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.

Update History:

  • 15-Sept-2013, 10:15 p.m. PDT: Added link to mathbabe post at “exorbitant short-term loan costs”.

24 Responses to “A conspiracy theory of the debt ceiling”

  1. Benedict writes:

    Aha! So this is the missing link in the ‘why have the banking elite who supposedly control things let this happen’ question! I like it. However, if they are planning to spring this, they’ll be dealing with some fairly formidable barriers to entry. Demonstrating for a true fact that one is due to receive money from the Federable government of the US can’t be an easy task. I’d be surprised if Dimon, whose shady outfit has to fund itself in the repo market, which a default will blow all to hell, will be prepared to accept the massively increased costs of churning over his balance sheet in order to milk comissions from Social security recipients! But then maybe he’ll do it just for kicks!

  2. Steve Roth writes:

    “the same principle underlies credit lines offered to individuals, including direct-deposit, payday, “structured settlement”, and tax-refund loans.”

    Let’s not forget the mainstay: credit cards.

    If government stops (delays) making deposits to people’s and businesses’ bank accounts, those people and businesses will inevitably (at least in aggregate) use their credit cards more and their debit cards less.

    Think the credit-card companies and their member banks would like that?

  3. So, the banks get a chance to screw the little guy again? Hoocoodanode?!?

  4. Philip Wallach writes:

    OK, I’ll be the one to say it: this is totally f’ing nuts. The number of unknowns just wished away in this little story is enormous, no matter how cozy a link between Treasury and big finance you imagine. It’s also very hard to understand why SRW thinks the situation would persist indefinitely, instead of most likely a short time, thereby offering no opportunity for any meaningful profits while clearly creating some real downside risk.

    That said, as usual, I enjoyed the thought-provoking comments about the relationship between sovereign debt and bank debt and money.

  5. Dan Kervick writes:

    Sounds plausible. But then there is just the standing hypothesis that large banking institutions have always had a long-term economic interest in shrinking government social insurance programs and turning them into private insurance programs. So they are politically attuned to the agenda of the anti-government wing.

    Old people don’t eat money. They don’t drive money or pump it into their cars. They don’t heat their homes with it. They use real resources to do that stuff, and these are not in any significant degree real resources that have been stockpiled in the past, but are instead resources that are produced in the same period during which they are consumed. In one way or another, retired seniors consume a portion of the resources produced by those who are presently working. Government social insurance programs tends to streamline the ongoing transfer from producers to retires without many private financial intermediaries taking a cut in between. For the private financial sector, that is an enormous lost opportunity and they are desperate to get a piece of that enormous action, and would ultimately like to control it all.

  6. Steve Roth writes:

    @Dan Kervick:

    “large banking institutions have always had a long-term economic interest in shrinking government social insurance programs and turning them into private insurancedebt programs.”

  7. EmmaZahn writes:

    I found reading Scott Skyrm after both you and Felix Salmon this morning to be calming. Not that either of you are wrong. Yes, financiers will make the most of the churn created by Congressional chaos. It is what they do. And, yes, as Salmon points out, we have already essentially defaulted on our ‘full faith and credit’ reputation. What was calming about it was how prepared the major money market players were this time compared to 2011. At the end of his article, he lists some of the possible work-arounds to a technical default on short-term Treasurys a hint of why the QE taper might have been postponed.

    Skyrm http://scottskyrm.com/2013/10/technical-default-treasurys-and-repo/

    Salmon http://blogs.reuters.com/felix-salmon/2013/10/14/the-default-has-already-begun/

  8. […] Steve Randy Waldman lays out default scenario. Quote: […]

  9. Mercury writes:

    So, when the government is forced (by completely legal means) to curtail expenditures they will prioritize themselves and their “payees with bargaining power” over the most vulnerable members of the public whom they are supposed to serve…and somehow this will be the Tea Party’s fault? No, this is the key problem with the out of control Leviathan to which they are trying to draw attention.

