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Mechanics and consequences of America hitting the debt ceiling

Larry Kummer, Editor

Summary: The debt crisis deserves attention not just as a potentially serious event, but also because it illuminates many aspects of America: the flaws in our political structure, weaknesses in the GOP, and our excessively credulity. This post, the sixth in this series, looks at the crisis, and why we have difficulty seeing it clearly.

Contents

  1. Significance of this debate
  2. The SecTsy warns us
  3. An analysis of the problem
  4. How quickly will the Treasury hit the wall?
  5. Effects of hitting the debt ceiling
  6. Other posts in this series
  7. For More Information

(1)  Significance of this debate

A characteristic of Americans today is our credulity. We believe whatever our political leaders tell us. Much of the Left believes that humanity faces not just a crisis but doom, or even extinction, from climate change — no matter what the IPCC and major climate agencies say.

On the Right their authorities give them a similar mixture of fact an fiction, but perhaps are even more delusional — Rush on radio, Fox TV, National Review in print, and countless right-wing websites.  Let’s look at the one example, concerning the debt limit crisis: “The AP Misreports the Debt Ceiling“, John Hinderaker, Powerline, 14 October 2013 — He makes several valid points. But he grossly underestimates the mechanical difficulty (and hence risk) of rolling over hundreds of billions in debt without violating the debt ceiling, and his conclusion is incorrect.

Would a default on U.S. Treasury bonds be a disaster? Of course. No one denies that. But what does that have to do with spending on programs like Social Security? Social Security is not a debt obligation; and, in any event, it is discretionary spending that would be cut if the debt ceiling were reached, not entitlements.

… The Treasury says that without the ability to borrow more than the $17 trillion we already owe, the federal government won’t be able to “pay its bills.” What they mean by that is that spending will be cut: henceforward, it will have to equal revenue, just as though a balanced budget amendment had been enacted. When Democrats talk about “paying our bills,” they mean maintaining spending at ever-growing levels.

It’s a common opinion on the Right:

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For an look at the range of GOP viewpoints:

They are wrong for three reasons. First, failure to pay bills owed to vendors is a form of default. Second, failure to make payments due for social security is not a default, but would mark a milestone — decreasing people’s confidence in the government (perhaps a feature, not a bug to some conservatives). Third, there would be even larger consequences (discussed below).

Cosplay makes every crisis better!

Let’s examine what experts say about the debit ceiling, the mechanics and consequences of hitting it.

(2)  The Secretary of the Treasury warns us

Letter from Secretary of the Treasury Jacob Lew to Congress about hitting the debt ceiling:

Treasury now estimates that extraordinary measures will be exhausted no later than October 17. We estimate that, at that point, Treasury would have only approximately $30 billion to meet our country’s commitments.

This amount would be far short of net expenditures on certain days, which can be as high as $60 billion. If we have insufficient cash on hand, it would be impossible for the United States of America to meet all of its obligations for the first time in our history.

… The House of Representatives recently passed legislation that includes an ill-advised provision to prioritize payments, which would not protect the full faith and credit of the United States. Any plan to prioritize some payments over others is simply default by another name. The United States should never have to choose, for example, whether to pay Social Security to seniors, pay benefits to our veterans, or make payments to state and local jurisdictions and health care providers under Medicare and Medicaid. There is no way of knowing the damage any prioritization plan would have on our economy and financial markets.

(2) An analysis of the problem

Analysis of this by the Bipartisan Policy Center

Interest on the federal debt would likely be prioritized in either scenario – it is paid on a separate computer system {Fedwire}.

… Treasury might attempt to prioritize some types of payments over others. Prioritized payments would be made on time, others would not. This option may not be possible to implement using Treasury’s current financial systems. It would involve sorting and choosing from nearly 100 million monthly payments. {run on many different systems}

Treasury must “roll over” well over $370 b in debt that will mature this year during the Oct 18 – Nov 15 period. As one security matures, the principal and interest for that security would be paid for with cash from the issuance of a new security. In a post-X Date environment, this operation may not run as smoothly.

If the X Date arrives on October 18 (the beginning of the BPC range), the Treasury would be about $106 billion short of paying all bills owed between October 18 and November 15 (20 business days). Approximately 32% of the funds owed for the period would go unpaid.

On a day-to-day basis, handling all payments for important and popular programs (e.g., Social Security, Medicare, Medicaid, Defense, military active duty pay) will quickly become impossible.

The reality would be chaotic:

  • Many service providers unpaid
  • Unfair results, unanswered questions
  • Treasury picking winners and losers
  • Widespread uncertainty
  • Public uproar and Intense global media focus
  • Economic disruption
Bipartisan Policy Center, September 2013

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Bipartisan Policy Center, September 2013

(3)  Why not just prioritize payments?

