Wednesday, October 09, 2013

More on Debt Limit and Default

A commenter on my previous post provides a link to an article that purports to justify the claim that hitting the debt limit might well lead to a default on interest payments on the debt. The arguments are:

1. "we don't know if the Treasury can legally or logistically prioritize payments." Because ... "presidents are legally required to carry out all of the spending that Congress authorizes"

A President cannot spend money he does not have; whatever the requirements, if the debt limit prevents borrowing he will have to reduce expenditure to revenue. Further, the author concedes that the only legal opinion on the subject, from the Government Accounting Office some time back, is that the President can indeed prioritize debt.

And, finally, Congress is always free to change its mind about what it authorizes. The Republican majority in the House would gladly pass a bill prioritizing interest payments, so unless the President and his party want to default there is no need to do so.

2. "the Treasury's payment systems are a bit convoluted." Hence even if the money is there, the treasury might be too disorganized to pay it out.

The treasury has been paying out interest to claimants for quite a long time now, and it is hard to see why the need to cut other expenditures would keep them from continuing to do so. The author cites a problem back in 1979 when the result of a similar situation was that "we temporarily defaulted on some of our debt." It does not seem to have occurred to him that if that particular glitch in payments did not cause the sky to fall, there is no reason to suppose that, if it somehow happened again, this time the result would be catastrophe.

3. "payments and revenues are lumpy. ... So the question is whether there could ever be a particular day when we owe more in interest than we have in cash on hand."

That might be a serious argument if average daily revenue was only a little higher than average interest, but with revenue more than ten times net interest it is hard to take it seriously. The author supports his argument by pointing out that, on November 15th, 30 billion dollars of interest comes due. It apparently does not occur to him that if the government, knowing that that bill is coming due, simply spends a billion dollars a day less than it takes in for the previous thirty days, it will have a cushion adequate to deal with that particular lump. It should not be hard given that, according to his graph, there is only one other day in that month on which any interest is due. 

Readers are invited to read the Atlantic article and see if they agree with me that it is evidence for my position. If those are the best arguments that can be produced for the claim that hitting the debt limit is likely to lead to default, the claim is indefensible and the people responsible are making a deliberate attempt to mislead the public.

And the author has the gall to claim that the belief of Republicans that hitting the debt limit will not lead to default show them to be the party of crazy ideas.


Anonymous said...

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Will McLean said...


Not an opinion that inspires a high level of confidence.

David Friedman said...

Will: So then what do you suggest is the legal implication of a situation where the federal government does not have the money to fulfill all appropriations? The president just throws up his hands in despair?

And what would prevent Congress from passing a bill giving interest payments priority? What Congress gives, or appropriates, Congress can take away.

Will McLean said...


One option in the situation you describe is that the executive branch does not prioritize, but pays all obligations in the order received as funding becomes available. This will create a lengthening backlog, but that's what Congress has chosen.

Congress could indeed pass a bill giving interest payments priority. How many Congressmen want to explain to their constituents why Chinese bondholders get paid first, before your mother's social security check? Also, why they need to do damage control in advance for a crisis they say they won't let happen?

Handle said...

The real problem with all this is that sometimes a 'default' is not a default.

When Detroit defaults because it actually lacks the wherewithal and economic capacity to fulfill financial obligations, then existing bonds trade at a discount (often long in advance of the actual default, through rational anticipation) because creditors do not expect to recoup the original expected value of their investment.

But every holder of US Treasuries knows that what is happening is a temporary political irregularity, and that even if there should be some short delay, they will be made whole and with interest once the politicians come to some kind of accord.

I work with a lot of federal civilians who were temporarily furloughed, and every single one of them expected to be made whole, and indeed, they will be. They won't even be charged vacation time (not even fractionally) for days on which they didn't work and yet for which they will still be paid.

David Friedman said...

"Also, why they need to do damage control in advance for a crisis they say they won't let happen?"

Because that is precisely how they don't let it happen.

Gordon said...

David, the article concludes by saying that the chance of default does not have to be "likely", but merely two percent, given the outcome, to be a cause of serious concern. Do you think the chance is really much less than two percent, or that the feared outcome would not, in fact, bring about a serious financial crisis?

Patrick Sullivan said...

'How many Congressmen want to explain to their constituents why Chinese bondholders get paid first, before your mother's social security check?'

Social Security has its own revenues. Every payday, and there's enough to cover about 98% of benefits owed.

David Friedman said...


I don't understand how your account is consistent with the events of the past few weeks. If the administration doesn't have the power to decide who to pay with their limited funds, how have they been closing offices and furloughing employees in anticipation of running short of money?

David Friedman said...

So far as social security, I covered this in a post a couple of years ago. Due to the odd accounting status of Social Security, its payments are not restricted by the debt limit.

This seems to be another case of supporters of the administration deliberately misrepresenting the situation.

David Friedman said...

Gordon: I don't know if the probability of something going wrong that leads to at least a temporary failure to pay interest on the debt is more or less than 2%. But if it is 2%, then the author has no business claiming that the fact that Republicans don't think it will happen means they are crazy.

