Debt Ceiling & Default - what's going to happen?

[Admiral Yi]

I sincerely doubt the Treasury has a default action plan prepared it is willing to share with the public.

[Jacob]

I sincerely doubt the Treasury has a default action plan prepared it is willing to share with the public.

I do as well. I'd settle for some informed speculation

[CountDeMoney]

Republicans don't have much posturing to back down from, but I predict they will pass an increase with no strings attached.

That's reassuring

He also said there would be no government shutdown, so there ya go.

[Admiral Yi]

Put your mouth where your mouth is.

[CountDeMoney]

I wouldn't mind seeing a nuts and bolt overview of what will happen if the debt ceiling is breached, without little focus on how the markets might react and more on exactly what chunks of money the US will pay to whom and what will stop functioning due to an absence of funds.

Think that'll be fun?  Wait until everybody else decides they would much rather see a certain fungible commodity traded globally on another currency, like the Euro.

[CountDeMoney]

Put your mouth where your mouth is.

I don't bet against sure things, like the GOP keeping the government closed and not raising the debt ceiling because they don't like black people in the White House or with healthcare.

[Admiral Yi]

And when you do bet, you don't pay off.

[CountDeMoney]

I have no idea what you're referring to.

[Ed Anger]

Yi has gone through those 20 quatloos he won off me and is now harassing Seedy. 

[Admiral Yi]

I have no idea what you're referring to.

You made a bet with me that Bush would produce bin Laden's head right before the 04 election.  You lost.  You welched.

[Sheilbh]

Look at it this way--The bureaucracy isn't going to default without being instructed to do so.

That's an extraordinarily benign view of the capabilities of bureaucracy

They may not be able to successfully and smoothly launch the signature policy of their President but they'd be able to juggle up to 4 million payments a day without fumbling?

Here's the FT on what's required:

Raise your hand if you know how the Treasury's payment systems work... Anyone?
Cardiff Garcia    | Oct 06 23:09 | 5 comments | Share
Begin with a snippet from the rates crew at 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.

There is a clear unwillingness to prioritize payments, and doing so would be politically messy, but if push comes to shove and Congress cannot strike a deal in time, the ability to pick and choose who gets paid does exist, if only on a broad basis.

In 2011, the press reported that there was some contingency planning going on, but the details of those plans were unknown.

The idea is that the Treasury would keep on the Fiscal Service and maybe the Department of Defense systems while shutting down the system that pays everything else.

Default would be avoided, while pressure for a resolution to the standoff would quickly build — especially after the nation's grandparents respond to their canceled retirement checks by knife-sharpening the tips of their walkers and thrusting them like lances at the nearest members of Congress.

But I'm not yet convinced that "if push comes to shove and Congress cannot strike a deal in time, the ability to pick and choose who gets paid does exist, if only on a broad basis". Strategists and other observers have given conflicting accounts over whether prioritising interest and principal payments on Treasuries is possible.

Certainly the Treasury department has emphasised the logistical complexity as much as the legal and political dubiousness of prioritizing payments. It has little choice, of course, but at this point I'm finding it difficult to know what to believe.

The web sites of the DoD Disbursing Offices, Fiscal Service, and Financial Management Service (which is part of the Fiscal Service office) are vague and unhelpful.

Mark Patterson, who was chief of staff at the Treasury Department during the 2011 debt ceiling negotiations, told Ezra Klein that the government's payment system "is sprawling. It involves multiple agencies. It involves multiple interacting computer systems. And all of them are designed for only one thing: To pay all bills on time. The technological challenge of trying to adapt that to some other system would be very daunting and I suspect that if we were forced into a mode like that the results would be riddled with all kinds of errors."

Again, vague and pessimistic — and Patterson has less of an incentive to be coy than his former colleagues still at Treasury.

The Treasury Inspector General's report surveying the 2011 showdown noted that the Treasury "makes more than 80 million payments per month" and that its systems "are designed to make each payment in the order it comes due".

According to the report, the Treasury decided that making payments in arrears — "no payments would be made until they could all be made on a day-by-day basis" — was probably the least awful option, less awful than prioritisation.

So, maybe? I'm assuming the Treasury department wouldn't have arrived at this conclusion unless it had considered the operational obstacles and believed them to be, at least, less insurmountable than those of the other options. But still the language is opaque, uncertain and cautious.

