How Will the Debt Limit “Game of Chicken” End?
It appears that Republicans are determined to hold the nation’s credit rating hostage to their demand that federal spending be slashed before allowing the debt limit to rise. Rep. Paul Ryan, chairman of the House Budget Committee, is already warning Wall Street that a “technical default” is likely; that is, some bondholders may not get their interest payments precisely on schedule.
The Treasury continues to warn that a financial apocalypse will occur if the debt limit isn’t raised soon, but Republicans pooh-pooh such concerns as political grandstanding. They maintain that as long as the Treasury has sufficient cash flow to pay interest on the debt, then Treasury can simply put off paying its other bills for a while and default will be avoided. They point to a 1985 opinion by the U.S. General Accounting Office (now known as the Government Accountability Office), which says that the Treasury is not obligated to pay its bills in the order in which they are received and can prioritize payments. Following is the opinion, which had been requested by the chairman of the Senate Finance Committee.
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…. 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…. We are aware of no statute or 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.
Undoubtedly, there are bills that can be put off for a few weeks or longer. The Office of Management and Budget has the authority to reapportion funds within budget accounts to some extent; it can order agencies to adjust their payment schedules for various payments they plan to make. The problem is that we are getting close to the end of the fiscal year, which ends on Sept. 30. Since funds are normally apportioned on a quarterly basis, once we are in the fourth quarter of a fiscal year, OMB’s flexibility is greatly reduced, although it could apportion funds on a monthly or even weekly basis if it chooses.
Where OMB may have some important flexibility is with spending for some Department of Defense projects that have multi-year appropriations. For example, if DoD is building an aircraft carrier the funds need to be appropriated for the entire project even though it may take several fiscal years to complete. OMB apportions the funds as needed to pay for various phases of the building. There is about $800 billion of future year appropriations in the budget. Assuming these funds are spent at an even rate throughout the year, there may be $200 billion or so of appropriations that can be shifted into fiscal year 2012 that may provide Treasury with flexibility to manage its cash.
The real problem is Social Security. It’s unthinkable that Treasury would fail to make Social Security payments on schedule; too many of the elderly live from hand-to-mouth on them and there’s no way Republicans would risk their wrath. But Treasury is inevitably going to be forced at some point to choose between paying Social Security benefits or making interest payments and may face an untenable situation. A May 17 report from investment bank Morgan Stanley explains the dilemma Treasury will face:
Some have argued that the Treasury can manage its cash in a way that avoids default…. However, the approach they are advocating does not seem workable to us. Treasury’s cash flows are too lumpy to simply prioritize one form of spending over another. For example, we would expect a significant political outburst if the Treasury withheld monthly Social Security checks at the beginning of the month (even though there was sufficient cash on hand to make the payments) just in case they needed the cash to make debt service payments at mid-month. Such a scenario is highly impractical – and probably not even legal.
When Treasury faced this problem back in March 1996, it told Congress that it could not make Social Security payments unless Congress passed a law specifically exempting such payments from the debt limit. Congress acted instantly. It will undoubtedly be forced to do so again if the debt fight is protracted, which it probably will be.
House Speak John Boehner and Majority Leader Eric Cantor have repeatedly said that massive cuts in Medicare are their price for allowing a debt limit increase. But the only plan Republicans have on the table is one that would effectively abolish Medicare and replace it with a voucher intentionally designed to pay less than the per-beneficiary cost of Medicare, which is how its costs would be cut. However, there is little public support for the Republican plan and as Democrats make people more aware of it, support will undoubtedly fall further.
The Republican strategy seems to be to ram their Medicare abolition plan into law within the next two months – Treasury says the ‘drop-dead” date for raising the debt limit is August 2 – before people learn what they are really doing to Medicare. But President Obama clearly has some strong cards to play – especially the real threat that Social Security benefits may not be paid if Republicans insist that interest payments to bondholders take precedence. Budget expert Stan Collender thinks the Democrats are holding a stronger hand and that the Republicans will blink first. We shall see.
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Sorry, Bruce, the WSJ is already pitching SocSec withholding
Remember, the entire discussion--including from Pete Davis--has been about avoiding "technical default." English translation: pay the bondholders, **** everyone else.
Very interesting post
Many thanks for providing all this information, and your analysis, in a single post. I definitely agree with you re Social Security versus Defence. I am not quite so sure about Medicare, in significant part because when the program started, in 1966 or so, and made the Medicare start dare age 65, I think average life expectancy was 74 at the time, making it a "9 year" program. I don't know life expectancy now but would bet money it's over 83.
