Felix Salmon

Felix Salmon smackdown watch, debt prioritization edition

By Felix Salmon
October 7, 2013

On Thursday I said that the US is not going to default on its bonded debt, even if the debt ceiling is reached: “with Jack Lew (or anybody else, really) as Treasury secretary, you can be sure that debt service payments would be priority number one”.

This is not a popular view within the blogosphere, maybe because it’s generally associated with Republicans trying to say that hitting the debt ceiling wouldn’t be that bad. Both Cardiff Garcia and Dylan Matthews have come out with sterling attempts to answer the question of whether debt prioritization is even possible; Danny Vinik, for one, says that there’s “pretty good evidence to demonstrate that prioritizing debt payments is not possible”. The problem, however, as Garcia says, is that most of the primary sources you’d want to go to on a question like this “are vague and unhelpful”.

It’s worth stipulating up front that hitting the debt ceiling would be disastrous even with prioritization: Garcia calls it “breaking the economy’s knees with a fiscal crowbar”, while Paul Krugman says that it would be “a catastrophe”. But it would be much better than the truly apocalyptic state of affairs that we would see in the event of a Treasury bond default. Deutsche Bank says that in that event, the S&P 500 would fall some 45% — and, boldly, puts a 0% probability on that actually happening.

It’s also worth stipulating that before the debt ceiling is hit, a lot of very sensible politicians want to make prioritization seem as unlikely as possible, because that maximizes the incentive to avoid hitting the ceiling at all. On the other hand, after the debt ceiling is hit, the very same politicians should be willing to move heaven and earth to ensure those bond coupons get paid.

So, why is Matt Yglesias so convinced that prioritization is impossible? He gives four reasons.

The first is that prioritization is illegal: “Treasury is not authorized to unilaterally decide to pay certain bills and not others”. This is true — but also a bit irrelevant. Treasury is under unambiguous Congressional orders to pay lots of bills — all of them, in fact. If it fails to pay those bills, it will be violating the law as laid down by Congress. Hence the 14th Amendment argument that the president should simply ignore the debt ceiling entirely, if it comes to that. But underneath it all, it’s hard to credit any argument which says “Treasury isn’t allowed to pay its own bonds”. If that’s what Treasury wants to do, then surely it can do so. Besides, who would even have standing to sue?

Yglesias’s second reason is that prioritization is just not feasible: it can’t be done in the real world. Both he and Matthews cite the Treasury inspector general, who does indeed say what they say he says:

Because Congress has never provided guidance to the contrary, Treasury’s systems are designed to make each payment in the order it comes due.

It’s worth reading the whole letter, however, because the inspector general says a lot more than that. And while the systems are designed to make payments in the order they come due, they have also been designed so as to effectively insulate bond repayments from all other payments. Bond repayments are made through a system called Fedwire, while all other payments are made through the standard banking ACH system. Logistically, it’s entirely possible to keep up to date on all Fedwire payments without making any ACH payments at all.

And the inspector general was very careful to keep all options open:

Ultimately, the decision of how Treasury would have operated if the U.S. had exhausted its borrowing authority would have been made by the President in consultation with the Secretary of the Treasury.

What’s more, the inspector general does rather fudge the central issue of prioritization, which is whether debt repayments can carry a higher priority than everything else. “Treasury officials determined that there is no fair or sensible way to pick and choose among the many bills that come due every day,” he said — but that’s false on its face: prioritizing debt repayments is very sensible, since defaulting on Treasury bonds would be much more harmful than simply paying all bills as they come due, whether they’re a bond coupon or a fighter jet.

There is an argument from the left that prioritization constitutes “paying China first”, and would “require the government to cut large checks to foreign countries, and major financial institutions, before paying off its obligations to Social Security beneficiaries and other citizens owed money by the Treasury”. Well, yes. But I don’t think anybody in Treasury is swayed by such arguments: they know that in the grand scheme of things, all Social Security beneficiaries would be much better off receiving their money in arrears than they would be if Treasury defaulted on US sovereign bonds.

Yglesias then rolls out the timing argument, which is further developed by Zero Hedge: debt repayments are lumpy things, and it would be hard to “save up” enough money before the big repayments were due, if you were paying any other bills at all. Zero Hedge improbably says that “Treasury will simply halt new Bill issuance” if the debt ceiling is reached, but I don’t buy it: no one’s requiring that the national debt go down. And investors generally want to be able to roll over their short term debt: failure to be able to do so would be better than default, but not much.

