Can Treasury prioritize bond payments?

By Felix Salmon
July 29, 2011

One of the more curious pieces of rhetoric in this whole debt-ceiling debate is coming from Treasury, which has a vested interest in making failure to raise the debt ceiling sound as bad as it possibly can. To that end, it’s trying as hard as it can to get people to believe that if the debt ceiling isn’t raised, it’ll end up defaulting on Treasury bonds. Here’s Binyamin Appelbaum:

Officials have said repeatedly that Treasury does not have the legal authority to pay bills based on political, moral or economic considerations. It cannot, for instance, set aside invoices from weapons companies to preserve money for children’s programs.

The implication is that the government will need to pay bills in the order that they come due. President Obama has warned as a result that the government “cannot guarantee” payments of Social Security benefits or other popular programs. Officials also have disputed the assertion of some Republicans that the government could prioritize interest payments.

This is scary — it raises the unthinkable spectre of a payment default on America’s bonded debt. Maybe that’s exactly what Treasury wants: a mini-crash in the bond market could be just the thing to concentrate minds in Congress and impress upon them just how important this issue is. But is it actually true? Does Treasury really have no legal authority to prioritize payments?

Appelbaum pointed me to this report from the Congressional Research Service for some background on the law here. And although it all gets very murky very quickly, that’s largely the fault of Treasury, which seems to be doing its best to muddy the waters:

Treasury officials have maintained that the department lacks formal legal authority to establish priorities to pay obligations, asserting, in effect, that each law obligating funds and authorizing expenditures stands on an equal footing. In other words, Treasury would have to make payments on obligations as they come due…

In contrast to this view, GAO wrote to then-Chairman Bob Packwood of the Senate Finance Committee in 1985 that it was aware of no requirement that Treasury must pay outstanding obligations in the order in which they are received. GAO concluded that “Treasury is free to liquidate obligations in any order it finds will best serve the interests of the United States.”…

While the positions of Treasury and GAO may appear at first glance to differ, closer analysis suggests that they merely offer two different interpretations of Congress’s silence with respect to a prioritization system for paying obligations. On one hand, GAO’s 1985 opinion posits that Congress’s legislative silence simply leaves the determination of payment prioritization to the discretion of the Treasury Department. Conversely, Treasury appears to assert that the lack of specific legislative direction from Congress operates as a legal barrier, effectively preventing it from establishing a prioritization system.

“Appears to assert” is right. A lot of this asserting is taking place on background: Treasury will talk a lot about the legality or otherwise of prioritizing payments if it’s off the record, but try to shine some daylight onto those arguments and they tend to scurry into the shadows. Check out how carefully Tim Geithner chooses his words here:

The idea of “prioritization” has been rejected by every President and Secretary of the Treasury who have considered it. It is unwise, unworkable, unacceptably risky, and unfair to the American people. There is no alternative to enactment of a timely increase in the debt limit.

All of this is absolutely true. But note the word conspicuous by its absence here: “unlawful”. When pressed, Treasury will say that prioritizing debt repayments is unwise — but will stop short of saying that they’re not allowed to do that.

And insofar as Treasury’s legal argument has any basis at all, it seems to be based on the absence of any explicit instructions from Congress with regard to what should be prioritized. Yet Treasury is the agency saying most vocally that it doesn’t want Congress to pass any such law.

If push comes to shove and the debt ceiling isn’t raised, then, my base-case scenario is that the government will continue to pay all of its debts. Either the president will invoke the 14th Amendment, or else the Fed will discover some way of extending an overdraft facility to the government in a form which doesn’t constitute outright debt, or else the executive branch will find some other way of ensuring that the government meets all its obligations — not just Treasury bonds, but everything else as well. After all, Treasury has repeatedly said that any kind of failure to pay an obligation constitutes an event of default — it’s not just bond coupons which matter. Here’s Geithner again, in his letter to Jim DeMint:

Your letter is based on an untested and unacceptably risky assumption: that if the United States were to continue to pay interest on its debt — yet failed to pay legally required obligations to its citizens, servicemen and women, and businesses — there would be no adverse market reaction and no damage to the full faith and credit of the United States. Again, this idea is starkly at odds with the judgment of every previous Administration, regardless of party, that has faced debt limit impasses.

