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Round 2 of the Debt-Ceiling Debate 

Peter Lefkin 

5 Questions with Peter Lefkin 


Peter Lefkin, head of government and external affairs at Allianz of America, breaks down the latest developments on the $16.4 trillion debt ceiling and related budget battles including the possibility of tax and entitlement reform.
The suspension of the national debt ceiling—a statutory limit for how much debt the Treasury can issue—has expired. But Treasury Secretary Jack Lew now says that the federal government has the ability to borrow money until after Labor Day to keep paying its bills. That’s possible partly because the Treasury plans to use “extraordinary measures” to avoid hitting the ceiling. But higher tax revenue, spending cuts and returned bailout money are also chipping in to help avoid default.

In 2011, a deadlock over raising the debt ceiling was broken only at the eleventh hour. But the standoff resulted in the stock market cratering and Standard & Poor’s downgrading the US government’s AAA rating. The next showdown could come at summer's end. In an interview, Peter Lefkin discusses the timeline for lawmakers to reach a deal, what’s on the table and whether or not we’re headed for another impasse that could sink markets.


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The temporary extension for the debt ceiling expired on May 19. What’s the latest from Washington?

The May 19 debt-ceiling deadline wasn’t all that eventful because, true to form, Congress once again kicked the can down the road. We’re probably not going to see any movement until after the summer. For now, the national debt is declining: The Congressional Budget Office has estimated that the deficit this year will be $642 billion, more than $200 billion less than it expected three months ago. With higher revenue, the United States will be able to take steps to stave off the $16.4 trillion debt limit until September, and maybe even later if Freddie Mac and Fannie Mae continue to make money and bring the Treasury additional revenue.

The Treasury Department is using some of the traditional tools in its arsenal to meet liabilities such as postponing pension-reserve payments, suspending government bond sales and deploying an array of accounting gimmicks. It’s also tapping Fannie Mae and Freddie Mac bailout reimbursements. There’s new revenue coming in from higher taxes, Fannie and Freddie and the spending cuts triggered by the sequester. But it isn’t that much money in the grand scheme of things. Half of the $85 billion under sequestration was never going to be spent. And the $60 billion in tax revenue from upper-income individuals under the fiscal-cliff legislation was equal to the amount earmarked for Superstorm Sandy relief efforts. It’s relatively insignificant in the context of the bigger deficit problem.
Are we headed for another impasse like the fiscal cliff?

Expect more brinkmanship from Democrats and Republicans. Both parties will go through the rhetoric and the charade of partisan politics. After several years of political uncertainty, markets generally discount dysfunction in Washington. But the political leverage has shifted: The fiscal cliff was a strategic loss for Republicans but it set the stage for them to stand pat on the sequester. The cards are now in their favor. And they’re going to play them. Earlier this year, everyone expected Republicans to demand sweeping changes to entitlement spending as a condition of agreeing to raise the debt limit. With the budget numbers improving, and the public already lulled into complacency about the deficit by low interest rates, many Republicans realize that they may have to shift gears. They could tie the debt-ceiling increase to something else. The Republican wish list includes comprehensive tax reform, entitlement reform and construction of the Keystone oil pipeline.

The president’s perspective is that Republicans are holding the nation hostage and their irresponsible behavior and brinkmanship will undermine capital markets. Republicans believe that the president doesn’t give a hoot about the deficits and that he just wants Americans to expand limits on their credit cards. It’s possible that the president might use summer vacation as leverage over Congress to get something done by July. That is, if they don’t get it done, then they could risk missing quality time with their families.

But both sides have to feel tremendous pain in getting to a compromise, whether it’s damage to the US economy or the possibility of losing their seats in Congress. There’s very little incentive for compromise. House Republicans have leverage and 90% of them are safely in their seats. Also, there are about six to 10 vulnerable Democrats in the Senate who know that the public hates when they raise the debt ceiling. Nervous about losing their seats, those Democrats will demand some political cover. Still, if the economy goes down the tubes, then we could see something happen more quickly.
What's the significance of the House passing the Full Faith and Credit Act or what Democrats have dubbed the “Pay China First” act earlier this month?

The bill compels the prioritization of payments to reduce the pressure of the full weight of a fiscal crunch. Essentially, it’s designed to avoid a default. If an agreement is not reached on the debt ceiling by September, then it will allow the government to immunize the liabilities on its balance sheet. At this point, the president would probably prefer a default because entitlement programs like Social Security would take a hit and that would come with political consequences for Republicans. But the bill is more cosmetic than anything else. Still, it would lead to a cleaner debt ceiling resolution and fewer accounting tricks. But it will never become law.
What are the chances we’ll see meaningful tax reform or entitlement reform?

My view is that the politics aren’t right for entitlement reform. Revenue is coming in the door, the deficit is declining and anything that the president has to offer would be small—and be coupled with tax increases that the Republicans won’t accept. Republicans cannot back away from a standoff on the debt ceiling without really antagonizing their base. They have to get some concessions on spending reductions, and perhaps, more notably, comprehensive tax reform. This might actually appeal to the president because he is looking for a legacy issue.

Under normal circumstances, I’d bet against tax reform because the politics are too complicated with every interest group in Washington D.C. working overtime to preserve their favorite tax credit. You’ve already got the debt ceiling. The president will demand new taxes. Republicans want meaningful changes to entitlements. The only way Republicans would agree to tax hikes is in the context of a tax-reform measure. Their position is that they already gave during the fiscal-cliff debate. There’s no room for more concessions. Mainstream Republicans have no issues with the higher taxes but that’s it for tax hikes. Democrats say there is more revenue to get. However, there’s a glimmer of hope for tax reform because there are two chairmen in their last year—Max Baucus (D-Mont.) and Dave Camp (R-Mich.)—who have a good relationship. It could happen.

Plus, the president has taken a hit in the last week as a result of three scandals: the Bengazi cover-up, the Justice Department’s gathering of journalists’ telephone records and the Internal Revenue Service singling out Tea Party and Patriot groups for special scrutiny. The IRS has never been popular and the bipartisan anger over a potential abuse of power might provide political ammo for those seeking tax reform—even if the issues are not directly related.
A balanced budget has alluded lawmakers for more than a decade. Will President Obama succeed in passing his 2014 budget?

It won’t pass. You’re going to end up with a stalemate on the budget. There’s no way the Republicans will agree to any variation of Senate Budget Committee Chairman Patty Murray’s (D-Wash) bill. The only significant savings are coming from cuts to funding for wars in Iraq and Afghanistan that we don’t plan on fighting anyway. It’s not really doing much and the demand for $1 trillion of revenue, applied mostly to corporations and the wealthy, will be rejected immediately out of hand.

The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.


Allianz Global Investors Distributors LLC, 1633 Broadway, New York NY, 10019-7585,, 1-800-926-4456.


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