And I await a public statement from the Administration saying that since there is a 2% chance that failure to raise the limit could result in default, the House has to raise the limit.

Will McLean said...
This comment has been removed by the author.
Will McLean said...

"But if it is 2%, then the author has no business claiming that the fact that Republicans don't think it will happen means they are crazy."

I don't see how this follows. If I say that there's at least a 2% chance of a Space Shuttle losing an entire crew on any given flight and someone claims that the chance of disaster is zero, then they are in fact seriously deluded.

Further, the author's argument is that some Republicans claim that "not raising the debt ceiling would be no big deal." That is, not only will the interest be flawlessly prioritized, but that bond markets will be serenely confident that this will happen, and the massive jolt of sudden austerity will have no negative impact.

David Friedman said...


I don't think he quoted anyone saying the chance was zero. In ordinary talk, saying something won't happen is consistent with a very small probability that it will.

Turn it around. Do you really think that the talk about default, in that article and more generally, is consistent with all concerned regarding it as a 2% probability? Isn't it commonly presented as if default was the expected result? And isn't that claim fraudulent if the real odds are 2% or anything close?

Will McLean said...

He doesn't quote them in the article, but the first link goes to people saying "risk of a default is practically nil" and "The likelihood of an actual default is zero, or as close to zero as you can possibly get"

The author is quite *explicit* that he doesn't think a default is an expected or likely result. He does however, think that the chance is enough more than practically nil that it's worth worrying about. Even 2% is enough to be frightening and we don't really know if it isn't worse than that.

Since the author explicitly denies that he thinks default is a *likely* outcome of failing to lift the debt ceiling, you may want to edit your paraphrases.

David Friedman said...


The first source quoted (Heritage) says "‘the Treasury would not necessarily default on debt obligations" and follows "practically nil" with "unless the President and Treasury choose to default, an unprecedented and almost inconceivable course of action.”

That seems reasonably accurate. And in ordinary speech, 2% qualifies as practically nil.

The second says:

"I think the likelihood of an actual default is zero, or as close to zero as you can possibly get, for the simple reason that the Treasury Department has plenty of competent people who would somehow figure out how to prioritize payments."

That's again consistent with 2%.

And I think your "explicitly denies that he thinks default is a likely outcome" is an exaggeration. He does say:

"These worst-case scenarios aren't likely, but they're still real." But he has offered several different scenarios each of which leads to default, so even if no one of them is likely it does not follow that default is likely. And the tone of his article doesn't suggest that he thinks 2% is the right number, but that he thinks we might well default, and doesn't have an opinion on just how likely it is.

I agree, however, that I slightly overstated his position--I think what I described is what he wants his readers to conclude but not quite what he claims--and I will modify accordingly.

David Friedman said...


Let me put a point made a little earlier more clearly. Do you agree that:

1. Many, perhaps most, of the supporters of the Administration in this conflict write or speak as if default on interest payments on the debt was the likely, if not inevitable, result of hitting the debt limit.

2. That claim is not only false but indefensible--the closest we have seen yet is a defense of the claim that it could possibly happen.

3. Hence defenders of the Administration are using an argument which is fraudulent and which at least some of them must know is fraudulent.

Will McLean said...

"That seems reasonably accurate. And in ordinary speech, 2% qualifies as practically nil."

No.A car with a 2% catastrophic failure rate bursts into flames and explodes at least six times a year. In ordinary speech, that is not practically nil.

David Friedman said...

Combining "would not necessarily" and "unless" with "practically nil" is consistent with 2%. And your car example assumes that the failure rate is happening each day for a year.

If we were considering the effect of having a separate and different event equivalent to running into the debt limit every day for a year, a 2% failure rate, independently for each one, would be a matter of concern. But we aren't. Your case of a car is substituting 365 tries for 1 in order to push 2% to practically certain.

If that isn't obvious, consider that however low the probability was, you could make the same argument--all you have to do is make a try every minute, or every second, or every millisecond, instead of every day--equally arbitrary and irrelevant.

Will McLean said...

When an entity is borrowing money, a 2% risk of default is not almost nil. And maybe it's only 2% but nobody really knows is worse. And frankly, I don't want to take a ride in a car with a 2% chance of exploding per trip even *once*.

Daublin said...

There is a stronger argument that the president can prioritize spending given a budget shortfall: he's already doing it.

Right this moment, the president has specifically closed down the parks, NSF, NASA, and the CDC. As such, I think we can safely say that given a continued funding shortfall, the president will get to continue to choose which things to shut down.

Based on that observation, I have come to think we are in a pretty healthy state at the moment. Yes, the decisions are painful about what should be shut down. However, grown ups just have to do that kind of thing. Sometimes you have to pay the mortgage and cancel the trip to Disney World.

Daublin said...

Err, sorry, I see that David already posted the same thing in the comments. So take my previous comment as a +1.

I will add that the subject is not a small detail. It's the difference between actual brinkmanship and mere theater.

Will McLean said...

