Tuesday, September 24, 2013

Shutdown versus default


I've previously argued that hitting the debt ceiling (which, by the way, has already happened in May of this year), and running out of extra cash to spend through extraordinary measures (which we have not yet done yet) will lead to a partial government shutdown, which, in turn, will lead to the resolution of any debt ceiling crisis.  That is, I've argued that a debt ceiling crisis is just another way to get to a shutdown.

The Treasury department disagrees with me. And a  recent article in the New York Times piles on.

Am I wrong? Well, as usual, it's complicated. Let me take you through the ins and outs of the argument.

An inspector general's report prepared during the 2011 crisis argues that while there are contingency plans for dealing with an orderly government shutdown, there are no contingency plans for dealing with hitting the debt ceiling and running out of enough cash to pay incoming debts.  That is a shutdown is "orderly," while reduction of government expenditures as a result of a debt ceiling crisis is "disorderly."

If we hit the debt ceiling and run out of money, uncertainty will reign supreme, people will go crazy, and markets will tank in ways they would not tank if there were merely a government shutdown. (This claim, it seems to me, is what is really at stake in the controversy-- that the market reactions will be much worse in one case than the other)

Why is that so, you may ask? Why wouldn't an ordinary government shutdown not also cause serious instability in the markets? And more to the point, why would there have to be greater uncertainty? Why can't the government simply use the very same contingency plans it has devised for a government shutdown in case the country reaches the debt ceiling and runs out of money?

After all, in the case of a shutdown the government may not spend any more other than money appropriated for mandatory programs. In the case of hitting the debt ceiling, the government may not spend any more money if it would increase the government's debt above the debt ceiling. However, since new revenues are always coming in, the government can spend whatever money it has on hand plus any money it is receiving. So why not devote the money on hand (and incoming receipts) to (1) paying off the bondholders and (2) paying off mandatory programs?

At this point, the explanations offered in the press get a bit more murky. One argument is simply to reiterate that there are no plans for such a contingency. But this simply begs the question why the existing shutdown plans can't act as those plans. After all, the shutdown plans at the very least prioritize mandatory expenditures over discretionary ones.  Those mandatory expenditures include, for example, Social Security and payments to bondholders, and, ironically many parts of Obamacare.

Another argument is that hitting the debt ceiling will put the President in a legal predicament. He will face two conflicting legal obligations: to pay monies appropriated and not to pay monies already appropriated (because doing so would require raising new debt). But this by itself does not seem to be much of a legal problem. Congressional statutes sometimes conflict, and when they do, the President has to decide if there is a way to interpret both to make them consistent. If that isn't possible, he has to decide which ones to follow. The same logic would seem to apply here. Hence, if there isn't enough money on hand to pay all the bills the President could and should initiate a partial government shutdown.

A better argument, it seems to me, is not about law but about technology. The Treasury Department has programmed its computers to send out checks automatically. There is no prioritization mechanism built in, and it would be too difficult to program a temporary prioritization mechanism in a hurry. But this argument, too, leads to some important unanswered questions.

First, once we learned that the Republican Party had breached existing political conventions two years ago and was willing to threaten default as a bargaining chip on a regular basis, why didn't the Administration set about creating new software programs for prioritization that would deal with such an eventuality? After all, if you have just avoided a flood and you think that another flood may be coming soon, you build levees. You would be foolish not to.

Perhaps the Obama Administration has already created new prioritization programs, and a system for issuing IOU's that promise payment but offer no interest pending resolution of the crisis (hence they are technically within the debt ceiling). But the Administration doesn't want to tell anyone about its preparations because that would encourage the Republicans to be irresponsible. This is a bit like the game of chicken in which the best strategy is to throw your steeling wheel out the window so that there is no way to avoid hitting the other car if it continues on its path. If so, then the Obama Administration is being less than fully candid about the consequences of a debt ceiling crisis in order to maximize its bargaining leverage.  That is certainly what some Republicans seem to believe. But the point is, they don't know what the Administration has actually done by way of preparations, and the Administration has no incentive to be forthcoming on this point. There is always that chance that Administration may actually have thrown the steering wheel out the window.

Second, and equally important, why doesn't an "orderly" government shutdown also involving stopping payments which may also be computerized? Remember that a shutdown does not affect mandatory spending, only non-mandatory spending. If the Treasury can stop those payments as part of an orderly shutdown, why not do so in the event of hitting the debt ceiling? Again this begs the legal question of why the President can't pick and choose once he faces conflicting legal commands.

Another possibility, which I think is also very plausible, is that if we hit the debt ceiling and cannot raise any more cash and our incoming revenues are insufficient, the government will very quickly reach a point where it cannot shut down the various operations of the government fast enough and still pay the bondholders without raising new debt. But this seems merely to be a claim that the shutdown, when it occurs, will move very quickly.

Fair enough. Yet the quicker and more pervasive the shutdown, the sooner the parties will be forced to get back to the bargaining table, and end the crisis, no? After all, if you stop paying Social Security and Medicare checks, lots of people in the Tea Party/ Republican coalition will start pushing for a quick settlement.

I'm not trying to be a Pollyanna here. I don't underestimate what will happen if we are at the debt ceiling (we already are) and we can't raise enough new cash to pay most of our bills (again, we are not quite there yet.) The results will be very bad indeed, and will seriously harm our economy. But it seems that the way this will happen is that the government will start to shutdown lots of programs, which will drive the parties quickly to make a deal.

Perhaps the best argument I've heard--and the one I mentioned at the beginning-- is that despite all I've just said, most people in markets will not realize that a debt ceiling crisis actually leads to a government shutdown. Therefore they will freak out much more (and hence cause much more damage to the economy) than they would if there was just a "regular" government shutdown. That may well be so, but I wonder why market participants haven't already duplicated the reasoning I've just set out here.

In any case, let's assume that's what people are fearing-- that the debt ceiling crisis will not turn out to be the same thing as a shutdown, and therefore will have far worse consequences.

If that is so, the President's correct strategy is fourfold.

(1) announce that you will not bargain over the debt ceiling under any circumstances.
(2) make preparations if you can't pay all your bills but don't tell anyone about your contingency plans;
(3) emphasize the difference between a debt ceiling crisis and an "orderly government shutdown;" and
(4) emphasize how terrible a debt ceiling crisis will be and how unprepared the country is for it. That is especially so even if you have made preparations.

Which, it seems, is exactly what the Obama Administration is doing.