Geithner’s odd attack on Toomey debt ceiling bill

February 8, 2011

All kinds of economic policy ideas are floating around Capitol Hill at any given moment. Very few of their congressional authors receive a direct rebuke from Team Geithner over at the Treasury Department.

So how did Sen. Pat Toomey get so lucky? Well, the Pennsylvania Republican proposed a simple legislative idea: If Congress is unable to quickly agree on a plan to raise the national debt ceiling, Treasury should prioritize U.S. debt payments so America doesn’t slip into default. (Treasury estimates that the limit will be reached between April  5 and May 31. It has already taken steps to avoid a breach and is reducing the amount of money it holds in a special account at the Federal Reserve. As of Jan. 31, the total public U.S. debt stood at $14.1 trillion, or $215 billion below the limit.) Spending would have to be sharply reduced elsewhere until an agreement was reached, one that would hopefully also include deep short-term and long-term spending cuts.

As Toomey puts it:

Certainly, no one should damage the full faith and credit of the United States. In fact, Democrats and Republicans should all agree on at least one thing: Under no circumstances is it acceptable for the U.S. government to default on its debt. Not only are we morally obligaed to honor our debts, but we benefit greatly from the nearly universal conviction that those who lend to us will always be repaid, on time and in full. We should never undermine that conviction.

Timothy Geithner is having none of it, calling the Toomey plan “unworkable” in a letter to Toomey:

In fact, the legislation would be quite harmful if enacted. A simple analogy may help illustrate the problem. A homeowner could decide to “prioritize” and continue paying monthly mortgage payments, while opting to cease paying other obligations, such as car payments, insurance premiums, student loan and credit card payments, utilities, and so forth. Although the mortgage would be paid, the damage to that homeowner’s creditworthiness would be severe.

Geithner’s right hand man, Neal Wolin, also goes after Toomey’s idea on the department’s blog:

While well-intentioned, this idea is unworkable.  It would not actually prevent default, since it would seek to protect only principal and interest payments, and not other legal obligations of the U.S., from non-payment.  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.

Here’s the problem: Geithner and Wolin are mistaken in assigning all U.S. obligations equal weight and importance. Take Social Security benefits, for instance. They’re an obligation to be sure, but the Supreme Court has ruled recipients have no legal right to receive them. And federal budget scorekeepers don’t even include money borrowed from the Social Security trust fund in their debt-to-GDP calculations. Also, back in the winter of 1995-96, a federal shutdown meant government vendors didn’t get paid. But long-term Treasury yields actually declined during that period. It borders on the ridiculous to think international investors would flee Treasury bonds because a government contractor in Virginia was not paid in a timely matter.

Treasury’s analysis, it seems, is at heart a political one — not a financial one. The Obama administration doesn’t want the debt ceiling to be used by Republicans as an effective lever to get large spending cuts. And anything which makes the perceived risk of default less likely — such as Toomey’s bill — undercuts the White House’s scary messaging.

Bondholders may actually favor Toomey’s idea, just like California bondholders are keen on how the Golden State’s constitution makes paying general obligation debt a top priority. The best option is for Republicans and Democrats to quickly agree on spending cuts as a part of a deal to raise the ceiling. And instead of having the limit be an absolute figure in the future, total debt should instead be calculated as a share of the total economy — preferably far less than the 60 percent level recommended by the IMF. That way it would be a fiscal feature rather than a budgetary bug.

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