Continuing wills for the United States?

July 28, 2011

The theatrics in Congress concerning the debt ceiling, now in their seventh month, have sent increasingly strong shock waves throughout the U.S. and global financial systems. The debt ceiling is the legislatively-imposed limit for the nation to issue debt to fund its activities. It’s been stalled at the same level of $14.3 trillion since May 16. The U.S. Treasury has been scrambling to find extra monies, including borrowing internally from the federal government workers’ pension plans, so that they can continue to pay the nation’s obligations. They say the cash drawer is near empty.

The United States borrows or issues debt for 40 cents of every dollar that it spends — that is a lot to borrow. The federal government turns around and distributes this borrowed money, along with taxes collected, to Social Security and Medicare beneficiaries, states and local governments and defense contractors. It also returns some of it to bond holders as interest payments. The federal government is so massive that this flow of payments equals about 24% of the gross national product. If this flow stops, substantial parts of the economy will stop.

Organizations that oversee, or participate in, the financial system are rightly concerned. One positive benefit of these long, drawn-out Congressional deliberations is that there is time for extensive planning and analysis. Credit rating agencies have particularly been concerned with the downstream effect on state and local governments. Today Moody’s issued a press release that affirmed the strong AAA rating of 400 local governments while saying it would review the AAA rating of 162 other local governments (emphasis mine):

The review for possible downgrade affects 162 Aaa-rated local governments and $63 billion of debt. Factors weighing on specific credits include high federal employment and exposure to capital markets disruptions.

The 162 local governments include 66 cities, 53 counties, 29 school districts and 14 special tax districts. The local governments are located in 31 states, with the heaviest concentrations in Virginia (15 credits) and Massachusetts (14 credits).

Moody’s is creating a map of the effects of a downgrade of the U.S. government. They’ve identified their main concern as areas where there are heavy concentrations of federal employment.

Similarly, the Federal Reserve and other bank regulators are preparing instructions for financial institutions in the event that the U.S. Treasury halts payments. Reuters reports:

The Office of the Comptroller of the Currency said it plans to advise the national banks it regulates that when assessing customer overdrafts, they should consider whether a customer failed to receive a government check due to the debt ceiling impasse. The Fed could be expected to follow suit.

In a sense the OCC would be recommending to the national banks that it regulates that they should provide some “float” to customers who have insufficient funds in their bank accounts because they didn’t receive their entitlement checks. This is smart advice, and it illustrates the idea of flexibility or “liquidity” in the banking system.

A large portion of the federal debt outstanding is actually held by the federal government itself in the form of “intergovernmental holdings.” This would be Treauries that are in the Social Security Trust Fund and other accounts held as assets by the country. The Bureau of Debt at the U.S. Treasury showed the following as of July 26:

Debt Held by the Public Intragovernmental Holdings Total Public Debt
$ 9,747,272,360,004 $ 4,595,557,756,547 $ 14,342,830,116,551

No one has publicly discussed what will happen with this “internal debt.” Maybe interest and principal payments can be deferred; maybe they can be paid last.

One of the most important outcomes of financial reform last year was the creation of “living wills” for too-big-to-fail banks. Regulators now require that these wind-down plans be created for large institutions so they can be more easily disassembled in case of default. It seems as though the financial system and its regulators are devising “continuing wills” for the U.S. government and all its dependents. This is good and it’s a testament to the destruction wrought by the Lehman Brothers failure that all involved see the value of planning ahead.

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