunately, both parties in Congress seem to be content, in this election year, to run very close to the cliff indeed. "I wouldn't want to be in Mr O'Neill's shoes," sympathises Mr Panetta.