January 14, 2013
Great Moments in Policy Analysis: Heritage on the Debt Ceiling
From the Heritage Foundation, today:
Very simply, reaching the debt limit means spending is limited by revenue arriving at the Treasury and is guided by prioritization among the government’s obligations. How the government would decide to meet these obligations under the circumstances is a matter of some conjecture. Certainly, vast inflows of federal tax receipts—inflows that far exceed amounts needed to pay monthly interest costs on debt—would continue. Thus, the government would never be forced to default on its debt because of a lack of income. [emphasis added - MDC]
As the Bipartisan Policy Center has noted, there are certain days when inflows exceed outflows for interest payments; Dr. Foster also assumes the government can roll over debt that matures over the February 15-March 15 period (approx. $500 bn). That Dr. Foster could assert with certainty that the Federal government would never default (that is, be late in a payment) strikes me as an unjustified degree of certitude, given what we know about daily inflows in February.
More analysis from Heritage on this issue is contained in "Debt Ceiling: Default Not at Issue, Federal Spending Is ", written by J.D. Foster.
Posted by Menzie Chinn at January 14, 2013 05:40 PMdigg this | reddit
Why would anyone even give the least attention to an analysis like this from the Heritage Foundation? Save your time for respectable opinion. Don't waste it on arguments from a discredited? right wing "think" tank.
Posted by: Chris Marquesas at January 14, 2013 10:35 PM
yeah, they really believe that. Even on RedState.com, heres Erick Erickson: "Contrary to a lot of the Democrats’ spin, the federal government will not default if the debt ceiling is not raised. Only if Little Timmy Geithner decides to not pay certain debts will the government default. It is his choice."
ack! What would it actually take to convince Republicans that this was false? Are they really that insular and divorced from reality? I guess fact are no barrier to having an opinion.
Posted by: dwb at January 15, 2013 05:17 AM
He could be certain at least for the short term, because the govt could prioritize paying interest over things like military pay.
Of course, with disgruntled military personnel, there is some question about a continued revenue stream to roll over bonds and make interest payments beyond a few months.
Posted by: Charlie at January 15, 2013 05:45 AM
The interest on the debt is 6% of the budget. Are you seriously asserting that government revenue would not fund 6% of our current debt?
Posted by: Ricardo at January 15, 2013 05:46 AM
Obama want immediate tax rate hikes which will push us into recession now. Republicans want some long term trimming to the growth rate of spending, spread across future years, so the Republican plan will not push us into recession.
The markets understand that if Republicans have their way, the U.S. will actually be more credit worthy upon completion of the debt ceiling negotiations.
However, if it looks like Obama is going to insist on immediate tax rate increases that will push us into recession this year, then the response of securities markets is uncertain. Equities will likely fall as the probability rises that more Obama tax rate hikes are on the way this year. The immediacy of recession trumps any long term gains to deficit reduction, especially if the majority of those gains come from Obama tax rate increases.
Posted by: tj at January 15, 2013 06:13 AM
Not paying our soldiers or not mailing out those Social Security checks isn't considered default at Heritage. WTF?!
Posted by: pgl at January 15, 2013 06:27 AM
What Heritage is recommending is called "Accounts Payable Financing" in the commercial world; although it is known by accountants by the less prosaic, but far more descriptive phrase: "Stringing Out Your Vendors".
It generally breaks down in the commercial world when your vendors realize what you are doing and introduce the dreaded "Cash With Order" terms. For Heritage to ask the U.S. Government to use such a sketchy financial arrangement rather flies in the face of their campaign to impose commercial GAAP accounting on governmental entities.
Posted by: Dr. Morbius at January 15, 2013 08:17 AM
Menzie, maybe you could explain it this way:
The government takes in $9B or so a day and every day has to pay out some money. Some obligations - like debt payments - can come on certain days rather than being spread out over a month, like for a household. The idea being pushed by Heritage seems to be that Treasury would simply stop paying all its bills as they come due - defaulting every day on all those obligations - in order to save up money to pay some other bills that come due. I'm not commenting on whether that would generate enough money or not. Your last post noted that it may not be legal to do this and it may not be physically possible. So what people are saying Treasury just can make happen is not exactly something that just can happen.
Consider the first, the legality of not paying some. The government owes money on a host of contracts. Not paying them is a default. Not paying them is perhaps not legally possible if funds are available because those creditors may have the same rights as the other creditors people imagine we should pay. How is that to be decided? By whom? With what lawsuits? With what consequences?
As to the second, the government pays huge amounts by direct deposits. I doubt there is a direct deposit "on/off switch". I have no idea what shutting this but not that off would entail. It might be extremely complicated. I know that in other cases where money has run out - in smaller examples of state authorities and cities and in other countries - some payments have continued to be made despite attempts to turn them off. There is no one big master checkbook.
