Tuesday, November 30, 2010

A Note on Government Shutdowns, the Debt Limit, Continuing Resolutions, and Appropriations

There is a misconception, unfortunately reinforced occasionally by press reports, that the failure to enact legislation to increase the federal government’s debt limit leads to a government shutdown. This is not true. Government shutdowns occur due to a failure to enact legislation granting the federal government the authority to spend money.

This confusion was reinforced by the government shutdown during the Clinton Administration when a failure to pass appropriation bills or continuing resolutions (“CRs”) occurred simultaneously with a failure to increase the debt limit, which the Treasury was bumping against.

Currently, the specter of a government shutdown looms because the federal government is operating under CR. Congress typically enacts CRs when it has failed to pass the yearly appropriation bills. CRs are usually for a limited time; the current one expires on December 3. The lame-duck Congress will have to pass another CR in order to avoid a shutdown. It is expected to pass one of short duration, but then will have to pass another one before it adjourns, unless it passes a spending bill.

In a debt limit crisis, the government continues to operate normally unless there is a concurrent lapse in spending authority. The Treasury begins to take some extraordinary actions to avoid breaching the debt limit but retaining enough cash to meet current expenditures. The fear during a debt limit crisis is that Congress or the Administration may carry the charade too far, and the Treasury will not have enough cash to make an interest payment or to make payments, such as the large Social Security payments at the beginning of each month. This has never happened.

In the past, when Treasury has reached the debt limit and Congress has not passed an increase, the Treasury has found a way to keep the government funded. For example, one of the first actions Treasury takes is to disinvest certain government trust funds (the securities in these funds count against the debt limit), such as the Exchange Stabilization Fund (“ESF”) and certain trust funds, such as the G Fund which is part of the Thrift Savings Plan (“TSP”) for government employees and invests in non-marketable Treasury securities. This frees up room to issue more securities to the market and thus raise cash.

To show how ridiculous this is, by law when the G Fund is disinvested, it is credited with the interest it would have received if it had been fully invested. The ESF, on the other hand, loses out on the interest.

In an exercise of spin, the Treasury has called such maneuvers as disinvesting the G Fund “a statutory tool” for managing a debt limit crisis. In fact, the reason for the legislation that reimburses the G Fund for missed interest due to it being disinvested during a debt limit crisis is to protect federal employees.

The first director of the TSP was Francis X. Cavanaugh, who had a long career at Treasury and had been the director of an office at Treasury which was responsible for, among other issues, managing the public debt. (I reported to Mr. Cavanaugh for about six years during the 1980s.) He knew that the Treasury would likely disinvest the G Fund during a debt limit crisis and asked Congress to pass legislation to protect federal employees when that happened.

Once Treasury has used a particular maneuver to remain solvent during a debt limit crisis, Congress knows about it and expects Treasury to use it again. Meanwhile, Treasury starts sending increasingly frantic letters to the Hill asking for an increase.

While this is all theater, and everyone knows that Congress will eventually do the right thing and pass debt limit legislation, it is not costless. There are market effects as Treasury cancels auctions and takes other actions such as suspending sales of special securities to state and local governments. Also, top Treasury officials, including the Secretary, have to spend an inordinate amount of time monitoring the level of the debt, the Treasury’s cash balance, and the daily projections of cash inflows and outflows. They also have to consider how to deal with the political problem. This time drain diverts them from dealing with real issues, because of the requirement to handle this artificial crisis.

The debt limit does not lead to a government shutdown. If the Treasury ever did run out of cash and began defaulting, all bets are off, but, as I recall Secretary Rubin saying in 1995, default is “unthinkable.”

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