Could Treasury decide to prioritize Fedwire payments, and then turn on the ACH payments sporadically, only insofar as they didn’t eat up enough cash to endanger bond repayments? I don’t see why not. Treasury wouldn’t like it, of course. And as Yglesias says in his final point, such a scheme might well be so messy that the markets would have to end up assigning some kind of credit risk to Treasury bonds anyway. Still, doing so would send a very clear message to markets, that Treasury cares about them more than it cares about the sick, the elderly, or any other recipients of government funds. And the markets, in return, would probably reward Treasury with lower interest rates on Treasury bonds. After all, in a crisis, money always flows into Treasuries — even when it’s a Treasury-bond crisis.

13 comments so far | RSS Comments RSS

Could Treasury decide to prioritize Fedwire payments, and then turn on the ACH payments sporadically, only insofar as they didn’t eat up enough cash to endanger bond repayments?

You make it sound easy, but computers aren’t people. Things that sound easy and reasonable to people aren’t always easy and reasonable for computers. A computer system that wasn’t designed to work with Fedwire only (because nobody thought that would ever be needed) may have all sorts of strange and unexpected glitches if it’s made to work with Fedwire only. Intermittently switching on the rest of the system may help, or may turn the whole thing into the worst nightmare. And the only way of finding out for sure would be to try. I’m hardly surprised that Treasury aren’t keen on trying.

And the problem with glitches is that, until a techie disentangles what happened, you might be stuck with whatever the situation is: a major database corrupted (which could screw thousands or millions of payments), payments stuck in limbo, people getting paid strange incorrect amounts. All of that might be possible. If uncertainty bothers you, the mere idea of trying to prioritize payments in a system that was never designed for that should terrify you.

Posted by Doly | Report as abusive

I just don’t see how Treasury stops paying bills in advance of an interest payment (illegally) in order to have cash on hand, _in case_ the Congress doesn’t come through.

Posted by notmsn | Report as abusive

The treasury is saying all the right things. You want the only viable option to be a deal.

I will point out that if the government were competently run then it could unquestionably arrange for the prioritization of payments with two weeks notice. It could petition the supreme court for a blessing if necessary. Bush V Gore was decided only about a month after the election… in times of crisis our judicial branch actually works pretty slick.

As disruptive as it would be I would love to see what a government where spending matched revenue looked like. I don’t dispute that the economy could not handle the stress… anyone arguing that it could can be summarily ignored. However like all bubbles or unsustainable systems the status quo will under no circumstances last. Debt to GDP can’t go to 200% as it will under present law.

Which is best, lots of pain now or even more later? Eventually government health benefits to non-workers will be limited to stabilitive / palliative care.(100billion annual savings no appreciable change in longevity / mortality statistics.) Eventually our military will need to subsist on about 100 billion more than what the entire EU spends annually. (Another 100 billion in annual savings) That alone solves much of the deficit. After that I guess you could raise even more revenue… for god sakes do it with a consumption tax though… let the poor and middle class pay SOMETHING for gods sakes.

Posted by y2kurtus | Report as abusive

If one chooses not to pay, rather than use any other alternative, one is doing so for political impact. For that reason, not paying voters is much more potent than possibly non-voting bondholders, so you would want to prioritize debt payments to pressure Congress.

Posted by MyLord | Report as abusive

If Treasury tried to prioritize payments I envision thousands of lawsuits from those that didn’t get paid on time.

Posted by ktonine | Report as abusive

Three things:

1. It’s not yet clear, how Fedwire satisfactorily buffers bond repayment. Is income one account and disbursements split between ACH and Fedwire?

2. I’d think that, as seen with 4-week bills, if effective yields creep up, we’re talking less cash available (more of the future debt is going towards repayment of bonds / bills), even if income stays the same.

3. Speaking of yield curves, I think the markets have begun to signal their expectation of another 2-year recession. All rates 2-years or shorter have gone up, while longer-term ones have gone down. Thus as I’ve started saying, a la Jerry Tarkanian: Boehner’s so mad at Obamacare, he’s going to send the US economy down a 2-year recession.

