Signals of greater openness to negotiate have at last emerged between the Democrats and the Republicans, and prelude to the reaching of an agreement that would prevent the United States from defaulting..…
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The Republicans have set forth a proposal, discussed during a previously scheduled meeting with President Obama, to raise the debt ceiling until 22 November, while measures to contain spending in the medium term are discussed. The proposal does not include the end of the government shutdown, and forbids the use of non-standard measures to temporarily work around the debt limit. Although it has been rejected by Democrats in its initial version, it marks a first step towards the solution of the crisis. In the next few days (this is a long weekend in the US), the first stage of the agreement is likely to be reached, removing the ominous default risk with a bridge law. Subsequent negotiations will probably follow the lines laid out by Paul Ryan, Chairman of the House Budget Committee, who has spotlighted as priority actions to end the stalemate a set of modest corrections to mandatory spending programmes (healthcare and Social Security), combined with a tax reform. Moving from these bases, the following talks should result in the debt ceiling being raised by at least 1.1 trillion dollars, to 18.7 trillion, so as to cover a period that will last until beyond next autumn’s mid-term elections.
Our forecast is that in a matter of days a lifting of the debt ceiling and an extension of the continuing resolutions to reopen the government will be agreed on, to cover the period until mid-December at the latest. During this period, talks will take place to reach a second-stage agreement, that would remove the issue of the debt ceiling until November 2014, define changes to Medicare spending for the medium term, and reallocate the Budget Control Act’s discretionary spending cuts in 2014.
But what will happen if next week comes and the stalemate continues? Let’s briefly ponder the unthinkable, i.e. that the “X date” is reached, when the Treasury will no longer have the necessary funds to honour its financial commitments. The “X date”, on which payments will exceed revenues, is estimated by the Bipartisan Policy Center (BPC) to come between 18 October and 5 November. The Treasury has indicated 17 October as the first possible default date; the CBO’s forecast is 22 October.
If the “X date” is reached without the debt ceiling having been raised, there will be two possible outcomes: 1) the Treasury could default on a part of the payments due, or 2) the President of the United States, or the Chairman of the Fed, will opt to break the law to work around the limit and fund the Treasury in any case. Given outcome 1), the likeliest, the BPC estimates that between 18 October and 5 November the Treasury would be in the red by around 106 billion dollars, and would be unable to honour approximately 32% of its financial commitments. The question would be on what ground to choose what to pay. One thing is reasonably certain: interest on debt would be paid in any case, also considering that such payments are channelled through a separate Fed account, whereas all the other payments are channelled into a single “combined” account. The “prioritisation” of payments would be difficult to implement for a number of reasons. First of all, the choice whether to pay pensions or health care, wages or veteran benefits, would be entirely arbitrary, and not defendable given the size of the problem.
Secondly, the payments are made based on automatic programmes, and changing their flows would require these programmes to also be altered. This would take time: the Treasury has said it does not have the instruments to “prioritise” payments. As an alternative to prioritisation, the Treasury could more likely opt to pay flows on a daily basis as the funds become available (Fig 3). This would in any case lead to failure to implement 32% of planned spending, implying dramatic fiscal restriction.
Outcome 2) would contemplate “illegal” alternative paths to keep the United States solvent. President Obama could invoke the 14th Amendment to the United States’ Constitution (which asserts the validity of the United States’ debt), or appeal to the contradictory laws passed by Congress (spending commitments and debt ceiling), and authorise the Treasury to issue new debt (in breach of the Constitution, which assigns the borrowing to the Congress). The President has indicated he intends not to follow these paths, also considering that such new debt would be subject to legal challenges, having been issued in breach of the law. An alternative solution could be the direct funding of the Treasury by the Fed; this would violate the Federal Reserve Act. In any case, these illegal courses of action seem unlikely to materialise, unless after the “X date” is reached, dramatic instances of financial instability prompt the President or the Fed to act using powers called for in situations of emergency.
Source: BONDWorld – Intesa Sanpaolo – Research Department
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