if the government was forced to go cold turkey into balanced budget mode, it would like waking up some morning to find that 40% of all ATM machines were no longer dispensing cash or as if 40% of bank customers were unable to withdraw cash from their savings/checking accounts. This would throw the economy back into recession which paradoxically would throw the budget back into deficit due to plunging tax revenues. However, since the government would not be legally authorized to issue any new debt, it would be forced to cut more spending and/or raise more taxes until the budget was in balance again, which could lead to a downward deflationary spiral with no bottom in sight.
1. I don't think a sudden and drastic reduction in federal spending would necessarily cause bank failures. However, if that were to happen, it would indicate that the banks can only remain solvent if the federal government continues to run gigantic deficits: i.e. we are destroying the country through massive federal spending for the benefit of the banks. That's not a good policy methinks. If the banks have to fail, they have to fail. Though, as I say, I don't see that happening merely because of cuts in federal spending.
2. I agree that budget cuts would cause a recession, and this would cause tax revenues to fall, requiring further budget cuts. However, firstly, this is a good thing! Even if federal spending were reduced to the level of present tax revenues, that's still far too much spending. Secondly, it is not true that this would prompt an endless downward spiral: that's Keynesian nonsense. The recession would allow for the reallocation of resources (currently misallocated thanks to government interventions) to more highly valued uses. For example, resources might flow away from housing (currently subsidizes by the federal government) and into a more productive field. This is the cure, not the disease, though it might be unpleasant in the short term.
The debt ceiling is the wrong time and place to pick a fight. In 2012, the federal budget deficit declined by $206 billion, not from spending cuts and not from tax increases, but from economic growth.... weak and tepid as it is. All else being equal, at that pace the budget will be back in balance in 5 years. Congress should follow the Hippocratic Oath.... "First Do No Harm".
So, in other words, you favor no spending cuts at all? You think we can grow our way out of this problem? That is not the case. Debt to GDP is rising rapidly, we are accruing debt much more quickly than the economy is growing. Moreover, the federal government spending (aka misallocating/wasting) ~25% of GDP every year, and otherwise interfering with the operation of the free market is precisely what is and will continue to prevent economic growth at anywhere near the level needed to keep up with debt accumulation.
The Treasury in 2012 had to issue $7.9 trillion in new debt, that's to cover the 2012 deficit and to refinance existing debt: up from $7.5 trillion the previous year. Realize the magnitude of this: every year the federal government is borrowing more than half of GDP. If the deficits are not brought under control ASAP, there is going to to be a funding crisis at some point in the near future. At this rate, we're not going to make it five years. I'd make book on that.