Treasury’s astonishing statement on US default

January 22, 2011
Four years ago, I started pushing back against the idea that whenever the government fails to make good on some obligation or other, that's exactly the same thing as a bond default.

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Four years ago, I started pushing back against the idea that whenever the government fails to make good on some obligation or other, that’s exactly the same thing as a bond default. Of course it isn’t: bond payments are a very special form of government obligation, involving specific sums of money to be paid in a specific manner on specific days. If you fail to make such payments, you’re in default. If a government takes money from, say, the military-salaries pot and uses it to make its bond payments, then that’s a drastic way of avoiding default. It’s a broken promise, to the servicemembers in question. But it’s not a default.

No one understands this better than Treasury. Just ask Tim Geithner himself, who was undersecretary for international affairs from 1998 to 2001, during the Asia and Russia crises. When he was dealing with sovereign defaults, there was a clear understanding that what mattered for such purposes was whether or not countries made their principal and coupon payments in full and on time. Domestic obligations, while important, were a separate issue — and in many cases the international community, led by Treasury and the IMF, would encourage countries to radically overhaul those obligations. No one at Treasury back then made the argument that such overhaul might itself be tantamount to default.

How things have changed now that the problem is domestic, rather than foreign. Neal Wolin has penned an astonishing blog entry at

Adopting a policy that payments to investors should take precedence over other U.S. legal obligations would merely be default by another name, since the world would recognize it as a failure by the U.S. to stand behind its commitments. It would therefore bring about the same catastrophic economic consequences Secretary Geithner has warned against.

Wolin really seems to be saying here that Illinois has already defaulted, since it’s late on many payments it’s legally obliged to make. And that a late Social Security check is just as bad in terms of America’s creditworthiness as a missed bond payment — even if Treasury is making all of its payments to the Social Security trust fund in a timely manner.

This is a dangerous and ill-advised rhetorical tack to take. For one thing, it’s false: the transfers made from a government to its citizens are qualitatively different from its bond payments to creditors, and if they’re missed the consequences are not nearly as catastrophic. On top of that, Wolin seems to be saying that Treasury has no particular desire to differentiate its bond obligations from any other obligations. Which, at the margin, increases the likelihood of a bond default. If bonds aren’t special — if they’re just one of many US government commitments — then bondholders should rightly worry that spending cuts might hurt them, too.

There may be some political or tactical reasons why it makes sense for Treasury to talk like this. But strategically, I fear, it could turn out to be very a big mistake indeed.


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