Stress Test

  FROM THE start of negotiations in early May, it was clear a grand bargain would be tough. The Republicans were combining their traditional orthodoxy of tax cuts skewed toward the rich with radical new ambitions for cutting government spending—slashing the safety net for the poor, shifting Medicare costs to retirees, and dramatically reducing “nondefense discretionary spending,” the roughly 15 percent of the budget that funds everything from the FBI to the National Institutes of Health. At the same time, they wanted to increase Pentagon spending.

  “I’m a whatever-it-takes kind of guy on defense,” Senator Jon Kyl, the Arizona Republican who had championed the expensive estate tax cut, said during one session.

  “That’s a fine position to take, but you need to be willing to pay for it,” I replied. “You can’t be a responsible national security hawk if you’re never willing to raise taxes, and you’re only willing to borrow or cut the safety net.”

  The age-old Republican hostility to new tax revenues was obviously going to be a problem. Even more troubling, Republicans were already suggesting they wouldn’t raise the federal debt limit unless we caved to their demands. Raising the debt limit would not authorize any new spending; it would merely allow the Treasury to pay for spending that Congress had previously authorized. Republican leaders knew the limit had to be raised to avoid a global financial meltdown. But they also recognized its value as a hostage. They could strap a financial bomb to their chests and try to extort a ransom in exchange for agreeing not to blow up the economy.

  “What are you going to give us for the debt limit?” Eric Cantor asked.

  “We’re not going to give you anything,” I said. “It’s your responsibility to raise the debt limit. It’s not a gift to us.”

  By that point, however, the White House had already signaled that we were willing to negotiate over the debt limit. Mark Patterson and I had argued that we should refuse to concede anything in exchange for a debt limit increase, but the White House did not believe that was a realistic position. In an austerity moment, even our Democratic allies were afraid to vote for a bill that would make them vulnerable to charges they were pro-debt.

  Still, I was appalled when the Speaker announced “the Boehner Rule” on May 11, declaring that Republicans would demand a dollar of spending cuts for every dollar of additional borrowing authority. I thought he was painting himself and the country into a dangerous corner. After all the agony caused by the most damaging financial crisis in generations, he and his party were threatening a completely unnecessary reprise in pursuit of a policy agenda that would make the economy worse.

  Historically, the debt limit had served mostly as a grandstanding opportunity for the minority party. Even President Obama, as a senator, had once voted against raising the debt limit, a symbolic gesture to protest the Bush deficits; that had been irresponsible, as he now admitted, but not consequential, because there had been no danger that the debt limit wouldn’t be raised. But what the Republicans were doing, using the debt limit as a tool of extortion to impose their political agenda, was without precedent. It jeopardized the full faith and credit of the United States, the good name and trust we had earned over more than two centuries. The assumption that the United States would always pay its debts underpinned the stability of global finance.

  I didn’t understand why Boehner would give so much leverage to the extremists in his caucus. He was raising their expectations that they could use a routine piece of legislative housekeeping to achieve their wildest policy dreams. Many of them truly seemed to believe that default could cleanse the sins of the U.S. economy, which was insane. Boehner knew perfectly well that default would have destroyed the U.S. economy. By creating mass uncertainty about the historically risk-free Treasury debt that was the foundation of global finance, it would have created an economic Armageddon. And the constitutional precedent was awful. Conceding to the demands of a party that controlled just one house of Congress would alter the balance of power between the executive and legislative branches in ways that Republicans would surely regret when they next occupied the White House. But Boehner was unwilling, at that point, to correct the delusions of much of his caucus.

  It was hard to believe that while Greece and Ireland and Portugal were desperately trying to avoid default, we were discussing voluntary default. I liked to remind people what President Reagan had said when confronting a considerably milder brushfire over the debt limit decades earlier: “The full consequences of a default—or even the serious prospect of default—by the United States are impossible to predict and awesome to contemplate.”

