UPDATE: Bloomberg reports that, contrary to the Times article cited below, Treasury will announce tomorrow that its contingency plan in the event the debt ceiling is reached will include prioritizing payments to bondholders. This is good news.
Tomorrow, after the markets close, the Department of the Treasury will announce what it plans to do in the event that the debt ceiling is reached and the Federal Government can no longer pay all of its bills. The New York Times expects that Treasury will announce that it is unable to prioritize payments in order of necessity, and will instead have to pay them on an first-in, first-out basis. That would create several problems, the largest being that the government would miss interest and possibly principal payments on Treasury bonds.
It is inconceivable to me that the Times is right about this—but if they are, we are in for a world of hurt.
Let me preface the remarks below by saying that I do not share the view of some on the Right that payment prioritization means hitting the debt cap is no big deal. When we hit the debt ceiling, the government will have to stop paying about 44 percent of the bills it normally does. Even if Treasury stiffs payees in a manner that causes the least damage possible—and particularly holds bondholders harmless—there will still be major havoc and damage to the economy.
That said, missing a payment on Treasury bonds is what would turn a major problem into a catastrophe. Certain other payments, such as Social Security checks, would also be particularly damaging to miss. Payment prioritization can significantly reduce the damage incurred if we hit the debt cap, even if it does not prevent all damage.
For months, the Treasury Department’s line has been that it lacks the legal authority to prioritize the federal government’s payments. In fact, this is an unclear area of law—a 1985 GAO ruling, prepared in the context of a previous debt limit showdown, concluded that Treasury has the power to pay the government’s obligations in whatever order it deems to be in the national interest, if it lacks the capacity to pay all the obligations.
But as Jay Powell notes, the GAO is not the Supreme Court and its say is not final. A 1974 federal law withdrew the President’s power to “impound” (i.e., decline to pay) federal appropriations. Payment prioritization would likely violate that law.
The trouble is that, once we hit the debt ceiling, all possible courses of action that the Treasury could take will violate some law, because our laws will be in conflict with each other. The amount of lawful obligations that the administration is supposed to pay will exceed the amount of funds that it can legally lay its hands on to pay them. So, saying that a strategy will violate a law is not fatal here—anything the Administration does will violate some law.
In such a situation, the only responsible course of action is for Treasury to interpret its powers in the way that allows it to cause the least economic damage possible—i.e., in line with the GAO report—and let the courts settle any objections later. Presumably, payees who get stiffed in the payment prioritization scheme will sue. But (one hopes) the debt ceiling impasse will be long over by the time the courts can decide the cases.
The precedent for aggressively interpreting the executive’s legal authority to manage a debt limit crisis was set by none other than Ronald Reagan. In 1985, he stayed under the debt cap by partly “disinvesting” the Social Security Trust Fund, which holds Treasury bonds that count toward the debt cap. AARP sued, but by the time the case could be litigated, Congress had raised the debt cap, the missing bonds had been put back in the Trust Fund (plus interest), and the issue was moot.
The tactic worked long enough to keep paying the country’s bills while Reagan haggled with Congress. Unfortunately, in the 1990s, Congress passed a law make disinvestment of the Social Security Trust Fund explicitly illegal, taking that option off the table today. But the general principle—that this is a situation where it is better to seek forgiveness than to ask permission—still applies.
In the run-up to the votes over the debt ceiling, it has been in the Administration’s tactical interest to claim that Treasury’s powers to blunt the negative effects of hitting the cap are limited. But once we actually hit the cap, that will change—it will suddenly make sense for the Administration to interpret its powers broadly, so that it can avert a financial crisis. As the GAO report demonstrates, such a position is defensible; it would be very strange (and very bad for the economy) if the Administration doesn’t stake it out.
P.S. There has also been discussion of whether Treasury lacks the technical ability to prioritize payments. The Wall Street Journal ran a story several days ago in which a Brookings fellow, and former Clinton-era Treasury official, suggested that the government’s computer systems may not be able to handle prioritizing the nearly 3 million payments the federal government makes every day.
Unlike on the legal issues, I have not seen any actual statements from the Administration on this matter. If that’s still true—meaning that Geithner didn’t have his people working months ago to find a way to prioritize payments—then that would be very embarrassing and reckless on the Administration’s part. As Joe Weisenthal wrote last week, it would be grounds for Geithner’s resignation.