A conspiracy theory of the debt ceiling
So, my working hypothesis is that, should the debt ceiling actually bind, the US Treasury will prioritize payment on formal debt securities and then institute some form of delayed payments on the rest of its obligations. Like the vaunted small business struggling to make payroll, it will borrow funds from suppliers and other creditors by stretching accounts payable. If I’m wrong about that, everything that follows will be wrong.
This is my second post trying to think through the consequences of such a regime. In the first, I pointed out that claims to future delayed payments would be securitized, and that prices of those securities would be informative, they would constitute a kind of back-door approximation of an NGDP futures market, which, as Scott Sumner has persuasively argued, would be a useful thing to have around.
That was an optimistic take on delayed payments. But there is a flip-side of the missing platinum coin that is a bit darker. If Treasury delays payments, what will not happen is a simple withdrawal of missing government expenditures from the economy. (It really is important to think about banks!) One of the oldest and most basic functions of a bank is to discount accounts receivable, to advance funds today against credible obligations of third parties to pay in the near future. Originally this was a service offered to business clients. Today, the same principle underlies credit lines offered to individuals, including direct-deposit, payday, “structured settlement”, and tax-refund loans.
If the government starts delaying payments, banks will be able to fill in the gap, quickly and profitably. Advances against government obligations would require no meaningful credit analysis. As they would be secured by obligations of the Treasury, they would have little or no cost in terms of regulatory capital. The banking system faces no meaningful reserve constraint. Nothing whatsoever would prevent the banks from simply lending “from thin air” payments that the US government is withholding.
The first hit might even be free! (ht Brad Plumer) But this service won’t be free over an indefinite long-term. Large business customers might pay the few basic points implied by a loan against government security for a few months time. But individual
marks customers will undoubtedly be charged “convenience fees” for the service of drawing advances on government payments that render the overall cost of the loans, when annualized, very high. We will, of course, be treated to the usually litany of justifications for exorbitant short-term loan costs: You don’t annualize hotel rates and compare them with apartment rents! Dealing with stinky, not-rich people is expensive! But in the end, this would be a nice line of business, which would multiply over time if delayed payments become the new normal for debt-ceiling-constrained government borrowing.
A delayed payments regime would amount to a regressive tax issued at two levels: first by the Federal government, and then by the financial industry. By delaying payments, the Federal government would tax recipients of government disbursements by forcing them to finance loans to the Treasury for free. Like all taxes, the actual incidence would be more complicated than the direct hit. Payees with bargaining power — say vendors of bespoke military systems or well-connected contractors — would find ways to add the finance cost to their bills, and largely escape the tax. Payees without bargaining power — your average social security recipient, for example — would have to simply accept the delayed payment and eat the interest cost that the government should be paying. A second regressive “tax” would be imposed by financial service providers. They would, as usual, compete to offer cost-efficient products to wealthier and more astute customers, while charging smaller, weaker, more desperate customers large fees. In the end, the Federal deficit would be reduced and bank profits would swell, primarily on the backs of the least-savvy, lowest-bargaining-power government payees.
A common narrative about the debt ceiling is basically a Frankenstein story: businesspeople funded these Tea Party crazies, and now despite pulling all their levers, they just can’t control the monster they have created. And maybe that’s right.
But suppose, plausibly, that the Jamie Dimons of the world know what Treasury has assiduously ensured the rest of us do not, which is exactly what Treasury is capable of and planning to do when George Washington bumps his head. And suppose it is debt prioritization plus delayed payments. Is it too much to wonder whether some quarters of the business community — you know, the ones who own the place — may not be pushing quite as hard as they pretend to raise or eliminate the debt ceiling?
I hope that it is too much to wonder. I hope it is evidence only of my own paranoia that I do wonder.
- 15-Sept-2013, 10:15 p.m. PDT: Added link to mathbabe post at “exorbitant short-term loan costs”.