  THERE WERE plenty of twists and turns in the debt-limit talks, but the basic narrative didn’t change much. House Republicans wouldn’t accept new tax revenues, and neither the President nor the Democratic leadership in the Senate would accept deep cuts in entitlements as part of a $4 trillion “grand bargain” without new tax revenues. For all their soliloquies about the tragic debt we were leaving our grandkids, Republicans didn’t consider it tragic enough to justify the elimination of a single tax break. They weren’t prepared to break their no-new-taxes pledges to cut a deal with a president their supporters loathed. Plenty of ink would be spilled on tick-tocks investigating who moved which goalposts, trying to unravel the mystery of who killed the bargain. At the time, though, it didn’t feel mysterious.

  There was a weird dynamic to the talks, because Boehner truly seemed to want a deal, while Cantor and his colleagues seemed to be watching Boehner to make sure he didn’t cut a deal. I found the Speaker’s obvious discomfort with the far right wing of his caucus sort of appealing; it was too visceral to be entirely tactical. He always warned that their intransigence might scuttle any compromise, that they would consider any deal he cut with the President inherently suspect.

  “I’m out in front of them,” Boehner once said in the Oval Office. “I don’t know if I can bring them along.”

  In our initial talks, we put the most controversial questions—taxes and potential reforms of Medicare, Medicaid, and Social Security—to the side. We focused on how to limit growth in other domestic spending, from civil service benefits to medical education subsidies to Pentagon programs. We did find some common ground on potential savings, and we hoped they could be a down payment on a larger deal. But on June 23, Cantor suddenly announced he was dropping out of the talks. He blamed our demand for new tax revenues, even though we had barely discussed tax revenues. “There is not support in the House for a tax increase,” he said. “Regardless of the progress that has been made, the tax issue must be resolved before discussions can continue.”

  Around that time, Boehner opened up a back-channel negotiation with the President. Initially, he signaled he was willing to accept tax reforms that would raise $800 billion in new revenues. But he then publicly withdrew from those talks as well, explaining that House Republicans couldn’t accept tax increases. “Despite good-faith efforts to find common ground, the White House will not pursue a bigger debt reduction agreement without tax hikes,” he said on July 9.

  Jack Lew had been the main White House liaison to the Hill, but a few days later, Boehner summoned Daley and me to his office to try yet again. “Most of my caucus thinks it’s crazy to do a deal with you guys, but we should keep talking,” he told us. The President and the Speaker met the next day, and things seemed to be back on track, with Boehner again suggesting he could accept $800 billion in new revenues through tax reforms that lowered overall rates while eliminating tax breaks, if we could accept reforms to Medicare, Medicaid, and Social Security.

  Of course, nothing could be agreed to until everything was agreed to, and we had no evidence Boehner had the support of his caucus. The Speaker and his staff kept insisting they needed a scalp for the right; at one point, he proposed we scrap Obamacare’s individual mandate for health insurance, an obvious nonstarter. We were getting a bit nervous about our side, too. Harry Reid and Nancy Pelosi had told the President they could support a grand bargain, but the outlines o
f the deal made the Democratic leaders uncomfortable. It would raise substantially less revenue than Simpson-Bowles or a draft proposal by a bipartisan Senate group known as the Gang of Six. And the entitlement reforms were going to be a tough vote for Democrats, especially with Republicans still insisting on some kind of Obamacare scalp. I remember during one Roosevelt Room prep session before I appeared on the Sunday shows, I objected when Dan Pfeiffer wanted me to say Social Security didn’t contribute to the deficit. It wasn’t a main driver of our future deficits, but it did contribute. Pfeiffer said the line was a “dog whistle” to the left, a phrase I had never heard before. He had to explain that the phrase was code to the Democratic base, signaling that we intended to protect Social Security.

