Yesterday Tim Geithner sent another letter to Congressional leadership urging them to cleanly pass the debt ceiling fast.
The Treasury’s special accounting tricks will only last until August, he says, at which point he’ll lose his borrowing authority.
The nut paragraph in his letter is this one: “As I have written previously, default by the United States on its obligations would have a catastrophic economic impact that would be felt by every American. A broad range of government payments would have to be stopped, limited or delayed, including military salaries, Social Security and Medicare payments, interest on debt, unemployment benefits and tax refunds. A default on the Nation’s legal obligations would lead to sharply higher interest rates and borrowing costs, declining home values and reduced retirement savings for Americans. Default would cause a financial crisis potentially more severe than the crisis from which we are only now starting to recover.”
He added “Failure to increase the debt limit in a timely manner would threaten this position and compromise America’s creditworthiness in the eyes of the world. Every Secretary of the Treasury in the modern era, regardless of party, has strongly held this view. Given the gravity of the challenges facing the U.S. and world economies, the world’s confidence in our creditworthiness is even more critical today.”
But is the connection between failing to lift the debt ceiling and default really so clear?
Geithner says so, obviously. And for the most part, the media has taken this line, as reporters ask Republicans whether they’re willing to risk default in this debt ceiling debate.
On the other hand, the US takes a lot more in in revenue than it does in interest payments, as this chart demonstrates.
So it’s obvious that the Treasury can make good on its bond payments.
So then it’s a matter of law. Can Geithner prioritise interest payments over domestic spending.
There’s currently a law being proposed by the GOP that would mandate the Treasury pay interest payments first, but what if the didn’t get passed?
It turns out, Geithner doesn’t need a new law to prioritise interest payments.
In 1985, Bob Packwood asked the GAO this very question: can the Treasury prioritise payments in such a situation?
You can find the response here:
YOU HAVE REQUESTED OUR VIEWS ON WHETHER THE SECRETARY OF THE TREASURY HAS AUTHORITY TO DETERMINE THE ORDER IN WHICH OBLIGATIONS ARE TO BE PAID SHOULD THE CONGRESS FAIL TO RAISE THE STATUTORY LIMIT ON THE PUBLIC DEBT OR WHETHER TREASURY WOULD BE FORCED TO OPERATE ON A FIRST IN-FIRST-OUT BASIS. BECAUSE OF YOUR NEED FOR AN IMMEDIATE ANSWER, OUR CONCLUSIONS MUST, OF NECESSITY, BE TENTATIVE, BEING BASED ON THE LIMITED RESEARCH WE HAVE BEEN ABLE TO DO. IT IS OUR CONCLUSION THAT THE SECRETARY OF THE TREASURY DOES HAVE THE AUTHORITY TO CHOOSE THE ORDER IN WHICH TO PAY OBLIGATIONS OF THE UNITED STATES.
ON A DAILY BASIS THE TREASURY DEPARTMENT RECEIVES A NORMAL FLOW OF REVENUES FROM TAXES AND OTHER SOURCES. AS THEY BECOME AVAILABLE IN THE OPERATING CASH BALANCE, TREASURY MAY USE THESE FUNDS TO PAY OBLIGATIONS OF THE GOVERNMENT AND TO REISSUE EXISTING DEBT AS IT MATURES. SEE GENERALLY H.R. REPT. NO. 31, 96TH CONG., 1ST SESS. 9-10 (1979).
WE ARE AWARE OF NO STATUTE OR ANY OTHER BASIS FOR CONCLUDING THAT TREASURY IS REQUIRED TO PAY OUTSTANDING OBLIGATIONS IN THE ORDER IN WHICH THEY ARE PRESENTED FOR PAYMENT UNLESS IT CHOOSES TO DO SO. TREASURY IS FREE TO LIQUIDATE OBLIGATIONS IN ANY ORDER IT FINDS WILL BEST SERVE THE INTERESTS OF THE UNITED STATES.
Granted, this opinion was rushed, but you just have to ask: If Geithner did take these measures and avoid a default, is anyone going to complain?
If it ever got to the Supreme Court, the ruling would almost certainly be in favour of paying debt first, given the belief that a default is constitutionally forbidden.
The Treasury’s response to this would be: Well, if we started not paying domestic obligations, the market might view this as a kind of default. Frankly, this is nonsense. Not paying domestic obligations won’t cause a huge run on money market funds breaking the buck, as could easily happen in a real bank default.
California didn’t lose credit market access when it started paying out obligations in IOUs. There’s simply a world of difference between and spending and interest payment, and there’s no great reason to think a debt ceiling impasse would impact the latter. And we doubt it could ever get to the latter, since the howls of a public deprived of government spending would force politicians to resolve the situation.
There are a few complicating factors. The Treasury’s revenue isn’t even every single day, and there may be some infrastructure issues with not paying the normal bills, as they’re used to paying them up.
But — although it’s clear that the debt ceiling must and will be hiked — the idea that not doing so soon would be total Lehman-like catastrophe, is not correct.