A payment default on Treasury bonds would be much worse than a DeMint-style default on non-bonded obligations, but even a DeMint-style default would be extremely bad. And in a sense it doesn’t even matter what the market thinks about the full faith and credit of the United States under that scenario; there would be a huge sell-off just on the grounds that the US was about to enter a brutal recession. Here’s an idea of what would have to get cut, completely: it includes things like military duty active pay, federal salaries, and schools.

How long would the Tea Party types in Congress hold out in the face of soldiers going without pay, not to mention themselves and their staffers? WIth any luck, not too long. But at that point it would be too late: the US would be a laughingstock in the eyes of the world, and it would be incredibly difficult for international investors to take us seriously.

Still, DeMint-style prioritization is Plan B, here. If Treasury does end up cutting spending by 40% or so in order to stay below the debt ceiling, then it would surely prioritize payments, making sure that Congressional salaries were at the very bottom of the list.

As Treasury’s stated idea that it would simply pay bills as they came due, on a pari passu basis, and then stop paying when it ran out of money, it’s simply unthinkable. Treasury bonds and bills will get paid — they have to be. The bond markets know that, which is why they’re still pretty sanguine about this whole debt-ceiling issue.

This is one of those cases where you’re much better off listening to what officials say on the record than you are listening to what they say off the record. Treasury’s off-the-record briefings on the debt-ceiling issue are designed to be as scary as possible. But there’s no way they’ll actually follow through and default on the country’s sovereign debt.

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Comments
12 comments so far

Treasury: We don’t have a law that allows us to prioritize payments.
GAO: Treasury doesn’t have a law that restricts it from prioritizing payments.

Posted by GRRR | Report as abusive

Thanks for this. I’d been wondering why you were so sanguine that Treasury would actually prioritize debt service, despite all their posturing about pari passu obligations. This post explains your view neatly and convincingly.

Still, this interpretation leaves me with a few questions:
1. How will Treasury operationalize a prioritization scheme? Will they announce a detailed plan today, or will it be vague and mushy? If it’s the latter, does that mean they haven’t yet sorted out the details, or merely that they’re unwilling to publicize them?
2. Given the state of the recovery and that any achievable debt ceiling deal seems tied to serious and immediate spending cuts, is it conceivable that the economy is better off without a deal? Maybe so, if Treasury & the Fed can convince themselves that it’s legal and desirable to come up with some scheme to make good on all payment obligations without the debt ceiling being raised. Of course, that’s a big If–and one we won’t know the answer to until & unless Treasury’s hand is forced.

Posted by Sandrew | Report as abusive

I doubt the fed (or in more general terms, the government) has _systems_ to prioritize payment.

There seems this assumption that bureaucracies, and computers, can think on their feet. Neither really has that ability.

Posted by jpersonna | Report as abusive

There is a glitch in the post: you appear to have intended to block-quote the paragraph beginning “Your letter is based …” but instead quoted the following paragraph beginning “A payment default …”, which I take to be your own writing.

Posted by Greycap | Report as abusive

What happens if there’s a natural disaster, like a hurricane or earthquake? Or wildfires? What if we get more than one natural disaster this summer?

What if we get hit by another terrorist attack?

Where’s the money going to come from to handle such events? Is Treasury going to keep paying China while Americans die and remain homeless in such a scenario?

Prioritizing payments is fraught with very many risks and roadblocks.

I’m convinced that if that’s where we’re going in this crisis, then the credit ratings agencies will see it similarly, and will hit America’s AAA very hard – down enough notches to truly endanger investor confidence even in short-term Treasuries.

