US: The anatomy of a financial Armageddon and the 14th Amendment

US: The anatomy of a financial Armageddon and the 14th Amendment

Just for the sheer nihilistic thrill of it, let’s assume Congress and the president do not reach agreement this week to authorise an increase in the American government’s debt ceiling - let alone deal comprehensively with the government shutdown, or come up with a mutually acceptable, “grand bargain” on debt, budget, the sequester - and everything. J. BROOKS SPECTOR swallows hard and tries to imagine what that actually means.

With that assumption, picture this sombre scene: It is the morning of 17 October. Treasury Secretary Jacob Lew, flanked by a veritable regiment of other officials, steps up to the podium in the Treasury Department’s media briefing room and intones, “In the judgement of the relevant officials in this department, and given the failure of the United States Congress to produce a measure that would authorise an increase in the government’s debt ceiling, it is my unhappy responsibility to announce the US government will, increasingly, be unable to meet all of its statutory financial obligations on time.”

Up until this point, it seems the Obama administration has been slowly achieving a political win over the Republicans in the House of Representatives. This has evolved out of the fact that the Republicans have been riven by a split between its Tea Party wing in the House (allied with several of senators like Ted Cruz) and the more moderate centrists still holding the party’s ostensible leadership positions. This has pushed the challenge of finding a solution in the hands of the Democratic Party-held Senate, with increasingly divided, uncertain Republicans ultimately bending to the aims of the president.

As Politico commented on Monday, “Whatever else came out of the shutdown, President Barack Obama said he wanted two things to change: no more negotiating under threat. And no more lurching from crisis to crisis.” The goal is that larger bargain that encompasses passage of a new debt ceiling, ending the ongoing government shutdown and modifying the sequester budget cuts passed last term, as well as the possibility of Social Security and Medicare funding reforms and tax changes.

Such a big bargain is almost certainly beyond the ability of politicians to achieve between now and Thursday morning, however. Nevertheless, a just released position paper by one of the nation’s premier think tanks, the Brookings Institution, argued, “A grand bargain is absolutely necessary, but not to negotiate temporary terms to reopen the government or raise the debt ceiling. We need a grand bargain for democracy. We need President Obama and Congress to agree to take off the table the partisan war’s new weapons of mass destruction – government shutdowns, threats of public default, and sequesters.”

Okay, then, so fasten your seat belts. Let’s assume that there is no last-second bargain, no grand bargain, and that the US Government continues to be held hostage by about 40-odd (and some very odd) Tea Party-oriented legislators, and that the government simply doesn’t have the cash on hand to pay everybody with an invoice, a treasury note come due or interest on the rest of the treasury notes outstanding, plus salaries, pensions and all the other costs of government. And let’s assume, further, that the president does not elect to ignore the debt ceiling business entirely and issue those trillion dollar coins, or fall back on the “full faith and credit” clause of the Fourteenth Amendment to the Constitution to simply pay the country’s bills regardless of what Congress says (more on that in a moment).

Once that metaphorical federal ATM flashes “insufficient funds” on its screen, the Obama administration will then have to make a myriad of invidious little decisions that will add up to some very big ones about delaying or even suspending many billions of dollars of payments of Social Security checks, food stamps and unemployment benefits. And behind those transactions, other, still larger, still more fraught ones loom.

As of Monday morning, the best estimates are the government began its working day with about $30 billion cash in the bank and a sliver of wiggle room left to borrow a bit more, after carrying out some unusual measures it took as the debt ceiling crisis began to come into view. By Thursday, administration officials are saying they will have maxed out the borrowing authority under the current debt ceiling and the only thing they will have left will be their cash on hand (or perhaps a fire sale that auctions off the Statue of Liberty, the Hoover Dam, the Smithsonian Institution, an aircraft carrier or two, and Air Force One).

A brief time out seems in order right now. The debt ceiling doesn’t actually incur new debt; it simply acknowledges that current government expenditures already authorised by law require the issuance of new debt (otherwise known as treasury bills or bonds) so the government has the money on hand to pay the bills it has already incurred. What has happened in recent years is that a fairly routine proposal to increase the debt ceiling has come to take on a special meaning for financial conservatives. They have made it – and therefore the government in power that requires this bit of legislation – a convenient whipping boy for supposed fiscal imprudence, despite the fact it is Congress that has already incurred the spending on all the things a government does. Generally speaking, US Treasury bonds have had virtually no problem being purchased – nobody has really contemplated the day – at least until a few weeks ago – when the US government might actually renege on paying its debts, unlike so many other less stable nations, miscellaneous 19th century railroad building companies in China, or 21st century cities like Detroit.