Posted by GRRR | Report as abusive

“Could Treasury decide to prioritize Fedwire payments, and then turn on the ACH payments sporadically, only insofar as they didn’t eat up enough cash to endanger bond repayments? I don’t see why not.”

That’s a remarkably easy statement for someone on the outside to make, but speaking as someone who covered federal civilian ADP — and who has a spouse who worked in federal civilian ADP for many years — the idea that Treasury would be able to improvise those procedures on the fly doesn’t even come close to passing the laugh out loud test.

Posted by PeterPrinciple | Report as abusive

How may extra days does partial default get us?
And if a party is unwilling to raise the debt ceiling prior or at that point, whatever shortterm benefit there might be of paying bondholders first is crushed by the long picture.

Posted by thispaceforsale | Report as abusive

well, haven only been in It for a few decades. I am thinking that unless the system were designed to prioritize, they mostly likely need to be changed to do that. problem there isnt any one left to do that as they all go furloughed due to the shutdown. the other issue of course is that even if they were designed with that being possible, has it been tested? and shown to work (if a feature you never use doesnt work do you even know that?). and while it might have worked as originally set up, that could have been decades ago, and many 1000′s of changes ago. and it may no longer work. and i am not sure that all of us want the pain some want to push on us. that might not work out so well, as the last time there really was a lot of pain (like back in 1930s) we just about scrapped capitalism as we practiced back then (which looks a lot like it does now. hm. and people were a lot more patient back then than now). for those who think they want the pain, you have it,. the rest of us dont want. and dont force it on us. cause the change you might get, might not be what you want

Posted by willid3 | Report as abusive

Let’s stipulate that prioritization is both technically feasible and legal. The problem is that though, on average days, the government brings in receipts in excess of outlays, payment schedules are lumpy. Look at the chart in this link and notice that interest obligations cannot be covered by cumulative cash flow at the beginning of November. On Salmon’s theory we buy no more than a couple of weeks. I also feel that a rational discussion about an event that is likely to be heavily freighted with intense emotionalism seems a bit out of touch.
http://www.businessinsider.com/chart-of- the-day-this-chart-destroys-the-debt-cei ling-truthers-2013-10

Posted by ptboy | Report as abusive

Even if we stipulate the legal and technical ability to prioritize, Salmon’s conjecture only works until Nov. 1, 2013. That’s the day cash flow falls behind the lumpy payment schedule of interest obligations.

http://www.businessinsider.com/chart-of- the-day-this-chart-destroys-the-debt-cei ling-truthers-2013-10

Posted by ptboy | Report as abusive

I’m trying to understand how prioritization, even if technically possible, will prevent a breach of the debt limit. By delaying SS benefits, wouldn’t Treasury be legally required to invest in the first month alone (this is a guess of withheld benefits + receipts) 150B extra in the SS trust fund? Since the buffer on the debt limit is currently only 25M, not only would you blow through the debt limit in SS Treasury bonds, but you’d do it really quickly. Of course, maybe this should be considered a feature, not a bug. Treasury could quickly announce that the debt limit had been breached in intragovernmental debt, and they are now legally required to resume ‘normal’ operations. Since the debt limit is no longer applicable, new debt issued as required by 31 U.S.C. § 3104(a) would again be backed by the full faith and credit of the US.

Posted by idapta | Report as abusive

“Because Congress has never provided guidance to the contrary, Treasury’s systems are designed to make each payment in the order it comes due.”

Yup, we’re on total auto-pilot. The system cannot be stopped, re-booted, intervened – its all hard-coded. Its a doomsday machine. Its a like a shark – if it stops swimming we all die.

“…speaking as someone who covered federal civilian ADP — and who has a spouse who worked in federal civilian ADP for many years — the idea that Treasury would be able to improvise those procedures on the fly doesn’t even come close to passing the laugh out loud test.”

Really? Just how close to the mainframes did they let you get, anyway? Here’s the bottom line: We’re being told not to touch the “concentrated evil” because if we do the entire world will explode. If THAT is the case then the systems group at Treasury has been run by legions of incompetents for literally decades.

Nobody, but NOBODY, engineers systems that poorly. This is classic progressive hyperbole and I discount it in it’s entirety.

Posted by HamsterHerder | Report as abusive

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