Posted by: jonathan at January 15, 2013 09:23 AM
Obama refuses to reduce spending and he has chosen not to raise income taxes except on a small group, the net effect of which is miniscule. Effectively, he has decreed that trillion dollar deficits will continue. How is there going to be a happy ending?
Posted by: Rich Berger at January 15, 2013 09:32 AM
Every time I read the comments on this blog, such as @Rich Berger's above at 9:32, I do a little liberal socialist communist muslim atheist keynesian dance while remembering that people actually thought Romney had a chance at winning.
You can gerrymander the house and protect your 50% there for maybe another decade or two...but good luck with the Presidency and Senate, Rethuglicans!
Posted by: Nick at January 15, 2013 10:44 AM
Last time this came up didn't the Republicans sponsor a bill something like "Pay Foreign Bondholders First?" to ensure an uninterrupted flow of money from us to them?
Posted by: randomworker at January 15, 2013 10:59 AM
Rich Berger: As I understand from the Constitution, President Obama does not decree. Rather, the executive proposes, the legislative (which in my understanding includes the House of Representatives) disposes -- in this case passes legislation that implements policy. Is there somethin I am missing? Please elaborate.
Posted by: Menzie Chinn at January 15, 2013 11:10 AM
Menzie, actually all bills relating to revenue must originate in the House. Article 1, Section 7.
Posted by: jonathan at January 15, 2013 11:19 AM
jonathan: Yes, formally, that's absolutely correct. President submits a budget. Revenue bills must originate in the House, and need not have any relationship to the President's budget.
Posted by: Menzie Chinn at January 15, 2013 11:27 AM
Why are we playing this gotcha semantics game? We all know there are two sides to this issue. One side believes it is best to keep Government spending at a higher level than the other side. I am one of those who think we should spend less and tax even "more less".
Frankly, I wish Republicans would force the administrations hand----but they wont---and they do not want to either. Growth has come to be viewed as a trick by the right to rip off the middle and lower classes. Therefore we need big government to protect the unrich. This is now the accepted wisdom.
Posted by: Mike Rulle at January 15, 2013 11:40 AM
The TARP vote made Article 1, Section 7 obsolete. All the Senate has to do is amend a revenue bill from the House to say anything they want concerning revenue and then return it to the House for a vote. In a sane world this would be considered unconstitutional based on Article 1, Section 7, but we have grown since the constitution was written. Those in our government are much smarter than the members of the Constitutional Convention. So we no longer need to follow the constitution if we decide not to.
Posted by: Ricardo at January 15, 2013 11:43 AM
President submits a budget. :))
Posted by: tj at January 15, 2013 11:57 AM
What Paul Krugman has taught is with his advocacy of the $trillion coin is that we no longer need to tax or borrow. The tag-team of FED and Treasury can simply create any money that the President and congress appropriate to spend. And pundit Krugman informs us that there would be no inflation from such an expansion of the money supply and MMT tells us essentially there would be no debt because we would owe any debt to ourselves.
Taxes and deficit spending are all an illusion from a bygone era. Today we have a greater understanding of monetary policy. Just ask Mr. Krugman.
Posted by: Ricardo at January 15, 2013 12:11 PM
You didn't answer my question but I didn't expect you to - it was rhetorical. The Dems controlled House and Senate starting in 2007, presidency in 2009. Even in Bush's last year they kicked the budgetary can down the road until Obama came in to initiate failed stimulus package. No budgets have been offered in 4 years (it will not be done on time again this year). President's budgets have garnered no votes and spending has been handled by continuing resolution. Republicans only come in for 2011. Obama rules by crisis and intimidation; did so in the 2011 debt ceiling negotiation and did it again at the end of 2012.
You don't have an answer - Obama and the Dems are driving the country over a cliff and eventually this will not be able to be papered over.
Posted by: Rich Berger at January 15, 2013 12:30 PM
Might I suggest you take a history lesson on a fiat money system. The "greenback" was printed by the government and spent to pay civil war cost. The only limit was self imposed. No taxing or borrowing required. Why can't people understand this simple concept? I would expect a University professor to get it. We can discuss the consequences like inflation or other economic distortions. But the govt not having money or needing more revenue should be immediately called out for the stupidity that it is!
Posted by: markg at January 15, 2013 01:54 PM
Nobody will do what needs to be done...and that is basically eliminate tax expenditures...all of them! (That and let defense spending atrophe a bit.) So actually the Romney idea wasn't half bad - cap deductions at $25K. But nobody has the stomach for this.
What we are left with is a bunch of half measures and penny ante stuff like PBS and foreign aid.
