It's pretty clear that if it was just John Boehner and Barack Obama in a room, they could come to a deal. If it was just the Senate that had to approve a bill, they could come to a deal -- perhaps even a big one. It's the House that's the problem. They rejected the $4 trillion deal the White House offered, suggesting they can't go big, and the Tea Party is whipping against the McConnell deal, which implies they can't go small. A lot of the dealmakers are, at this point, stymied. “We want to accommodate their needs,” Sen. Benjamin L. Cardin said of the House leaders. “We just don’t understand what their needs are.”

It's not clear they do, either. One common explanation for where we are in the talks is that we're waiting for the last minute. No deal struck before the last minute will be credible as the best deal Republicans could possibly get, because in this negotiation, time is leverage, and if the clock isn't one minute from midnight, that means there's leverage Republicans chose not to use. Until we hit that point, there's just not enough incentive for the House GOP to say "yes" to anything, not enough pressure to force them to say "yes" to anything, and there's an argument, popular among some conservatives, that it would in fact be a mistake to say "yes" to anything.

But what no one quite knows is what the House GOP will accept when the clock is one minute from midnight, or, in more pessimistic tellings, the Dow is 1,000 points below whatever it was at the day before. We're hearing talk that the "Big Deal" is being revived, but the bigger the deal, the tougher it is to pass quickly. And so if it is the case that we can't strike a deal until the markets are beginning to bottom out or the debt ceiling is about to cave in, it's a pretty good bet that we're not going to strike a big deal, and it's very hard to predict what sort of small deal the politics will permit at that point. Which is worrying. The political dynamics here imply a lot of uncertainty all the way to the end, but excess uncertainty is the one thing that could lead the market dynamicsto turn sharply against us.

Five in the morning

1) Obama is open to a short-term debt limit increase if it was part of signing a long-term deal, report Paul Kane and Lori Montgomery: "The contentious budget talks that have dominated Washington for months intensified Wednesday, prompting President Obama to say he would accept a short-term hike in the debt ceiling if it gave lawmakers time to finalize a comprehensive deal. Obama had pledged to veto any short-term measure, but White House spokesman Jay Carney said Wednesday that the president could accept an extension of 'a few days' if it allowed a long-term deficit-reduction and debt-ceiling deal to work its way through Congress...By Wednesday evening, as House Speaker John A. Boehner (R-Ohio) and Majority Leader Eric Cantor (R-Va.) huddled with Obama at the White House, aides in both parties said a grand bargain to slice $4 trillion out of the federal budget over the next decade was back on the table."

2) Senate and House Republican leadership are starting to split, report Jonathan Allen and Manu Raju: "Senate Republicans are starting to send a message to their increasingly isolated House counterparts: It’s time to abandon the hard line or face a public backlash.Whether it’s the top two Senate leaders’ plan to avert a debt crisis or the recently resurrected Gang of Six framework, most senators have shown interest in the kind of bipartisan compromise that provides political cover to all involved. But House Republicans leaped further to the right this week, endorsing a Cut, Cap and Balance bill that attracted just five Democratic votes...House Republican insiders acknowledge that passage of a bipartisan Senate plan would put enormous pressure on them to follow suit or get blamed for any ensuing economic calamity. But most House Republicans aren’t ready to move off their mark."

3) House conservatives are whipping against the McConnell plan, reports Greg Sargent: "The key metric for judging whether the McConnell plan can get through the House is a letter that Tea Party-backed Rep. Joe Walsh is distributing among colleagues. He’s hoping to amass 100 members on the letter, which would be a strong statement of opposition that would call into question whether the McConnell plan has any chance of passing. The GOP aide tells me he’s roughly 20 signatures away from that goal. The letter with final signatories wil be released tonight. So what does the 80 total mean? If the letter does get around 100 signatories, that would mean there are around 140 remaining Republicans. Even if all of them voted for the plan, that would mean you’d need roughly another 80 House Dems. That is probably gettable, though it may be difficult."

