And if the debt ceiling isn’t raised …

November 10, 2010

Josh Barro sketches out some option if the Tea Party Republicans hold up raising the debt ceiling.

The most financially promising of those options would be to “disinvest” government trust funds that hold Treasury debt, most principally the Social Security Trust Fund. Essentially, the trust funds would redeem bonds they hold ahead of schedule, in exchange for a promise to be paid back later — and such an IOU would not count against the debt limit. Because the trust fund balances exceed $2.5 trillion, this tactic could be used to run the government for several years without hitting the debt limit. …

The 1995 Post article also provides a list of similar but smaller cash management options: borrowing from public employee retirement funds (a tactic that President Bush used when we nearly hit the debt limit in 2002 and 2003); recalling federal funds on deposit with commercial banks; borrowing from the Exchange Stabilization Fund; taking out a loan from the IMF (!); selling the government’s gold reserves. However, these options would not buy as much breathing space as raiding the trust funds.

One other option is present now that was unavailable in 1995: some sort of manipulation of the Treasury debt that the Federal Reserve has purchased in the last two years as part of quantitative easing efforts. The Fed could forgive interest payments on this debt; since the Fed ultimately gives its returns on assets back to the federal government, this would not actually cost money, though it also wouldn’t do that much to ease the government’s cash flow crunch.

More radically, the Fed could forgive principal on the bonds it holds, which is to say it could monetize the debt. This would lead to inflation, which could be a feature or a bug, depending on the quantity. But such a move would also likely enrage members of Congress and add fuel to some conservatives’ desires to rewrite the Federal Reserve Act. As such, I suspect the Fed would not endanger its independence by taking this step unless all other non-default options had been exhausted.

The last option the Post discusses is the one most frequently used by states facing cash flow crunches, and one that I would expect to be a feature of any prolonged debt limit standoff: “delaying payments to government contractors or federal employees.”

I assume none of these will be necessary, though I am also unsure exactly what the path to compromise lo0ks like. I would guess there would have to be some big budget cuts and somet solid plans to put the budget on better glide path to solvency.

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