The Treasury has been up against the debt ceiling since May 19. But Secretary Jack Lew warned last week that his ability to create headroom under the $16.7 trillion limit will run out in mid-October. The threat facing the Treasury, and the nation, is what happens then if Congress doesn’t raise the limit.
In the worst-case scenario, the government fails to make payments on the interest on its debt, an outcome that could create a global financial crisis.
Yet Congress is not close to lifting the limit. With just a few weeks to go, House Speaker John Boehner, R-Ohio, is demanding spending cuts in return for the House voting to raise the ceiling, while President Obama is saying he won’t negotiate over the government paying its debts.
What if Congress doesn’t raise the debt ceiling in time? The following is a stage-by-stage guide to the consequences that would unfold if the cap isn't raised. It is based on the last brush with the debt ceiling in 2011 as well as earlier episodes — the debt ceiling has been raised 78 times since 1960.
The Treasury currently is paying all of the government’s bills without issuing new debt by engaging in what it calls “extraordinary measures.” By manipulating accounts and postponing scheduled intra-government transfers, the Treasury can eliminate the need to issue bonds to finance those needs, and instead use newly issued bonds to pay obligations as they come due, without adding to the level of debt.
According to the Government Accountability Office, the available extraordinary measures include skipping payments to federal employees’ retirement funds, taking money out of the fund used to stabilize exchange rates in case of an emergency, and maxing out the Federal Financing Bank’s credit limit.
Exhausting extraordinary measures: Lew indicated in a letter to Boehner that mid-October is when he will run out of extraordinary measures. It’s likely that “mid-October” means up to a week after Oct. 15. When Congress was debating raising the debt ceiling in 2004, then-Treasury Secretary John Snow said on Oct. 14 that he would exhaust all available extraordinary measures by mid-November. In fact, The increase wasn’t signed by President George W. Bush until Nov. 19, with relatively little notice.
Once Lew has exhausted all extraordinary measures, the Treasury will have only about $50 billion in cash on hand and incoming tax revenus with which to pay daily obligations.
Reaching the X-Date
Once the Treasury reaches that point, the government will quickly reach what the Bipartisan Policy Center calls the “X-Date": “the first day that the federal government is unable to meet all of its obligations in full and on time.”
According to Lew, the Treasury makes about 80 million payments per month, and it has enough incoming revenue to make only 60 percent of those payments.
The Treasury technically would still have the resources to make monthly interest payments. Nevertheless, if the debt ceiling is not raised before the X-Date, uncertainty over which payments would be made — and the possibility that the Treasury wouldn’t have enough cash to pay the interest on a given day — would begin to roil financial markets. There obviously would be public uproar as well. The crisis in 2011 was the closest politicians have come to breaching the X-Date, and most financial analysts do not expect Congress and the president to push the envelope any further this year.
In the unlikely event that the arguments over the debt ceiling extend beyond the X-Date, the economic outlook would become increasingly dicey as the Treasury would do everything in its power to avoid missing an interest payment.
Earlier this year, the GOP-led House tried to codify prioritization of debt interest payments with a bill that would have directed the Treasury Secretary to make interest payments before any other obligations, such as Social Security checks and payments to contractors. Both Senate Democrats and the president opposed the bill, and it went no further.
The administration’s alternative to prioritization was laid out in an August 2012 letter the Treasury’s inspector general sent in response to a query from Sen. Orrin Hatch, R-Utah. According to the IG, Treasury officials were skeptical of prioritization because they were uncertain that the agency's computer payment system was capable of prioritizing among its millions of monthly scheduled payments.
Instead, the officials determined that the “least harmful” course of action would be a “delayed payment regime,” in which “no payments would be made until they could all be made on a day-by-day basis.” Because the U.S. operates at a deficit, the payment delays would get increasingly worse with each day past the X-Date.
At some point after the delayed payment regime begins, likely early, the administration might begin contemplating extreme measures at the limits of its legal authority as the confusion and chaos created by the debt ceiling fight begin to disrupt the economy.
These include some steps that the Obama administration has previously dismissed, such as claiming that the 14th Amendment grants the president authority to raise the debt ceiling unilaterally. They also would include some of the outlandish-sounding measures that have been suggested, such as exploiting a loophole in the law regarding commemorative coins by minting a trillion-dollar platinum coin and depositing it in the Treasury’s account at the Federal Reserve. Earlier this year, the administration was forced to say that it didn’t consider the trillion-dollar coin a viable option when advocates of that approach became increasingly vocal.
Failing any last-ditch attempts by the administration to avoid default, the Treasury eventually would fail to make payments on the interest.
But financial markets already would have been thrown into disarray and the economy would have been damaged.
It wouldn’t be the first time in modern history the federal government defaulted on its debt. As former Bush economic adviser Donald Marron has noted, the Treasury briefly failed to make payments on some securities in 1979 because “Treasury’s back office was on the fritz,” partly because of the debt ceiling.
Although 1979’s missed payments were quickly paid back and did little to harm the economy, things would be different this time.