In the meantime all the various players come on CNBC and mouth the talking points which usually contradict each other in the same sentence. It's maddening.
Posted by: randomworker at January 15, 2013 02:08 PM
markg: My understanding is that legislation must authorize the borrowing that was embodied in legal tender notes issued during the Civil War. So, sure, get the House to do that, problem solved. Oh. Or are you saying the legal authority exists now to issue said debt -- that is the 1862 legislation is stil in effect?
Posted by: Menzie Chinn at January 15, 2013 02:39 PM
Ricardo Those in our government are much smarter than the members of the Constitutional Convention.
Not all members of the government. Clearly the Tea Party types are dumber. At a Tea Party rally in front of the Capitol one Tea Party congress critter said he was going to read the Constitution...and then proceeded to read the Declaration of Independence. Worse yet, none of the Tea Party faithful in the audience even noticed this whopper. But a lot of us are smarter than members of the Constitutional Convention. Afterall, the Founders gave us slavery, the electoral college, a three-fifths rule, and the 2nd Amendment. Case closed. You should try reading some of the biographies of our Founders. Most were drunks, deadbeats who died in debtor's prison, adulterers, poisoned by family members (their idea of "family values"), two died in duals, two committed treason, one became Chief Justice of the Suppreme Court and went to prison for skipping out on his debts. Another (Rutledge) became Chief Justice and committed suicide...and many scholars credit him and Pinckney as being the true fathers of the Constitution, not Madison. So yes, with the benefit of 200+ years of learning and experience some of us are at least as smart as the Founders.
Rich Berger The Dems controlled House and Senate starting in 2007, presidency in 2009.
No. The Democrats had a majority in the House and a majority in the Senate. That is not the same thing as saying they "controlled" the Senate. Throughout much of 2009 the Democrats only had 59 votes...if you want to include Ben Nelson and Max Baucus as Democrats. Remember, Al Franken was not seated until well after the ARRA was passed. And Mitch McConnell filibustered things that he even supported.
There is nothing in the Constitution that mandates the current budget process. In fact, it's relatively recent. The President is required to submit a budget, which Obama has been doing. The GOP House regularlly ignores it and writes its own budget. Sen. Harry Reid has decided that there is no point in even bothering with the GOP budget because it is completely removed from reality and because Sen. McConnell has promised to use any budget debate as an excuse to throw sand in the gears. Maybe you like fruitless jestures. We'll get back to a sane budget process when we get rid of insane Tea Party types who have no real interest in governing.
Obama rules by crisis and intimidation; did so in the 2011 debt ceiling negotiation
I see. So the GOP wanted to pass a clean debt ceiling bill but Obama objected. Right. You betcha. When are you returning to planet Earth?
Posted by: 2slugbaits at January 15, 2013 02:59 PM
Posted by: Rich Berger at January 15, 2013 04:03 PM
Menzie Actually, those of us that work for DoD know that there is one exception to the general rule that requires congressional authorization of all spending, and that's the Feed and Forage Act of 1861. It is still in effect today and was (ab)used by the Bush Administration on a number of occassions.
One interpretation of the 4th clause of the 14th Amendment is that it (retroactively) constitutionally validated the Feed and Forage Act. Basically any IOUs that commanders in the field issued to property owners in states not in rebellion were entitled to compensation even if those IOUs violated the Anti-Deficiency Act.
Posted by: 2slugbaits at January 15, 2013 04:43 PM
This entire discussion is missing the point by a long shot. Instead of arguing about whether we spend too much or tax too little, let's focus on getting the economy humming again! Once the economy is producing 200k+ jobs a month and the unemployment rate is really coming down, then we can argue about the merits of more or less government. Neither Democrats nor Republicans really seem interesting in jobs, though. It's the economy stupid!
Posted by: Brian at January 15, 2013 05:16 PM
Rich Berger: Oh, now it's not rhetorical. OK, I'm just trying to remember who couldn't even pass Plan B.
Posted by: Menzie Chinn at January 15, 2013 07:46 PM
Constitutionally, only congress has the authority to collect taxes, authorize spending, issue debt, pay off debts, or coin money. Those are all explicitly laid out in the constitution. So the only reason anyone else can do any of that is if congress delegated it.
So if there's any crisis here, it's entirely the responsibility of congress. It's their spending, and their debt. The president should just say he's not going to participate in any negotiations on this and congress is going to have to learn to work out how to meet their constitutional responsibilities themselves.
Posted by: acerimusdux at January 15, 2013 09:02 PM
acerimusdux makes a truthful statement: "Constitutionally, only congress has the authority to collect taxes, authorize spending, issue debt, pay off debts, or coin money."