Experts now say $30 billion and some change might be enough to make payments for a few days, but certainly not for more than a fortnight. As a result, the president – or somebody – is going to be put into the position of making some unprecedented choices about who or what to pay when the cash runs out. This is because daily tax receipts only make up around 70% of obligated government spending. Further, economists also generally agree (except for the occasional renegade who figures the 21st century equivalent of a Samson and the Temple–style government policy is the right thing to do under the circumstances) that no matter what course Obama chooses, a fall in federal spending of this magnitude would become a massive drag on the country’s economic growth (and readers can figure what that does to the rest of the globe).

By contrast to what happens during a standard-issue economic slump when the government-funded safety net expands to help people without funds, in this version of things, aid to seniors and the poor might well come later than expected or even be reduced substantially if the debt ceiling remains stuck where it is now. Depending on how things are counted up, it may also be the case – although no one knows for certain yet – that the treasury will not have sufficient funds to pay for major parts of the government that have remained open so far during the current partial shutdown, including bodies like the Federal Aviation Administration (including those useful air traffic controllers) and the FBI.

Of course the very first way Americans may come to witness the actual default would be from some strong financial market reactions, but there will be others soon enough. The Washington Post commented, “According to the Bipartisan Policy Center, which has done the most detailed analysis of federal finances in a debt-ceiling breach, administration officials would have to consider delaying or suspending tens of billions of dollars in critical payments to low-income people and seniors. Under the most alarming scenario, as soon as Friday, payments to Medicare and Medicaid providers, unemployment benefits, Social Security checks and tax refunds would be postponed for one to four days. Food stamps due to be distributed Oct. 25 could be held until Oct. 30. The same would happen to payments to defense contractors.”

But then the first day of November becomes rather more unpleasant still. On that date, around $60 billion in Social Security checks, veterans benefits and pay for active-duty troops will come due. The imbalance between expenses and revenue would mean these obligations could be delayed for up to two weeks, says the Bipartisan Policy Center. The Post added, “ ‘Right now, Grandma is getting a Social Security check. In a few weeks, unless we solve this, she won’t,’ said Steve Bell, a former top Republican Senate staff member and a senior vice president at the policy center.” At this point, at least, the exact timing of such delays can not yet be predicted precisely because of the vagaries in federal tax income.

Certainly the US Treasury would make an overwhelming effort to pay all the bond interest payments if the debt ceiling isn’t raised in time to avoid the dreaded term, a “default”, as defined by the credit-rating agencies. Regardless of a technical default, the actual circumstances would send tremors through the financial markets at home and abroad. In fact, a major test of investor reactions is already coming at the government in just a few days. On Thursday, the Treasury is set to refinance more than $100 billion of its current debt. If investors feel nervous enough about the federal government’s finances to take a pass on refinancing this paper or insist on higher interest rates before doing so, it could be one very unpleasant day in the financial markets once the traders and investors notice the problem.

The social impact of postponing the payment of those safety-net benefits could have a major league economic impact as well. Many people obviously have come to depend on such programs – especially in an economy that is still wobbly – for their daily necessities and rent money. Moody’s Analytics estimates every $1 spent on food stamps or unemployment benefits ultimately drives about $1.70 in economic growth. That lost spending would be a real hit on the economy and in this environment, those without benefits would have no government help to fall back on – it would become a true vicious cycle that would have no upside.

Meanwhile, the economists at Citi Research say their worst-case scenario where Congress doesn’t get to a solution to the debt ceiling for a longer period says unemployment might well bounce back to 10% and the economy would be right back in a real live recession. It might be even worse than that because their model makes the usual assumption that as the economy slides into recession, government spending would rise as additional people begin to draw unemployment compensation and food stamps.

In an effort to minimise the debt ceiling impasse’s impact on the most vulnerable, officials might well try to up the priority of some kinds of payments over others – a step that is probably impractical and quite possibly illegal as well. Who chooses? Then, if the government somehow managed to hang onto funding for much of the safety net and then military pay (imagine the shock of something like that going sour), it would then have to forgo yet other spending. That might mean giving a pass on something like some or all federal salaries and benefits, or pensions, as well as the actual operations of a clutch of government agencies – but which ones? The FAA? The Environmental Protection Agency? The Energy Department? Education? Or all of them?

Ah, but these are just the direct impacts of a so-called “hard cap” on federal spending. Then there are all the broader effects in the financial markets. Short-term borrowing markets – usually a critically important safe spot for cash – might well evaporate. And that would have yet other impacts on the rest of the financial community. None of them good. In such a situation, short-term-borrowing markets, which play a critical role as a safe place for cash, could dry up. That could lead to liquidity problems for financial firms, which would have trouble raising the daily funding they need to maintain their operations — and that probably would have spill-over effects elsewhere, such as the stock market.

As things stand now, between 18 October and 15 November, the Treasury is – or was – set to refinance some $370 billion in current indebtedness. When that happens, the Treasury borrows new money to pay back old investors. But if those new investors get nervous about a coming default, they could easily insist on higher interest rates to compensate them for the now-increased risk of lending to the government.