Assuming that payment in arrears can work logistically — and remember that there's no way to know how financial markets will react during the arrears period — it might function only for a little while if the delay for a given interest payment doesn't last too long. At least by the rating agencies' definition, the security would likely be placed on temporary selective default and reversed quickly when the payment arrives.

But:

1) Maybe that's wrong and the fallout of even a temporary missed payment would be enough to trigger one of the terrible chain reactions that have been frequently pondered. Would a selective default be enough to provoke margin calls in repo markets (where, according to RBC, the systems aren't set up to sort the defaulted from non-defaulted Treasuries) and on clearinghouses?

2) The success of this idea would seem to depend on the Treasury not being in arrears for very long at any given time.

And on that note, here's Alec Phillips of Goldman Sachs:

...the practical problem is that on November 1, the payments the Treasury must make are so large that the Treasury would already be nearly a week in arrears after the first day it has depleted its cash. So while this sort of strategy might be employed, the practical effect in early November would probably be indistinguishable from a decision to cease payments entirely.

I dunno, perhaps it can work. And when I say "work", I strictly mean "keep the Treasury servicing its debt while still breaking the economy's knees with a fiscal crowbar".

Murky stories and indiscrete quotes about payment contingency plans occasionally see daylight, but never anything detailed.

And yes, obviously Jack Lew has to be evasive about the possibility. The game-theoretic considerations of the Million Dollar Coin debate from earlier this year still apply equally to this case. To acknowledge that payment prioritisation is possible would enable the Republicans to force the president to use it. That goes for all the other backup plans, from the trillion dollar coin to issuing high-coupon bonds to invoking the 14th amendment.

Nevertheless it's really striking just how little is widely known about how the Treasury department goes about the normally mundane business of paying its bills — and that this seemingly crucial knowledge didn't become more accessible in the aftermath of either the 2011 or early-2013 debt ceiling showdowns.

And there does exist the possibility that it's not possible — ie that it's not a bluff — or that the Treasury department simply doesn't know how well it would work.

If so, then there is no purely mechanical way to avoid default if the Treasury runs out of cash. The White House would instead have to keep the payment systems running as normal — and either try to legally justify having ignored the debt ceiling, or resort to an innovative but unprecedented idea to get around it.

I mean maybe that's doable, but how much would you put on it?

I'm personally pretty sanguine though. I don't think there'll be a default. I don't think Boehner would do it - they may abolish the medical device tax, which was something many Democrats want abolished anyway. My impression is that the markets are also pretty sanguine. The rising talk among Republicans that this wouldn't lead to a default is a worry and if it builds I think that could worry the markets.

I wouldn't mind seeing a nuts and bolt overview of what will happen if the debt ceiling is breached, without little focus on how the markets might react and more on exactly what chunks of money the US will pay to whom and what will stop functioning due to an absence of funds.

http://bipartisanpolicy.org/library/staff-paper/debt-limit
Is a pretty good overview.
Also this, note the Deutsche Bank chart at the bottom:
http://www.washingtonpost.com/blogs/wonkblog/wp/2013/10/07/if-we-hit-the-debt-ceiling-can-obama-choose-which-bills-to-pay-2/

Also this is fun:



Edit: And also what would the consequences be for the US government's debt, even if they managed not to default, but in effect said if a political crisis is so extreme the executive can choose which legally mandated liabilities to pay. Even if all this jiggery pokery worked I don't think it'd be positive.

[CountDeMoney]

I have no idea what you're referring to.

You made a bet with me that Bush would produce bin Laden's head right before the 04 election.  You lost.  You welched.

LOL, yeah I did. 

But hey, jacking up the Homeland Security threat level after the Edwards running mate announcement and again immediately after the Democratic National Convention made fear mongering a nice replacement in any case.

[Admiral Yi]

Shelf:  You understand that last graph is not measuring yields, right?

[Sheilbh]

Shelf:  You understand that last graph is not measuring yields, right?

Yeah. I've not been talking about yields of just 3% as historic lows

It's volatility. A US bond is both low-yielding and ever-changing, while the Euro-periphery is becalmed but costly. Given that they've been dealing with Berlusconi getting convicted and the right splitting in Italy that's an extraordinary comparison.

[Ideologue]

I have no idea what you're referring to.

You made a bet with me that Bush would produce bin Laden's head right before the 04 election.  You lost.  You welched.

Troubling, if true.  A wager is a sacred bond.