How Will the Debt Limit “Game of Chicken” End?

How Will the Debt Limit “Game of Chicken” End?

The Fiscal Times

It appears that Republicans are determined to hold the nation’s credit rating hostage to their demand that federal spending be slashed before allowing the debt limit to rise. Rep. Paul Ryan, chairman of the House Budget Committee, is already warning Wall Street that a “technical default” is likely; that is, some bondholders may not get their interest payments precisely on schedule.

The Treasury continues to warn that a financial apocalypse will occur if the debt limit isn’t raised soon, but Republicans pooh-pooh such concerns as political grandstanding. They maintain that as long as the Treasury has sufficient cash flow to pay interest on the debt, then Treasury can simply put off paying its other bills for a while and default will be avoided. They point to a 1985 opinion by the U.S. General Accounting Office (now known as the Government Accountability Office), which says that the Treasury is not obligated to pay its bills in the order in which they are received and can prioritize payments. Following is the opinion, which had been requested by the chairman of the Senate Finance Committee.

“You have requested our views on whether the Secretary of 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…. It is our conclusion that the Secretary of the Treasury does have the authority to choose the order in which to pay obligations of the United States…. We are aware of no statute or 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.”

Undoubtedly, there are bills that can be put off for a few weeks or longer. The Office of Management and Budget has the authority to reapportion funds within budget accounts to some extent; it can order agencies to adjust their payment schedules for various payments they plan to make. The problem is that we are getting close to the end of the fiscal year, which ends on Sept. 30. Since funds are normally apportioned on a quarterly basis, once we are in the fourth quarter of a fiscal year, OMB’s flexibility is greatly reduced, although it could apportion funds on a monthly or even weekly basis if it chooses.

Where OMB may have some important flexibility is with spending for some Department of Defense projects that have multi-year appropriations. For example, if DoD is building an aircraft carrier the funds need to be appropriated for the entire project even though it may take several fiscal years to complete. OMB apportions the funds as needed to pay for various phases of the building. There is about $800 billion of future year appropriations in the budget. Assuming these funds are spent at an even rate throughout the year, there may be $200 billion or so of appropriations that can be shifted into fiscal year 2012 that may provide Treasury with flexibility to manage its cash.

The real problem is Social Security. It’s unthinkable that Treasury would fail to make Social Security payments on schedule; too many of the elderly live from hand-to-mouth on them and there’s no way Republicans would risk their wrath. But Treasury is inevitably going to be forced at some point to choose between paying Social Security benefits or making interest payments and may face an untenable situation. A May 17 report from investment bank Morgan Stanley explains the dilemma Treasury will face:

“Some have argued that the Treasury can manage its cash in a way that avoids default…. However, the approach they are advocating does not seem workable to us. Treasury’s cash flows are too lumpy to simply prioritize one form of spending over another. For example, we would expect a significant political outburst if the Treasury withheld monthly Social Security checks at the beginning of the month (even though there was sufficient cash on hand to make the payments) just in case they needed the cash to make debt service payments at mid-month. Such a scenario is highly impractical – and probably not even legal.”

When Treasury faced this problem back in March 1996, it told Congress that it could not make Social Security payments unless Congress passed a law specifically exempting such payments from the debt limit. Congress acted instantly. It will undoubtedly be forced to do so again if the debt fight is protracted, which it probably will be.

Senate Minority Leader Mitch McConnell and other GOP leaders have insisted that Medicare cuts are their price for allowing a debt limit increase. But the only plan Republicans have on the table is one that would effectively abolish Medicare and replace it with a voucher intentionally designed to pay less than the per-beneficiary cost of Medicare, which is how its costs would be cut. However, there is little public support for the Republican plan and as Democrats make people more aware of it, support will undoubtedly fall further.

President Obama clearly has some strong cards to play – especially the real threat that Social Security benefits may not be paid if Republicans insist that interest payments to bondholders take precedence. Budget expert Stan Collender thinks the Democrats are holding a stronger hand and that the Republicans will blink first. We shall see.

Related Links: 
The Debt Limit Option President Obama Can Use (TFT)
Debt Ceiling May Come Crashing Down on Treasury (TFT)
One Man's Debt Ceiling is Another Man's Floor (TFT)