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No Default in Our Day

I suppose it should not be surprising that there is a great deal of misinformation and misunderstanding about the debt limit and government default. A lot of people and especially folks in the media don’t understand these issues because they have never confronted them, and the warring parties seem to believe they have an incentive to get the media telling their story by whatever means necessary, even if that means spreading disinformation.

Some of this is confusion among non-financial people about what “default” actually means. An individual defaults when he or she fails to pay bills within a reasonable time after they come due. If the default is serious enough, a creditor can force the defaulting party into bankruptcy and attach assets.

This isn’t what it means to default as a sovereign country, however. A sovereign default is when a nation fails to pay interest or principal on its debt when due. And that’s all. If the U.S. fails to pay its soldiers, that is not default. It’s a bad move, perhaps, but it is not default. If the government doesn’t pay you, you can sue…but even if you win, there is no Chapter 7 or Chapter 11 bankruptcy for the U.S. government so you cannot attach assets. So this distinction is key: if the U.S. services the debt, there is no default. This is the case whether or not the debt limit increases or not.

It is much more surprising to read James Baker, who among other things has been Treasury Secretary, equating the debt limit increase with solvency. Mr. Baker was interviewed for Peggy Noonan’s column this week in the Wall Street Journal and said, speaking of the President, “He has to get the debt limit raised to avoid default.”

We can walk this through and show why there need not be a default in the case where the debt limit is not raised.

While the government at some point ceases to spend, since it doesn’t have Congressional authorization to do so, it still continues to collect revenue. The U.S. takes in a little less than $3 trillion per year in revenues, and if you think those taxes don’t need to be paid while the government is shut down I invite you to try. Against that revenue, interest payments on Treasury bonds are on the order of $300bln (I don’t have the exact figure). Principal repayments aren’t relevant for this calculation, because as bonds mature the Treasury can re-issue the same nominal amount of bonds. So all the Treasury needs to do in order to avoid default is to pay the interest. They probably also want to pay the $1.6 trillion in Social Security and Medicare payments, and maybe a fair amount of the $700bln in defense and homeland security spending although a lot of that is procurement. But there’s plenty more than is needed to avoid a default.

Incidentally, in theory the Treasury could take in more money by issuing Treasuries with above-market coupons. Perhaps there is a statute that requires the Treasury to always pay the minimum coupon possible, although I am not aware of it. But if there isn’t such a statute, then the Treasury could raise more money by doing the following: when a $10bln TBill issue comes due, the Treasury immediately re-issues a $10bln, 10-year, 10% bond at a price of around 165% of par. Voila, an extra $6.5bln for the coffers. What is limited by statute, as far as I know, is the face amount of bonds that may be issued, not the amount of money that can be taken in.

Now, the Treasury claims that it is unable to pay selected obligations. According to them, it is not operationally possible – the check run is either on, or it is off. All, or nothing. This represents either ridiculous incompetence, or an outright lie. Seriously? The Treasury has no way to cut a single check if it wants to? How about this: take a big stack of blanks and, instead of running them through the printer, fill them out by hand and have the Secretary sign ’em. Painful? Absolutely. But it is inconceivable that it isn’t possible to run only some checks. The Secretary should speak to his I.T. guys.

We should keep in mind that the Secretary is the President’s former Chief of Staff, and probably knows a lot more about the politics of appearing to be unable to pay than he does the actual capabilities of the machinery.

Does any of this make default impossible? Of course not. There is always the possibility that politics or petulance cause the President to simply refuse to order the Secretary to prioritize interest payments on the debt. It would most likely cause dramatic long-term costs for the government and precipitate a real crisis, and I wonder if it might even be impeachable (the 14th Amendment does not seem to me to give the President the power to raise the debt ceiling and pay anything he wants, but it certainly seems to give him the power to cut checks in order to defend the “validity of the public debt of the United States authorized by law, including debts incurred for payments of pensions.”) But there is no financial reason that failure to raise the debt ceiling should result in an actual default.

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  1. Marshall Jung
    October 4, 2013 at 9:46 am

    There is a reason I read this blog every day. This type of information (and inflation reality checks) are impossible to get straight from any other source. Thank you for your time and effort.

    • October 4, 2013 at 11:57 am

      Thank you for the kind words! Refer your friends! 🙂


  2. eric
    October 4, 2013 at 1:56 pm

    I dunno. I wonder if you are underestimating what a kludged, out-of-any-individual-person’s-control, complex system the treasury is. I can almost believe the “no selected obligations” claim. But all I need to believe is something even weaker: even if the claim is false, but someone important enough is willing to _stand by_ the claim, then it is effectively true.

    Another interesting fact: I read somewhere today that some think the market is up today because this chaos means the fed cant taper in october. wow. why dont we start a nuclear war? then the market should really go up.

    • October 4, 2013 at 2:03 pm

      The Street consensus seems to be March right now. Seems to be room for disappointment on that!

      I believe there may be someone to stand by the claim of incompetence, but at some point I suspect there will be folks who realize that an investigation will reveal the truth, and there most certainly will be investigations if the market drops 30% on a default!

      And remember this about these sorts of claims…think about the IRS here…you only need one whistleblower to make the whole thing untenable.

      However, while I stand by my belief that there is no REASON to default, I agree with you that there is a non-zero chance that there WILL be default because of the idiots in charge. I hope that probability is low.

