After the short White House meeting today, Congressional leaders of both parties met on Capitol Hill to work out an agreement to increase the debt limit. Earlier, House Speaker John Boehner held a conference call with his caucus, where he said he wanted a debt limit plan in place by tomorrow to avoid causing a drop in the Asian markets.

This concern about the markets has happened very suddenly. All of a sudden there’s a belief that a clean increase or a small debt deal with a minor amount of spending cuts would not be enough to avoid a downgrade. Standard and Poor’s basically forced this by saying that they would downgrade if there wasn’t a $4 trillion deficit deal in the next 90 days. The claim is that this has been caused by political leaders attaching the debt limit to a deal on reducing the deficit, and the inability to reach an agreement, the political stalemate, has led the markets to lose confidence.

But this is absolutely crazy. The market was up 2% last week. 10-year Treasuries are at 2.96%. There’s no difference between this week and last week in terms of the country’s deficit problem. This is about perception, and it doesn’t seem to even be about the perception of the actual market. It’s about the perception of someone at Standard and Poor’s. The rating agencies, which played a major role in the financial meltdown, has just up and put a gun to the head of the country and demanded austerity in the middle of a jobs crisis. Are you kidding me?

Washington certainly deserves blame for attaching a huge lift of deficit reduction to the debt limit, which is so routine but which has such adverse consequences. But this is completely irresponsible on the part of not just DC but the rating agencies. The word “collusion” comes to mind, with the elites of the world demanding that their tax cuts be paid for with someone else’s money.

On top of this, you have both the President and Harry Reid vowing never to agree to a short-term extension of the debt limit, wanting instead something that pushes the debt limit through the Presidential election. Press Secretary Jay Carney said in a statement that at today’s meeting, “The President restated his opposition to a short-term extension of the debt ceiling, explaining that a short-term extension could cause our country’s credit rating to be downgraded, causing harm to our economy and causing every American to pay higher credit cards rates and more for home and car loans.”  Reid was more explicit:

I want to reaffirm my statement from last night. I will not support any short-term agreement, and neither will President Obama nor Leader Pelosi. We seek an extension of the debt ceiling through at least the end of 2012. We will not send a message of uncertainty to the world.

If you link this up with Boehner’s demand of a dollar-for-dollar relationship between the increase in the debt limit and deficit reduction, then there’s no way there would be less than $2.4 trillion in any deal (the approximate number it is expected to take to get through the elections). On the conference call with the Republican caucus, Boehner claimed that solutions of anywhere between $3 trillion and $5 trillion were available.

I don’t believe the maximalist number for a second. But Nancy Pelosi charted the course to $2.4 trillion. It includes one big accounting gimmick – $1 trillion in “savings” from drawing down in Iraq and Afghanistan, mainly through a change in how CBO would score it. And then there are $1-$1.2 trillion in agreed-to spending cuts, and an additional $300 billion or so from foregone interest payments from the reduction of debt. If you added reductions to mandatory spending it could be even bigger. No health spending or entitlements would be touched.

It’s somewhat doable, but without revenue, the leader of the House Democratic caucus, John Larson, said that there would be no Democratic votes available. And there are enough Republicans who flat-out won’t raise the debt limit at all that it’s difficult to plot a path to passage in the House, to say nothing of the Senate.

The Wall Street Journal is reporting that there’s a deal for around $4 trillion in deficit reduction being floated, but it’s being held up on the structure of how the debt limit would be raised.

The emerging proposal would work in two phases, according to aides. Congressional staff has identified an initial package of between $900 billion and $1 trillion in spending cuts, which Congress would pass by the Aug. 2 deadline along with an increase in the debt ceiling by the same amount, aides said. That would increase the government’s borrowing authority through the end of the year, aides said.

At the same time, the plan would establish a commission that would be charged with further cutting the deficit by the end of the year through an overhaul of the tax code and changes to entitlement programs, such as Medicare, Medicaid and Social Security, aides said.

The amount of the deficit reduction package that the commission comes up with would be the amount Congress would then vote to raise the debt ceiling, aides said, presumably increasing the government’s borrowing authority through 2012.

The question is whether the President and the Senate Majority Leader consider this a short-term debt limit increase or not; it doesn’t seem so. It’s unclear whether or not the proposed Catfood Commission II would have a guarantee to hit certain targets, meaning that it would have to reduce the deficit – and thereby increase the debt limit – later. So the Dems want the debt limit increase in one shot, even if the deficit reduction comes in two tranches.

It’s pretty incredible that you have a rogue credit rating agency forcing a large deficit reduction package based on their cockeyed view of the political process.

UPDATE: Pelosi confirms the two-tier idea. The question looks to be whether Republicans will agree to increase the debt limit all at once.

UPDATE II: I put this on Twitter, but not here. S&P says they’re so worried about political gridlock that they would downgrade US debt without $4 trillion in deficit reduction right now. But if the Congress does nothing – if there is political gridlock – the Bush tax cuts expire, and revenue increases by… $4 trillion. That just shows you how absurd this all is.

UPDATE III: Harry Reid’s latest statement doesn’t sound encouraging:

I am deeply disappointed in the status of negotiations with my Republican colleagues. I have said repeatedly, including last night and again today, that I will not support any agreement that fails to raise the debt ceiling though the end of 2012. Anything less than that will fail to provide the certainty that the markets – and the world – are looking for, risking an immediate downgrade of America’s credit rating. This would force a tax increase on all Americans, and drain their savings funds and retirement plans as well.

I hope that Speaker Boehner and Leader McConnell will reconsider their intransigence. Their unwillingness to compromise is pushing us to the brink of a default on the full faith and credit of the United States. We have run out of time for politics. Now is the time for cooperation.

Canned foods – strong buy!

David Dayen

David Dayen