debt ceiling

Debt Ceiling Contingency Plans

Philip Brewer — Fri, 29 Jul 2011 22:59:53 +0000

What will the Treasury do if there's no increase in the debt ceiling? What should you do?

Back in April I wrote a post about what would happen if the debt ceiling were not raised. I suggested that the Treasury could deal with a cash shortage the same way Illinois had — by delaying some payments and prioritizing others. I also suggested that Congress, seeing the Executive branch grab all that power, would move quickly to end that experiment.

Looking back, even though I intended that post to be a bit tongue-in-cheek, I'm thinking I was a bit blasé about the whole thing. (See also: The Debt Ceiling Crisis in Everyday English)

Can the Treasury Prioritize?

Everyone has been assuming that the Treasury will respond by prioritizing certain payments — interest on the debt will be paid, social security will be paid, soldiers will be paid — and that other bills will be deferred.

The Treasury has been at pains to refute this assumption:

Treasury officials have maintained that the department lacks formal legal authority to establish priorities to pay obligations, asserting, in effect, that each law obligating funds and authorizing expenditures stands on an equal footing. In other words, Treasury would have to make payments on obligations as they come due. — Reaching the Debt Limit: Background and Potential Effects on Government Operations (PDF)

Beyond statements like that, the Treasury (and the Federal Reserve) have been quite steadfast about refusing to discuss contingency plans.

This is primarily a tactical move. Their position is that not raising the debt limit is unthinkable. Any indication that they're thinking about it would tend to undermine that position.

Still, their position is not unreasonable. Several presidents have tried the tactic of not spending all the money that Congress had appropriated — sometimes because they didn't like the program the money was being spent on, other times because they wanted to reduce government spending. Whenever this has been done, the courts have ruled against the practice. Congress has the power to spend money; the president has no power to "just not spend" money that Congress has appropriated.

Of course, this is a special case. The power to tax and to borrow also belongs to Congress. When Congress chooses not to get the arithmetic right — when the spending is greater than the sum of the taxing and the borrowing — the Treasury is placed in an untenable position. When it's impossible to follow the law, the Treasury has to make a choice. Currently the Treasury is playing its cards very close to the vest. There were rumors that it would provide some hints as to its contingency plans last night or today, but so far it has not.

Prioritizing payments has been the preferred strategy of the House Republicans who have been most adamant about refusing to raise the debt ceiling. They claim that the government should just live within its means, and that refusing to raise the debt limit, combined with prioritization, would be a way to force that.

Other people point out that the arithmetic goes against this strategy very quickly. Once you pay for Social Security, Medicare, Medicaid, the Defense Department, and unemployment, you've already spent all the money.

As I explained in my post Stalemate on the Debt Ceiling, that's not how I figure things will go — because government contractors will go on providing services for some time, even if they aren't getting paid, so those are the bills to not pay. Seniors would still get health care (for a little while), even if the Medicare service providers didn't get paid. Fuel for fighter jets would still get delivered (for a little while), even if the oil companies didn't get paid.

I still think the most likely option would be for the Treasury to prioritize spending. It would pay the interest on the debt, it would pay Social Security, it would pay federal employees (perhaps after laying off non-essential ones), it would pay soldiers. What it wouldn't pay would be the ordinary business debts of the government — defense contractors, drug companies, landlords, utility bills — including the big ones, like payments for Medicare and Medicaid, etc. (No smart drug company executive would quit delivering drugs to a VA hospital just because its bill was a bit late getting paid.)

And, as I said, I think Congress would cave pretty quickly, once business interests found that they were still providing services for the government, but were no longer getting paid.

Other Options

With the Treasury being so coy, I thought I'd at least touch on the other possibilities.

Pay Late

The Treasury has hinted that it would just pay the government's obligations in the order that they were due, making payments as and when the money arrives. For the first few days, we'd just be paying a few days late. Very shortly after, we'd be paying several days late. They'd treat every debt the same, including interest payments on the national debt. The result would be technical default almost immediately.

I think that's pretty unlikely. The Treasury is keeping the option on the table to pressure Congress, but managing the debt is the department's whole reason for existence; they'd never willingly make an interest payment late.

Issue Debt Anyway

Some people have pointed to a provision in the 14th Amendment to the Constitution, which says, "The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned," and suggested that the Treasury could call that authority for selling enough debt to make the payments that Congress has already authorized.

I think that's even less likely.

Run an Overdraft at the Fed

The Federal Reserve acts as the Treasury's bank. When someone deposits a government check, the bank presents it to the Fed. The Fed then gives the bank money, and debits the Treasury's account at the Fed. The Treasury's accounts are kept topped off through tax receipts and issuing government debt.

Suppose the Treasury just went right on writing checks, even though there wasn't enough money in the account? The Fed could either bounce the check, or pay it — letting the Treasury run an overdraft.

Paying the check would create money out of thin air, threatening inflation. However, the Fed could "sterilize" that money by selling enough assets to soak up the excess cash.

