Now, for the next crisis — the debt ceiling

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Debt ceiling

Markets on Wednesday breathed a sigh of relief that the U.S. Congress was able to pass legislation avoiding the fiscal cliff.

After much wrangling over the holiday season, the House of Representatives passed a Senate-approved bill that would make most tax cuts permanent and raise taxes on individuals earning more than $400,000 and couples making more than $450,000.

Here are some of the details of the new law from the Wall Street Journal:

The far-reaching agreement will have lasting implications for the tax code, future budget battles and the balance of power in Washington. It raises income-tax rates for the first time in almost two decades and fulfills Mr. Obama’s signature campaign promise to prevent rates from rising on the middle class. Not since 1991 has a Republican in Congress supported such a move—a challenge to its brand as the antitax party.

In policy terms, it permanently codifies most of the tax rates that were set only temporarily in the Bush era. After years of failed efforts, the bill permanently keeps the middle class from being hit by the alternative minimum tax, a 1960s edifice intended only for America’s wealthiest.

At the same time, the bill defers some of America’s toughest spending problems—in particular the ballooning cost of health care—and it doesn’t come close to the kind of $4 trillion deficit-reduction deal the country’s leaders had hoped to negotiate. By some estimates, it would cut the deficit by $600 billion over 10 years.

The compromise dodges one cliff, but it sends Congress barreling toward another. In two months, the delayed $110 billion in spending cuts will again kick in. At the same time, the U.S. will face the need to increase its borrowing limit, a change that can only be made by Congress. That sets up another rancorous fight, one with potentially more damaging consequences. Republicans want to use the debt ceiling to extract spending cuts. Mr. Obama has said he won’t negotiate.

According to Bloomberg, the details of the bill didn’t matter so much as just simply having an end to the standoff. Here’s what it said:

“We sold off on the uncertainty of what it means to go over the fiscal cliff and that’s been removed,” James Paulsen, the chief investment strategist at Minneapolis-based Wells Capital Management, which oversees about $325 billion, said in a telephone interview. “We’re re-valuing the market based on what’s closer to the underlying economy and most of the economic reports have been pretty good.”

The House of Representatives passed a bill just after 11 p.m. in Washington yesterday by a vote of 257-167, undoing income tax increases for more than 99 percent of households. The S&P 500 surged 1.7 percent on Dec. 31, the biggest rally on the final day of a year since 1974, as Republican and Democratic lawmakers made last-minute concessions to finalize the deal.

The bipartisan vote broke a yearlong impasse over how to prevent more than $600 billion in tax increases and spending cuts that could lead the economy back into recession. President Barack Obama said he will sign the bill into law.

The measure isn’t the grand bargain on deficit reduction lawmakers wanted when they created the tax-and-spending deadlines over the past three years. While avoiding most of the immediate pain, it is only one step toward curbing the federal deficit — an issue that will return with a February fight over raising the $16.4 trillion debt limit.

The New York Times wrote a whole sidebar on the issue of the debt ceiling. Here’s an excerpt from that:

In the wake of the president’s victory on taxes over the New Year’s holiday, Republicans in Congress are betting that by refusing to unconditionally raise the $16.4 trillion debt ceiling, they can force Mr. Obama to the bargaining table on spending cuts and issues like reform of Medicare and Social Security.

That would inevitably reprise the bitter clash over the debt ceiling in the summer of 2011, when the government came close to shutting down before lawmakers and the president agreed to a $1.2 trillion package of spending cuts in exchange for Republican agreement to raise the debt ceiling by about the same amount.

And that is exactly what Republicans want.

The party’s caucus in the House will discuss its debt ceiling strategy at its retreat In Williamsburg, Va., in a couple of weeks, according to a top Republican aide, who said it was determined to insist again on spending cuts that equal the increase in the amount the country can borrow.

“The speaker told the president to his face that everything you want in life comes with a price. That doesn’t change here,” the Republican aide said. “I don’t think he has any choice.”

That strategy could risk a new round of criticism aimed at Republicans from a public weary of brinkmanship. The 2011 fight ended with a last-minute deal but led to a downgrade in the rating of the nation’s debt and a slump in the economic recovery.

So with Round 1 out of the way, the uncertainty over Round 2 is sure to weigh on investors. At least we had one day of good news and returns before moving onto the next government-created fiscal crisis.

Here’s opening that both sides can come together and find a solution to avoid any last minute deals.  But given the rhetoric we’ve seen, that doesn’t seem likely.