Federal Debt: Dancing on the Ceiling

Talk of America defaulting on its debt is just that

Jan 13th 2011 | WASHINGTON, DC | from the print edition

[Greg Ip] FOR most finance ministers default is usually a subject to be avoided at all costs. Not so in America, where Tim Geithner, the treasury secretary, sent Congress a letter on January 6th describing in gory detail the “catastrophic economic consequences” such an event would entail.

The letter was part of the dance that takes place whenever the administration asks Congress to raise the ceiling on the national debt. America is unusual in requiring a vote both to adopt a budget, and to issue any debt necessary to finance it. Grandstanding legislators typically demand concessions from the administration before raising the ceiling. There is obvious potential for a stand-off, just as there was in 1995-96, when Bill Clinton rejected the budget cuts proposed by congressional Republicans as a condition for raising the debt ceiling.

A similar confrontation now looms. The Republicans, who took control of the House of Representatives on January 5th, say they will not raise the debt ceiling until they get $50 billion cut from spending for the fiscal year that ends on September 30th.

The Treasury can still borrow an extra $327 billion and draw down some $200 billion in deposits at the Federal Reserve before it breaches the current ceiling of $14.3 trillion. Mr Geithner says that will happen between March 31st and May 16th. He can then get additional breathing space by means of various gimmicks, such as redeeming debt issued to civil-service pension plans. Lou Crandall of Wrightson ICAP, a research firm, reckons the Treasury could free as much as $223 billion that way, and another $278 billion by selling mortgage-backed securities and privately originated student loans it acquired during the crisis. These steps, he says, could tide the government over until the autumn.

Once all such devices were exhausted, Mr Geithner warned, the Treasury would have to default on something. But he did not specify exactly what. The ambiguity may be deliberate. Even with no increase in the ceiling, the Treasury can easily service its existing debt; it is free to roll over maturing issues, and tax revenue covers monthly interest payments by a large multiple. But in that case it would have to postpone paying something else: tax refunds, Medicare or Medicaid payments, civil-service salaries, or Social Security (pensions) cheques.

It is not clear what the legal priority is among the Treasury’s obligations, whether contractual such as bond debt or statutory such as social security. “This is an area where the federal government itself is often the interpreter,” says a former official. Yet if it came to it, deciding between the two should not be hard. Delayed payments may hurt pensioners and cause political damage, but a default on Treasury debt would unleash global financial chaos. Either outcome would be deeply unpleasant; that may be Mr Geithner’s most potent weapon.

from the print edition | United States

The original article is linked here.

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