Friday, April 29, 2011

Emil Henry’s WSJ Article on the Debt Limit

In yesterday's (April 28) Wall Street Journal, there is an article by Emil W. Henry, Jr. in the opinion pages with the headline "The Debt Ceiling: Myths and Facts" (subscription required). Mr. Henry was Treasury Assistant Secretary for Financial Markets from 2005 to 2007 and was involved in convincing the Congress in 2006 to raise the debt limit. Consequently, one might assume he writes with some knowledge and authority on this subject. His article, though, is disappointing. (I do not know and have never met Emil Henry. I had left the Domestic Finance section of Treasury before he arrived.)

The first "myth" Henry attacks is that "the Treasury is certain that there will be wrenching dislocations in the capital markets if the ceiling is not raised." In his debunking of this, Henry states that "in fact, there is no secret Treasury analysis suggesting the world will collapse." While there may be no written analysis or study, the Treasury has always maintained that it would be catastrophic for it to default. Henry argues that default would not happen if the debt ceiling is not raised, since all Treasury has to do is lower expenditures. As discussed below, it's more complicated than that.

Moreover, Henry argues that not raising the debt limit would be a good thing. He writes: "The real disruption would result from the sudden drop in federal spending and its significant impact on economic activity. But that would be partly offset by a stronger dollar, a healthier balance sheet, and the removal of the uncertainty which clouds our markets today. Near-term economic dislocation might be the painful medicine necessary for long-term health." This argument is truly remarkable. Does Henry really believe that demonstrating that the U.S. is incapable of governing itself is a good way to reassure private market participants or foreign central banks, for that matter?

His second myth is that the Treasury will raid pension funds to avoid exceeding the debt limit. Mr. Henry is correct that the funds for civil servants do not lose money by being disinvested. He does not mention, though, that the Exchange Stabilization Fund, which has in the past also been disinvested, does lose interest income, though of course this is not a pension fund and no one much cares except those at Treasury responsible for managing this fund. (The ESF is used for foreign currency intervention and has also been used to make an emergency loan Mexico and to provide a guarantee for existing money market mutual fund investments during the 2008 financial crisis.)

His third myth is that "the government will default on Treasury obligations if the ceiling is not raised." In debunking this "myth," Henry argues that "hitting the ceiling means we can spend only what we collect in taxes." As a former Treasury official, Henry has to know that it is not that simple. Receipts and outlays do not occur at the same time. For example, outlays are concentrated at the beginning of the month, particularly because Social Security payments are made at the beginning of each month. Certain months have large interest payments on the 15th (or the next business day if the 15th is not one). Tax receipts tend to come during the last half of any given month. April has some peculiarities because of the personal income tax deadline. (I wrote about this in a previous post.) The operational and legal issues surrounding not making or delaying payments when Treasury does have cash on hand in order to make an interest payment are formidable. Also, how does Treasury decide to do this without making an assumption that Congress will not increase the debt limit before an announced "drop-dead" date?

One issue, of course, is that it is sometimes not clear when the drop dead date is. This is easier to ascertain when a temporary increase in the debt limit expires, since in that case Treasury would not have the authority to refinance maturing debt. This puts more pressure on Congress to act. However, with daily cash projections that Treasury makes not being entirely accurate and with Treasury able to roll over maturing debt and to use some accounting tricks (such as the ones Henry mentions), there can be some uncertainty about the exact day Treasury will run out of cash and have no room under the debt limit to borrow more. Moreover, Henry's proposal that Congress "pass legislation requiring the government to honor interest payments before any other expense" has operational difficulties, as well as political ones. For example, what politician wants to tell Social Security recipients that they will not be receiving any checks because Congress has not passed the debt limit and Treasury wants to make sure it has enough cash on hand to make a large interest payment in a couple of weeks?

At the end of the article, Henry bemoans the fact that Congress will raise the debt limit. He argues: "Not raising the current ceiling would please our creditors who, like all lenders, care simply that they be paid timely interest and principal. Leaving the ceiling in place and restricting further debt would, in the long run, make that more likely."

In short, this article is irresponsible coming from a former Treasury official who should know better. One has to wonder whether some part of the motivation to write this article is due to political aspirations. (He reportedly considered running for governor of New York at one time.) Whatever the motivation, the political passions surrounding the debt limit does seem to motivate some people to say crazy things.

As I have noted before, it is perfectly legitimate to have an impassioned argument about the size and role of government. The debt limit legislation, though, is not the appropriate vehicle. The need to increase the debt limit is the result of past legislative decisions Congress has made on taxation and spending. If some or most in Congress wants to change those decisions going forward, the appropriate legislative vehicles include appropriation and tax bills, not the debt limit. 

Update:  On May 4, The Wall Street Journal published a letter I wrote commenting on Emil Henry's article.  (I'm not sure how long the link will work.)  


  1. What are the likely consequences, in your view, of not raising the debt limit?

  2. Mr. Carleton, you can see the article in full for any newspaper, even with firewalls. Just put the title of the article into the google search box. Blamo, read IN FULL. At least it always works for me, for NYT, WSJ.

    Keep up the good work.