    And Jack Lew is full of crap. The sky will not actually fall if the debt ceiling is not raised RIGHT NOW. Debt service is a small part of what the Treasury brings in. But, like an entrenched, small town selectman threatening to cut the high school football program before bloated bureaucracy even makes it to the table, he will make it as painful as possible for the peons who dare to look behind the curtain.

    When QE, ZIRP and the rest of the centrally planned entitlement state is humming along at cruising speed money is ALSO being funneled to the top from the middle and the bottom. But I guess it’s OK when Jamie Dimon is making money running the food stamp program.

  10. […] Source […]

  11. John writes:

    While it is possible the bankers see the world this way, I doubt the lawyers would agree. Who’s payments get delayed? Why would they agree to discount their a account receivables, instead of suing? What legal authority does the Administration have to prioritize and withhold funds that Congress appropriated? Wouldn’t this be impoundment by another name? And isn’t there a law called the Impoundment control Act of 1974 that prohibit this as well as several court decisions, including the Supreme Court ruling the line item veto unconstitutional that support this interpretation?

    On a more practice level, this approach would last until the first Social security check is not sent out.

    I understand that somehow we have accepted that contracts are inviolable only when ever the banks expect to be paid, but if Washington goes down that road, we may finally get to through the bums out.

  12. “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.”

    I’ve read a lot of stuff from good sources, saying the computer systems that make the payments can’t do this. They were designed to just pay all bills, not to pick and choose. At the time, no one ever dreamed that a major political party would threaten to make their own country default if their demands weren’t met. From what I’ve read, it would take to long to redesign these systems, even if there was legal authorization to do so. Try googling this issue.

  13. For example:

    “Here’s Mark Patterson, a former chief of staff at Treasury: “The U.S. government’s payment system is sprawling,” he explained. “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.””

    at: http://www.washingtonpost.com/blogs/wonkblog/wp/2013/10/07/if-we-hit-the-debt-ceiling-can-obama-choose-which-bills-to-pay-2/

  14. mike writes:

    So Treasury makes 100 million payments per month. It has no IT system in place for determining which payments go first, not to mention no statutory authority to do anything other than pay in the order the obligations come due. Explain how they could set up a system that pays interest or SS or whatever first? Your basic premise about Treasury behaving like a small business is wrong.

  15. I have my doubts that this could work operationally, for the reasons given in the above comments.

    But even if it were possible for the banks to discount Treasury payments, I think it would still have to be for a very short period. In other words, the expectation that normal payments would resume relatively quickly. Otherwise, doubts about the banking system itself would rise due to the damage to the economy, and the unknowns about the balance sheets of banks would rise.

  16. Peter K. writes:

    Looks like Boehner refused to shoot the hostage again – as in January – and will violate the Hastert rule and allow the House to pass the Senate compromise.

    It will become less likely people will take him seriously next time. “Oh this time you’re serious? Really?”

    Obama hung tough PACE people like Dan Kervick and his ilk. My prediction is that Republicans get hammered in the Mid-term elections next year.

    The open question is what happens to the Republican party.

  17. Greg writes:

    They are probably going to rework the Treasury payments computer programs in the next four months just so such a deal could happen. Dimon and friends no doubt want something of this sort, they prefer getting a cut of everyone elses work rather than working themselves, but saw it was un workable now due to the reasons already given.

    This isnt the last debt ceiling fight Obama is going to have. At least 5 more while he’s president. Cant we just end this stupid crap?
    What a bunch of disgusting bankers/plutocrats we have.

  18. First, the Congress + president will kick the can.

    Second, the Fed is more likely to finance the Treasury in the lurch rather than any other entity — although in the end the financiers always lend (because they create the money by doing so). Since the Treasury cannot issue securities after the debt ceiling is reached, the only other entity (besides China) with Treasuries is the Fed.