I see that as almost as unlikely as the 14th Amendment scenario. The folks at the Fed are bankers; they're not going to let the Treasury run an unlimited overdraft.

What You Can Do

I've been wracking my brain to come up with anything clever that individuals can do to make the whole situation less fraught, and I haven't come up with anything.

You could sell your Treasury securities, but what would you do with the money? If U.S. government bonds are no good, in what way would U.S. government currency be better? You could invest in foreign bonds, but which ones? The euro has its own problems — arguably worse than ours, because they're real (while ours are entirely self-inflicted). You could put some money in Swiss francs or Japanese yen or Canadian dollars, but that's a lot of trouble for no particular gain that I can see. You could buy gold, but it's already gone up a lot on the panic trade, and will almost certainly come down if debt problems are resolved.

The only bit of advice I've got is to trust banks over money funds. Money funds invest all their money in just the sort of securities that suddenly become worthless if the markets seize up (as they did after the Lehman bankruptcy in 2008). Banks, on the other hand, have actual assets (loans to local businesses) and they have access to the Federal Reserve to get cash if necessary.

The Treasury has started hinting that it will provide some guidance about its contingency plans before August 2nd. I'll keep an eye out and will post further, if there's any new news.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

The Debt Ceiling Crisis in Everyday English

Sarah Winfrey — Fri, 29 Jul 2011 22:46:06 +0000

If you’re like most Americans, you’ve heard more than you ever wanted to hear about the debt ceiling crisis. However, hearing is different from understanding, and this is a complex problem that can be difficult to grasp. In this case, it's been even harder to get an accurate explanation about what is going on in language that’s easy to understand. After all, if you’re not an economist or a financier, it’s easy to wonder what the big deal is, anyway.

This week, I had the chance to talk to FOX Business Network reporter Shibani Joshi to see if she could shed some light on this situation and what it means for everyday Americans. She’s been following the story closely for weeks now and was eager to help Wise Bread readers gain a deeper understanding of the debt crisis. (See also: Debt Ceiling Contingency Plans)

What Is the Debt Crisis All About?

Basically, the country is running out of money. As of next Tuesday, August 2nd, the country will no longer be able to borrow more money because it will already have borrowed the maximum amount allowed under current laws. While this may not have a huge effect immediately (since the country does have other sources of income), if not resolved it means that, eventually, the U.S. will not be able to pay its bills. This includes payments owed on the money we’ve already borrowed, as well as veteran’s benefits, Social Security, Medicare and Medicaid, and more.

The government’s problem is similar to the problems that, on a smaller level, caused the recession. Joshi puts it this way, “In the same way we saw Americans living outside of their means by taking out too much credit to buy bigger homes than they could afford and maxing out their credit cards, the U.S. government uses too much credit. This is a magnified example of what happened to millions of Americans in the last decade.”

Is it a Big Deal?

According to Joshi, this is a significant problem. “If the U.S. can’t pay its bills,” she says, “it defaults on its loans and then the entire world will be impacted.” Many countries look to the United States as a financial leader, even during a recession. If we cannot meet our financial responsibilities, this will trickle down to effect people worldwide.

Not raising the debt ceiling will not only effect people around the world financially, but in other ways, too. “We are the most stable nation in the world, and the beacon that the world looks to for security,” Joshi says. If we are proven to be less secure than we appear, that will effect how other countries interact with us and could, eventually, lead to shifts in power around the globe.

Should You Panic?

Not yet. The August 2nd deadline isn’t hard and fast, except that we cannot borrow more money after that date. However, “we still have cash coming into the government, and the government will be able to pay its bills for a short time after August 2nd,” Joshi explains. This means that there is more time and space for lawmakers to agree on a plan than is being touted in many news sources.

In addition, Joshi stresses that “this is sometimes just how the system works. An outcome will be reached. It may not be fun or pretty, but it is how our system works.” She believes that, while lawmakers may hold out until the very last minute, they are not willing to sacrifice the well-being of the country they serve and the rest of the world for a few partisan ideals.

If We Don’t Raise the Debt Ceiling, How Does It Affect Average Americans?

The most significant place that average Americans will see an effect from this crisis is in the value of their investments. The Dow has fallen nearly 500 points during the last week because of the disagreements in Washington on this issue. “That is your money,” Joshi explains, “in retirement funds, college funds, and more.” It’s expected that interest rates will also rise, which means that mortgage, auto loan, and credit card rates will go up, too. The prices of certain commodities, like oil and gold, are also expected to rise. “This could affect your grocery bills and the price at the pump,” Joshi says, which hits every American where it counts.

Beyond that, Americans who rely on money from the government may be put in very difficult situations. If the country cannot provide that depended-upon income, these individuals and families could face serious financial difficulty.

However, it’s also important to note that we don’t know exactly what will happen. We’ve never defaulted on loans before, nor have we had a lowered credit rating. So for the moment, all of this is speculation.

What Can Every American Do in Regards to this Crisis?

