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Is There A Default Playbook?

Amidst a stalemate in the debt ceiling negotiations, could the Treasury Department prioritize debt payments?

While the rest of the world may be paying attention to all sorts of other more uplifting things (like the NBA lottery, for instance, where the San Antonio Spurs won the first pick, which means they will likely pick up French phenom Victor Wembanyama come June), in Washington, all attention was focused on the White House yesterday, where congressional leaders met again with President Joe Biden regarding the debt ceiling.

While the Spurs are likely already rewriting their playbook to incorporate Wembanyama into their starting lineup, Washington policymakers seem to be shooting without a net. Worse, we’re in the fourth quarter: the United States is expected to default around June 1.

Leaving basketball aside, let’s look at what happened yesterday at the White House and what might happen next month if Republicans and the president cannot agree to a debt limit deal.

Progress On A Debt Limit Deal?

White House officials and congressional leadership did not offer a single point of agreement coming out of yesterday’s meeting. In fact, they appeared further apart than they did just 48 hours earlier.

Over the weekend, President Biden had suggested that Democrats could accept enhanced work requirements for certain federal benefit programs, including the Supplemental Nutrition Assistance Program (better known as “food stamps”), in exchange for raising the debt ceiling. Yesterday, however, President Biden walked back those comments — just as House Speaker Kevin McCarthy (R-Calif.) made it clear work requirements are a “must have” for Republicans to accept a deal. (As Politico reported, though, the speaker may be bluffing since it is unclear if rank-and-file Republicans are on board with the demand for enhanced work requirements.)

There were few bright spots coming out of yesterday.

One, however, was that President Biden and Speaker McCarthy agreed to “shrink the room” and delegate the negotiations to three people: Counselor to the President Steve Richetti, Office of Management and Budget Director Shalanda Young, and Rep. Garett Graves (R-La), a close ally of Speaker McCarthy’s. This move whittles the negotiating group down from an unwieldy group of 15 to just a handful of trusted aides.

Importantly, this small-group approach ultimately helped to facilitate the 2011 agreement between then-President Barack Obama and then-Speaker John Boehner that averted a default. The group met last night and will continue to huddle in the days ahead.

Additionally, President Biden indicated he is willing to consider discretionary spending caps through the remainder of his term and signaled the GOP’s insistence on reprogramming unspent pandemic assistance funds also is on the table.

That movement is certainly something, but time certainly is running out.

It is likely to take up to 10 days to move any debt limit agreement through Congress. Which is why Speaker McCarthy reiterated again yesterday that a deal must be reached this week in order to allow time for Congress to consider and vote on a deal before June 1. In a sign that this week is important, President Biden announced he would cut short his G-7 trip. He will still depart today for Japan but will be returning on Sunday rather than later next week. At the same time, House Democrats today have started collecting the 218 signatures needed for a discharge petition, a parliamentary procedure that would allow lawmakers to force a vote in that chamber on raising the debt limit over Republican leaders’ objections.

The economic fallout from a default has been well discussed — market chaos, lost jobs, a potential recession, or even depression — but which creditors, and which federal government program beneficiaries, actually would get paid in the event of a default? As importantly: Who would be left high and dry?

If you think the answer to that question is clear, or above partisan bickering, think again.

Can The Federal Government Prioritize Payments?

This past March, Republicans on the U.S. House Committee on Ways and Means approved a bill, the Default Prevention Act, that, if enacted, would require the U.S. Department of the Treasury to pay Social Security benefits first and protect “veterans, military families, and national defense” in the event of a default. The bill would bar payments for:

  • Executive Branch pay, including for the president and vice president;

  • Government travel;

  • Official union time; and,

  • Members of Congress.

Democrats have argued this rank ordering by the Treasury Department is simply not possible. In fact, as the Bipartisan Policy Center has explained, department “officials have long denied the existence of any Plan B to finance government” if it defaults. These officials have insisted “there is no established playbook.”