  3. eric
    October 4, 2013 at 2:15 pm

    I think the conventional wisdom is underestimating how politically cluster@#%ed we are. I dont think this is ordinary brinkmanship.

    We may be reaching the point when the conventional political order that has been holding since at least WW2 is reorganizing itself, (I don’t think there really is a Republican Party anymore) and this may the mechanism by which its playing out. We are living in interesting times–in many more ways than one.

    • October 4, 2013 at 3:05 pm

      That’s a very interesting insight. When you look back over the history of the US, it has been very unusual to have any one political party that lasted for a long time, much less two. I have been expecting the Democrats to splinter for a while but it may be the Republicans. Or maybe both, and we end up having a riot of parties. In a way that’s bad because it will become a game of who-can-promise-the-most as in Italy. The advantage of 2-party rule is that in theory they can get together and do the smart thing for the country even if it isn’t popular today. But that’s not been the case for about 15 years.

  4. eric
    October 4, 2013 at 3:30 pm

    I don’t see much evidence of the Democrats splintering. I think they are becoming very powerful at the national level. The only thing keeping them out of total power is past strength of the GOP produced districting that favors them strongly in the house. But this is also becoming the GOPs undoing, because it has produced so many safe GOP districts where there is no incentive to behave yourself in the primaries. This has produced so many tea party candidates who don’t really have core GOP interests (i.e. chamber of commerce types,etc.)

    So, now you have a Republican establishment that you would ordinarily expect to be the “grownups” about things like debt default. But they can’t afford to be, because to do so would fracture their party permanently. If Boehner calls a straight up vote on a CR, or possibly even on the debt ceiling, 30-40 republicans will join the Dems in voting yes, and he will immediately find himself being the leader of a minority 3rd party in a coalition government with the Democrats.

    I think the democrats know this and are hoping to force him into doing it.

    I could be wrong. And we could certainly end up kicking the can down to the next “crisis,” but I don’t think this is a problem that is going to go away anytime soon, and I think fundamental problems with our governing structure are being revealed. And _one_ aspect of this is that we find agents everywhere grabbing power they are traditionally supposed to have by exploiting technicalities. The treasury saying “we can’t honor selected obligations” is just one of those.

    • October 4, 2013 at 3:37 pm

      This whole discussion is very saddening.

      • HP Bunker
        October 5, 2013 at 4:44 pm

        Honestly this whole drama makes perfect sense, and I don’t even think the Republican position is necessarily petty or irrational. Due more or less entirely to demographic shifts, the Republican party is increasingly nonviable at the national level.

        Democrats (and establishment Republicans) say “if you want to repeal Obamacare, you need to first win the Senate and White House, while holding onto your majority in the House”. A completely rational, nonpartisan observer could easily see that proposition as an uphill battle, to say the least. At the national level, the GOP may well be doomed to a permanent minority party status, and if (due to favorable redistricting with regards to the House), Republicans will for the foreseeable future control only one half of the legislative branch of government, their options are a) “go along to get along” or b) adopt non-traditional tactics such as the current standoff as a means of forcing concessions from the majority party.

        Those who say that the only “legitimate” way to modify or repeal a law is by first regaining control of the executive and both halves of the legislative branch of government are really saying that Republicans should limit themselves to ineffectual efforts at accomplishing their goals.

      • October 6, 2013 at 8:28 am

        well…that’s true if the Republicans are simply a party, and don’t have ideas which inspire. Reagan didn’t just win Republicans in his landslides, after all…he won huge groups of new voters and formerly-Democratic voters who were inspired by his vision.

        What the Republicans need is a leader with vision, not just for the right but for the whole country. I rather suspect one of the young fellows could do it if he took control and clear leadership, but as long as there are multiple leaders it will be hard to be a majority party except by redistricting.

        By the way, until two or three years ago more voters identify themselves as Republicans than Democrats, and there are more Republican governors and Democrat governors, so I am not really convinced that there is a big tectonic shift here. But if you’re going to try to win by cobbling together a coalition of small ideas, it makes sense to think this way. I just think that victory at a national electoral level requires being able to express big picture ideals (like Obama with “hey! free stuff! and the rich guy is buying!”).

  5. eric
    October 4, 2013 at 3:31 pm

    *not traditionally supposed to have

  6. eric
    October 4, 2013 at 6:03 pm

    Just read something on zerohedge about paying “selected obligations” that strikes me as profoundly right. If the WH (via the treasury) decides to prioritize interest payments on treasury bonds, they will be open to the charge that they are “paying china ahead of (fill in the blank.)” Of course this is a stupid charge. But we are talking about American politics.

  7. Mike
    October 10, 2013 at 6:58 am

    Hello, great blog i enjoy reading it very much. quick question, everywhere I read its states without a debt ceiling rise there will only be $30bill left in the coffers, would this be enough to avoid selective default? Seems very low based on the annual interest charge of $300bil

    • October 10, 2013 at 9:49 am

      yes, because the government takes in $2.9 trillion. Now, a lot of that comes in April, but they also get tax payments more or less constantly. A few analysts have looked at it with a sharp pencil and concluded that the cash flows aren’t very difficult at all until mid-November (when there are a lot of coupons that come due and a lot of interest to be paid), and even that is fairly easy to work around with some notice.

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