Tuesday, August 2, 2011

The Debt Limit – What if there had been no agreement?

While most private analysts who follow Treasury's cash position did not believe that tomorrow was the day everything would have fallen apart if the debt limit had not passed, at some point there would have been a major problem with Treasury either having run out of cash or close to it. The Administration is very unlikely to say what its contingency plans or options were.

It is interesting that there is some dispute about what Vice President Biden said to congressmen recently about the 14th Amendment. According to some press reports, such as the one on the Los Angeles Times website, "Rep. Peter DeFazio (D-Ore.) told reporters that Biden said President Obama 'was willing to invoke the 14th Amendment' if the parties could not reach a debt deal by Tuesday's deadline." However, a CNN blog post about this meeting, says: "The Vice President said the 14th amendment was NOT an option for the President."

There were other ideas floating around. The most amusing, and clever, idea was to use a little known provision of law which apparently allows Treasury to reap unlimited amount of seignorage by minting platinum coins. Jack M. Balkin, a Yale law school professor, argued that this would be a legal way to keep the government funded if the debt limit were not increased in an article on the CNN website. Brad Delong, a former Treasury Deputy Assistant Secretary for Economic Policy during the Clinton Administration and now an economics professor at the U.C. Berkeley, seemed to like the idea, and somebody even posted a hilarious design for this potential coin.

Perhaps Treasury would have started prioritizing payments, starting on August 3, even though its legal authority to do this is questionable. This would have served to make sure that there was enough cash to make the August 15 interest payment, and it would have put pressure on Congress to resolve the issue as they heard from the many people affected by this.

It's worth pointing out, though, that, if Treasury had withheld Social Security payments, it would have been criticized for going beyond its authority. When Social Security payments are made, non-marketable Treasury securities in the trust fund are redeemed. This serves to lower the debt subject to limit, which would allow Treasury to borrow the necessary amount of money by issuing marketable securities. Apparently, some Treasury officials have questioned the practicality of this because they are not sure they can redeem securities before benefit payments are made. It seems likely, though, that, if all the transactions took place on the same day, which admittedly would be expensive for Treasury, no one would raise a serious objection. There may also be other provisions in the law governing Social Security trust funds which would allow some timing gap between the redemption of securities and payments if necessary to ensure that payments go out.

As for the general problem of Treasury running out of cash, there would have been no good options, and that is why the Administration had to keep the pressure on to get the issue resolved. Even if Congressional leaders suspected that the August 2 deadline might not be entirely real, they wanted this to end too. But it seems that Congress thinks playing with the debt politically is so much fun that they will not entertain putting an end to this by tying the size of the debt to whatever is necessary given their spending and tax decisions and economic conditions affecting expenditures and receipts.

If the debt limit had not passed before the measures already taken were not sufficient to prevent Treasury from running out of cash, no one really knows what the Treasury would have done, perhaps not even the relevant Treasury officials and the President. The fixed income markets clearly did not believe there would be a default on the debt. They most certainly agreed with Brad Delong who wrote that "default was never in the cards, at least not with lawyers at the president's disposal 10% as inventive as those who claim that we are not engaged in 'hostilities' in Libya." But no one knows for sure what would have happened, and the risk was not worth taking. That is why there was eventually an agreement, bad as it is.

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