No Weird Tricks Needed to Stave Off Debt-Ceiling Default

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The debt ceiling debate stepped up another notch this week, with negotiations stalling Friday as the mooted June 1 deadline loomed ever closer. Unsurprisingly, this triggered more frenzied “default” warnings, along with chatter about “invoking” the 14^th Amendment, which states “the validity of the public debt of the United States, authorized by law, … shall not be questioned.” Increasingly, there is talk from commentators that the Biden Administration could use the 14^th to declare the debt ceiling null and void and keep issuing debt. This has prompted a slew of arguments on both sides. But to us, it is perplexing, because there is a much easier, less controversial application of the 14^th Amendment: prioritizing debt interest payments ahead of all others. Past administrations have acknowledged this. So has the Government Accountability Office (GAO). And so has the Supreme Court, in 1935’s Perry v United States. Take a tour with us through this history, and you will see that if Congress somehow fails to lift the ceiling in time—which we think is unlikely—the Treasury doesn’t need weird tricks to stave off a default.

Let us start with the court case, which dealt with the terms and obligations of US Treasury bonds. In 1918, one John M. Perry of New York City bought $10,000 in US Treasurys that would become eligible for redemption in 1933. The bond stated: “The principal and interest hereof are payable in United States gold coin at the present standard of value.” At the time, every dollar was backed by a fixed amount of gold. But the Roosevelt Administration chucked the gold standard in 1933, during the Great Depression, and Congress retroactively applied that to extant debt shortly afterward. So when the Treasury called the bond in 1934, they wanted to pay $10,000 in greenbacks. Perry refused, demanding instead the originally pledged gold or $16,931.25 in “legal tender currency,” his estimation of the market value of said gold. The Treasury demurred, he sued, and it ended up before the Supreme Court on January 10 and 11, 1935.

In deciding this case (spoiler alert: Perry lost), the justices delved into a number of issues, including Congress’s power to regulate the value of money and set the terms of Treasury obligations, as well as whether the Treasury had an obligation to pay Perry more than the bond’s face value. In doing this, they had to consider the constitutionality of Congress’s Joint Resolution of June 5, 1933, which declared every Treasury obligation to pay in gold “to be against public policy” and retroactively mandated that all such obligations, both extant and future, be paid “dollar for dollar, in any coin or currency which at the time of payment is legal tender for public or private debts.”^[i] The government argued this permitted a retroactive change in bond repayment terms because earlier Congresses weren’t allowed to restrict the 73^rd Congress’s ability to carry out its duties. The Court took this to its logical conclusion, stating, “The contention necessarily imports that the Congress can disregard the obligations of the government at its discretion and that, when the government borrows money, the credit of the United States is an illusory pledge.”^[ii]

That invited a harsh smackdown: “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 pledgor. This Court has given no sanction to such a conception of the obligations of our government.”^[iii] The ruling went on to say that Congress’s joint resolution illegally abrogated the United States’ contractual obligations. So Perry won on principal but lost on his main question, as the Justices went on to rule that paying more than the bond’s face value would also be illegal. So, moral victory, but no dice.

There is a lot of legalese in the preceding paragraphs, but it boils down to this: By retroactively changing bond terms in the 1933 joint resolution, Congress started sliding down a slippery slope toward arbitrarily deciding whether to pay bond interest and principal as promised. The Court stopped this in its tracks, citing the 14^th Amendment and affirming it required the United States to carry out all obligations enumerated on Treasury bonds. In other words, Uncle Sam has a legal, constitutional requirement to make every interest payment due.

So if Congress doesn’t lift the debt ceiling and the Treasury were to burn through its cash reserves, the Court’s interpretation of the 14^th Amendment points to prioritizing interest payments ahead of all other bills. Not throwing the statutory debt limit out the window to keep borrowing—just to make interest payments first with incoming revenues. A government that attempted to do otherwise would face a rigorous legal challenge and invite myriad questions about the sanctity of the Constitution’s separation of powers. It is impractical, in our view. And unnecessary.

Historically, the major issue the Treasury has grappled with in debt ceiling squabbles is whether it can prioritize payments. Perhaps to motivate Congress to act, some prior Treasury officials have argued they can’t put interest payments first but rather have to pay bills as they come in. But that isn’t the case. In 1985, Congress asked the nonpartisan GAO whether “the Treasury has authority to determine the order in which obligations are to be paid should the Congress fail to raise the statutory limit on the public debt or whether Treasury would be forced to operate on a first-in first-out basis.” The GAO confirmed it could prioritize, saying, “We are aware of no statute or any other basis for concluding that Treasury is required to pay outstanding obligations in the order in which they are presented for payment unless it chooses to do so. Treasury is free to liquidate obligations in any order it finds will best serve the interests of the United States.”^[iv]

So, legal requirement to pay all interest? Check. Legal ability to put some bills aside in order to pay interest as it comes due? Check. But what about operational capacity? In 2013, then-Treasury Secretary Jack Lew claimed the government’s computer systems weren’t set up to accommodate prioritization and called it “unworkable.” That got a lot of headlines. What didn’t get as much attention: He was referring to the tough choice of which bills to pay after interest was already taken care of. Thing is, his predecessor, Tim Geithner, presided over the development of a payment prioritization contingency plan during 2011’s debt ceiling mega-standoff—except they called it “Delay of Payments,” and it involved putting every payment except bond interest on ice until the ceiling was lifted. This eventually came to light in 2012 in a Treasury inspector general report. Lew sort of acknowledged this during Congressional testimony in 2013 but shifted the discussion from interest payments to entitlements every time the question came up, in keeping with the administration’s preferred messaging.

So the question is really whether the Treasury has updated its systems over the last decade. But when you hear talk about prioritization not being feasible operationally, keep in mind that probably doesn’t refer to interest payments, but rather, everything else. And even that may not be that much of an issue. During a debt-ceiling fight in February 1996, Congress temporarily permitted the Treasury to issue a select amount of bonds that wouldn’t count against the ceiling to fund Social Security payments.[v] That suggests two things: The government has a precedent of carving out politically sensitive payments after accounting for interest. And two, they have the operational means to do so. Is it hard? Maybe. But difficult isn’t impossible, and we doubt “computer said no” would hold up in court if Uncle Sam got sued for missing an interest payment.

Now, again, in all likelihood this will turn out moot—Congress has always raised the debt ceiling, sometimes at the last possible millisecond, and it is overwhelmingly likely to do so again. With 2024 looming, neither party will want to face voters after having fomented payment chaos. A politician’s primary goal is always to win re-election, after all. Debt ceiling theatrics are part of that, as they give everyone an opportunity to grandstand and claim they fought for this, that and the other and won such and such concession all while averting financial disaster. Tiresome? You bet. A financial crisis? Nope, just politics as usual.