Several computer systems run the government’s payment systems:

One valid point made by conservatives is that articles about the potential effects of hitting the debt ceiling often describe as a certainty (often with hysteria) our default on principal and interest payments. That need not happen. The Treasury could give priority to payments through Fedwire, and the 14th Amendment gives it the authority to do so.  It would be operationally difficult, with high risk of error. Also, the logic of that — paying creditors but letting grandmothers starve — might prove politically problematic, as explained by Morgan Stanley economist David Greenlaw in a July 8 report:

While it is true that the government takes in a good deal more in receipts than it pays out in interest on the debt over the course of a full year, on certain days the government takes in much less than it pays out. For example, the Treasury has an interest payment of about $30 billion due on August 15. On that day, it will take in about $15 billion in tax receipts, so it won’t even have enough to make the interest payment alone. Are the proponents of prioritization suggesting that the Treasury should withhold all of the $22 billion social security payment due on August 3, so it can cover a debt service interest payment that is due a couple of weeks later?

Further prioritization (choosing which bills to pay) is legally problematic, as explained in a report by the Inspector General of the Department of the Treasury, 24 August 2012 — Excerpt:

Treasury officials stated that Treasury also reviewed the idea of attempting to prioritize the many payments made by the federal government each day. Treasury noted that it makes more than 80 million payments per month, all of which have been authorized and appropriated by Congress.

… While Congress enacted these expenditures, it did not prioritize them, nor did it direct the President or the Treasury to pay some expenses and not pay others. As a result, Treasury officials determined that there is no fair or sensible way to pick and choose among the many bills that come due every day. Furthermore, because Congress has never provided guidance to the contrary, Tr easury’s systems are designed to make each payment in the order it comes due.

Further prioritization is also operationally problematic, as explained by Mark A. Patterson — now senior fellow at the Center for American Progress, was chief of staff at the Treasury Department from 2009 until May 2013 where he was deeply involved in the 2011 debt-ceiling negotiations — in an interview by Ezra Klein of the Washington Post.

That’s an underappreciated complication with any prioritization scheme. The U.S. government’s payment system is sprawling. It involves multiple agencies. It involves multiple interacting computer systems. And all of them are designed for only one thing: To pay all bills on time. The technological challenge of trying to adapt that to some other system would be very daunting and I suspect that if we were forced into a mode like that the results would be riddled with all kinds of errors.

(4) How quickly will the Treasury hit the wall?

Alec Phillips of Goldman Sachs, quoted by the Financial Times:

…the practical problem is that on November 1, the payments the Treasury must make are so large that the Treasury would already be nearly a week in arrears after the first day it has depleted its cash. So while this sort of strategy might be employed, the practical effect in early November would probably be indistinguishable from a decision to cease payments entirely.

(5)  Effects of hitting the debt limit

Bad in the short-term, with a recession likely from anything but a brief default. However even a brief delay in payments will stain our credit record for decades. The reputational loss might be the largest long-term result.

(a)  Business Insider quotes a October 5 research report by Goldman Sachs economists Alec Phillips and Kris Dawsey about the effects of cutting government spending after hitting the debt ceiling:

Failure to raise the debt limit would eventually lead to a sharp reduction in spending and could result in a rapid downturn in near-term economic activity. A very short delay past the October deadline — for instance, a few days — could delay the payment of some obligations already incurred and would create instability in the financial markets. As noted in prior research, this uncertainty alone could weigh on growth.But a long delay — for example, several weeks — would likely result in a government shutdown much broader than the one that started October 1.

… Using our cash flow projections as a guide, we estimate that the revenues the Treasury will receive in the month following the October 17 deadline would equal only about 65% of spending going out, implying a far greater fiscal pullback than will occur as a result of the ongoing shutdown. In essence, a prolonged delay would force the Treasury to rapidly eliminate the budget deficit to stay under the debt ceiling. (The deficit has significant seasonal fluctuations and CY Q4 is normally a higher-deficit period, offset by lower deficits or surpluses in other periods, particularly CY Q2.)

We estimate that the minimum pullback in spending that would be required to remain under the debt limit for one month without an increase would be equivalent to 1.7% of GDP (annualized). However, if the Treasury decided to set aside interest payments and make other payments in arrears, we estimate it would result in a pullback in primary (i.e., noninterest) outlays of 4.2% of GDP (annualized). In both cases, the effect on quarterly growth rates (rather than levels) could be even greater. If this were allowed to occur, it could lead to a rapid downturn in economic activity if not reversed very quickly.

(b)  “Analysis of 2011-2012 Actions Taken and Effect of Delayed Increase on Borrowing Costs“, General Accountability Office, 23 July 2012 — Consequences of the brief debt ceiling crisis in 2011:

GAO estimated that delays in raising the debt limit in 2011 led to an increase in Treasury’s borrowing costs of about $1.3 billion in fiscal year 2011. However, this does not account for the multiyear effects on increased costs for Treasury securities that will remain outstanding after fiscal year 2011.

(6)  Other posts in this series

  1. Most of what Democrats say is wrong about the Republicans’ recent actions in Congress
  2. Let’s learn from this inevitable crisis, which results from flaws in our system
  3. About the crisis: The GOP is right. So is Obama. That’s why it’s a crisis.
  4. A new political party for a New America: the Tea Party GOP
  5. Minting a trillion dollar platinum coin: the easy fake solution, so we can avoid fixing our problems

(7)  For More Information

A comprehensive analysis: “On The Debt Limit“, Bruce Bartlett, 8 October 2013

“The electoral ramifications of the shutdown are far from clear“, John Sides (Assoc Prof, Political Science), Washington Post, 14 October 2013

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