4) Wall Street is developing backup plans for if the debt ceiling isn't raised, report Louise Story and Julie Creswell: "Lawmakers in Washington are racing to reach a deal to save the country from defaulting on its debt, but on Wall Street, financial players are devising doomsday plans in case the clock runs out. These companies are taking steps to reduce the risk of holding Treasury bonds or angling for ways to make profits from any possible upheaval. And even if a deal is reached in Washington, some in the industry fear that the dickering has already harmed the country’s market credibility...In the Treasury market, investors are starting to sell, fearing that the government will not make good on some interest payments that will be due next month. And complex financial instruments that will pay out if the United States defaults have become twice as expensive to buy as they were at the start of the year."

5) House Democrats are skeptical of the McConnell plan, reports Mike Lillis: "House Democratic leaders are attacking Senate Minority Leader Mitch McConnell’s (R-Ky.) debt-ceiling fallback plan, characterizing it as a political ruse intended to scapegoat Democrats and taint them at the polls. 'I’m not a fan of the McConnell proposal,' Rep. Chris Van Hollen (Md.), the senior Democrat on the House Budget Committee, said Tuesday during a press briefing in the Capitol. 'It’s designed to protect mostly Republican members of Congress from taking responsibility for votes that they’ve already made.'...'It’s somewhat clever of Mr. McConnell to, in effect, try to transfer all responsibility [for raising the debt limit]...to the president of the United States, solo,' Rep. Steny Hoyer (Md.), the House Democratic whip, told reporters Tuesday."

Studio session interlude: Frankie Rose & the Outs play "Little Brown Haired Girl".

Got tips, additions, or comments? E-mail me.

Still to come: Regulators say the problem of "too big to fail" banks has been solved; health cuts were key to getting the Gang of Six back together; the Pentagon is bracing for big cuts; a bipartisan bill seeks to roll back EPA boiler rules; and how a legal quirk let a Texas man buy a $330,000 house for $16.

Economy

There's still dispute over Dodd-Frank's effect on the "too big to fail" problem, report Victoria McGrane and Deborah Solomon: "If it was supposed to do anything, the Dodd-Frank financial overhaul was designed to end the prospect that the U.S. would ever again step in to save a large, failing financial firm. One year later, a debate is raging as to whether the legislation has achieved that core goal. Regulators and administration officials argue that the law has effectively ended the phenomenon called 'Too Big To Fail'--the idea that a company is so large and interconnected that its collapse could harm the whole financial system, essentially guaranteeing a bailout. Regulators say the Federal Deposit Insurance Corp. now has the tools to safely wind down such a large, failing firm, and that Dodd-Frank effectively outlawed bailouts. The FDIC has finished several rules implementing the new regime."

The EU still hasn't reached a deal to bail out Greece, reports Howard Schneider: "European leaders continued negotiations on Wednesday in hopes of crafting both a renewed rescue program for Greece and larger steps to keep the region’s economic problems from deepening. Focus was on a session between German Chancellor Angela Merkel and French President Nicolas Sarkozy, heads of the two largest of the 17 nations that share the euro as a currency but who are at odds over the ambitions for a Thursday summit in Brussels. Merkel has been insisting that banks and other private investors contribute to a solution, but her demand has been difficult to put into practice. Even if investors voluntarily accept less than the full value for their holdings of Greek bonds, ratings agencies have said it would constitute a default, an event that could touch off deeper financial problems within Europe and beyond."

Keith Hennessey breaks down the Gang of Six proposal in great detail: "The Gang of Six plan is designed in three legislative parts. Part 1 is 'a $500 B down payment' that would presumably be implemented quickly/immediately through a bill. Part 2 contains the bulk of the plan’s deficit reduction, and would require enactment of at least two more pieces of legislation, a budget resolution followed by a reconciliation bill. Part 3 is a process for considering Social Security legislation that would, if successful, be combined with the reconciliation bill from Part 2 after both had passed the Senate. The Gang’s plan says nothing about increasing the debt limit. It would be natural to package Part 1 with a debt limit increase, but they stay silent on that point."

My Bloomberg column: It can get really difficult to tell the difference between tax expenditures and spending. "Former Federal Reserve Chairman Alan Greenspan says that tax expenditures are 'misclassified' because they are identical to outlays. Gregory Mankiw, who led President George W. Bush’s Council of Economic Advisers, calls expenditures 'stealth spending implemented through the tax code.' You can’t find a serious economist on God’s green earth who thinks the economy differentiates between cutting a government program that subsidizes health insurance and cutting an equally large tax break that subsidizes the purchase of health insurance."

