The Corner

Are We Misquoting S&P?

In the last few weeks, I’ve heard many times that S&P has warned the United States government that if Treasury were to fail to pay any of its bills, its rating would be downgraded to D. The implication is that the debt ceiling should be raised before August 2 so we can borrow more money and pay all of our bills. But that wasn’t my understanding of what S&P had actually said.

I went back to check and found this Reuters story titled “Exclusive: S&P to deeply cut U.S. ratings if debt payment missed,” which was then reproduced everywhere. The title explains that we would see a downgrade in our ratings if debt payments, not any payments, were missed. Reading the article reinforces this point:

Chambers, who is also the chairman of S&P’s sovereign ratings committee, told Reuters on Tuesday that U.S. Treasury bills maturing on August 4 would be rated ‘D’ if the government fails to honor them. Unaffected Treasuries would be downgraded as well, but not as sharply, he said.

“If the U.S. government misses a payment, it goes to D,” Chambers said. “That would happen right after August 4, when the bills mature, because they don’t have a grace period.”

[. . .]

On August 4, the Treasury Department is due to pay off $30 billion in maturing short-term debt.

If I am reading correctly, the technical default occurs after a failure to pay interests on our debt, not all of our bills. However, I am not sure why Treasury should consider this option (though it wouldn’t be unprecedented). We know now that Treasury has the ability to prioritize its payments and pay that particular $30 billion out of $172 billion in tax revenue. The Bipartisan Policy Center calculated that after paying its $30 billion in interest payments in August, it could also pay for Social Security, Medicare, unemployment benefits, and payments to defense contractors, if it ceased all other functions (page 13 of this document). So technically, there shouldn’t be a default on our debt payments.

Obviously, this is not a good solution and there are some risks associated with that option (mainly timing difficulties), but it could be done if necessary. In addition, in order to pay other bills, Treasury could sell some assets — an expensive option since, at this point, it would probably mean selling them at a lower price than what they may be worth, but, as I have said before, these are not normal times and it beats a default.

Alternatively, Treasury can “disinvest” from some of its trust funds. Here’s how it works:

Each day, the U.S. Treasury takes in several billion dollars for federal trust funds. For Social Security, these dollars come in the form of employer and employee payroll taxes. Federal employee and Postal Service contributions to the CSRDF also inject cash into the Treasury. Usually, this cash is immediately invested in nonmarketable government securities – to remain available to finance future benefits. But if a debt limit breach appears imminent, the Treasury Department could “underinvest” this revenue as it arrives. The trust funds would be given a temporary IOU that does not count against the debt ceiling, and the withholdings would be used to pay off the government’s cash obligations until an increase in the debt ceiling could be settled. 

The Treasury Department could also make cash available from the trust fund by “disinvesting” some of the money used to buy government bonds. Under this approach, bonds held on behalf of trust funds would be converted to cash earlier than normally needed. Like the “underinvestment” option, cash from this transaction would be used to pay federal obligations on a temporary basis.    

The disinvesting approach is a temporary accounting device that would help maintain the Treasury’s cash flow.

This explanation comes from the legislative director of the National Active and Retired Federal Employees.

This “disinvestment” has been done before. Jason Fichtner sent me the following GAO quotes from different reports:

In the past, Treasury has taken a number of extraordinary actions such as temporarily disinvesting securities held as part of federal employees’ retirement plans to meet the government’s obligations as they came due without exceeding the debt limit, until the debt limit was raised.

And this

GAO found that: (1) during the 1995-1996 debt ceiling crisis, Treasury followed normal investment and redemption procedures for 12 of the 15 major government trust funds; (2) Treasury suspended normal investments and redemptions for the Civil Service Retirement and Disability Trust, Government Securities Investment (G-fund), and Exchange Stabilization Funds and took other actions to stay within the debt ceiling; (3) these actions were proper and consistent with the Secretary of the Treasury’s legal authority; (4) as required, the Secretary of the Treasury determined in November 1995 that a debt issuance suspension period existed prior to exercising his authority; (5) Treasury redeemed $46 billion in Civil Service fund securities in November 1995 and February 1996 and suspended investment of $14 billion in fund receipts in December 1995; (6) Treasury exchanged about $8.6 billion in Civil Service fund securities for Federal Financing Bank (FFB) securities, which FFB then used to repay borrowings from the Treasury; (7) Treasury suspended some investments and reinvestments of G-fund receipts and maturing securities during the crisis; (8) on several occasions, Treasury did not reinvest some of the maturing securities held by the Exchange Stabilization Fund; (9) in March 1996, Treasury issued some securities that were temporarily exempt from the debt ceiling, which allowed it to pay $29 billion in social security benefits and invest $58.2 billion in fund receipts and maturing securities; (10) although the Treasury did not technically exceed the debt ceiling during the crisis, the government incurred about $138.9 billion in additional debt that normally would have been subject to the ceiling; (11) several Treasury actions resulted in interest losses to certain government trust funds; and (12) Congress raised the debt ceiling to $5.5 billion at the end of March 1996, and Treasury fully restored the Civil Service fund’s and the G-fund’s interest losses by June 1996, but it could not restore the Stabilization fund’s interest loss without special legislation.

And this:

In the past, Treasury has often used extraordinary actions, such as suspending investments or temporarily disinvesting securities held in federal employee retirement funds, to remain under the statutory limit.

Again, these actions are nothing more than short-term budget gimmicks, but they would avoid a U.S. default, which is the most important thing to do. Unless spending is reduced approximately $1.6 trillion dollars a year, the Treasury will eventually run out of options and a debt-ceiling increase won’t be able to wait. Then we’d better hope that lawmakers agree on a deal.

Going back to my original question and to the Reuters piece, I would like to note that what seems to worry S&P the most is our financial prospect in as early as two years:

Chambers made clear, however, that S&P is more worried about the ability of the U.S. government to meaningfully cut its deficit over the next two years, with presidential elections in 2012 making a bipartisan agreement much tougher.

S&P is so far the only of the big-three credit ratings agencies to revise the outlook on the U.S. AAA credit rating to negative. It has said it sees a one-in-three chance of a downgrade within the next two years.

You can read S&P’s rationale here.

For months now, I have been called irresponsible for simply pointing out that we don’t have to default on our debt come August 2 and that there are things that can be done to avoid this painful outcome. The feeling is, I guess, that a responsible person would favor continuing on the path we are on — raising the debt ceiling without trying to address the explosion of spending for autopilot programs — rather than choose options that are painful or expensive (such as selling any assets or prioritizing payments) in order to give Congress a little time to find an arrangement that could change our financial outlook. If that’s being responsible, then it’s true, I am not. I do want things to change and the outlook of this country to be better.


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