A Couple of Things That Puzzle Me in the Debt Ceiling Negotiations

Watching the current negotiations unfold, I remain puzzled by a couple of things.

First, what would happen – purely hypothetically, obviously – if the Republicans suddenly announced that they would support raising the debt ceiling to a trillion trillion dollars – infinity.  The immediate effect is to remove the (contested) matter of default from the table.  One might almost say, stretching concepts a bit, that the liquidity problem had been removed from the discussion.  So the rating agencies should now go away?  But isn’t the far more important issue one of sovereign solvency, not liquidity?  The immediate pressure of a default, if a default were assumed to be truly at risk, is gone.  Okay.  So then the question becomes not the default, but the debt.  The rating agencies, and the markets, now have to focus on the longer term, but less and less long term, question, is the debt sustainable?

Another way to put this, I suppose, is that Democrats are arguing about liquidity; Republicans about solvency.  I understand that the debt ceiling, or my hypothetical removal of it, creates many “signaling” issues both to the other political party as well as to rating agencies and markets.  The assumption has been that Republicans holding tough on the debt ceiling is signaling behavior about their seriousness in addressing the solvency question.  If that’s so, then dropping the debt ceiling issue is interpreted as surrender.

But it is possible that the signal sent by raising the ceiling effectively to infinity, not incrementally and in amounts that take the debt ceiling as an important barrier, is to signal that it is no longer at issue.  No longer at issue, that is, in the sense that the Republicans are brushing aside the liquidity question in order to force the only parties that the Democrats will care about – markets and rating agencies – to engage on the question of solvency.  The signal, presumably, is that the attempt by Democrats to avoid the solvency question by using the pressure of the liquidity-default trigger has been called (from the Republicans’ view) as a bluff, and now the Democrats face the markets and the rating agencies not through the Republicans, but directly and unbuffered, and on the question of the deficits and the debt, not the ceiling.

What would be the effect of my hypothetical?

Second, I don’t understand the F**k Washington rhetoric.  I mean, sure, at 40,000 feet, everyone can say that Washington is the problem.  I get that; I agree on most things, but not specially on this issue.  Sure, this “negotiation” reflects the basic breakdown of Congress – but it also reflects that even a more functional Congress would still break down into bitter disagreement on this issue.  Come down to 20,000 feet, in other words, and the happy consensus breaks down into a near perfect dissensus because people genuinely disagree.  The call to come together is illusory, because there is a genuinely deep fault line around fundamental economic policy.

I call Washington all f**ked up and mean, because no rational person would seriously entertain default.  You call Washington all f**ked up and mean, because no rational person would agree to these kinds of deficits.  We think – in the current twitter-talk of a pox on both their DC houses – Washington is a mess because we can’t find a compromise.  The truth is, however, we don’t actually think there is much room to compromise and, given that our principles on this represent a fairly sizable difference in world view, that’s probably right.  The structural problem of Washington is that everyone has a hold-up; “let’s vote and majority policy wins” doesn’t work because we’ve allowed a consensus system informally to take hold, rather than a majoritarian one (albeit one revisable at least in part by a future majority).

Third, although the negotiations seem to appear amenable to compromise and splitting of differences – it’s just how much of this and how much of that – this is deceptive.  The structure of the game is closer to chicken, with sharp downside discontinuities – train wrecks – built into the nature of the game.  Meaning, if you are the Republicans, your only ability to address the long term deficit issue is by using the debt ceiling as hostage; you have some room to manuever as to when increases are triggered and how much, but it is fundamentally your hostage.  If you are the Democrats, by contrast, then you have an incentive to raise the stakes around the hostage on the downside as much as possible – no Social Security check for Grandma – and hold your own hostage on tax increases.  Again, I don’t think it’s simply bad negotiating on each side that has led to so much brinkmanship – apparently incremental and continuous issues, presumably favorable to compromise, are actually much more hostage-like, not surrenderable in parts, as it were.  It seems to me much more like a game of chicken, and the sides have not been irrational, from their own perspectives, in keeping their guns to their hostages’ foreheads.

But perhaps I am wrong about the nature of the game at issue.  If you want, explain the game theory of this particular negotiation.  If you want to comment, please remain with these issues; I don’t think there’s much point in rants on why one side or the other is right or wrong.

Update: I see that Professor David Barash writes in the NYT today on the game theory and behavioral gaming aspects of the negotiations.  Barash describes this as a game of chicken, and goes on to add the strategy of the Rogue Elephant – the “craziest person in the room controls the agenda.”  I think it’s more complicated – a game of chicken combined with a version of hostage-taking.  There’s nothing inconsistent about that, any more than there is of playing chicken in a car in real life, with a hostage in the front seat.  The bigger problem for game theory here is that the games are far too complicated, involving so many players with altogether different agendas, and quite different stakes and standards of winning and losing.  However, Barash’s opinion essay is a very good read.