    Reaching the debt ceiling means the Treasury cannot issue new bonds (Treasury has never been allowed to borrow without issuing IOUs as collateral). However, the Treasury can collect tax payments, rent, fees and royalties as well as interest from the Federal Reserve.

    The Fed can finance the government by itself by ‘selling’ some of the $2 tn in Treasuries it already owns in place of new issue … then forwarding the proceeds to the Treasury as ‘interest forwards’, or whatever else it wants to call them.

    If the Fed sells Treasuries monetary policy would not change @ macroeconomic level because the Treasury borrows from primary dealers now w/ the Fed accepting Treasury IOUs in exchange for credits on reserve accounts @ the Fed after the fact (QE).

    The primary dealers would become ‘Little Feds for a Day’, the Fed itself would become ‘Treasury for a Day’. Monetary policy would pretty much remain intact as ‘inverse QE’ or ‘QE 3.5′. The Fed would act as the Treasury, the primary dealers would buy securities in the place of the Fed which would supply the securities from its own inventory.

    Flow of funds to the Treasury: Primary dealers => Fed => Treasury (as interest payments)

    Flow of securities to lenders: Fed => primary dealers. Fed and Treasury would keep records of payments from the Fed to the Treasury and settle up later.

    The idea is to eliminate the Congress’ ability to meddle by holding debt issue hostage. Once Congress realizes they cannot effect the function of the Treasury by oversleeping they will have little choice but to find another tactic. Some in Congress would argue that the Federal Reserve is not allowed to fund the government directly, but the Fed already makes direct interest payments to the Treasury on the loans it currently holds.

    The Fed has been buying securities — lending to the government — but the Fed Reserve itself has not been generating the funds, it has been simply a middleman or conduit between finance and the state. Finance => Fed => primary dealers => Treasury.

    Once the crisis has ended and the Treasury can legally issue securities, it can return the ‘interest forwards’ in the form of new bonds thereby unwinding the ‘Inverse QE’ trade. At the end of the day the government would be even more under the thumbs of the banks.

    Perhaps, this is the plan, after all. Inching privatization of the Treasury borrowing regime by large lenders acting in an ’emergency’ that is entirely contrived.

  19. richard writes:

    You might find the US Assignment of Claims Act interesting re paperwork requirements when discounting US government receivables.

    A little off topic, I have been wondering why, among those who have an urge to limit the Federal debt, there has been no talk about legislating the around the size of the Federal Reserve balance sheet, the pace or taper of its long term asset purchases, the disposition of its current holdings of same, etc.

    And why wouldnt they fix the coupon on the ten year note goin g forward at say 3% and the maximum interest rate on a Federally guarantied consumer mortgage at say 5%, and then let the market trade the instruments with premiums or discounts.

    Why arent cumulative Social Security and Medicare distributions taxed back as an estate tax on estates over say 2 million. Not to do so is to transform the social safety net into a intergenerational wealth transfer for those who dont need it.

  20. Mercury writes:

    Looks like shutdown theatre is over for now folks but here is a perfect example of what I mentioned above – that the federal government has tried to inflict maximum pain (and threatened worse) during this “shutdown” to draw attention away from the sunlight this phony crisis has let in: that huge swaths of the government cost a lot of money and create little to no value whatsoever.

    Behold another finance blogger who runs a private outfit which operates a bunch of camp grounds on public lands. The government doesn’t do anything in this relationship but collect their cut from his business yet, not immediately but eventually he was ordered by Washington to cease operations: send campers home, cancel wedding and event plans and basically just make life unpleasant for as many people as possible because that was part of Obama’s (not the Tea Party’s) PR campaign:


    The only conspiracy here SRW is that the state (just as Trotsky predicted in a totalitarian, soviet system I might add) has gone into business for itself.

  21. Justin Cidertrades writes:

    RIGHT NOW. Debt service is a small part of what the Treasury


    99% of the time you can predict that change will be substantially predictable. 1% of the time will be like 2008. 2008 proved that we should be reducing public debt before the next unexpected Schlage hits us. More we reduce, the more of a hit we can take without going down for the count. The count of seeing debt service expand faster than the gdp used to get a proper handle on it before it becomes a bomb, a weapon of mass destruction.