"So if there's any crisis here, it's entirely the responsibility of congress."
So if Congress thinks their delegation of authority is being misused the can withdraw that delegation. Correct? The political impacts belong, therefore, to Congress. Correct?
The economic impact(s), however, belong to both Congressional and the Executive Branches. Both branches are drying to duck the blame for those impacts.
The overwhelming percentage of the populace understand that it is a spending problem, and the Executive Branch is trying to pin it only on Congress. Won't happen!
Only those reliant on Government largesse, the low information voters, for which the Democratic party relies upon and the hard over Democratic believers in Big Government accept the potential for the future economic impacts as better than any change. That Government reliant group has deliberately been expanded to ensure their votes.
History however, is replete with examples of what will eventuate if we continue on the current path.
Posted by: CoRev at January 16, 2013 04:09 AM
It is my understanding the Congress could not raise sufficient revenue through taxing or borrowing to pay civil war cost. So Lincoln got them to pass legal tender laws and issue greenbacks. How could Congress borrow greenbacks from the public before the Treasury created them and spent them??? The legal tender laws made the greenback valid for debts public and private. What is public debt - taxes. The law also allowed people to buy govt securities with greenbacks. So if people could pay taxes and/or earn interest with greenbacks they had value. The lesson learned is fiat money must first be spent by the govt. Then the public uses the money to pay taxes and buy govt securites. Swirl that around your coconut for a few days and apply it to our present monetary system.
Posted by: markg at January 16, 2013 06:15 AM
Not that facts matter, but:
Treasury receives about 2 million invoices a day. The process for payment is automated: the computer checks the amount, payee, etc. and makes the payment. This happens, by simple division, many times a second.
The computer system that pays US debt obligations is separate. It's unclear how the process would work. The legality of prioritizing obligations is so unclear a bill was introduced in 2011 making it legal. Treasury's Inspector General 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.”
To clarify, some days the government could pay some of the so-called critical bills and other days not while not paying the rest.
Posted by: jonathan at January 16, 2013 08:37 AM
1. Re: there are certain days when inflows exceed outflows for interest payments
Based on these 2011 monthly projections http://www.economist.com/blogs/freeexchange/2011/01/americas_debt (which I assume are a close enough surrogate for 2013 for these purposes), monthly revenue would greatly exceed monthly interest payments even in the months in which the two are closest. Is there some reason why the Treasury couldn't bank the abundance of surpluses during each month to use on any days with a shortfall (including a cushion for any plausible error in projecting these cash flows)? If not -- if the Treasury could do that -- isn't your point moot?
2. Re: Dr. Foster also assumes the government can roll over debt that matures over the February 15-March 15 period
Why is that not a reasonable assumption? Why is there significant risk that we couldn't roll over that debt?
Posted by: Gordon / Brooks at January 16, 2013 01:14 PM
Gordon / Brooks: Yes, if Treasury accepts a technical default (putting off vendors, not paying soldiers, not making transfers for social security recipients), then in a mechanical sense it is possible for Treasury to avoid debt default. Personally, if I saw the USG defaulting on payments because of the intransigence of a certain set of policymakers, I might think twice of purchasing new Treasurys as the old ones matured. Likely? I don't know. Impossible (as implied by the Heritage piece -- he did use the word "never")? I don't think so.
Just remember the Argentine peso would be forever convertible into dollars, as written into the Constitution... That's why I don't make predictions with the word "never".
Posted by: Menzie Chinn at January 16, 2013 01:58 PM
The Heritage Foundation is claiming that if the debt ceiling is not raised, Treasury will miss an interest payment only if it chooses to do so. Once again, as has happened so many times on this blog, the Heritage Foundation's point is correct.
The argument Menzie and others on this blog are making against Heritage is:
1) Treasury can't prioritize payments or engage in some other cash management actions since the law is unclear
2) Treasury computer systems do not permit any procedure other than paying each claims as they come in so even if there were a legal basis to prioritize payments or manage cash, Treasury computer systems would be inadequate
3) Since Treasury can't prioritize payments or manage its cash, there are days in February as shown by the Bipartisan Policy Center in which Treasury will have zero balances and realized tax receipts that are less than the interest due on Treasury securities
4) Thus, there are days in which Treasury will miss interest payments
This argument is wrong.
It's true that the law is unclear. But it's unclear because in the event of a failure to raise the debt ceiling just about anything Treasury decides to do will be in conflict with some law. But it doesn't follow from that fact
that Treasury will decide to do nothing. As a responsible Federal agency, it will and should investigate contingency plans to deal with these extraordinary circumstances.