The GOP is negotiating a surrender on the debt ceiling, writes Jonathan Bernstein: "Mitch McConnell’s original proposal to transfer control of the debt ceiling to the president with absolutely no deficit reduction was basically a strong warning to Republicans: you’re not going to get what you really want. He was letting them know that they could choose to negotiate their best surrender -- or, if they refused to do so, they would wind up getting almost nothing at all. I think that’s also the best way to understand the Gang of Six revived package -- it offers Republicans another way out of their mess. Of course, it’s almost entirely symbolic. Down the line it’s possible that some actual legislation can emerge from it, but there’s no chance that 'down the line' will be before the debt limit is extended, and there’s no way to guarantee that 'down the line' will ever happen."

'80s/90s economic policy worked, writes John Taylor: "Economic policy in the '80s and '90s was decidedly noninterventionist, especially in comparison with the damaging wage and price controls of the '70s. Attention was paid to the principles of economic and political liberty: limited government, incentives, private markets, and a predictable rule of law. Monetary policy focused on price stability. Tax reform led to lower marginal tax rates. Regulatory reform encouraged competition and innovation. Welfare reform devolved decisions to the states. And with strong economic growth and spending restraint, the federal budget moved into balance...But policy veered in a different direction. Public officials from both parties apparently found the limited government approach to be a disadvantage, some simply because they wanted to do more."

The administration should let its nominees talk, writes Faiz Shakir: "The White House should take the muzzle off its nominees. Let them talk to the press over and over again to tout their accomplishments. Allow them to publicly defend their records, as they are best and uniquely qualified to do. By silencing a nominee, the administration gives its critics the opportunity to spout unfounded concerns about the nominee’s fitness to serve. The conversation quickly descends from one about the individual’s merit to meritless attacks on his or her character or qualifications. The White House must be willing to cede a degree of control over its day-to-day messaging in favor of the greater victory of getting its nominees passed and its policies enacted. The administration...should instead be picking and choosing the venues that can give the nominee a fair and reasonable hearing."

Aviation interlude: Two planes crash in midair, the pilots avoid major injury.

Health Care

Tom Coburn rejoined the Gang of Six because of its health care cuts, reports Matt Dobias: "A central figure in the Senate’s “Gang of Six” on Wednesday described what he called 'ferocious' negotiations over additional cuts to Medicare and Medicaid that were needed to woo back Sen. Tom Coburn, the Oklahoma Republican whose return to the group helped cinch a plan to slash federal spending...'I understood Sen. Coburn,' [Sen. Mark Warner] said. 'He wanted even more reductions in certain entitlement programs. He wanted specific policy adjustments that [Sen. Dick Durbin] and others did not.' Coburn’s return to the group provided the necessary ballast needed to sway both Democrats and Republicans. But it came at a cost. The group’s Democrats had to concede an additional $116 billion in entitlement cuts to secure Coburn’s endorsement."

Obama has to approve or sink California Gov. Jerry Brown's proposed Medicaid cuts, reports Julian Pecquet: "President Obama and congressional Democrats have been put in a tough spot by California Gov. Jerry Brown’s (D) request to cut Medicaid spending 10 percent. Brown says he needs to make the cuts to the state Medicaid program, known as Medi-Cal, to ease his state’s severe budget woes. But advocates say cuts of that size would be devastating to California's most vulnerable residents. The federal Centers for Medicare and Medicaid Services (CMS) -- and, by extension, the White House -- must choose between helping a first-term Democratic governor who has been a leader on healthcare reform and signing off on a policy that advocates say would be devastating to people with disabilities."

The US could take a cue from Britain on long-term care, writes Howard Gleckman: "The problem is that while Congress seems on its way to both dumping CLASS and further shredding the already-tattered Medicaid safety net, it has no ideas for an alternative. Meanwhile the U.S. struggles with the fate of CLASS, a high-profile government commission in the U.K. laid out a reform plan July 4 to address its long-term care needs. And this blueprint heads in a very different direction...It proposed a new universal social insurance plan. This one, though, would provide only catastrophic benefits for many middle-class and wealthy seniors...Dilnot's plan would protect those who most need financial support...But by requiring those who can finance some of their own care to do so, it could hold down public costs."

