Different solutions
The US federal debt reached $31.4 trillion, its legal limit on January 19th. This has happened before. In particular, since 1960 there have been 78 such episodes – 49 under Republican and 29 under Democratic presidents – with the most recent episode taking place in 2011. In all instances, Congress has raised the debt limit, or extended it, or suspended it. This time though, argues Jeffrey Frankel the situation i more dangerous because of the intransigence of Republicans in Congress who could “refuse to raise the debt ceiling until after they have driven the car over the cliff.” It’s important to note that raising the debt ceiling is not a decision to spend more money but instead, it is a decision by the government to honor the bills that it already owes, as a result of spending and tax decisions Congress has enacted in the past. Some creative responses might be necessary to avoid a disaster:
- The Biden administration could invoke the 14th amendment which asserts that the “validity of the public debt of the United States, authorized by law, …, shall not be questioned,” fulfill its financial obligations, effectively taking control away from Congress. Courts would eventually have to rule on the legality of such action.
- The Treasury has enough money to meet at least 80%-83% of its already-legislated outlays without further borrowing. But which 80%? Should interest rate payments to bondholders be prioritized in order to avoid a credit rating downgrade? One disadvantage is that the government would find it politically awkward to put bondholders, who are presumably wealthy, ahead of everyone else.
- The Fed could mitigate a shock to the financial system in the event of a temporary or technical default:
First, the Fed can say right now, in the event of a debt ceiling technical default, we will suspend all our rules and allow financial institutions to lend against treasury collateral with customary (tiny) haircuts, ignoring the technical default. Second, the Fed can say it will lend freely against treasury collateral to banks, or via reverse repos to financial institutions, with no haircut, even if the securities are in default. Third, the Fed can say it will buy Treasurys. It will fix a low rate of interest and buy all anyone wants to sell at that price. Will private markets make some money off this? Yes. Fine. That’s the point. Hang on to your treasurys, you’ll make some money is a lot better than starting a crisis. If the Fed overpays, it just remits less to Treasury eventually. Say it now, so there is no run as the debt ceiling approaches.
Crashing Through the Debt Ceiling
By: Jeffrey Frankel – Harvard University
The Fed and the Debt Limit
By: John Cochrane – Stanford University
A fact worth remembering
The debt ceiling showdown of 2011 is estimated to have cost taxpayers $1.3 billion during that fiscal year, and $18.9 billion over the following 10 years.
From a survey of U.S. academic economists
Debt Ceiling
From: The Initiative on Global Markets – University of Chicago