We don't need to speculate about Treasury might do. After the debt crisis in 2011, Orin Hatch wrote the Inspector General at Treasury with a number of specific questions about, among other things, Treasury's contingency plans in
the event the debt ceiling was not raised. The Inspector General's Aug 2012 response is here:
The response letter goes through a number of possibilities that Treasury considered including selling gold and prioritizing payments. Although it fortunately never got to the point that Treasury formalized a plan to present to the President, Treasury officials converged on a delayed payment program. The way that would work is that Treasury would wait until it had collected enough funds to make a full day's payments and then would instruct its systems to make the payments. That solution neatly sidesteps any potential payment systems problems and the need to prioritize payments.
Interest rate payments are made on Fedwire, a separate system. Thus, Treasury would just need to predict when interest payments are due and then delay payments enough to have sufficient funds to make the interest rate payments
on Fedwire plus a full day's payments through its standard payments systems. The Bipartisan Policy Center's assumption of zero daily balance plus insufficient tax receipts need never arise.
If necessary, Treasury could execute this plan, showing that Heritage is correct in pointing out that if Treasury did not make an interest
rate payment, it would be because it chose not to.
Posted by: Rick Stryker at January 16, 2013 05:57 PM
Rick Stryker: Your faith is touching. Like those that believed the Argentine currency board would never be attacked because it was credible. I would wonder what happens if Treasury encounters difficulty in rolling over the $500 billion of maturing debt during the February 15-March 15 period. Will Treasury then be able to pay all interest payments by technical default on all other payments? If you say, "yes", then I envy your certainty.
Posted by: Menzie Chinn at January 16, 2013 06:46 PM
Of course the debt can be rolled over although a higher spread will likely be necessary. To believe otherwise is to think that there is no spread that will clear the market.
Posted by: Rick Stryker at January 17, 2013 06:02 AM
Rick Stryker: Spread against what? Don't we usually calculate spread against Treasurys because they are considered the risk free rate. You now understand the challenges by playing around with the Treasury market, where Treasurys are the benchmark.
I guess you mean the Treasury yield will adjust (well, it'll have to be the coupon rate, since this pertains to yield at auction). The financial price always adjusts to clear the market. OK, will have to tell Dick Fuld that next time I see him. And any other folks where sovereign bonds have been defaulted on.
I don't see a full on default as likely, but Foster said never and I can see situations where a delay in a payment on interest could occur.
Posted by: Menzie Chinn at January 17, 2013 06:28 AM
Wow, it's been a while since I saw anything as wrong as what CoRev has posted. That's probably because it's been a while since I saw a CoRev post.
The majority of the public wants higher taxes on the well-off. The majority of the public, whatever view it may offer regarding "spending" as a gross concept, wants spending on broad categories of government outlays - such as Medicare, highways, SHIPS, and the like - to continue or to grow. All CoRev has done - as CoRev commonly does - is to claim that the majority hold his view. They do not.
The claim that the political impact "belongs" to one branch of government or other is weird. Political impact falls on who ever voters decide to blame. Typically, presidents are highly susceptible to voter views of the economy. In the latest election, as Nate Silver pointed out, economic conditions were slightly favorable to the incumbent President, and he won. The notion that economic impact "belongs" to anybody in particular depends, I guess, on what "belongs" means. That penultimate paragraph is mostly just a paraphrase of Romney's 47% speech, or the excuse he offered for losing when his advisors assured him he'd win - the undeserving poor aren't meant to vote, but they did, the scum!
The fact that the mechanism for making a certain set of payments - the Fed wire - is different from the mechanism for making other payments in no way assures that Treasury has the capacity to separate out items to go unpaid in just the right amount to make the Heritage view correct. I'm interested to see examples of when Heritage was right and Menzie was wrong. Real outcomes, mind you, not just in the eye of the beholder. Heritage seems to start its analysis with the desired conclusion and then work backward - not the approach that tends to produce "right" answers.
By using the term "technical default" in referring to default on any payment by a Treasury security, you are surrendering to rhetoric of default-giddy House Republicans. Failure to meet one's payroll or contractual obligations to pay is default - true and simple. Tacking "technical" on the front tends to mitigate when no mitigation is justified.
Posted by: kharris at January 17, 2013 06:31 AM
I don't think your response really addresses my first question (and you seem to have overlooked my second question).
I am not suggesting delaying or failing to fully pay any debts already incurred (money owed to vendors, benefit payments that are due, compensation due to government employees, etc.). I am saying that, if we chose, we could avoid incurring new debts of that sort (whichever we choose) by laying off employees, not ordering new products/services, and/or, in the case of entitlements, changing the law to lower the amounts that will be owed to beneficiaries, and we could do this to an extent that there would be plenty of surplus revenue on a monthly basis, and therefore more than enough to cover any possible shortfall on particular days (if that is a real possibility), assuming the Treasury could save those surpluses for such "rainy days." That's why I asked you if it would or wouldn't be possible for the Treasury to so bank such surpluses, and if so, if your concern about such shortfall days is moot, as I think it would be, and is.
