February 4, 2011
In November 1995, then-Treasury Secretary Robert Rubin set in motion a series of extraordinary financial maneuvers to keep the government afloat after a bitter budget dispute between Democratic President Bill Clinton and a Republican-controlled Congress threatened to force the United States to default on its bond obligations for the first time in history.
Rubin knew that without congressional consent to raise the legal debt ceiling, he had only a matter of weeks before the Treasury exhausted its borrowing authority and would have to renege on interest and principal payments to its creditors – something that the secretary described as “unthinkable” and “akin to nuclear war.” Through a series of arcane financial maneuvers – including postponing or downsizing debt auctions and speeding up the redemption of some government bonds – Rubin was able to forestall a default for an additional four and a half months. Congress finally relented and voted to raise the debt ceiling on March 19, 1996.
Today, another Democratic president and congressional Republicans are locked in a budget test of wills that could end in default on the federal debt this spring unless the two sides can negotiate a budget deal that includes a boost in the federal debt authority.
Yesterday, Federal Board Chairman Ben Bernanke warned of potentially “catastrophic” economic consequences if Congress plays politics with the debt ceiling. “We must be very careful that we don’t leave any impression that the U.S. will not pay its creditors,” Bernanke told a packed house at the National Press Club.
Obama Administration officials and GOP leaders are downplaying the possibility of a crisis of that magnitude. Earlier this week, the Treasury Department said it is about $200 billion shy of its $14.3 trillion borrowing cap, and on track to reach that point between April 5 and May 31 – a slightly rosier scenario than previously announced. However, Treasury Secretary Timothy F. Geithner has warned Congress that once the government bumps up against the debt ceiling, the Treasury at most could buy an additional “several weeks” of time if it resorts to the same gimmicks that Rubin used 14 years ago.
“Once these steps have been taken, no remaining legal and prudent measures would be available to create additional headroom under the debt limit, and the United States would begin to default on its obligations,” Geithner wrote in a letter to congressional leaders, adding that government default would have catastrophic economic consequences and shatter the U.S. credit rating. “Even a very short-term or limited default would have catastrophic economic consequences that would last for decades,” Geithner said.
The debt ceiling, first imposed by Congress in 1917 as part of the World War I-era Second Liberty Bond Act, limits the amount of obligations that may be issued by the U.S. government to finance its general activities or that can be borrowed from trust funds, including Social Security, to fund daily operations. Congress has voted to raise the debt limit 10 times since 2001 – but invariably the vote has been politically charged, with each party attempting to shift blame to the other for the ever-mounting debt.
GOP leaders including House Speaker John Boehner, R-Ohio, and Senate Republican Leader Mitch McConnell, R-Ky., say they don’t want a default but that any increase in Treasury borrowing authority must be linked to a package of deep cuts in domestic spending programs. Yet many freshmen lawmakers closely allied to the Tea Party have vowed to oppose any hike in the debt ceiling, and there’s no way to predict what might happen if political tensions flare.
"We are not looking to shut the government down; no one benefits," Rep. Michele Bachmann, R-Minn., leader of the House Tea Party caucus, said recently on CBS's Face the Nation. "But at the same time, we are not looking at wanting to continually raise the debt ceiling."
Jay Powell, a visiting scholar at the Bipartisan Policy Center and a former Under Secretary of the Treasury for Finance under Republican President George H.W. Bush, cautioned Republicans that “it’s not wise to push the debt limit issue too far … You win the spending battle at the appropriations and budget committees, and not on the debt limit vote,” he said.
While administration officials voice optimism that a debt ceiling crisis can be averted, Treasury officials clearly will have far less room to maneuver to keep the government afloat in the event of an impasse than the Treasury did during the protracted budget crisis of 1995-1996. That’s largely because the sheer magnitude of the federal deficit and debt – and the associated borrowing needs – overwhelms whatever benefits the Treasury might derive from manipulating government accounts and investment strategies.
In 1995, at the start of the Clinton era debt crisis, the annual budget deficit was $163.9 billion and the overall national debt was $4.97 trillion. By contrast, the deficit last year was $1.3 trillion – or nearly eight times as large as in 1995 – while the gross national debt was $13.5 trillion – or nearly three times as large. At most, the Treasury could buy about one-sixth as much extra time before breaching the debt ceiling as Rubin was able to do, according to Treasury officials.
“It’s fairly straightforward,” a senior Treasury official told The Fiscal Times this week. “The tools that have been used in the past have grown in value but they are not keeping up with the pace with which we’re borrowing. If you look at the slope of the line we’re borrowing versus the slope of the line of what the tools have added up to over the time, the slope of the line for borrowing is way steeper.”