There is a further ripple from that, of course, because Treasury bonds are the benchmark for most other types of lending. As a result, all types of other loans would end up bearing higher interest rates – everything from personal credit card debt to mortgages, corporate loans, and auto loans. That, in turn, would help stall home buying, corporate investment and auto and other large personal purchases. The longer it goes on, the worse it gets, and that too is the opposite of a virtuous circle.

Of course the Congress could pass a debt ceiling increase before the clock strikes twelve midnight on the night of the 16th. Or the Treasury could decide that the wackier proposal of issuing some one trillion dollar coins or notes to cover expenses could work out. (But someone would have to take them and then disburse funds in return – and isn’t that just about the same as a bond? Just how this plan really works remains a mystery to some of us.)

But there is another argument now being made – and it is a reprise of a discussion first debated back in 2011 during that earlier debt ceiling wrangle. This resides in the “full faith and credit” clause of the 14th Amendment to the Constitution. This amendment is one third of a clutch of three amendments passed at the end of the Civil War after the victorious Union Army under General Ulysses S Grant had defeated the South under General Robert E Lee to free slaves, make them citizens and insure they had the right to vote. This particular amendment was primarily designed to insure the now-former slaves were to be seen legally as citizens, as opposed to their previous status as chattel property.

Its first paragraph reads:

Section 1. All persons born or naturalised in the United States, and subject to the jurisdiction thereof, are citizens of the United States and of the State wherein they reside. No State shall make or enforce any law which shall abridge the privileges or immunities of citizens of the United States; nor shall any State deprive any person of life, liberty, or property, without due process of law; nor deny to any person within its jurisdiction the equal protection of the laws.

But the amendment also contained the “full faith and credit” clause in its fourth paragraph:

Section 4. The validity of the public debt of the United States, authorised by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void.

The ostensible point of this paragraph was to ensure the debt issued by the federal government to finance the prosecution of war would never to be renounced by any future congressional action, and that the debts incurred by the by-then no longer existing Confederate government nor the states in rebellion would not be honoured by the national polity. While the language of the paragraph seems rooted in the time of the Civil War, proponents of an executive branch solution to the debt ceiling focus on the rather all-encompassing impact of the first phrase of the fourth paragraph – “The validity of the public debt of the United States, authorised by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.”

The argument of proponents for using this clause as a constitutional foundation for action in a dispute like this current one, all point to the Hobson’s choice of violating some law that would be faced by the president. His choice would seem to be either accept the inability of government to carry out all those payments that are embedded in law, or accept the need to violate the debt ceiling already in law in order to pay the bills. Moreover, proponents argue executive action to pay those bills is rooted in the explicit language of the Constitution itself, while the debt ceiling is “merely” a law, rather than a constitutional provision.

Contra wise, Harvard law professor Lawrence Tribe, in discussing this idea during the 2011 debt ceiling debate, argued that this interpretation was wrongheaded, however. He wrote then, “The Supreme Court has addressed the public debt clause only once, in 1935, in the case of Perry v. United States. The court observed only that the clause confirmed the “fundamental principle” that Congress may not “alter or destroy” debts already incurred. Some have argued that this principle prohibits any government action that “jeopardises” the validity of the public debt. By increasing the risk of default, they contend, any debt ceiling automatically violates the public debt clause.”

So far, at least, the White House has made it clear that neither that trillion dollar coin solution nor what is sometimes being termed the nuclear option of a unilateral payment of government obligations under this amendment are getting serious consideration from President Obama and his advisors. However, what the presidency will actually do if Congress doesn’t step up and pass an increased debt ceiling is still something of a mystery. But given the acrimony that has enveloped this crisis, it seems pretty certain that if that nuclear option becomes the weapon of last resort, it will quickly become one humdinger of a case for the Supreme Court to hear in record time. DM

Read more:

  • Mark Halperin: GOP ‘terms of surrender’ at Politico
  • A Grand Bargain for American Democracy at the Brookings Institution
  • Hurts So Good – If the debt ceiling fight ends soon, thank polls and markets for bringing pain to the GOP at Slate
  • Democrats Push for GOP Concessions as Debt-Limit Negotiations at Time
  • Experts See Potential Ways Out for Obama in Debt Ceiling Maze at the New York Times
  • A Historical Reassessment Of Full Faith And Credit at the George Mason Law Review
  • Can Obama Ignore the Debt Ceiling? (a debate among experts) at the New York Times
  • If Obama endorses his own impeachment, GOP will agree not to destroy the U.S. economy at the Washington Post
  • Debt Ceiling is Constitutional (analysis by Lawrence Tribe) at the Frum

Photo: U.S. House Speaker John Boehner (R-OH) (C) addresses reporters at the U.S. Capitol in Washington, October 10, 2013.  REUTERS/Jonathan Ernst


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