I'm NOT suggesting it would be good for the nation to refuse to raise the debt limit indefinitely (or at all). Quite the contrary, I assume that a sudden cut in federal spending of about 6% of GDP would cause a severe recession and overall would be very bad for the nation.
Nor am I addressing the political likelihood of the necessary measures being taken to avoid incurring an excess of such new debts, nor am I addressing what could or would be bond market perceptions or other perceptions of risk that we'd default on Treasury debt or other debt. I'm just addressing what possibilities of "default" (even broadly defined to include all debts) could plausibly be caused by failure to raise the debt limit itself, as opposed to being avoidable if we made the necessary choices.
And I'm just addressing two arguments you made, the first being your assertion that failing to raise the debt ceiling could cause default on our Treasury debt (or for that matter, on other debts) because of possible cash shortfalls on a daily basis. That assertion seems invalid to me, and I'm asking you to address my reasoning as to why it seems invalid (which is that the Treasury could, I assume, save surpluses to cover any such shortfall days, thus providing enough cash to cover all debts, Treasury and other).
Posted by: Gordon / Brooks at January 17, 2013 08:24 AM
...just to add to my comment of a couple of minutes ago: Apparently a change in law would also be required to avoid incurring new debts related to at least some discretionary spending as well, because apparently the Treasury is legally obligated to spend per related Congressional appropriations.
Posted by: Gordon / Brooks at January 17, 2013 08:30 AM
Menzie, I was incorrect to say you overlooked my second question, but you didn't really address it either, because your response is based on the same (apparently) invalid premise as your response to my first question.
Posted by: Gordon / Brooks at January 17, 2013 08:41 AM
Gordon / Brooks: Let me remind you Dr. Foster said never. "Never" is pretty unequivocal; I can say nobody will ever hijack airliners to use as bombs (despite being a plot in a popular Clancy novel) and be proved wrong.
So let me get this straight. Suppose if Treasury has extraordinary measures available to go through Feb. 14, but anticipates no raising of the debt ceiling by Feb. 15, it should (and will) deliberately go into technical default on the 14th in order to have enough on-hand for the $30 billion interest payment on the 15th. Not sure that'll be enough, in which case the Treasury should go into technical default on the 13th, even if negotiations are going on. Is that what you are proposing.
Posted by: Menzie Chinn at January 17, 2013 11:07 AM
OK, I guess I wasn't loud enough before. Treasury will go into absolute, covenant-busting, trust-breaking, screw-your-vendor, veteran-and-retiree betraying, honest-to-dog DEFAULT if it fails to pay any obligation on time. Where in accounting texts, contract law, the Constitution or the Boy Scout by-laws does the "technical default" thingee you keep mentioning come from?
"Technical" in that combination of words is what we in the scribbling trades refer to as "wordy nonsense". Or perhaps "a distinction without a difference". Not paying a Treasury coupon on time would, technically, be a default, so would qualify as a "technical default". Why not refer to missed coupon payments as "technical default"? If you mean "default on something other than Treasury debt", why not say that instead of using a made-up term?
Are you too young to know a bit of Gringrich-spawned propaganda when you see it?
Posted by: kharris at January 17, 2013 12:25 PM
Yes, I mean that the coupon will have to adjust. I used the term spread because credit default swaps are available on sovereign debt and the US indeed has a spread. I see no reason why there is not some rate for which the Treasury could roll over the debt.
Heritage said "never be forced to default on its debt because of a lack of income," not never default for any reason whatsoever. Your argument and that of others was that legal, timing, and systems reasons would prevent them from making payments on time but I showed that they already had formulated a plan to do it. Of course, there are always operational risks. For example, in the scheme that I laid out, it's possible for them to miss a payment. If they were under pressure to delay payments as little as possible, they might miscalculate and give themselves too little time to accumulate tax receipts. Since incoming tax receipts are stochastic, they might get an unusually low amount of funds and thus find themselves short on a particular day. But that's a risk that they control. They can reduce that risk to zero by extending the payment delay window sufficiently long.
Posted by: Rick Stryker at January 17, 2013 02:56 PM
I think you missed my point. What Treasury did was to identify a solution in which it would not have to change any of its systems. The only way you can pay interest rate payments on time in a delayed payment regime is if the interest rate payments are paid on a separate system that is not part of the delayed payment regime. Since interest rates are paid on Fedwire, a separate system, it works.