There's been upward creep [bizarre term] in llfe expectation; there are hundreds of excellent technologies that have been developed because of Medicare. At the same time, costs have Galloped Forward. As Helen Darling of NBGH puts it [and various data sources show] "American workers have been giving their wage increases to the health care industry for years."
Re: Very Interesting Post
A couple things:
Google tells me that the NIH pegs our current life expectancy at 78 years, so its only a four year increase. Also, a lot of that increase is because of a reduction in deaths among younger people. The best way to look at it is "what is the increase in life expectancy among people who are already 65?"
I don't know the answer, but I suspect its even less than four years.
if-then
"Budget expert Stan Collender thinks the Democrats are holding a stronger hand"
Inarguably. Their ideas are more popular, they aren't the party that created the debt problem in the '00s to begin with, they control the Senate and executive.
"and that the Republicans will blink first."
That assumes that Republicans are rational actors. That's... a debatable proposition.
Priorities for payment
I'm assuming that congressional salaries will have a really low priority.
I hope the Dems are successful
I hope the Dems are successful at getting the Republicans to blink, but I am not confident. Why should I be? A massive downturn in the economy, a whole lot of people out of work, and our central debate is about whether or not to destroy Medicare in exchange for more massive tax cuts for the wealthy--something seems wrong with this to me. Is this really a wise, or fair, plan?
What gets cut
The real problem is Social Security. It’s unthinkable that Treasury would fail to make Social Security payments on schedule; too many of the elderly live from hand-to-mouth on them and there’s no way Republicans would risk their wrath
Social Security is covered by its dedicated payroll tax. That's the last thing that will be cut.
A look at how the govt spends its money shows that after interest and SS are paid, the big cuts will have to eviscerate health care (from Mediare on) and defense combined, pretty much wipe them out.
If the Republicans want to take credit for that then Obama and the Democrats should be very glad to let them.
It seems like there is no party in DC that knows the meaning of the word "overreach". Every two years, back and forth we go.
Payments on government bonds
Payments on government bonds have to take priority, under Section 4 of the 14th Amendment (public debt may not be questioned). You're probably right about exempting Social Security.
the Democrats are holding a stronger hand and that the Republicans will blink first
The Democrats have the stronger hand, but they have a history of blinking instead of playing it.
Not paying US obligations unconstutional
U.S. Supreme Court
Perry v. United States, 294 U.S. 330 (1935)
Syllabus
5. By virtue of the power to borrow money "on the credit of the United States," Congress is authorized to pledge that credit as assurance of payment as stipulated -- as the highest assurance the Government can give -- its plighted faith. To say that Congress may withdraw or ignore that pledge is to assume that the Constitution contemplates a vain promise, a pledge having no other sanction than the pleasure and convenience of the pledgor. P. 294 U. S. 351.
6. When the United States, with constitutional authority, makes contracts, it has rights and incurs responsibilities similar to those of individuals who are parties to such instruments. P. 294 U. S. 352.
11. Section 4 of the Fourteenth Amendment, declaring that "The validity of the public debt of the United States, authorized by law, . . . shall not be questioned," is confirmatory of a fundamental principle, applying as well to bonds issued after, as to those issued before, the adoption of the Amendment, and the expression "validity of the public debt " embraces whatever concerns the integrity of the public obligations. P. 294 U. S. 354.
comparing with recent history
This situation brings to mind the last two major "hostage" situations - the Bush tax cuts and this year's budget debate. In the first case, I can only surmise that Obama didn't really want to increase taxes on people above $250,000, at least not as much as he wanted some more stimulus. Which kind of makes sense, if he's trying to get swing voters to vote for him, even though it's probably somewhat bad for the long-term fiscal outlook. In the second case, my current understanding is that while significant numbers were attached to the budget cuts, the effective cuts are very minor, in that a lot of the cuts amounted to rescinding spending authority that was already going unused, such as a legal victim compensation funds, and food stamps (since food inflation was lower than expected). I score that as more of a win for the White House.
