Republicans Don't Think They Have to Raise the Debt Ceiling—They're Dangerously Wrong

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The latest absurdity to migrate from the fever swamps to the slightly more respectable Heritage Foundation and on to Congressional Republicans is that not raising the debt ceiling would be no big deal.

Freshman Tea Partier Ted Yoho ventured furthest down this cul-de-sac when he said it would be salutary and "bring stability to world markets." But even Republicans like Tom Coburn have rushed headlong into this intellectual quagmire. As you can see below, Coburn doesn't think there's any chance that breaching the debt ceiling could mean a debt default, because he thinks that even then the Treasury could always pay the interest on the debt. This is not a minority position on the right: 64 percent of Tea Partiers and 54 percent of Republicans overall think there wouldn't be "any major problems" if Congress doesn't raise the debt ceiling in time. Call them the default deniers.

It's touching how much faith Republicans have in the government's ability to seamlessly pick-and-choose which of its 100 million monthly payments to make. But Republicans should perhaps be a bit more skeptical about how much government could solve this problem. See, we don't know if the Treasury can legally or logistically prioritize payments. And if it can't (or markets just think it can't) a debt ceiling breach could go from disaster to historic calamity.

Is prioritization even legal? One of the many legacies of Nixon's criminality is that presidents are legally required to carry out all of the spending that Congress authorizes. A Democratic president can't unilaterally withhold funds from the Pentagon, nor can a Republican president do so from the Environmental Protection Agency. Like them or not, the president has to execute all of the laws. Well, unless Congress won't let them. Suppose, for instance, that Congress won't let the president borrow more money to pay for the spending that Congress has already authorized. Could the president then decide who and who not to pay? Back in 1985, the Government Accountability Office ruled that the Treasury could indeed prioritize during a debt ceiling standoff -- but that's it. There's no other legal basis for it. That's not much to go on if it did get challenged in court.

Is prioritization even logistically possible? The government will have to cut roughly 32 percent of its spending overnight if the debt ceiling isn't raised. That's because the Treasury wouldn't be allowed to take out new debt to pay for already authorized spending, but would rather have to pay what we owe out of incoming tax revenue and rolled-over debt. But why should that mean there's any chance of default? Shouldn't the Treasury be able to rather easily cover the interest on the debt out of incoming revenue? That's what conservative politicians and some conservative economists have told themselves at least. Harvard professor and former Reagan adviser Marty Feldstein, for one, thinks "there is really no need for a default" if the debt limit isn't increased.

Maybe. But maybe not. The truth is we don't know. As Cardiff Garcia of FT Alphaville points out, the Treasury's payment systems are a bit convoluted. In theory, it shouldn't be too hard to make sure we pay the interest on the debt on time and in full before all else. But in practice, we know that theory doesn't always pan out.

For one, it might not be so easy to reprogram all these payment systems without a hitch. That isn't a scare story. It's a true story. Back in 1979, Congress waited and waited and waited to lift the debt ceiling, and when it finally did, the surge in demand for T-bills was too much for the Treasury's glitchy word-processors to handle. So we temporarily defaulted on some of our debt. It's possible, and not unlikely enough, that something similar could happen this time around if House Republicans won't lift the debt ceiling. And if this kind of government incompetence sounds inconceivable to you, I invite you to try buying health insurance on one of the Obamacare exchanges.

But even if the government is completely competent, the Treasury could still miss a debt payment. Why? Well, payments and revenues are lumpy. We owe more on some days, and we have more cash come in on some days. More importantly, we owe bondholders more on some days. 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. And there is. Look at the chart below from Goldman Sachs (via FT Alphaville): there's a big lump of interest payments (yellow) due on October 31st that could very well be more than we could afford if Republicans won't lift the debt ceiling. That's a polite way of saying we could default on the debt, at least temporarily, and 

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These worst-case scenarios aren't likely, but they're still real. But, as Dave Weigel of Slate points out, Republicans don't seem to think so. Republicans think Obama cried wolf over the sequester and over the government shutdown, and that he's crying wolf again over the debt ceiling. They're wrong. Even in the relatively happy case where the Treasury can prioritize payments and we avoid an outright debt default, there would still be immediate austerity of about 4 percent of GDP on an annualized basis. That much austerity would maim the recovery and send the economy back into recession if it lasted for very long.

Then there's the unhappy case where, for whatever reason, the Treasury can't prioritize payments and we do default on the debt (at least temporarily). That has the potential to be a Lehman-style disaster. See, Treasury bonds are built into the architecture of the financial system as the ultimate risk-free collateral. If it turns out they're not so risk-free, credit markets could freeze all over again, and send us into a Greater Recession. It's such an extreme outcome that even if you think there's just, say, a 2 percent chance of it happening, you can't ignore it.

Doing so isn't just irresponsible. It's crazy.





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