"Do you agree that:

1. Many, perhaps most, of the supporters of the Administration in this conflict write or speak as if default on interest payments on the debt was the likely, if not inevitable, result of hitting the debt limit."

No. Most of the writers I've read who think that not raising debt ceiling is stupid give similar arguments to O'Brien's: that there is some unknown risk of default on the debt, some risk of bond markets reacting badly, and significant risk of a negative impact from the sudden massive austerity shock.

David Friedman said...


Looking through Google news articles, I find:

"...raising hopes that Washington would avert its first default on the national debt."

"Briefing reporters after financial markets closed for the week, Carney welcomed a “new willingness” among congressional Republicans to open the government and avoid default, "

(Carney identified as a White House Spokesman)

"The Republicans had to stop using default as a weapon, a cudgel, and "remove the gun from the table". "

"With time running short, President Barack Obama and House Speaker John Boehner accelerated efforts Friday to prevent the U.S. Treasury from default"

"America is now careening toward a catastrophic voluntary default on our debt because ..."

I did not find a single reference to "the risk of a possible default" or the equivalent. All of the talk implies that if we hit the debt limit we default.

Do you disagree? If not, do you think this is the news media refusing to believe what both the Administration and the Republicans are telling them--which is what your version implies?

I think you are fooling yourself--refusing to face the fact that the side you support is being deliberately dishonest in this discussion (which isn't to say that the other side is not also dishonest--you are welcome to offer examples, and it wouldn't surprise me if you found some).

Will McLean said...

Well, it seems Google is feeding me different stories than it is feeding you. I understand that it does do that.

My search on Google News was "debt ceiling" and default.

"What is the debt ceiling? What happens if America defaults?"

One option is the implementation of instant austerity measures, which would hold spending at existing levels. That move could push the United States and possibly the world's economy into a recession. America could also reprioritize what it spends on and reallocate funding to other places.

The least pleasant solution is to default on the debt; a catastrophe of enormous proportions that would send confidence in the American economy tumbling. Because there's so much debt in the global economy, any form of default would have disastrous consequences for the markets.

"Hitting the debt ceiling doesn’t mean default"

"Debt Ceiling 2013: Wall Street rebounds on news that government default could be averted"

"The market has been sliding since mid-September as the gridlock in Washington got investors worried that the U.S. could default on its debt and wreak havoc on financial markets."

"What happens in a US debt default?

"Ideally, though, the Treasury would use the money from tax receipts - which would still be flowing into its coffers after the debt ceiling is breached - to pay only the interest it owes on bonds that have already been issued."

"No, Failure To Raise Debt Ceiling Won't Cause Default"

"On Default, Obama Is Not Lying"

"As the nation is approaching its debt limit, views as to what constitutes default, whether default can be avoided through payment prioritization and what the consequences of default would be are still diverging along partisan lines."

I should note that two parties tend to use "default" in different senses. Republicans define it narrowly as a failure to pay bondholders interest and principal. Democrats tend to define it as any failure to pay legal obligations when due.

David Friedman said...

I can do a search on Google. How do you do a search on Google News? I simply read through relevant news stories looking for references to default.

Incidentally, I'm not sure what "legal obligations" means in this context. I believe there are court cases establishing that the government has no legal obligation to pay Social Security, no legal obligation to protect people from crime, ... . As what is now happening demonstrates, the Administration does not believe it has a legal obligation to keep paying employees.

Aside from the obligation to pay off on actual existing contracts and the obligation to pay interest on the debt, what else qualifies as a legal obligation? In particular, what is a legal obligation that cannot be eliminated by Congress?

Will McLean said...

Existing contracts, pay for employees authorized by Congress, which included the active duty military, Medicare and Medicaid.

Also, my understanding is that Congress *can* change the mandated obligations of Social Security, but that the obligations continue to exist until they change the law.

David Friedman said...


Aren't all the things you list other than existing contracts obligations that Congress is free to change if it so wishes?

Will McLean said...

It *could* do such a thing, just as it *could* default on its debts.

David Friedman said...


I think there are different degrees of "could" here. Congress could vote to spend more money without voting to raise the debt limit, but it's arguable that it would not be legal to actually spend the money if doing so required borrowing.

Congress could vote not to pay interest on the debt, but it is arguable that doing so violates the constitutional requirement wrt the debt.

Congress could vote to not pay money it owed on an existing contract, but it is arguable that the federal government would be subject to a lawsuit as a result--I don't know whether the combination of sovereign immunity and the Tort Claims Act would or would not permit such.

On the other hand, Congress is, as I understand it, entirely free to alter ordinary appropriations--to change the Social Security law, to fail to appropriate money to pay employees, at least employees not on a long term contract, to decide not to buy military hardware. None of that involves any conflict with any legal obligation to anyone--although, of course, it might be politically very costly to do some of those things.

David Friedman said...


wrt Social Security, as I've just pointed out in another post, repeating a point made a couple of years ago, the debt limit doesn't restrict Social Security payments until the Trust Fund is exhausted, since very time the Treasury pays a dollar to the Trust Fund to redeem bonds, the debt falls by a dollar, letting the Treasury borrow a dollar.