Also, I think Menzie is using the term "technical default" in a way that makes sense. For bonds and loans, a "debt services default" is a default in which an interest rate payment is missed or delayed. A "technical default" is a violation of a covenant of the debt instrument. In the context of sovereign debt instruments, a "technical default" means a restructuring of the debt in a way that's detrimental to the creditors. In both cases, a "technical default" does not imply that an interest rate payment was missed. So, in using the term "technical default" Menzie is just distinguishing not paying social security payments and the like from not paying interest rate payments due on Treasuries. These distinctions are not obvious to the non-specialist but Menzie is an economics professor after all and this is an economics blog.
Posted by: Rick Stryker at January 17, 2013 03:13 PM
First of all, let me state again that I think failure to raise the debt limit would become very harmful to the nation, so I'm not advocating the scenario I'm discussing, but the main reason I think it would be very harmful would be because a sudden cut in federal spending equal to 6% of GDP would cause a severe recession, and also I assume the scenario could (sooner or later) have the effect of increasing the bond market's perception of political risk associated with Treasury debt.
The claim that I am challenging is the claim that failing to raise the debt limit would necessarily -- or likely, or even with some meaningful probability -- cause either default on Treasury debt or technical default because of days when revenues would fall short of payments due.
As for literally "never" (literally impossible) vs. extremely unlikely, well, if one were to take things that literally one would have to acknowledge that even if the debt limit were increased, theoretically it's possible that, due to some wildly extraordinary developments, there would be a shortfall on some given day, so for our practical purposes, we are talking not about absolute impossibilities, but rather of likelihood (probabilities) and magnitudes (how big a problem with how large adverse effects if the undesired outcome -- technical default -- were to occur).
You raise a good question. If the Treasury anticipates such a shortfall on Feb 15, or in any case given that it should have a cushion in case of an unexpected shortfall day, two approaches occur to me:
1. Initiate the process I spoke of sooner than Feb 15 -- a process that I do not think involves technical default, but rather avoiding new debts (by laying off employees, forgoing new orders for products/services, reducing entitlement benefits, etc., with whatever changes in law may be necessary to avoid these payments becoming owed). Obviously the closer we get to whatever day we expect (or there is significant risk of) a shortfall, the less likely it is that Congress will act in time to remove the Treasury's legal obligation to spend by passing new legislation, IF the Treasury would need such new legislation to avoid enough new debt (to suppliers, employees, beneficiaries, etc.) to, in turn, avoid technical default (and perhaps such new legislation wouldn't be necessary to reach that level of avoidance of new debt, but I don't know).
2. IF we would face the kind of shortfall you describe, and IF the legislation I describe above (in #1) is not enacted, and IF such legislation is/were needed to avoid enough new debt to, in turn, avoid technical default on that day, then I suppose we'd end up "technically defaulting" on such debts, but with everyone involved knowing that it would be only a matter of a couple of days (I assume) before there would be more than enough cash to pay them what they are owed, because, as I noted, on the monthly basis revenues far exceed debt service (interest expense), leaving most revenue available for whatever else we wish to expend it on, and presumably that would very soon cover debts (to suppliers, employees, etc.) that had already been incurred. In other words, this worst-case scenario means everyone (suppliers, employees, and/or beneficiaries, etc.) would know that payment would be a couple of days late, but sure to arrive as long as the Treasury and Congress did what they could at that point to ensure payment on debts already incurred. And everyone would know that even this "couple of days late, but sure to arrive very soon" sort of technical default would almost certainly NOT happen again as long as Congress and the Treasury did what they could from then on to avoid too much new debt, meaning that failure to raise the debt limit would not be the cause of any future (even very brief) technical default. So the question then is: IF all my "ifs" above turned out to be the case, and thus we had this worst-case scenario of being a couple of days late on some such payments, yet clear that it wouldn't happen again, would it have any significant or enduring effect on the bond market's perception of Treasury bond risk and thus cause higher interest rates (I mean any such effect vs. the scenario of no increase in the debt limit without such technical default of a couple of days)?
Posted by: Gordon / Brooks at January 17, 2013 05:01 PM
Gordon / Brooks: Thanks. All I wanted to highlight is that Dr. Foster's use of the word "never" was ill-advised. I am also not as sanguine that the Treasury would blithely pre-default (even if technical) on say Social Security payments (I'm guessing not hiring a few people is not going to do the trick), especially if negotiations go down to the wire. As they seem to do. So count me as saying that the likelihood of default on interest payments is greater in my assessment than in yours.
Bottom line: I won't say "never" in my predictions.
Posted by: Menzie Chinn at January 17, 2013 06:08 PM
So count me as saying that the likelihood of default on interest payments is greater in my assessment than in yours.