  On July 21, Boehner, remarkably, stopped returning the President’s calls. He soon announced he was abandoning the grand bargain. This time, his rationale was that the President had moved the goalposts by asking for an extra $400 billion in revenues. But that was just a pretext; the negotiations were fluid. We had raised the revenue target, and their drafts still were calling for unacceptable political scalps, but the President hadn’t drawn a line in the sand. The problem was that most of Boehner’s caucus was unwilling to accept any new revenues, and many had pledged never to vote to raise the debt ceiling; he once told us that he was more interested in doing big things than being Speaker, but ultimately he was unwilling to split his caucus and risk his job. The President, by contrast, was willing to alienate some of his Democratic allies to pass an agreement he believed would be good for the country.

  For months, I had been urging the markets to ignore the political theater, assuring the world it was inconceivable the United States would decide not to pay its bills. But it was starting to look conceivable. Our deadline to raise the debt limit was August 2, and the “fear index” measuring market volatility shot up 40 percent the week before. Analysts questioned the dollar’s status as the world’s reserve currency. Some commentators wanted us to sell gold from Fort Knox to pay our bills, or unilaterally invoke the Fourteenth Amendment’s assurance that U.S. debt “shall not be questioned,” or use a loophole in a law authorizing commemorative coins to mint a trillion-dollar platinum coin to circumvent the debt ceiling. But none of those options were viable. We were not a banana republic. We needed a deal through the democratic process.

  Behind the scenes, Vice President Biden was making progress with McConnell on a deal with more modest spending cuts, drawing on the negotiations earlier in the summer, as well as the President’s budget. We had the outlines of an agreement on Sunday morning, July 31, 2011, but Boehner was holding out for more Pentagon spending, saying his caucus was balking. Whoa. That afternoon, two days before the deadline, we met in the Oval Office to discuss whether I should make a statement preparing the world for the gruesome spectacle of the United States defaulting on its obligations for the first time in history. Even at my lowest points after Lehman and in early 2009, I had never felt this kind of dread. One reason we had been able to resolve our financial crisis was the exceptional faith that prevailed around the world in the credit of the United States of America. If House Republicans couldn’t bring themselves to support anything that could pass, we could destroy that faith and create a much worse crisis—this time, a voluntary crisis.

  But by nightfall, we had a deal. And on August 2, Congress barely made its deadline to pass the Budget Control Act, which would initially save $900 billion over ten years by capping growth in discretionary spending. The new law also created a bipartisan “supercommittee” that would try to agree on more savings; otherwise, starting in January 2013, a “sequester” would automatically trigger another $1.2 trillion in across-the-board spending cuts over the next nine years, half of them from defense. Republicans would later try to blame the President for the “Obamaquester,” which was kind of amazing; they were the ones who threatened to force a default if we didn’t agree to spending cuts equivalent to any debt-ceiling increase.

  We didn’t like inflexible across-the-board cuts—some programs are more important than others—or the focus on discretionary nondefense spending that was already low by historical standards. But the hope was the sequester would be so unpalatable to both parties that there would be motivation to compromise to avoid it. And we were relieved the deal delayed most of the cuts until 2013. With the unemployment rate still at 9 percent, and with Recovery Act spending tapering off, we feared that drastic short-term austerity could have killed the recovery. The deal also suspended the debt ceiling until after the 2012 election, which was an important substantive victory, not just a political one. Another hostage drama in the heat of a campaign could have ended in disaster, with Republicans under even more pressure to avoid compromise with the President.

  Still, this was no way to run a superpower.

  The drop in consumer confidence during the debt limit debate was larger than the drop during any U.S. recession since World War II. And growth had already slowed considerably in the second quarter. This was partly because of continued dysfunction in Europe, higher gas prices driven by unrest in the Middle East, auto supply chain slowdowns caused by the devastating tsunami in Japan, and continued state and local budget cuts. We had a lot of economic headwinds, and a brutal drought that summer would create more. But our fiscal wars and political dysfunction were self-inflicted problems.

  DESPITE ALL my efforts to escape Washington, those problems would continue to be my problems. Rumors had been flying that I would leave Treasury once the debt ceiling mess was resolved, but the President was adamant that I stay.

