Accounting Calculus, Debt-Ceiling Edition

In yesterday’s post I profiled my thinking on the big-picture outlook for estimating the risk associated with the debt-ceiling battle that’s brewing in Washington. To round out this analysis I’m going to dig into some of the details in pursuit of a clearer view on how this potential crisis may unfold.

The analysis will come in two installments. In today’s column I’ll summarize the possible solutions that are being discussed for a scenario where Democrats and Republicans are unable (or unwilling) to find common ground and pass legislation ahead of the date when the Treasury is unable to pay the government’s liabilities. Tomorrow I’ll look at the political mechanics for insight into guesstimating how events may unfold.

In both cases the core issue centers on the Republican conference in the House, led by Speaker Kevin McCarthy, a topic that I’ll discuss in more detail tomorrow. For now the main point is that McCarthy’s position, which he outlined on Monday, is that a so-called clean bill that would lift the debt ceiling, with no strings attached, is off the table. Instead, he insists on federal spending cuts as the price tag for lifting the ceiling, which is needed to fund the government’s previously approved budget.

The challenge arises because the Democrats, led by President Biden, want Congress to raise the debt limit and carve out budget negotiations as a separate effort. For the moment, the two sides aren’t backing down and so the government is at an impasse.

There are numerous paths ahead for solutions, including one side or the other backing down and agreeing to a compromise in some degree that gives in. That path looks unlikely as each side’s political position hardens. Assuming the stalemate persists, the potential for a government default is on the near-term horizon. In tomorrow’s column I’ll kick the tires in this corner in terms of the political calculus. Meanwhile, let’s consider the technical solutions that are thought to be a way of out of this mess if the politicians remain inflexible.

The Treasury reached the debt limit on January 19 and is currently using “extraordinary measures” to pay the bills. But this is a temporary fix and it will run out of road in several months — at some point in the summer, according to various estimates. Moody’s Analytics calculates the so-called X-Date as roughly Aug. 18, when the financing supplied by the extraordinary measures will be exhausted.

Forecasting whether the government will actually default, or not, depends on expectations for possible workarounds. One option is an order from President Biden that instructs the Treasury to continue paying the government’s bill by invoking Section 4 of the 14th Amendment, which advises that the “validity of the public debt of the United States…shall not be questioned.” This is a questionable view of how the president can use the Constitution as a solution, although some analysts think it’s a plausible alternative to defaulting.

Other possibilities include minting a $1 trillion-dollar coin, depositing it at the Federal Reserve and using the account to pay the bills. Another idea, as Moody’s explains, “is to have the Treasury issue premium bonds rather than par bonds as Treasury debt comes due, lowering the face amount of debt outstanding and subject to the debt limit.”

Yet another path is prioritizing Treasury payments. In this case, the Treasury decides who gets paid on time and who does not. The idea is to give priority to Treasury securities, which would sidestep a default, although rating agencies might still downgrade the credit rating of US government bonds in this scenario.

The problem with prioritization is that some bills would not be paid. It’s a safe assumption that those on the losing end – Social Security and/or Medicare recipients, for instance – would likely scream far and wide, which in turn would trigger a new political crisis.

Each of the technical solutions noted above has its own set of flaws and it’s hard to imagine that any one would be used. That leads us back to most likely solution, namely, a political solution. In tomorrow’s column I’ll explore the outlook for this tortured road ahead which, despite the pitfalls and challenges, is almost certainly the only game in town.

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