Posted by NukerDoggie | Report as abusive

I don’t think they’ll physically be able to prioritize payments any more than they’ll be able to halt any of the thousands of payments that get payed automatically.

From one of Felix’s posts earlier this month, “purely as a practical matter, it’s far from clear that it’s even possible to stop making the 3 million payments that Treasury makes automatically every day. Doing so involves a massive computer-reprogramming effort which I’m sure could not be implemented overnight”

http://blogs.reuters.com/felix-salmon/20 11/07/07/what-happens-on-august-3/

Posted by tom_o | Report as abusive

@jpersonna, exactly right. Although it is entirely possible to do “by hand” what was once done on paper, the people who used to implement those actions are no longer around. Now that nearly everything is electronic and computerized, asking anyone to do most ANYTHING in their heads is laughable.

Reprogramming the system means the system will be stymied. People will have to think on their feet. (I see deer in the headlights looks galore) The people who can do that kind of programming are hard to find and it could be months before a system is in place. (which may be why there is no plan B… why reprogram for temporary payments when there isn’t even a budget in place?)

Posted by hsvkitty | Report as abusive

Worldwide the US is being made to look an ass (the equine variety, although if the cap fits…) from this idiotic self-righteous sour grapes of the ultra right wing Republicans.

If Military spending hadn’t doubled all that time ago, there really wouldn’t be a deficit problem now. Who spent that money? Republicans. Who benefitted from that money? Republicans. Who do Republicans care about? Republicans.

People used to worry about the political influence the Communist Party had over the Chinese economy; now we worry about the political influence the Republican Party has over the US economy. From over here, it looks like the laissez faire Communists are better at running an economy than the partisan Republicans.

Posted by FifthDecade | Report as abusive

My question, and I’m hoping someone can answer it, is prioritization of payments Constitutional? The executive branch has the power to faithfully execute laws… but if it is left up to the Treasury or the President to decide what bills get paid and what bills do not, is that not essentially picking and choosing which laws are being executed and essentially forcing the President to make his own budget based on tax revenue being brought in? And thereby bypassing the budget making process?

Furthermore, if it does actually come to pass and its left up to the President to decide what bills get paid, is that not a terrible precedent to set? Who is to say that a future President can use this event to decide what he wants to pay for, regardless of the budget passed by Congress.

It seems to me that the President is bound to execute the last budget resolution passed by Congress. No prioritization, just pay the bills as they come in and when the money runs out, it runs out… the government will then shut down and default. Constitutionally speaking it would be left to Congress to come up with a new budget that will allow the government to operate under the debt ceiling based on revenue brought in. God help us all if that happens.

I am not a constitutional law expert by any means… but I don’t see how the President choosing what to spend can be seen as constitutional, especially considering Clinton v. New York City, where the SCOTUS declared the line item veto unconstitutional. This would be essentially a budgetary line item veto.

Posted by doc19 | Report as abusive

doc19, I have the same question. At the heart of the matter is this: there is no constitutional authority that allows Tim Geithner to decide who the U.S. will pay. In fact, there isn’t one that allows the President this power. All of the debt of this country is equal with regards to its need to be repaid.

@hsvkitty, in a theoretical world, it’s possible to do by hand what is now done by computer. In our real world, it’s no longer possible. It’s been at least two decades since both the volume and speed of the computer processing used by Treasury’s FMS exceeded the capability of an equivalent all-human system.

Posted by lauradeen | Report as abusive

@Greycap — Thanks, fixed

Posted by FelixSalmon | Report as abusive

“It’s been at least two decades since both the volume and speed of the computer processing used by Treasury’s FMS exceeded the capability of an equivalent all-human system.”

It is a very weak system if they can’t already differentiate between categories of payments. Would take huge amounts of reprogramming to do anything complicated, but it shouldn’t be impossible to simply halt all Medicare reimbursements, or all contractor payments, or something like that.

No?

Posted by TFF | Report as abusive
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