1. Don’t panic. Give the government a bit more time to figure things out.

2. Get educated. Before you decide what you think about this issue, learn more about it. The information in this article is a bare-bones explanation. If you want to know more, continue researching until you feel like you understand what’s going on. Then, and only then, decide how you think it should be resolved.

3. Take action. When you know how you’d like to see the situation handled, contact your federal representatives to let them know. You can call, email, write, or Tweet your opinions. Talk to friends and family members, too. After all, many Americans still don’t understand the issue very well.

4. Be open to compromise. Issues as complex as these almost always require conversation and concessions on all sides before they’re resolved. Instead of insisting that your solution is correct, dialogue with others and try to come to a mutual understanding, just like we all want our representatives to do right now.

5. Be open to change. This country needs to operate on a balanced budget that doesn’t involve burgeoning debt, and that means that things cannot continue the way they are. “We have major issues to deal with that go beyond the debt ceiling,” Joshi says, “including a huge spending problem, entitlements that are dysfunctional, and a tax code that could use a house cleaning.” Making things better means change, and it will be easier if we all see it coming.

Shibani Joshi joined FOX Business Network (FBN) in September 2007 as a reporter. To her role, Joshi brings experience in investment banking, strategy and business development. Joshi began her career as an investment banking analyst at Morgan Stanley, where she worked on merger, acquisition, and corporate finance deals in the real estate sector.

Joshi holds an MBA degree from Harvard Business School. She also earned a bachelor’s degree in finance and accounting at the University of Oklahoma. Joshi is a native of Oklahoma City and her parents are originally from Pune, India. FOX Business Network will be airing a special report on the debt crisis on Monday, August 1 at 5AM/ET, where you can hear more of her thoughts and explanations on the current issues.

This article is from Sarah Winfrey of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Stalemate on the Debt Ceiling?

Philip Brewer — Fri, 29 Apr 2011 10:00:14 +0000

The news is full of speculation about the result if there's a stalemate on the debt ceiling, but I know what would really happen. I live in Illinois.

You see, Illinois has been in much the same situation for years now. The legislature has appropriated more in spending than they raise in taxes, but there are sharp restrictions on how much money the state can borrow. (See also: Borrowers, Lenders, and Others — Beware Trusting the Government)

So what happened? Well, interest on our debt got paid. State employees' salaries got paid. State pensions got paid. Tax refunds got paid. Unemployment checks got paid. Direct benefits like food stamps got paid.

Who didn't get paid? Anyone who did business with the state. The state quit paying its bills. Business and contractors who provided services for the state got stiffed for months, and the state is by no means caught up on paying its bills (even though it recently raised taxes).

I'm confident that, if there's no increase in the debt limit for the federal government, the result would be much the same. There are a number of temporary measures the Treasury would take first — redeeming some debt owed to states, cities, and federal retirement funds — but once it exhausted those maneuvers, it would have to stop making some budgeted payments. But the Treasury would be deciding which payments to make and which to delay. The effect would be to give Treasury Secretary Geithner complete control over who gets paid when.

As I read it, there is only one constitutional requirement for federal payments — judges have to get paid. After that, if there's not enough money, the Treasury can pretty much pick and choose.

I'm sure the Treasury would pay the interest on the debt, because the public debt of the United States is what it cares about most. It'd also go ahead and roll over maturing debt (staying under the ceiling). It would go on paying military personnel and government employees. It would go on paying social security, railroad pensions, and other direct payments to individuals.

What the Treasury would quit doing, just like in Illinois, is paying contractors. It wouldn't refuse to pay them, it just wouldn't cut a check until the money came in. (It would rack up late-payment charges, but neither those nor the unpaid bills themselves count against the debt ceiling.)

In Illinois, where this went on for years, the government didn't just pay the bills in order. They gave priority to businesses that might fail if they didn't get paid. (Lots of businesses that contracted with the government to provide services to the poor had no non-government business. If they didn't get paid, they would be out of businesses in a matter of a weeks.) There was a whole procedure in place for businesses to make urgent claims for relief. If the situation went on at the Federal level for any length of time, I'm sure the same sort of thing would happen.

Think of the power this gives the Treasury! I'm sure they wouldn't do anything so crass as to pay companies that were donors to their party before paying companies that donated to the other party, but I wouldn't be surprised to see the power brought to bear only a little more subtly than that. For example, employers in a state where a senator was blocking a bill to raise the debt ceiling might have particular trouble getting their bills paid.

Personally, I don't think that situation would go on for very long. When the many large companies that do business with the United States quit getting paid, they'd have a quick chat with the Senators from every state where they have an office. When the many, many small businesses that have contracts with the federal government quit getting paid, they'd call up their Representatives and make it clear that they wanted the problem fixed. Most especially, once members of Congress realized that what they'd done was to hand the power of the purse over to the Treasury — give Timothy Geithner the power to decide who gets paid and who doesn't — they'd raise the debt ceiling and grab that power right back.

These insights brought to you thanks to my long experience living in Illinois.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: