Can Treasury prioritize bond payments?

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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