In the present case, the White House has no interest in going along with "right wing social engineering" as Newt Gingrich so nicely put it, and he knows that the major GOP donors will scream bloody murder if default happens on Boehner's watch. So the GOP can't pull the trigger without shooting themselves in the head. Thus, Obama has no need to make any concessions he doesn't want to make anyway. The issue that seems to be making some Democrats nervous is the sense that Obama doesn't share the same priorities. To them I'd say, there is some truth to that, but only up to a point. Obama doesn't want to throw the baby out with the bathwater, he just wants to keep his job. From that perspective, I think Obama's actions are quite predictable....
Enforce Defense Cuts
Who is strapped for cash?
Instead of letting the F-35 repeat second semester freshman year for the eighth year in a row, kill it. The F-22 and B-2 should be mothballed too expensive for no utility. Figure out why the Air Force passes a billion pounds of 'gas' in the air each for airplanes fighting insurgents from 40,000'. Need better ways to run perpetual occupying wars. Stop delivering cabbage by air.
Same for Super carriers, and Amphib ready groups. The 17 largest fleets in the world. Put off building new missile subs. Stop making up need for new classes of ships: littoral combat what is that, new destroyers what is the hurry?
About half the Army Brigades and Marine regiments should be retired.
The US spends 49% of the entire world's war budgets, and several times the percent of outlays as any developed country.
End the corporate welfare and stop the unwarranted influence.
GAO says the 10 Combatant Commands don't have (most done care much or have the time/interest to assign personnel) a say in what DoD buys, often because they don't have the 'needs' to keep the weapons acquisition schemes running.
Part D
Your analysis of the lumpiness of Treasury cash flows makes sense. The concept that Treasury could finely tune and categorize which bills to pay and which not is pretty ridiculous. There are too many, going through too many agencies and authorities, and they don't line up neatly into categories as in a small business the way I would surmise that many Republicans mentally picture them.
What I would be interested in hearing from the Republicans is why they want to end Medicare entirely, having only recently vandalized our fiscal position by ramming through the creation of Part D? Why not make a down-payment on our fiscal diet by admitting it was a catastrophic, expensive, and cynical program from the get-go, and simply abolish it? If Republicans want "a price" for their assent on the debt limit, why don't the Dems state this as one of the prices of theirs? These Republican rectitude-preachers manque should be forced to acknowledge and clean up their own mess before being let loose on bigger problems.
Amen! Part D was an obvious
Amen! Part D was an obvious pandering to the elderly, who vote religiously. But we now know that republicans have no loyalty to them at all. The only loyalty I see among them is to the mega wealthy of the nation.
Technical default is not what we think
The Federal Government owes about $10 trillion and is increasing that balance by more than $1 trillion every year. But the annual flow of funds is approaching $100 trillion. This includes Social Security payments, tax receipts, and debt servicing. The mechanics of this huge flow of funds is what allows Treasury to postpone the effective impact of the debt ceiling but it increases the risk that the mechanics can break down. Some bills, notes and bonds are always maturing and they are generally replaced with new bills, notes or bonds. For thirty years, interest rates have been declining so the Federal government has had an incentive to let these rollovers build and compound. But a default, even a technical default, will pour sand into these gears with unknown consequences to the operation of the Treasury and our Federal Government. Then there are the credit markets which have been estimated to exceed $600 trillion. They will also have sand in their gears. Some in the financial sector will have hedges that do very well but I can't think of anyone else that can benefit from a breakdown of this system.
New issues only?
Here's a naive question that came to me after I thought about Ryman's post for a little while. Treasury finances the payments by a combination of issuing new bills and bonds at auction and rolling over old debt that matures. The latter happens on a really big scale. Does hitting the debt ceiling mean that only new issues are forbidden, or does it also affect the rollovers?
Either way seems bad. If it freezes all auctions we're duck soup in a hurry. But even if it only stops new issues we obviously can't keep up with the bills. And even more, we're financing such a huge deficit right now that the new issues have to be integral to the financial markets. Stopping them would not only curtail income for the firms involved, but in terms of what happens as a result of these issues, wouldn't stopping them be pretty contractionary, as in cutting expansion of the money supply? That couldn't be good.
I have to suppose somebody's thinking it'll all be made right on the back end when we play catch-up, but what happens in the meantime? Not comforting to think about.
I really wish these people could think about more than stupid grandstanding. Maybe tonight's results in NY-26 can take some of the wind out of their sails. On the other hand, who could disagree that the Dems have an abysmal record on playing strong hands?
Everybody knows politics ain't beanbags, but whatever game these guys are playing, it'll massacre too many bystanders to allow it to go on much longer.