I don't know why you'd say that, because I didn't say anything about how likely (or not) I think default on interest payments is, nor for that matter how likely (or not) I think technical default is, nor how likely it is that we'd choose to reduce Social Security benefits (or anything else) rather than opt instead for default or technical default.
Any or all of the above could occur (as far as I know) by choice (in effect) -- choice of the Treasury and/or choice of Congress, either active or passive choice, by not taking actions think would be available and sufficient to avoid either default on Treasury debt or technical default on other debt. I said nothing about the likelihood that we would, in effect, choose default or technical default rather than take such actions to avoid either of those results.
All I have been speaking and asking about is (1) the likelihood that failure to raise the debt limit would make technical default unavoidable, in particular due to the possibility you mentioned of a shortfall of funds on a particular day, and (2) based on your hypothetical, and assuming the aforementioned protective measures weren't taken ahead of time, and if we then were a couple of days late on payments to suppliers, employees, beneficiaries, etc., but only due to that one-time glitch, would it have any significant or enduring adverse effect on perceptions of risk of Treasury debt (vs. no such technical default but otherwise the same scenario of not raising the debt limit).
I'm unclear on what your views are re: both #1 and #2. So if I may put them as questions again:
1. How likely do you think it is that failing to raise the debt limit would cause technical default (or Treasury debt default) to be unavoidable (even if Treasury and Congress did all it could to avoid them per what I've described) due to a shortfall on a particular day, despite the huge monthly surpluses we'd have?
2. If, in your hypothetical scenario, and without the protective measures I mentioned being taken to avoid technical default, we had a shortfall for a couple of days and thus were in technical default for a couple of days until the very reliably anticipated surpluses came in, and if Congress and Treasury from that Feb 15 point did all it could to avoid incurring future debts -- so that it would be extremely unlikely that we'd again face a shortfall, since we'd have saved up surpluses -- how likely is it that merely the couple of days in technical default in itself would have the significant or enduring effect of upward pressure on Treasury interest rates (due to a higher risk perception)?
And to be clear about how my point would relate to Social Security, as I indicated, Congress could change the law to reduce benefits, and if it did so, paying the lower benefit amounts thereafter would not be technical default because that wouldn't be money owed to beneficiaries (except, I assume, for part or all of each beneficiary's month since the last check, meaning the period of time during which the law had their benefit at the previous level but had not yet been paid for that month).
Posted by: Gordon / Brooks at January 17, 2013 06:44 PM
No, I didn't miss your point. I think you are simply wrong. You have taken the Heritage on no evidence. You claim that Treasury is being disingenuous, refusing to change rather than unable to change, without offering evidence. You simply haven't made a credible showing for your position.
As to your defense of "technical default", it is a bit too convenient, and without real substance. "Technical" is, in this case, not a technical term. As I pointed out, it comes not from accounting or law, but from a prior, partisan debate over the debt limit and default. It's a term adopted to make default on some obligations seem somehow less bad than it is. It was adopted by Newt Gingrich - a man who talks better than he thinks. I'm urging our host to avoid a term adopted to push a political agenda that he doesn't support. You apparently do support that agenda, so your defense of the term is no surprise.
We can default on obligations to debt holders. We can default on obligations to government workers. We can default on obligations to the sick, the aged, soldiers, suppliers... Each would constitute a default in a "technical sense". None is more a "technical default" than any other. If, as a nation, we don't have the decency to meet our obligations, we ought at least to have the decency to say so plainly. Weasel words are for weasels.
By the way, has anybody else noticed the parallel between the GOP demand during the "cliff" debate that Obama offer spending cuts Republicans want and the demand that Obama prioritize who gets cheated by a default? Republicans want a policy the public in general doesn't support, but lacks the courage to be specific. They demand the policy, but want Obama to take the blame for the choices forced on him by that policy.
Posted by: kharris at January 18, 2013 05:27 AM
You certainly did miss the point as I gave plenty of evidence as to exactly how Treasury could manage cash in order to not miss a payment. First, rather than speculating as others on this blog did, I linked to the Inspector General's letter which showed exactly how Treasury had decided to deal with this situation. Then I explained how that would work given Treasury's payment systems. I then pointed out the additional essential fact that interest rate payments are on Fed wire and why that's important. In one of my replies to Menzie, I also discussed the operational risk implicit in this procedure and how Treasury could mitigate or eliminate it.
You have only made accusations and have provided no counter argument.
Your harping on "technical default" is getting ridiculous. As I tried to explain to you, it's not an ideological term made up by Newt Gingrich. It is a commonly used term among credit analysts. Here is the definition from the financial dictionary:
And from investopedia:
Posted by: Rick Stryker at January 18, 2013 07:45 AM