WASHINGTON -- At some point after Oct. 17, the U.S. government won't have enough money to pay all its bills. And, if Congress fails to raise the debt ceiling, which still is a real possibility, the government won't be able to borrow more to meet those obligations.
That creates the risk the United States may default on its debt if there's not enough cash to pay bondholders when interest payments come due.
Both the Treasury Department and financial analysts agree that this could lead to Armageddon. Large swaths of the global financial system are structured around the idea that U.S. debt is the safest in the world. If that assumption was ever called into question, chaos would ensue.
Some Republicans, however, are now playing down this possibility: If the United States does breach its debt ceiling, they say, why can't President Barack Obama just choose which bills to pay? Surely he could just keep paying bondholders to avert a financial calamity while delaying payments for everyone else, right? "There's always revenue coming into the Treasury -- certainly enough revenue to pay interest," Rep. Justin Amash, R-Mich., told National Journal.
But there are a few big problems with this "prioritization" plan: For one, it could prove extremely difficult, logistically and legally, for the Treasury Department to prioritize payments in this way and avoid default. Second, even if the Obama administration could put bondholders first, breaching the debt ceiling would cause major U.S. economic disruption.
The Treasury Department typically receives around 2 million invoices a day from various agencies. Treasury's computers make sure the figures are correct and then authorize payment. This is all done automatically, dozens of times per second. Payments flow through the new Office of Fiscal Service.
There appear to be two broad systems here: 1) The Bureau of the Public Debt handles U.S. sovereign debt payments through a system called Fedwire, and 2) the Financial Management Service handles other payments to agencies and vendors, through the Automated Clearing House.
What happens if the United States breaches the debt ceiling, and sufficient funds stop coming in because the government can't keep borrowing? The Treasury Department maintains that it has no ability to choose which bills to pay if it's short of cash. The agency's inspector general says its computer systems are designed to "make each payment in the order it comes due." Full stop.
So, if Congress fails to lift the debt ceiling, the U.S. government will have money to cover only about 65 percent of its bills. Some payments will fail to clear. Perhaps a defense contractor's payment comes up short. Maybe a Social Security check bounces. Maybe an interest payment to bondholders fails.
That last is the most worrisome. If the U.S. government misses a payment to bondholders, "a default would be unprecedented and has the potential to be catastrophic," Treasury warns. "Credit markets could freeze, the value of the dollar could plummet, U.S. interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse."
Other financial analysts agree. "Let us be perfectly clear," warns a note from RBC Capital Markets, "crossing the debt ceiling would be catastrophic."
That's why some market analysts, and many Republicans, think the Treasury will do all in its power to avoid the apocalypse -- paying bondholders first and, if necessary, delaying payments to everyone else. One possible way this might work is that the Bureau of the Public Debt would keep making payments to bondholders through Fedwire, and Treasury would halt computer systems that pay other federal agencies and vendors.
But prioritization isn't a sure thing. Here are two hitches:
1) It's unclear whether Treasury even has legal authority to prioritize payments. "Anyone who says they know for sure whether this is legal is not telling the truth," said the Bipartisan Policy Center's Steve Bell, a former Senate Budget Committee GOP staff director.
The key question is whether the Treasury could stop paying people on certain days to "save up" money for debt service -- say, for the $31 billion in interest payments that come due Nov. 15. Back in 2011, Sen. Pat Toomey, R-Pa., introduced a bill to require the Treasury to prioritize bondholders above all else, but it never passed Congress.
2) It might fail logistically. Treasury has long insisted its payment systems simply aren't set up for prioritization. Former Treasury chief of staff Mark Patterson says: "The U.S. government's payment system is sprawling. It involves multiple agencies; it involves multiple interacting computer systems. And all of them are designed for only one thing: To pay all bills on time. The technological challenge of trying to adapt that to some other system would be very daunting, and I suspect that if we were forced into a mode like that, the results would be riddled with all kinds of errors."
Now, it's possible that the Treasury Department is secretly at work on a plan to avoid a debt default in the event of a financial meltdown. As the libertarian Cato Institute's Dan Mitchell says, "Treasury Department has plenty of competent people who would somehow figure out how to prioritize payments." But that's placing much faith in federal technology experts (more than Cato typically does). Note that the government is still struggling to set up a glitch-free website for Affordable Care Act federal exchanges.
In 1979, after Congress dithered on a debt-ceiling increase, the government inadvertently defaulted on about $122 million worth of Treasury bills due to unexpectedly high demand and a word-processing error. Treasury quickly fixed the error; still, the damage was long-lasting. A 1989 study in the Financial Review estimated that the incident raised U.S. borrowing costs by about 0.6 percent, or $12 billion. The damage lasted for months.
A breach today would be an intentional action inidicating serious changes, and new risks, in the U.S. political system.
Even if the government could prioritize bondholders, a debt-ceiling breach could still inflict plenty of economic harm.
Let's imagine Treasury figured out how to revamp its systems to prioritize bondholders and skirted all legal questions. Even in this scenario, a debt-ceiling breach could still cause economic havoc. Once we blow past the debt ceiling, the U.S. government will bring in only enough revenue to cover about 65 percent of expenses. The government would need to cut something else: Social Security or Medicare or veterans benefits, or any of millions of other payments it approves daily. More than $100 billion would get sucked from the economy over the coming month.
So it's possible, though not certain, that the Obama administration could avert a default and financial markets meltdown in the event of a debt-ceiling breach. But avoiding a recession would be extremely difficult.
Markets would likely react badly in either case: A recent note from Deutsche Bank's David Bianco estimates that if we blow past the debt ceiling, and Treasury starts prioritizing payments, the S&P 500 could lose 10 percent of its value -- even without an actual debt default.
That helps explain why administration officials are dead set against prioritization: "Any plan to prioritize some payments over others is simply default by another name," Treasury Secretary Jack Lew wrote in a letter to Congress. "There is no way of knowing the damage any prioritization plan would have on our economy and financial markets."
First Published October 8, 2013 8:00 PM