U.S. Contingency Plan Said to Give Priority to Bondholders
The U.S. Treasury will give priority to making interest payments to holders of government bonds when due if lawmakers fail to reach an agreement to raise the debt ceiling, according to an administration official.
The official requested anonymity because no announcement has been made. The Treasury has said about $90 billion in debt matures on Aug. 4 and more than $30 billion in interest comes due Aug. 15. Overall, more than $500 billion matures in August.
The $90 billion in six-month Treasury bills maturing Aug. 4 pared losses after the comments. Obama administration officials will brief the public no earlier than after financial markets close tomorrow on priorities for paying the nation’s bills if the $14.3 trillion limit isn’t raised, a Democratic Party official said earlier.
“The announcement is reassuring, but there’s really no alternative to favoring the bondholders,” said Christian Cooper, head of U.S. dollar derivatives trading in New York at Jefferies Group Inc., which as one of the 20 primary dealers is obligated to bid in Treasury sales. “The alternative would point to a default”
Treasury Secretary Timothy F. Geithner has repeatedly said the government’s authority to borrow will run out on Aug. 2 unless Congress raises the debt ceiling. Republicans and Democrats have been unable to agree on an increase in the debt cap or budget cuts, leading to concerns that the U.S. will lose its AAA credit rating.
The rate on six-month Treasury bills due two days after the debt-ceiling was 0.155 percent at 4:51 p.m. in New York, down from as much as 0.2 percent. It was 0.11 percent yesterday.
The House and Senate are at odds over budget cuts tied to a vote to raise the debt ceiling. House Speaker John Boehner, Republican of Ohio, would cut $915 billion in spending and tie a future borrowing increase to enactment of a deficit-slashing law late this year. Senate Majority Leader Harry Reid, Democrat of Nevada, said he would move to kill Boehner’s plan, paving the way for Senate votes this weekend on a possible compromise.
“The consequences of inaction -- for our economy, the already struggling job market, the financial circumstances of American businesses and families, and for America’s global economic leadership -- would be very grave,” the executives wrote in the letter sent today by the Financial Services Forum, a Washington-based trade group representing the largest banks.
Federal Reserve Bank of San Francisco President John C. Williams said the central bank doesn’t have a “magic wand” to help the economy if the U.S. government defaults.
“Make no mistake -- the Federal Reserve doesn’t have a magic wand that will allow the economy to get through a crisis of this magnitude unscathed,” Williams said during a speech in Salt Lake City today. “A federal default must be avoided.”
Treasury officials have a previously scheduled meeting for tomorrow with Wall Street bond dealers ahead of next week’s quarterly auctions of notes and bonds. The officials will talk with the Treasury Borrowing Advisory Committee, which includes executives from financial firms such as JPMorgan, Goldman Sachs, Bank of America Corp. and Pacific Investment Management Co.
The Treasury has in the past said it cannot pick and choose which bills to pay in the event it can’t borrow enough to cover all its obligations, a process members of Congress called “prioritization.”
“This ‘prioritization’ proposal advocates a radical and deeply irresponsible departure from the commitment by presidents of both parties, throughout American history, to honor all of the commitments our nation has made,” Geithner said in a letter to Congress last month.
Deciding which obligations to pay first poses legal and practical challenges, forcing the administration to choose among the Social Security recipients, bondholders and military personnel.
“You’re picking winners and losers,” said Stephen Myrow, managing director and chief operating officer of ACG Analytics in Washington and a former chief of staff to Deputy Treasury Robert M. Kimmitt during the administration of President George W. Bush. “It’s a lose-lose proposition.”
In the month of August, Treasury has $49.2 billion in Social Security benefits due, including $23 billion on Aug. 3, according to the Bipartisan Policy Center, a coalition of former budget officials. Also due next month are $50 billion in payments for Medicare and Medicaid, $12.8 billion in unemployment benefits, $2.9 billion in military active-duty pay and $14.2 billion in federal salaries and benefits.
“The size and complexity of the federal government to prioritize payments, especially in a compressed time under pressure -- no doubt it’s difficult,” said Brian Gardner, senior vice president of Washington research at New York-based Keefe, Bruyette & Woods Inc.
The administration has also been reluctant to discuss prioritization because it wants to maintain pressure on Congress to raise the debt ceiling before the Aug. 2 deadline, said J.D. Foster, a senior fellow at The Heritage Foundation in Washington.
“Prioritization is about how to function if the ceiling does not go up, which the administration is adamant must never happen,” Foster said.
The government’s legal authority to pay some debts and not others is unclear, said Jay Powell, visiting scholar for the Bipartisan Policy Center and under secretary of the Treasury for finance for President George H.W. Bush.
In 1985, the Government Accountability Office released a legal opinion affirming Treasury’s authority to prioritize payments. No administration has taken advantage of that opinion.
“There is no explicit statutory authority for the executive branch to prioritize payments,” Powell said. “In our system of government Congress decides what to pay and orders the executive branch to carry out its wishes.”
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