    Do Americans come out ahead because of their foreign investments? Investment that ship foreign profit, interest, and dividends to Americans? No! Foreigners get more rent from us than we get from them. Ah! Then surely it must be from a positive trade balance. N’est-ce pas? No, once again. We Yankee-s have a trade deficit. Then how can we maintain the life style of the wealthy and famous without doing actual work, the kind of labour that actually sells on the free and open market? Ah!

    We are being paid not for work but for print job, for GTF, global Triffin fiat.

    How long will our GTF be in demand? How long can we sell it?

    Until it stops deflating with respect to other currencies. Until it starts to inflate. Hey man! Would you pay for anything that looses value? Would you buy a Zim-dollar? Not to worry, by printing half as much we get twice the real value for same nominal wad. Add to that, our cash on hand doubles in value as we slow printing press to half speed. Conversely, excessive printing could cause a deluge of dollars coming home toward us, enough dollars now held by foreigners to buy up every back-pocket-Congressman in Peoria. A leveraged buyout that would make us the hapless subjects of a banana republic, menials forever.

    Yet another proof of Mulligan’s second postulate :

    2. By several orders of magnitude life is usually simpler than you thought.

  22. Peter K. writes:

    SRW may be right. When Bush failed to privatize Social Security, you know Wall Street was eyeing all of that money with dreams of endless fees. Krugman here points to the open conspiracy of “Fix the Debt.”


    Exortionist Fellow Travelers by Krugman

    “…Actually, it’s even worse than he says (a line I find myself using a lot these days.) Fix the Debt didn’t just help create a climate of crisis with its fearmongering over the deficit; the fiscal scolds actively cheered GOP hostage-taking in 2011, and were still lending support to hostage tactics this time around.

    Furthermore, neutrality is not an option here. If one political party attempts to defy due process and extract concessions from the other party by threatening financial and economic catastrophe, and your response is to condemn partisanship in the abstract and suggest that both sides are equally to blame, you are in effect lending cover to the hostage-takers.

    In other words, Fix the Debt isn’t just ineffectual in its pursuit of a Grand Bargain, it’s an actively malign force in our politics, in effect acting as an ally of the extortionists.”

    Fix the Debt is about cutting taxes and cutting social insurance, not the debt and basic macroeconomics.

  23. stone writes:

    Am I right in thinking that some European countries do actually simply simply stop paying for work whilst still servicing treasury debt? I found this news item:

    “The massive backlog of unpaid bills owed by Italy’s public administration has been a longstanding source of complaint by companies which have struggled to raise credit from banks facing increasingly tight credit conditions themselves.

    The government says settling the bills will provide a sorely needed cash injection for an economy now stuck in its longest recession for 20 years.

    But it has proved difficult to find the money to pay the companies, most in the healthcare and construction sectors, which have total accumulated claims estimated by the Bank of Italy at some 90 billion euros at the end of 2011.”

    Do they have some clever market in IOU like you suggest? My impression is that the companies simply go bust and they get 20% unemployment and it is pure waste all round.

  24. Time marches on …

    Anyway, Treasury can do as you suggest but it would be easier for it to use the Fed as a sock puppet and have them (the Fed) sell Treasuries and forward the gains to the government as ‘interest paid forward’ or some other such legerdemain/tom-foolery. When the debt ceiling is reached, the Treasury cannot issue more securities but it can receive payments, the Fed would only have to keep account. At some point the Treasury would ‘settle up’ and replace the securities sold by the Fed.

    The beauty is the Fed doing so would not effect its easing programs as there would be no net decrease in securities as the Fed’s portfolio is considered ‘dead money’ already by the market. The Fed could also buy ‘names’ and Euro-dollar bonds from banks overseas.