Photographer: Andrew Harrer/Bloomberg

Treasury Reassures Markets About Secret Debt-Ceiling Plan

  • Mnuchin staff tells traders debt prioritization not an option
  • Trump administration is leaning on Congress to raise ceiling

Treasury Department officials called bond traders and their advisers on Friday to assure them that the Trump administration isn’t considering prioritizing U.S. debt payments if Congress fails to increase the nation’s borrowing authority later this year, according to two people familiar with the matter.

The calls came after Bloomberg News published a story about worries among traders that Treasury Secretary Steven Mnuchin may have to employ a secret plan written by the Obama administration to make sure debt payments are made, potentially at the expense of salaries for government employees, payments to contractors and other obligations.

The Congressional Budget Office forecasts the federal government will hit its debt ceiling some time in October. Treasury Secretary Steven Mnuchin has urged Congress to increase the nation’s borrowing authority without brinkmanship, as in 2011 when a political showdown triggered the first downgrade of U.S. debt.

That year, the Treasury and Federal Reserve developed a secret contingency plan to prioritize payments on government securities over other obligations in case Congress didn’t act in time. The plan was publicly revealed in January.

‘Dangerous’ Option

While some conservative Republicans have pointed to debt-payment prioritization as an option for Treasury, perhaps even a preferred one, some financial market participants may regard it as the equivalent of a first-ever default on the national debt. 

Anxiety among traders is gradually increasing as Congress shows no sign of grappling with the issue. Citigroup Inc. has said prioritizing debt payments would be a “dangerous precedent,” and Wrightson ICAP LLC’s Lou Crandall has called it a “truly terrible idea.” Bank of America Corp., and Jefferies LLC have mentioned the option in client notes, saying it’s unlikely.

Still, the market for Treasury debt hasn’t shown any signs yet of being unsettled. Investors haven’t started shunning short-term government debt and yields haven’t risen.

Prioritizing U.S. debt is a contentious issue, with no consensus over whether it constitutes a default. Former Treasury Secretary Jacob Lew called it “default by another name” while in office. Fitch Ratings disagrees but says it would trigger a review of whether the U.S. still warrants a AAA rating.

The Obama-era plan is now six years old and there have been no preparations to use it, the Treasury officials told traders and other bond market participants, according to people familiar with Friday’s phone calls. The point of the conversations appeared to be to emphasize ambiguity in how the debt-ceiling debate could unfold this year, they said. When asked why Mnuchin himself was not explicitly saying in public that he wouldn’t prioritize debt payments if the ceiling isn’t increased, the officials said in the calls to take their word for it: there is no current plan to prioritize.

Read more: Trump may need Obama’s secret debt plan, worrying markets

Treasury officials scheduled individual phone calls with debt prioritization as the subject, the people said. Treasury’s debt management officials make routine calls to discuss general market conditions with primary dealers of Treasury bonds, strategists and investment bankers. Less often, they schedule calls on specific subjects. Friday’s outreach was the first of that sort of call in several quarters, one person said.

‘Bully and Intimidate’

A Treasury spokeswoman said that it’s common practice for the agency’s officials to maintain a dialogue with bond market participants on key issues. Asked whether Mnuchin would consider debt-payment prioritization, she referred to comments Mnuchin made in an interview with Bloomberg Television on June 20: “Congress should raise the ceiling so that we don’t have to talk about prioritization.”

See here: Fed debt-limit contingency plans detailed in 2011 transcripts

Mnuchin ruled out prioritization during his confirmation hearing in January but has recently avoided answering direct questions about the possibility. Knowing that it’s under consideration could encourage some Republicans to take a harder line against a debt-ceiling increase without accompanying spending reductions.

“From a political standpoint, Treasury has decided to bully and intimidate Congress into raising the debt limit as soon as possible,” said Brian Riedl, a senior fellow at the Manhattan Institute and a former chief economist for Ohio Senator Rob Portman. “It does change the debate knowing that prioritization is possible, and that essentially principal and interest payments are walled off from the rest of the budget and the situation,” Riedl said.

Former Treasury Secretary Tim Geithner, who was in office when the secret prioritization plan was written, warned in apocalyptic terms against allowing the debt ceiling to be reached. America would face a crisis that “would shake the basic foundation of the entire global financial system,” Geithner said on April 14, 2011, four months before S&P Global Ratings downgraded U.S. debt to to AA+ from AAA. The same year, he also referred to “catastrophic economic consequences that would last for decades.”

The standoff in 2011 was enough to trigger the New York Fed, which serves as Treasury’s fiscal agent, to run “tabletop” exercises to check its ability to prioritize and its potential impact on markets. Those started as early as March of that year, five months before the debt-ceiling was expected to be reached.

New York Fed spokeswoman Suzanne Elio declined to comment on whether the bank is running tests in case prioritization is warranted this year.

Read more: Trump White House divided on how to handle the debt ceiling

Under the contingency plan, holders of U.S. debt and recipients of social security, veterans benefits and other entitlements would be paid first. Everyone else, including government contractors and federal employees, would be at risk of payment delays or partial payments.

Treasury’s own stance has shifted since 2011, even during the Obama administration. In 2011, officials called it an “unworkable” idea, but in 2014, Lew conceded that the U.S. was “technologically capable” of prioritization. That ignited a furor among Congressional Republicans, especially Mick Mulvaney, now budget director at the White House, who criticized the Obama administration for keeping the backup plan secret.

— With assistance by Craig Torres, and Alex Harris

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