Here's The Uncomfortable Answer To Whether Treasury Can 'Prioritize' Payments In The Event Of A Debt Ceiling Breach

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U.S. Treasury Secretary Jack Lew testifies before a Senate Banking hearing on "The Financial Stability Oversight Council Annual Report to Congress." on Capitol Hill in Washington, May 21, 2013.

Theoretically, breaching the debt limit doesn't mean the U.S. needs to default on its debt.

Those who are sympathetic to debt ceiling brinksmanship rightly point out that the U.S. has way more tax revenue coming in each day* than it has to pay each day in interest payments, and so therefore the U.S. does have the financial means to be good on its debt obligations without incurring more debt.

The argument is that after the debt limit is hit the Treasury can "prioritize" payments, meaning that it would guarantee that bondholders get paid, while withholding money from, say, soldiers or Social Security.

Of course, this would obliterate the economy (Goldman estimates that this would erase 4.2% of GDP) but it wouldn't mean a debt default.

But is this actually possible?

Here's the answer: Nobody knows.

Seriously, it is remarkably difficult for anyone outside of Treasury to get any real answer to what is possible with regard to prioritization.

Cardiff Garcia has a must-read post at FT Alphaville just walking through the ABCs of the Treasury payment system. Suffice to say, just the ABCs are very complicated.

Over 80 million payments go out per month, and they're handled by three different systems.

From Credit Suisse:

As we understand it, there are three main systems – the Department of Defense Disbursing Offices, the Bureau of the Fiscal Service (which deals with Treasury security related payments), and the Financial Management Service (which makes all other payments). 

The way that they are set up, they can either be set to “on” or “off” – i.e., a system either makes all of its payments or it doesn’t make any at all.

The extent to which the system can be rearranged to honor Treasury payments first, and then disbursing what's left over is unclear, though at a minimum it would be extremely difficult.

But even if there were some technical approach to all this, you'd still have the legality.

Morgan Stanley recently published an FAQ on the debt ceiling, and this was the first question.

In the Event Congress Fails to Raise the Debt Ceiling, Is the Treasury Allowed to Prioritize Its Obligations?

Bottom Line : No, there is no legal basis for the Treasury to prioritize payments. As noted in our previous report, if the debt ceiling is not raised before October 17th, the Treasury will have approximately $30 billion left in the coffers to fulfill its obligations.

Given reasonable assumptions for receipts and planned expenditures, the remaining cash could last until November 1st, when large Social Security, Medicare, pension and other benefit payments are scheduled (about $67 billion in total). On November 15th, $31 billion in interest is due to bondholders. There is no legal basis for Treasury officials to fulfill certain obligations at the expense of others, and they therefore have no authority to cancel payments scheduled for November 1st. Further, without illegally stockpiling cash over the first two weeks of November, there will not be enough tax receipts on November 15th alone to prioritize bondholder interest payments over other expenses on that particular day.

That last point, about what happens on Nov. 15 is why we included the asterisk above, when we mentioned that the U.S. has more cash coming in each day than it has interest payments to make. While that is true most days, that's not true every single day.

So you have a technically difficult operation possibly running afoul of the law.

Does that mean it's not going to happen? Not necessarily. One can only surmise that The White House and The Treasury have crafted various escape hatches in the event the  debt ceiling isn't raised. And an effort at prioritization would certainly be better than missing a Treasury payment. But this is incredibly murky territory, and almost nobody on the outside has a great grasp of what would happen.



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