Domestic Policy

The Pentagon is bracing for deep cuts, reports Craig Whitlock: "The Pentagon is bracing for spending cuts far deeper than what it was expecting just a few weeks ago, including the possible elimination of an aircraft carrier group and other weapons programs, as an increasing number of lawmakers float proposals for slashing the once-sacrosanct defense budget. Defense officials have been warning for months that the Pentagon must prepare for a new era of austerity after a long period of growth that has swelled military spending to its highest level...since World War II. But as lawmakers and the White House move closer to a grand bargain that could reshape the country’s fiscal priorities, Pentagon budget planners are scrambling to keep up. Military officials said they are girding for the possibility that they will have to reduce projected spending by as much as $800 billion over the next 12 years."

Michelle Obama is working to build supermarkets in poor neighborhoods, reports Ylan Mui: "Supermarkets joined with first lady Michelle Obama on Wednesday in a pledge to build stores in poor neighborhoods that have historically lacked access to fresh groceries, part of her signature effort to combat childhood obesity. Participating retailers include Wal-Mart, the country’s largest grocer, Walgreens and Supervalu and regional supermarkets such as Brown’s Super Stores in Philadelphia and Calhoun Foods in Alabama and Tennessee. Together, they promised to open more than 500 stores that will employ tens of thousands of people...Traditionally, grocers have been wary of opening stores in low-income areas, creating food deserts in many urban and rural markets."

America isn't built for polarized parties, writes Fareed Zakaria: "Some political scientists long hoped that American parties would become more ideologically pure and coherent, like European parties. They have gotten their wish, and the result is abysmal -- and predictable. America does not have a parliamentary system in which one party takes control of all levers of power -- executive and legislative -- enacts its agenda and then goes back to the voters. Power in the United States is shared by a set of institutions with overlapping authorities. The parties have to cooperate for anything to get done. That’s why the Founding Fathers despised political parties -- Tea Party please note -- and barely tolerated even the looser notion of 'factions.'"

We need to take vocational training seriously to reduce youth unemployment, writes Dana Goldstein: "Unemployment among young people without a college degree is high, at 22.5 percent, and staggering among young people without a high school degree, at 42.7 percent....A full 18 percent of 16 to 24-year olds are considered 'disconnected youth'--neither enrolled in school nor working...Such individuals, if they are lucky enough to find work, often become mired in low-wage, service sector jobs with few employee benefits and unstable hours. There are other options, but we need public schools to do their part in guiding students toward them. This means eschewing nice-sounding 'college for all' rhetoric and instead embracing curricular reforms that introduce teenagers to all of the many opportunities available to them in the world of work."

Fun with real estate law interlude: A man buys a house valued at $330,000 for $16.

Energy

A bipartisan bill would delay the EPA's boiler rule, reports Andrew Restuccia: "A bipartisan coalition of senators introduced legislation Wednesday aimed at delaying and reworking a set of Environmental Protection Agency regulations for industrial boilers that industry groups have blasted as overly burdensome. The legislation mandates that the EPA rework the regulations over a 15-month period. EPA’s current regulations require that industrial boilers and incinerators install 'maximum achievable control technology' to reduce harmful emissions like mercury. The bill was introduced Wednesday by three Democrats and three Republicans: Sens. Susan Collins (R-Maine), Ron Wyden (D-Ore.), Lamar Alexander (R-Tenn.), Mary Landrieu (D-La.), Mark Pryor (D-Ark.) and Pat Toomey (R-Pa.)."

Obama should adopt tough car mileage rules, write Daniel Becker and James Gerstenzang: "Under standards that Mr. Obama set last year, cars and S.U.V.’s and other light trucks must reduce their greenhouse gas emissions by 5 percent a year, resulting in a 35.5 m.p.g. national average in 2016. Now, the president is deciding how much to cut emissions through 2025. He has said the reductions will range from 3 percent to 6 percent. Automakers are pushing for the weakest standard and want the president to riddle it with loopholes. Americans want much better. A survey conducted in May for the Consumer Federation of America, for instance, found that 65 percent of Americans, including 62 percent of Republicans, supported a tough mileage standard-- 60 m.p.g...It is the biggest single step the president can take against global warming -- and its benefits go beyond that."

Closing credits: Wonkbook is compiled and produced with help from Dylan Matthews and Michelle Williams.

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July 21, 2011