With Republicans Caught Between Wall Street and the Tea Party, Dems Just Might Win the Debt Ceiling Standoff

The country may have dodged a bullet as a result of the Republicans' unwavering intransigence on the debt ceiling. Democrats, after all, appeared ready to bend over backward to give them most of what they wanted – a series of incredibly painful spending cuts, perhaps including Medicare “reforms” -- in the middle of a gruelingly inadequate “recovery.”

Sources told the Washington Post's Ezra Klein that Obama's decision to publicly call out the GOP was a sign that the deal was well and truly dead, at least until the government starts shutting down operations. According to reports, the Republicans walked away from an offer that would have landed them $2 trillion in cuts over the next decade because they refused to tolerate closing $400 billion in tax loopholes for their corporate patrons. Senate Democrats, meanwhile, are set to unveil their own budget, which is expected to fall to the left of not only what might have come out of the failed negotiations but also Obama's own budget outline.

While the pundits wring their hands over Washington's lack of “bipartisanship,” the reality that everyone understands is that the GOP leadership is far more frightened of its base than the Dems are of theirs. The Tea Partiers may have been promoted and employed to great effect by the Republican Party during the health-care debate, but as one Tea Party organizer told New York Times reporter Kate Zernike, “the people who have failed to represent us in the Republican Party have got to be targeted, they have to go.” In the last cycle they knocked off Sen Bob Bennett, R-Utah, a stalwart conservative. Freedomworks is now going after his erstwhile colleague, Orrin Hatch -- he of the 90 percent-plus rating from the American Conservative Union -- for the apostasy of supporting some rather corporate-friendly cap-and-trade legislation.

Given those circumstances, gridlock is the best thing for the economy and the American people. These may well be political games, but they have real-world consequences – the GOP's deep cuts to spending would not only fall heavily on the neediest Americans, they would also cost us hundreds of thousands of jobs over the next few years. What's more, holding the line sends the message – especially important in light of the tax deal Obama cut with Senate Republicans last fall – that the administration won't negotiate with hostage-takers acting in bad faith.

A number of Republicans have chosen to spin the debt ceiling as a non-issue, insisting, contrary to what every expert believes, that defaulting on the debt would be no big deal. Their base has bought the spin, and thus can't be moved to accept a deal at this point. There may well be a last-minute deal to raise the debt ceiling, but the GOP establishment has painted itself into a corner – with their Wall Street backers terrified of the consequences of default on one side, and their base on the other, unwilling to tolerate any effort to work with Democrats.

The Republicans may not be bluffing, but Obama and the Democrats appear for the moment to be holding their ground. They believe they've framed the debate well – arguing that the Republicans are so hellbent on preserving tax breaks for those at the top that they're refusing to do their jobs and, in the process, threatening the Main Street economy. And because the GOP is afraid to flinch, and Obama thinks he has a winning political argument, it seems unlikely that a deal will be forthcoming before August 3, when the Treasury's ability to shuffle money between accounts will play out and the United States will begin to default on some of its obligations, including, perhaps, its obligation to retirees on Social Security.

And that brings us to the heart of the matter: gridlock may be good in this case, but not if it sends the economy into a tailspin. And here it's important to understand that perception is everything. There is no automatic mechanism that would cause the financial system to crash should the federal government default; it all rests on whether the bond markets retain faith that Washington will pay its bills, eventually. If they don't, the cost of borrowing will rise – for everyone, not just the government – and the economic recovery, as anemic as it has been, will come to a grinding halt.

If the White House is indeed confident that it has framed the argument to its advantage, there are two things it can do that might prevent that bleak scenario from playing out. Both are risky, but either may allow the administration to keep the government operating without giving in to the Tea Partiers' recklessly ideological demands.

First, there is what some Democrats are calling the “Constitutional option.” The 14th Amendment says that “the validity of the public debt of the United States, authorized by law… shall not be questioned,” and it has long been debated whether the debt ceiling violates that clause. (Preventing political parties from playing games with the public debt appears to be exactly what the clause was intended to accomplish.) The idea would be for Obama to hold a press conference announcing that since Congress had authorized more spending than it raised in taxes but failed to reach an agreement on raising the debt limit, he would honor his oath to uphold the Constitution by ordering the Treasury to continue to meet the government's obligations.

That would essentially rescue the Republicans' hostage – the American economy. At least it would if the very fact that the two parties couldn't come to an agreement didn't send the bond markets into a panic. That's a scenario that worries Ezra Klein. But it's also exactly the kind of move George W. Bush would have made had he thought he had the upper hand politically – he'd have happily played procedural hardball.

It would almost certainly lead to a push to impeach Obama in the GOP-controlled House. And that would be an interesting fight, with the Tea Party freshman who were elected promising an unwavering fealty to the Constitution fighting so swept up in their Obama Derangement Syndrome that they're moved to stake out a position violating its terms.

Another, more radical proposal (and therefore less likely to happen) was offered by Rep. Ron Paul, R-Texas. He suggested that the government default on the debt held by the Federal Reserve. It's ironic that a strict Constitutionalist would "question the validity of the public debt" in violation of the 14th Amendment, but stiffing the Fed would clear $1.6 trillion from under the debt ceiling, allowing the government to operate through the end of the fiscal year. The Federal Reserve banks could sue the government and probably win, but by the time they did, the debt ceiling would presumably have been raised.

This is obviously a very serious game of brinksmanship, and none of these options represent a safe bet. But the stakes are high, the GOP's position appears to be deeply entrenched and the White House has done a good job defining the terms of the debate. So while it's risky, holding fast – showing backbone – seems at this point to be the least-bad option available to them.

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