July 19, 2011 / 9:15 PM / in 6 years

SCENARIOS-Possible outcomes for U.S. debt limit talks

WASHINGTON/NEW YORK, July 19 (Reuters) - Budget talks between President Barack Obama and Republican lawmakers to raise the U.S. debt ceiling have entered crunch time with just two weeks to avoid a devastating U.S. default.

Here are some possible scenarios for how a debt limit deal might be passed by Congress before Aug. 2, when the Treasury Department says it will run out of ways to service government debt without an increase in the borrowing cap.

$4 TRILLION “GRAND BARGAIN” AGREED

Republicans have said they will refuse to back an increase of the $14.3 trillion debt ceiling without a corresponding plan to bring deficits under control.

Obama and John Boehner, the Republican House speaker, entered into secret negotiations last month to try to reach a $4 trillion, 10-year savings plan, which became known as the “grand bargain.”

As envisioned by the White House, the package would combine about $3 trillion in spending cuts with $1 trillion in revenue increases.

The increases would come from letting the Bush-era tax cuts for the wealthiest Americans expire in 2013, together with the closing of some tax loopholes.

The major credit rating agencies have warned that if a big enough deficit-reduction plan of about $4 trillion is not agreed on -- even if the debt limit is raised -- they could still downgrade America’s coveted triple-A rating.

More than just averting default, investors want to see Congress act quickly with a long-term solution to the nation’s debt problems.

“Obviously the devils are in the details but a plan that brings down the deficit by $4 trillion will probably be met positively by ratings agencies as well,” said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington.

But Eric Cantor, Boehner’s deputy, appeared to nix the deal when he told Boehner rank-and-file conservatives in the House would never support a plan that includes revenue increases.

GANG OF SIX TO THE RESCUE?

On Tuesday, a bipartisan group of senators known as the “Gang of Six” unexpectedly unveiled a deficit-reduction plan they had been working on for months.

The plan, which was welcomed by Obama and was positively received by markets, would see savings of $3.7 trillion over 10 years.

It would bring spending cuts of nearly $3 trillion through changes to entitlement programs such as Medicare and Social Security, as well as cuts in defense. Nearly $1 trillion in revenues would come in from closing tax loopholes.

Like the grand bargain, the plan will struggle to pass the House, where conservatives object to any revenue increases. But unlike the $4 trillion plan, it does not include tax increases -- just loophole closings, which might give it a slightly better chance of passage.

The plan likely would be big enough to avoid a ratings downgrade.

A MEDIUM $2.4 TRILLION PLAN

A medium-sized, $2.4 trillion plan also has been discussed by the two sides. It would be a dollar-for-dollar package that would equal the amount the debt limit is raised.

The Obama administration says the borrowing cap needs to be extended by $2.4 trillion to let the U.S. government meet its obligations through the 2012 elections.

On the table were roughly $1 trillion in cuts. Democrats wanted to include $400 billion in new revenue by ending a range of tax breaks.

Again, talks over this package fell apart because of opposition among House Republicans to the revenues element.

With the insistence of ratings agencies that only a deficit-reduction deal of $4 trillion will be enough to avert a downgrade, a medium-sized package might leave the United States’ triple-A rating in danger.

But it could stabilize investor sentiment. “If they just cut by $2 trillion, I think we’ll see some disappointment but the largest near-term threat to the market will still be coming from Europe,” Esiner said.

A LAST-DITCH FALLBACK

A backup plan first proposed by Mitch McConnell, the top Senate Republican, has begun to emerge as the most likely proposal that will allow the debt limit to be raised.

Through a complex back-and-forth between the White House and Congress, it would allow Obama to raise the debt limit by $2.4 trillion in three installments through November 2012.

Under the congressional procedure Republicans would not have to vote to raise the debt limit.

With Aug. 2 looming, support for this approach has been growing. Obama on Tuesday said it could be necessary.

But the plan currently only envisages $1.5 trillion in spending cuts, which ratings agencies warn will probably not be enough to avoid a downgrade.

On Tuesday Moody’s said the McConnell plan could still lead to a downgrade within a year because it would not bring long-term deficits under control.

TALKS FAIL, U.S. DEFAULTS

A default likely would lead to market panic, a devastating spike in interest rates, lack of credit, a plunging U.S. dollar and another, potentially more severe, recession -- and a downgrade. Obama has called it “Armageddon.” (Additional reporting by Wanfeng Zhou; Editing by Bill Trott)

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