Defeat of Larry Summers could lead to a government shutdown

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Thewithdrawal of Larry Summers as a candidate for the Federal Reserve chairmanship is a serious setback for President Barack Obama's economic team that could lead to a government shutdown.

Recall that every top economic advisor to Obama supported Summers. This support indicated what I've described as a frightening closed-mindedness, a kind of insider cognitive cascade where everyone bright about economics supported Summers because everyone bright about economics supported Summers.

Resisting Summers was an indication, at least to Obama economics insiders, that you just weren't too bright.

But it was also indicative of a certain political tone-deafness, if not outright arrogance.

The economics team pushed hard for Summers because they believed they could get him nominated and confirmed. They underestimated the depth of opposition to Summers in their own party and in the Republican party.

In fact, I've seen no evidence that they ever developed even a slight understanding of the sources of that opposition.

Very briefly, in case there are shell-shocked members of the administration reading this, here's the case against Summers:

For liberal Democrats, Summers came across as both too hawkish on monetary policy and too pro-bank on financial regulation. He was deemed inadequately concerned with high unemployment and ill-prepared to play the role of regulatory watchdog over the financial sector.

The Republican objection was different.

Summers was considered just too close to the Obama administration. Rather than an independent central banker, Obama seemed to desire a Fed chair who would essentially be an extension of his administration. That was just not acceptable to the opposition party.

The troubling thing is that Obama is going to have to lean hard on his economic team once again in the very near future. While all the focus has lately been on the contest for the Fed chair and the possibility of slowing down the Fed's large-scale asset purchases (aka, the taper), we've quietly been heading toward another big showdown on fiscal policy.

(See also: Obama buries Summers)

First off, we've got a fight over the budget that will rapidly come to a head in the coming weeks. Congress and the president will have to agree to what's known as a "continuing resolution" to avoid a government shutdown at the end of the month.

The Republicans are divided among themselves on the budget. Conservatives in the House have been pushing for a deal that would make passing a continuing resolution contingent on delaying for one year the implementation of some aspects of Obamacare.

House majority leader John Boehner wants to pass a continuing resolution that would fund the government at levels slightly below the current sequestered levels. One of his members proposed just such a bill last week, with an end of the year budget of $986.3 billion.

The goal is to avoid a government shutdown for fear that the public would, as it has in the past, blame the Republican House majority for the impasse.

Let's say that Boehner is able to get his party in line and pass a continuing resolution. The bill would then pass to the Senate, where the Democrats control.

Liberals are already describing the spending levels proposed in the House as "intolerable." The victory against Summers' nomination is likely to embolden resistance among the liberal Democrats to a budget resolution that includes further spending cuts.

It would fall to the Obama administration to try to bring reluctant Democrats along. But after failing to convince Democrats to support Summers, it seems more likely that the White House will fail to convince them to support the Republican budget cuts. The economics team in the Obama administration just is not very good at this these days.

This is a recipe for a government shutdown.

If the Obama administration won't agree to a budget close to what the Republicans are supporting, it's unlikely that Boehner will be able to get his conservative members to drop the linkage to delaying Obamacare.

They're not going to give up both the cuts and the Obamacare delay. But if the Obama administration agrees to the cuts, he may lack support in the Senate. Which means the Obama administration will be reluctant to agree to the cuts—making a standoff followed by a shutdown all the more likely.

This is an extraordinary situation—and one that could have serious economic consequences.

The president's weakness makes something ordinarily unthinkable—opposition among Senate Democrats to a budget deal the president would agree to—a very real possibility.

That means a government shutdown that nobody wants may be the most likely outcome of the coming budget fight.

And we haven't even begun to discuss the approaching debt ceiling.

—BY CNBC's John Carney. Follow me on Twitter @Carney