Paul Krugman had the bad luck to write a column aboyut the perils of breaching the debt ceiling just as a deal to avoid that horror started to come together. But undaunted, he pressed forward with another addition to the Krugman laugh track. No, this time he was not promoting unworkable Magic Coins; this time, he was making the Social Security Trust Fund disappear and re-writing securities and financing law. In the course of his recitation of the list of horribles if the debt ceiling is not raised we find these puzzlers:
A report last year from the Treasury Department suggested that hitting the debt ceiling would lead to a “delayed payment regime”: bills, including bills for interest due on federal debt, would be paid in the order received, as cash became available. Since the bills coming in each day would exceed cash receipts, this would mean falling further and further behind. And this could create an immediate financial crisis, because U.S. debt — heretofore considered the ultimate safe asset — would be reclassified as an asset in default, possibly forcing financial institutions to sell off their U.S. bonds and seek other forms of collateral.
All US debt would be reclassified as an "asset in default"? By whom? Legally, US Treasuries stand nearly alone in not having cross default provisions. No banker would agree to such terms for a banana republic like Argentina, but the lack of a cross-default on Treasuries means that a missed interest payment on a bond paying interest in October (and April) will have no legal impact on the legal status of bonds paying interest in May/November. Hence, global repo markets and nervous lawyers will remain satisfied with most outstanding debt. (True debt nerds can opine on the possibility of deep selective prioritization - if multiple bonds have interest due at the end of October and the Treasury is short of cash, could and would the Treasury jiggle the FedWire payment system to pay all the interest on some of the bonds and minimize the number of bonds that slip to default status? That is a systems rather than legal question. Such an approach would give Treasury traders a whole new way to make money as they guess which bonds will be paid in full and which will get stiffed, but that might create more net confusion than simply having an equal haircut on all interest payments. Tricky, and we hope never to learn the answer.)
Krugman takes up the question of prioritization but loses the multi-trillion dollar Social Security Trust Fund:
That’s a scary prospect. So many people — especially, but not only, Republican-leaning economists [and do note Moodys in these ranks] — have suggested that the Treasury Department could instead “prioritize”: It could pay off bonds in full, so that the whole burden of the cash shortage fell on other things. And by “other things,” we largely mean Social Security, Medicare, and Medicaid, which account for the majority of federal spending other than defense and interest.
Back in 2005 Krugman was all about the Social Security Trust Fund but now he has forgotten it. A reminder - the debt ceiling applies to all debt issued by the Treasury, not just debt held by the public. So Treasury obligations held by the Trust Fund are already included in the debt ceiling; when payroll tax receipts are insufficient, the Trust Fund delivers bonds to Treasury for cash, thereby reducing total Treasury indebtedness; Treasury then has new debt-ceiling room to issue debt to the public. Obama likes to score political points and scare seniors by claiming that Social Security checks might not go out, but as a one-time defender of the Trust Fund Krugman ought to have the intellectual courage not to play along. (Full Disclosure - I have always said that the Trust Fund is pretty phony from a financial perspective but have always admitted it has legal clout, and noted the debt ceiling in passing here. Geez, 2005, when the debt ceiling was a cloud no larger than a mans hand...)
More fabulism from Krugman:
Some advocates of prioritization seem to believe that everything will be O.K. as long as we keep making our interest payments. Let me give four reasons they’re wrong.
First, the U.S. government would still be going into default, failing to meet its legal obligations to pay. You may say that things like Social Security checks aren’t the same as interest due on bonds because Congress can’t repudiate debt, but it can, if it chooses, pass a law reducing benefits. But Congress hasn’t passed such a law, and until or unless it does, Social Security benefits have the same inviolable legal status as payments to investors.
We are delighted to see him not obfuscating the "legislate lower benefits" point. But really - "the same inviolable legal status"? Has anyone pledged their Social Security check as part of a repo transaction? Are amounts owed to vendors really in the same legal boat with securities issued by the Treasury? If the Treasury decides to hold up a payment to General Electric for a few days, does GE have the basis for a suit? And when did we overturn the Federal Assignment of Claims Act (1, 2)? Given Krugman's obvious lack of legal curiousity I am reluctant to assume he is right about this. Since he is not.
Second, prioritizing interest payments would reinforce the terrible precedent we set after the 2008 crisis, when Wall Street was bailed out but distressed workers and homeowners got little or nothing. We would, once again, be signaling that the financial industry gets special treatment because it can threaten to shut down the economy if it doesn’t.
The Princeton Populist rides again. Wall Street isn't threatening to shut down anything; it is noting the reality of its operations.
Third, the spending cuts would create great hardship if they go on for any length of time. Think Medicare recipients turned away from hospitals because the government isn’t paying claims.
Geez, I think that when I think of Obamacare. But if Krugman agrees with me that the Treasury Secretary will do that poor a job of prioritizing payments while engaging in Debt Ceiling Theater (especially now that Social Security is solved!) then let's throw the bums out.
Finally, while prioritizing might avoid an immediate financial crisis, it would still have devastating economic effects. We’d be looking at an immediate spending cut roughly comparable to the plunge in housing investment after the bubble burst, a plunge that was the most important cause of the Great Recession of 2007-9. That by itself would surely be enough to push us into recession.
You knew he couldn't go 0 for 4. The fiscal crunch caused by selective prioritization and the resulting Mad Hatter Sequester will crush the economy. Moodys Chief Economist Mark Zandi agrees:
If the impasse over the debt limit lasted through November, the Treasury would have no choice but to eliminate a cash deficit of approximately $130 billion by slashing government spending. This is about 9% of annual GDP, enough to trigger a severe recession.