Back in 2013, Susan Irving, a senior official at the Government Accountability Office, began meeting with executives of prominent New York and Boston investment houses and securities experts to get their take on another festering dispute in Washington over raising the debt ceiling.
With some Republicans once again threatening to block an increase in the government’s borrowing authority unless President Obama agreed to important spending concessions, the Treasury was forced to begin taking “extraordinary measures” or bookkeeping maneuvers to keep from bumping up against its legal borrowing limit. It was a repeat of a 2011 political drama in which the government came within hours of defaulting on its debt for the first time in history and hurt its credit rating.
The so called “X-Hour” surprised Irving by how many investors were extremely nervous and had begun shunning Treasury notes for fear of getting stuck with losses or delayed repayment.
“You had something on the order of $3 trillion worth of securities that people really weren’t eager to hold,” she recalled in an interview on Thursday. “Most of them were treasury bills” which at almost any other time would have been treated by investors like gold or cold cash because of the integrity of the government.
“The problem is what happens when you get this close to the cliff?” Irving said, in recalling the meetings. “You don’t want to mess around with the full faith and credit of the United States.”
Irving headed a review of the 2013 debt crisis that was just published last week. The report offers important insights into what happens within the bond and security market when Congress and the White House flirt with financial disaster. And it offers a cautionary tale for what might happen if President Obama and Republican leaders allow the current debt ceiling controversy to get out of hand.
The debt ceiling is a legally imposed limit on how much the Treasury may borrow to pay debts already incurred by the government. Although lawmakers on both sides of the aisle over the years have used the debt ceiling as a rallying cry to block future spending, in fact it reflects spending that has already been approved by Congress and the president.
This year’s drama began in March when a debt ceiling limit of $18.1 trillion snapped into place after Congress had temporarily suspended it last year. The reinstatement of the debt ceiling started the clock ticking on when the Treasury would authority have to begin prioritizing its payments.
Without that approval, the Treasury Department began imposing “extraordinary measures,” which allowed the government to continue temporarily making all payments in full and on time while technically operating below the debt ceiling.
Treasury Secretary Jack Lew notified congressional leaders that beginning March 16 he planned to declare a “debt issuance suspension period” with respect to investments of the Civil Service Retirement and Disability Fund and other funds.
Although this all sounds like fiscal mumble jumble, the bottom line was that Lew and his deputies had begun holding the line on fresh borrowing that would put them above the debt cap.
“Protecting the full faith and credit of the United States is the responsibility of Congress, because only Congress can extend the nation’s borrowing authority,” Lew said in his letter to the leaders.
While substantial uncertainty remains, the Bipartisan Policy Center projects that extraordinary measures and cash on hand will most likely allow Treasury to meet all its financial obligations until sometime in November or December. After that, all bets are off and the government could be back in extreme crisis mode by Christmas.
Controversies over the debt ceiling pose serious challenges for the government and the economy, although for now at least, the latest controversy has been placed on the backburner as Congress and the administration fight over spending measures and the U.S.-Iran nuclear deal.
The Last Debt Crisis
In 2013, President Obama and Federal Reserve Chairman Ben Bernanke urged Congress to raise the debt ceiling without conditions to avoid a default. However, House Speaker John Boehner (R-OH) and then-Senate Republican Minority Leader Mitch McConnell (R-KY) argued that the debt ceiling should not be raised above its existing $16.3 trillion level unless government spending was cut by an equal or greater amount than the debt ceiling increase.
That touched off a protracted political debate that took months to resolve. While Treasury was scrambling to avoid a default, many major securities investors were biting their nails in fear of the worst – a fact that got only fleeting recognition at the time. According to the new, detailed autopsy of the 2013 crisis by GAO, “Investors reported taking the unprecedented action of systematically avoiding certain Treasury securities—those that matured around the dates when the Treasury projected it would exhaust the extraordinary measures that it uses to manage federal debt when it is at the limit.”
Securities that matured around those dates were subject to “both a dramatic increase in rates and a decline in liquidity in the secondary market where securities are traded among investors,” the GAO found.
Moreover, there were also unusually low levels of demand at the relevant auctions and additional borrowing costs to Treasury, the study found. “Treasury securities are one of the lowest cost and widely used forms of collateral for financial transactions; because of this, disruptions to the Treasury market extended into other markets, such as short-term financing,” the GAO found.
GAO estimated that the total increased borrowing costs incurred by the government through September 30, 2014 on securities issued by Treasury during the 2013 debt limit impasse ranged from roughly $38 million to more than $70 million.
While that is a relatively modest sum in the context of debt issues involving trillions of dollars, Irving said what struck her most was how fast those costs escalated in a relatively short period of time. “If I look at the ramp up, it shows me more a slope of nervousness than a slope of higher cost,” she said yesterday
Investors told GAO that they are now prepared to take similar steps to systematically avoid certain Treasury securities during future debt limit impasses. “Market participants with whom GAO spoke said market reaction to future impasses could be more severe, in part because of changes in market practices since the financial crisis and in part because of contingency plans that many investors now have in place,” the report warned.
Separately, there was an effort across the financial sector to develop a contingency plan to address the potential of a delayed Treasury payment, the report revealed. However, industry groups emphasized that even a temporary delay in payment could undermine confidence in the United States “and therefore cause significant damage to markets for Treasury securities and other assets. This would affect not only institutions, but also individuals,” according to the report.