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Monday, October 20, 2014         

NEW YORK TIMES


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Washington split over specter of U.S. default

By Binyamin Appelbaum / New York Times

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WASHINGTON » The federal government will not run short of money to pay its bills May 16, when the federal debt reaches the legal maximum of $14.3 trillion.

The government will not even run short of money Aug. 2, the deadline the Treasury Department set this week for Congress to lift the borrowing limit. Asset sales and bookkeeping devices could delay the inevitable crisis, perhaps for a few months.

But with every passing week of political stalemate over the debt ceiling, the risk increases that investors will start to fret that the United States will not pay its debts and demand higher interest rates for lending money to the federal government.

Should that happen, the cost could be vast and the damage difficult to reverse.

Debates over the debt ceiling have become a regular feature of political life in Washington. Congress has lifted the ceiling more than once a year, on average, over the past half-century — often walking right up to the deadline before acting. But the debt has never been so large, and the political climate has rarely been as contentious.

Republicans and some Democrats insist that an increase in the debt ceiling must be accompanied by concrete limits on future spending, entangling an issue that requires urgent attention with a debate unlikely to be resolved before the 2012 elections.

"When I talk to investors, their general reaction is they've seen this movie before. They expect that Congress will increase the debt ceiling," said Mary Miller, assistant Treasury secretary for financial markets. "But I'm concerned because the stakes are higher here and the amount of time we can buy with extraordinary measures is smaller."

The debt ceiling basically is the credit limit on the national credit card, the maximum amount that can be owed at any one time. The government hits the limit with some regularity because federal spending vastly exceeds its revenue. Over the years, Congress always has raised the limit; after all, it ordered the government to spend the money.

When the current limit is reached May 16, after the Treasury completes its latest round of borrowing, the government will need to find $125 billion a month to pay its bills.

The Treasury estimates that it can avoid a crisis until early August with few if any lasting consequences by spending about $100 billion in cash that it keeps on deposit with the Federal Reserve, the nation's central bank, and by temporarily suspending $232 billion in special-purpose borrowing programs so it can instead borrow money to finance general operations.

The Treasury secretary, Timothy Geithner, warned Congress in an April letter that once those resources were exhausted, the government would be forced to default.

"A broad range of government payments would have to be stopped, limited or delayed, including military salaries and retirement benefits, Social Security and Medicare payments, interest on the debt, unemployment benefits and tax refunds," he wrote.

A range of experts, including the Federal Reserve chairman, Ben Bernanke; former Treasury officials from both political parties; and economists from across the ideological spectrum, warn that missing payments would be catastrophic. In particular, they say, investors would view Treasury debt as risky and Washington would be forced to pay higher interest rates.

The government plans to borrow $405 billion during the second half of 2011. If rates increased even a tenth of a percentage point, the added cost on those borrowings would be $405 million a year.

Many Republicans dismiss these warnings. They argue the government could maintain the confidence of investors by prioritizing interest payments. There is ample revenue to make those payments, and the Republicans — also backed by economists and financial experts — say investors would not punish the government for failing to fulfill other financial obligations.

"I think the important thing to do would be to make it clear to markets that the government is not going to default on its debt," said Sen. Patrick Toomey, R-Pa., who is sponsoring a bill that assigns priority to interest payments. "It would be easy, I think, to make it clear to the markets that they don't have to worry about this."

Treasury officials respond that the failure to pay any obligations would set off a crisis.

"What participant in the market would want to buy our debt as we are defaulting on other obligations?" asked Miller. "I think the markets would be completely spooked."

Prioritizing interest payments would also require cutting spending immediately by much more than either party has ever proposed. The Congressional Research Service reported in February that the government would need to stop all discretionary spending and reduce payments under programs like Social Security.

So far, investors have shown no signs of concern. Moreover, the market reaction to past standoffs suggests that investors have learned over time to ignore the theatrics in Washington.

Investors demanded risk premiums of as much as half a percentage point during a confrontation in 1995 and 1996 between House Republicans and the Clinton administration. They demanded smaller risk premiums during standoffs in 2002 and 2003, according to research by Pu Liu, a finance professor at the University of Arkansas. But during more recent standoffs in 2005 and 2006, Liu found no evidence of any risk premium.

Investors, he wrote, have taken to treating Washington "like the boy that cried wolf."

Of course, investors were more sanguine about risk in 2006 than they are now.

But even if markets do remain calm, the cost of a standoff will rise sharply when Treasury exhausts its current measures around Aug. 2.

Then the government could stave off default for a time by selling assets. The United States owns about $402 billion in gold at Monday's prices and about $81 billion in oil. It holds a portfolio of loans estimated to total $923 billion by September, including more than $100 billion in mortgage-backed securities it is selling slowly to investors, and more than $400 billion in college student loans.

Administration officials, however, say such a fire sale would amount to a modest grace period bought at extravagant and wasteful expense. It would not change the fundamental need for Congress to raise the debt ceiling.

A more likely approach would borrow a page from the Clinton administration, which threatened in early 1996 to suspend Social Security payments for a month.

Congress immediately passed special legislation permitting the government to borrow the necessary money without counting it against the debt ceiling for one month. One day shy of a month later, Congress permanently raised the ceiling.






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