More specifically, as The Wall Street Journal noted, during the 2011 debt ceiling standoff, Obama administration Treasury Department officials said that, because Congress has never provided guidance on how to prioritize payments, “there is no fair or sensible way to pick and choose among the many bills that come due every day.” In the event of a default, its systems simply would decide on a daily basis without prejudice which payments were due and pay them if possible.

Five years later, however, evidence surfaced that showed Obama administration officials were, indeed, thinking about how to prioritize payments in the event of a default.

In 2016, Republicans the U.S. House Committee on Financial Services subpoenaed Obama administration documents they said showed that White House and Treasury Department officials not only could prioritize payments in the event of a default, but also that, during the 2011 debt ceiling standoff, the Obama administration and Federal Reserve officials had “run ‘tabletop exercises’ to prepare for such a contingency.”

Republicans said the Obama administration planned to prioritize Social Security payments, veterans’ benefits, and principal and interest payments on the debt over other government obligations. More specifically, as The Wall Street Journal reported at the time, Louise Roseman, the director of the Fed’s division of reserve bank operations and payment systems, told officials that the central bank, its regional reserve banks, and the Treasury Department “had jointly developed and codified the procedures into a ‘special operating circular,’ which it planned to issue to banks if Congress failed to strike a timely agreement.”

Roseman said the plan was “approved by the Treasury.”

The Journal also reported that Federal Reserve officials “discussed ways they might respond in the event of a default or renewed market turbulence. Those options included valuing defaulted securities at their own market prices, conducting reverse repurchase operations to address strains in money markets, providing emergency liquidity to money market mutual funds and buying defaulted Treasury securities outright.”

Even if the Treasury Department can set priorities, there are risks. According to the Bipartisan Policy Center, for example, “under any hypothetical prioritization scenario, the federal government would be failing to meet some of its obligations. There is no legal precedent for choosing to pay certain bills before others. Immediate court battles would likely arise over the legality of paying, for example, foreign bondholders over American citizens.”

Other scholars have agreed. This past February, Robert Kagan from the Center for Budget and Policy Priorities said, “Lawmakers shouldn’t fool themselves: prioritization cannot avert financial chaos or soothe creditors.”

Is there any past precedent for the Treasury Department prioritizing payments? It does not seem so, though clearly it has declined to meet certain obligations in the past.

Default History: No Playbook

According to author and former Treasury Department official Alex Pollock, the U.S. government has defaulted on its obligations before. It did so in:

  • In 1862, when it was having trouble paying for the Civil War and decided to print pure paper money;

  • In 1933, when it refused to redeem gold bonds, offering depreciated paper currency instead. In a 5-4 decision, the Supreme Court said the federal government was well within its rights and that the sovereign power of the government allowed the Treasury Department to default if it chooses to.

  • In 1968, when it refused to honor its explicit promise to redeem silver certificate paper dollars for silver dollars after an “embarrassingly large number of bearers of these certificates demanded the promised silver dollars.”

  • In 1971, when it refused to redeem dollars held by foreign governments for gold under the Bretton Woods Agreement.

Additionally, according to AXIOS, the Treasury Department could not service its debts in 1814 during a war with the British and, in 1979, Treasury briefly missed payments on $122 million in Treasury bills due to a technological snafu. (In that case, investors were repaid with interest.)

To be clear: while these instances can be defined as “defaults” — and may indicate there are certain obligations policymakers can let fall by the wayside — when it comes to potential economic fallout, they are in no way akin to the kind of default the U.S. government faces in about two weeks. If Congress and the White House do not come to an agreement before June 1, every single federal financial obligation would be called into question on an ongoing basis until Congress had passed, and the president had signed, a new debt limit bill into law.

The good news, at least for the political fortunes of the president and Speaker McCarthy, is that U.S. voters do not think those decisions will impact them personally. According to a brand new Morning Consult survey, while 71 percent of Americans think the federal government's default would hurt the U.S. economy only 39 percent said it would hurt them personally.

Here’s hoping we don’t have to test that hypothesis.

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