  Carole was eager for us to return to a life with more privacy. She had been my anchor of stability and reality throughout the darkness of the crisis, always supportive, always having faith in me, though never caught up in the glamour or power of the office. She was justifiably hard on me at times, usually about my failure to be there for her and the kids. Now she and our son, Ben, were moving back to Larchmont for the start of his senior year. I’d have to commute again.

  On August 4, two days after the deficit deal, we were sitting in the Rose Garden for the President’s fiftieth birthday party. While the military band was playing, the President took Carole by the hand and asked her to take a walk.

  “Usually, I’m good about people’s family priorities,” the President said to Carole. “But I can’t let Tim go. I need him. Other countries need him. Things are so fragile now.” I had told the President how Carole hates to see me attacked, especially by liberal columnists she often agreed with. “I know you don’t like the criticism,” he told her. “Michelle hates it, too. These jobs are incredibly difficult.” Carole listened but didn’t really respond; she’s tough about standing up to pressure, even from the commander-in-chief. She later told me his tone shifted a bit at that point.

  “As President, I just can’t let him go,” he said. He ended the conversation by walking over and introducing Carole to Tom Hanks and his wife, Rita Wilson, who the President said knew something about the challenges of living apart for long periods of time. Carole wasn’t exactly appeased, and she didn’t feel any better when Michelle’s toast mentioned how nice it was that the President came home for dinner every night at 6:30 p.m. The next day, though, she wrote the President a gracious note thanking him for the personal explanation.

  “It was hard for me, but I got your message,” she wrote. “Even when I am most anxious for Tim’s liberation, I am in complete support of you.”

  The President was generous to me; for my own fiftieth birthday two weeks later, he gave me a framed nineteenth-century patent for a tennis racket, with a funny inscription about how it might remind me of the equipment of my youth. While it was great to have the support of my boss, I was eager for my liberation from Washington, too. And while Carole was writing her conciliatory note, the United States was absorbing yet another blow to its financial reputation.

  ON FRIDAY, August 5, three days after we avoided Armageddon, Standard & Poor’s called the Treasury around 1
p.m. to let us know it planned to downgrade the AAA credit rating of the U.S. government. In April, S&P had warned that we had two years to demonstrate our commitment to deficit reduction to avoid a downgrade; now that we had passed a deficit reduction package, a rating agency that had given AAA seals of approval to all kinds of toxic mortgage securities suddenly planned to declare the world’s safest investment a credit risk. It was a stunning act of folly. Even during the crisis, Treasuries had been the favored refuge from risk for global investors. Our deficits were falling as a share of our economy, and our new fiscal agreement had locked in significant additional savings. But as I said to my team: “It is what it is.”

  Except it wasn’t. John Bellows, a twenty-nine-year-old economist on my team, quickly realized that S&P’s numbers were way off. They had used the wrong baseline to evaluate the Budget Control Act, so they had overstated our projected deficits by an astounding $2 trillion over ten years. In their draft press release, S&P justified the downgrade by projecting a rapid rise in the U.S. debt-to-GDP ratio; without the $2 trillion error, the ratio would be much less scary, in line with plenty of AAA-rated countries with less productive economies than ours. My team called S&P’s analysts to explain the problem and, a few hours later, they admitted their mistake.

  That evening, S&P decided to go ahead with the downgrade anyway. It simply corrected its math error and rewrote its press release to suggest that its main rationale was political dysfunction—that the debt limit standoff had reduced their confidence that the American political system would be able to agree on more substantial fiscal reforms any time soon.

  “I think S&P has shown really terrible judgment,” I said on CNBC that Sunday. “They’ve handled themselves very poorly, and they’ve shown a stunning lack of knowledge about basic U.S. fiscal budget math.”

  On Monday, the stock market dropped 6.7 percent, the worst day since the height of the financial crisis. And the first-ever downgrade of the U.S. government was not even the worst problem in the global financial markets. Europe was burning again. I remember calling Trichet to commiserate from a chair outside Daley’s office.