Difficult Choices on Debt if the U.S. Hits the Ceiling

John Boehner

Some legislators have theorized that a quick breach in the debt ceiling might cause only a minor disruption to government finances. And some commentators have suggested that the United States could pass legislation to prioritize or guarantee payments to bondholders, thus erasing what they describe as the worst of the financial market reaction and removing the threat of technical default.

But experts in government finance and markets described running up against the debt ceiling as an event that might quickly precipitate a financial crisis and eventually lead to a recession — an event with far greater disruptive potential than the “fiscal cliff” package of tax increases and spending cuts, a government shutdown or even the collapse of Lehman Brothers.

A debt-ceiling crisis would be at its heart a cash-management problem. Every day the government receives millions of bills to pay, to its employees, older Americans, soldiers, bondholders and contractors, among others. Under normal circumstances, it makes payments with new revenue as well as with the proceeds from bond sales. But the country has already run out of authority to issue new debt, as of Dec. 31, and Congress has not yet raised the statutory debt ceiling, currently around $16.4 trillion.

The Treasury Department is undertaking “extraordinary measures,” like suspending the reinvestment of certain government retirement funds, to leave it with more cash on hand. But such measures buy the country only so much time, and in a matter of weeks outflows will overwhelm inflows.

That day might be Feb. 15, for instance. According to a Bipartisan Policy Center analysis, the government expects about $9 billion in revenue to arrive in its coffers that day. But it has $52 billion in committed spending on that day: $30 billion in interest payments, $6.8 billion in tax refunds, $3.5 billion in federal salaries, $2.7 billion in military pay, $2.3 billion in Medicaid and Medicare payments, $1.5 billion owed to military contractors and a smattering of other commitments.

The Treasury would be confronted with paying doctors but not soldiers, Chinese bondholders but not defense companies. Worse, it is not clear whether the Treasury secretary would have the legal latitude or even the technical ability to prioritize some payments over others. Every day the country remained in breach of the ceiling, the problems would be compounded.

The Treasury Department has shed little light on what actions it would take if the country breached the ceiling.

But there are a few clues as to how the Obama administration might react. A Treasury inspector general’s report from last year described some of the planning for the debt ceiling standoff in 2011, which caused a broad slump in the market and raised the country’s borrowing costs by about $1.3 billion in that fiscal year. “Treasury considered asset sales; imposing across-the-board payment reductions; various ways of attempting to prioritize payments; and various ways of delaying payments,” the report said.

It determined that delaying payments might be the least harmful option, but made no decisions about the best route forward. Moreover, “Treasury reached the same conclusion that other administrations had reached about these options — none of them could reasonably protect the full faith and credit of the U.S., the American economy, or individual citizens from very serious harm,” the report said.

Some Republican lawmakers have suggested giving the Treasury more guidance. For instance, Representative Daniel Webster of Florida has put forward a bill ordering the Treasury to pay obligations to bondholders, followed by troops, national security “priorities,” Social Security and then Medicare.

But organized chaos would still be chaos, analysts said. Consider again the day of Feb. 15. The country would not have enough money to pay its bondholders, let alone anyone else. Moreover, analysts have raised questions about whether the Treasury would be able to reprogram its automated payment systems to prioritize some payments over others. With bills stacking up day by day, the government would be able to make only about 60 percent of its payments over time.

Businesses and individuals would be left without expected funds from the government, and a tremendous financial crisis might ensue. “We’re the reserve currency of the entire world,” said Steve Bell of the Bipartisan Policy Center, in Washington. “There’s trillions of dollars of our debt sliced and diced into all sorts of financial instruments around the world. If you’re a 28-year-old bond trader for Nomura in Tokyo, and someone says, ‘Hey, we just heard a rumor Treasury isn’t making all its payments,’ what do you do? You panic and you sell.”

For that reason, 84 percent of the top economists surveyed by the University of Chicago’s Booth School of Business this week said the debt ceiling “periodically creates unneeded uncertainty and can potentially lead to worse fiscal outcomes” for the country.

“Deciding whether or not to pay the debts incurred to fund the previously approved tax and spending is nuts,” responded Anil K. Kashyap of the University of Chicago.

Richard H. Thaler, also of Chicago, said, “The debt ceiling is a dumb idea with no benefits and potentially catastrophic costs if ever used.”

A standoff in the debt ceiling — even a brief one, with bondholders paid on time — might also raise the country’s borrowing costs permanently. “It is not assured that the Treasury would or legally could prioritize debt service over its myriad other obligations, including Social Security payments, tax rebates and payments to contractors and employees,” Fitch, the major ratings agency, said on Tuesday. “Arrears on such obligations would not constitute a default event from a sovereign rating perspective but very likely prompt a downgrade even as debt obligations continued to be met.”

For that reason, some Republicans are shying away from using the debt ceiling as leverage — with some quietly suggesting that a forthcoming debate over the continuing spending resolution necessary to finance the government might be a better time to wrangle for budget cuts.

In an interview with The Wall Street Journal, Speaker John A. Boehner described the debt ceiling as “one point of leverage” but “not the ultimate leverage.” The White House has refused to negotiate any budget cuts as part of talks over the ceiling, and has suggested that Congress give up most its authority over the debt ceiling to begin with.

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