Defaulty Logic

The original text of the 14^th Amendment, which forbids the Treasury from skipping interest payments. Photo by Hulton Archive/Getty Images.

One week into a government shutdown and nine days from the estimated expiration of the Treasury’s “extraordinary measures” to avoid hitting the debt ceiling, Congress remains far from compromise. According to many (some of whom should know better), failure to raise the debt limit ensures a US default—a global catastrophe! Freaked out? Don’t be: This is just another case of politicians being politicians—whipping up a frenzy to goad the opposing side into action. Should Congress fail to raise the ceiling, default risk will remain slim to none—investors needn’t panic.

Public service announcement: Default refers only to missing payments on bonded US debt—interest payments on outstanding Treasurys and redemptions of maturing notes. Default doesn’t mean delaying payments to Federal employees or contractors—or Social Security, Medicare, pensions and other entitlements.

The latter is what leadership from both parties refers to when they warn of default. But if their definition were true, we’d already be in default, thanks to the shutdown—and we would have defaulted the other 17 times the US government shuttered since 1976. That we haven’t—that investors remain confident in debt backed by the US Treasury’s full faith and credit—tells you recent default warnings are a bunch of hot air. Their allegedly dire outcome—missing “obligations” other than interest payments—is already happening. Yet 10-year US Treasury yields have fallen over 30 bps since September 5—the opposite of what would happen if we were in (or nearing) default.

So why do our President, Treasury Secretary and House Speaker howl about imminent default and planetary doom? Perhaps they truly don’t understand the distinction between debt service and other payments—though we rather have our doubts. More likely, they’re just being politicians—manufacturing a supposed crisis to make it appear the other side doesn’t have the nation’s best interests at heart, all so they can heroically ride to the rescue. Ladies and gentlemen, your tax dollars at work.

Our suggestion: Instead of getting caught up in political theatrics, consider the likelihood of a true default. The numbers suggest it’s practically nonexistent. According to Treasury Secretary Jacob Lew’s latest estimate, if the debt ceiling isn’t raised on or around October 17, the Treasury must operate with daily cash on hand—about $30 billion per day. Some days, this will cover the bills. On others, officials must prioritize—and interest payments get top billing (more on this in a bit). Will $30 billion per day cover interest? Probably. At last tally, annual Federal interest payments were $224.7 billion—$860 million per working day, or about 2.98% of daily cash. Granted, interest payments aren’t distributed evenly over every day. But Treasury officials know what’s due when and can stockpile cash in advance of larger payments if needed.

Some suggest this scenario rests on an unproven assumption: That the Treasury will, in fact, prioritize interest payments above all else—and not let bond payments slide simply to make a political point. This scary endgame is highly unlikely. For one, as mentioned above, these are politicians—and politicians want to get re-elected (or re-appointed). Call us crazy, but we imagine anyone who makes the US default on purpose wouldn’t win another term in office. No one has any incentive whatsoever to do this.

It is also a fallacy to presume (as some have) the government must pay bills in the order they’re presented—that if a bill for the Capitol cafeteria’s plastic forks appeared on Lew’s desk before the day’s interest bill, the forks would win. This memorandum from Congress’s non-partisan watchdog—the Government Accountability Office—released during 1985’s debt ceiling debate, states unequivocally:

“The Secretary of the Treasury has the authority to determine the order in which obligations are to be paid should the Congress fail to raise the statutory debt ceiling and revenues are inadequate to cover all required payments. There is no statute or any other basis for concluding that the Treasury must pay outstanding obligations in the order they are presented for payment. Treasury is free to liquidate obligations in any order it determines will best serve the interests of the United States.”

Moreover, there is a very strong case skipping interest payments would be unconstitutional. Amendment XIV, Section 4 of the Constitution states: “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.” In its decision on 1935’s Perry v. United States, the Supreme Court interpreted this clause thusly:

“In authorizing the Congress to borrow money, the Constitution empowers the Congress to fix the amount to be borrowed and the terms of payment. By virtue of the power to borrow money ‘on the credit of the United States,’ the Congress is authorized to pledge that credit as an assurance of payment as stipulated, as the highest assurance the government can give, its plighted faith. To say that the Congress may withdraw or ignore that pledge is to assume that the Constitution contemplates a vain promise; a pledge having no other sanction than the pleasure and convenience of the pledger. This Court has given no sanction to such a conception of the obligations of our government.”

In other words—pay the darned interest, people, or else. No skipping payments to prove a point. And if for any reason cash on hand weren’t sufficient, Congress could very well be Constitutionally bound to issue more debt as needed to meet the obligation, debt ceiling or none.

Politicians won’t admit this, though—not when they want to stir voters’ emotions. But that leaders on both sides seemingly choose to ignore facts for their own gain is a political issue, not an economic one—and an issue older than the debt ceiling. The economics and legal specifics of the debt ceiling are as plain as day—investors simply needn’t fret a true default.