For example, the main tools used by Rubin provided the Treasury with roughly $40 billion of additional debt ceiling “head room,” according to a Harvard Law School research paper by Ellen Bradford and Russell Constantine, while those same tools might buy Geithner roughly $150 billion of additional debt ceiling this year, according to one administration estimate. While Geithner would get roughly four times as much value out of the gimmicks than Rubin did, the Treasury’s borrowing requirements are eight times as great as they were in 1995.
“I think the only thing we can really do is be very clear with people and be very transparent about, ‘Here’s what we’ve got, here’s how long we think it can get us, you need to raise the debt limit before then, otherwise we’re going to have a real big problem,’” the Treasury official said. “We’re not trying to pull any tricks out of the bag basically.”
Some experts believe that Treasury officials are grossly low-balling their ability to buy extra time if necessary. The Treasury yesterday began winding down the Supplemental Financing Program, which was instituted during the early stages of the financial crisis to help the Fed manage its balance sheet by having Treasury issue short-term government debt and placing the proceeds at the Fed. And in desperation, the government might choose to defer other payments, such as federal tax returns or Social Security checks, to avoid default. “There’s a lot of maneuvering Treasury can do to get to July or August,” David Greenlaw, chief U.S. fixed-income economist at Morgan Stanley, told the Wall Street Journal last month.
Some Republican lawmakers have proposed legislation to minimize the risk that a battle between President Obama and the Republicans over the debt ceiling would spark a crisis in the credit markets. Rep. Tom McClintock, R-Calif., and freshman Sen. Pat Toomey, R-Pa., introduced a bill last week requiring the government to prevent default by paying the principal and interest due on the U.S. debt before making any other payments.
If a dispute between the White House and congressional Republicans does reach crisis proportions, the Treasury has several avenues available to buy some extra time. The most likely maneuvers – and the ones utilized by Rubin – are these:
- Redeem existing holdings and suspend new investments in the Civil Service Retirement and Disability Fund, the massive federal pension and disabilities program. The Treasury Secretary may postpone investing funds in government securities for the pension fund if such action threatens to breach the debt ceiling, with the understanding the Treasury would restore the principal and interest to the pension fund once the debt crisis was over.
- Temporarily prevent the Thrift Savings Fund – a government retirement savings plan – from investing in the Government Securities Investment Fund (G-Fund). Suspend sales of State and Local Government Series (SLGS) Treasury securities. The program was established in 1972 to prevent state and local governments from earning arbitrage profits by investing bond proceeds in higher yielding investments.
- Suspend reinvestment of maturing Treasury securities in the Exchange Stabilization Fund (ESF). The fund is used by the Treasury to stabilize the exchange rates and to deal in gold, foreign exchange and other instruments of credit and securities the secretary considers necessary. Funds can also be used to invest in government obligations. The secretary, if need be, can redeem exchange stabilization fund obligations in order to reduce the debt.
Scholars and political experts generally agree that the Clinton administration debt limit crisis of 1995-1996 was the most dramatic and dangerous such episode since enactment of the debt ceiling legislation. That crisis began shortly after Republicans took control of the House and Senate in the 1994 mid-term election. In early April 1995, then-House Speaker Newt Gingrich, R-Ga., vowed to force the government to default on its debt unless President Clinton accepted the Republicans’ budget plan for deep cuts in domestic programs – something Clinton was unwilling to do.
In late July, 1995, the Congressional Budget Office projected that the government would be able to “squeak through September” without breaching the debt ceiling, and with “a little ingenuity, the Treasury may even be able to hold out into November.”
Rubin began worrying about the possibility of a default on the debt shortly after he was sworn in as Clinton’s Treasury Secretary in January 1995, and ordered his aides to begin researching the problem and coming up with possible strategies. Edward S. Knight, who served as general counsel to the Treasury Department at the time, said recently that “we worked closely with the Justice Department to make sure that our exercise of the administrative authority and disinvesting these funds and other actions that we took were well supported by a record, and that they wouldn’t be the subject to successful legal challenges.
“Arguably the primary mission of the department and the Treasury Secretary is to protect the good name of the United States in the world economy and its financial markets,” Knight, executive vice president and general counsel for NASDAQ, said in an interview with The Fiscal Times. “So the world after default on an obligation by the United States is, for me, like the Secretary of Defense contemplating a world after a nuclear war. It’s something you’ve got to think about, but you are trying to run an economic policy and manage the debt in such a way that you never have to deal with that world.”