Federal debt ceiling: would T-bonds be first in line?

Investment Analysis Clubs Macro Economic Trends and Risks
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Wall Street Is Counting on a Debt Limit Trick That Could Entail Trouble

If the debt limit is breached, investors expect Treasury to put bond payments first. It’d be politically and practically fraught.
Joe Rennison

By Jeanna Smialek, Jim Tankersley and Joe Rennison, The New York Times, Jan. 30, 2023, 12:16 p.m. ET

…
Many on Wall Street believe that the Treasury Department, in order to avoid defaulting on U.S. debt, would “prioritize” payments on its bonds if it could no longer borrow funds to cover all its expenses. They expect that America’s lenders — the bondholders who own U.S. Treasury debt — would be first in line to receive interest and other payments, even if it meant delaying other obligations like government salaries or retirement benefits…

“Treasury systems have all been built to pay all of our bills when they’re due and on time, and not to prioritize one form of spending over another,” Treasury Secretary Janet Yellen told reporters earlier this month…

The government hit its debt limit on Jan. 19, and the Treasury Department has said that it can use temporary measures to keep covering expenses until at least June. After those are exhausted, the debt limit must be raised or suspended in order for the United States to borrow money to pay its bills…[end quote]

This article describes a game of chicken (or swan?) which could come to a head within 6 months.

Like the market’s determination to ignore the Federal Reserve’s predictions of interest rates, the market is determined to ignore the potential crisis…for the time being.

The 10-year Treasury futures contracts show that traders believe the yield of the 10YT will fall between March and June (since the price of the contract is higher for June than March). If the traders felt that a crisis was likely in June the price of the June contract would fall.

Are bond traders right to rather smugly assume that they will be paid off while retirees, disability beneficiaries and military personnel may be stiffed?

The risk of Treasury bond defaults would also affect the stock market. Even if this risk is low METARs should be aware of it.
Wendy

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Its been argued that, according to law, America cannot default on its debts. Salaries and benefits have no such protection. This is a safe bet being made by bond traders.

This is also roughly 6 months away, which is a long time. Way too early for markets to get jittery or react to a catastrophe that might be avoided.

Personally, my thoughts are only a few radicals are threatening default if they do not get their way. Their party surely has a few sane individuals left to avert such a crisis?

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After the latest comments from the other branch of government, I am more optimistic that we will get through this:

On Sunday, McCarthy said that Republicans will not allow a U.S. default and that cuts to Social Security and Medicare would be “off the table” in any debt ceiling negotiations.

Both sides will likely give a little, like they did last time they played a game of chicken.

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Right.

What’s the expression that could be adopted here? Something like “while past returns are no guarantee of future results, there exists some correlation which makes similar future results more likely, just not guaranteed.” We can hope the correlation does not hold…

Pete

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I am inclined to agree. I remember when Fanny and Freddie went bust. Jim Jubak, who seemed to be one of the more reasonable talking heads, was howling that, if the government didn’t make all the GSE paper good (in spite of the prospectus clearly saying it was not backed by the US government), financial armageddon would ensue. I am sure the (L&Ses) will agree to take care of the money interests first. The pain will be felt by “We The People”, because that is how political points are scored against the opposition.

Supposedly, people have declared SS and Medicare “off limits”. But that leaves the way clear to defund all of welfare, and “foreign aid”, the two primary targets of certain factions in Shiny-land.

In 2021, the Federal government spent $1.056T on “welfare” including Medicaid.

“Foreign aid” is put at $60B for this year, which probably does not include the Billions going to Ukraine, as that is some $45B.

The projected deficit for 23 is $1.2T.

Any more cuts required after giving the poor and threatened in the US and abroad a lecture on “personal responsibility” could probably be made up by giving US states the same lecture, and cutting off funding for police, blight clearance, roads…

Steve

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I think they’re mostly counting on it not coming to that at all. That a deal gets reached.

If it does come to that, I think the assumption is that the Federal Government doesn’t actually have to “stiff” retirees and disability beneficiaries and military personnel. Rather, that we could end up with something like an “ordinary” government shutdown. Scare quotes because that’s still a ridiculously horrible outcome, but one at least with precedent.

The budget deficit is “only” about 20% of the budget. While specifically wrong, it’s generally correct to say that the government takes in enough revenue each month to cover 80% of its expenses for that month. Which means that if the government could and did spend that 80% on just the things that you describe (debt service, social security, health care repayments, and military spending), and just shut down the other 20% of government, it could service the debt and keep all the retirees and servicepeople happy.

The counter to that is noted in the original article - the Federal Government has no mechanism in place to actually do that. Theoretically they could set up a system that accommodates the fact that their bank account only has 80 cents on the dollar.
But they haven’t actually done that, and there’s probably no way they could actually set up a system that effectively did that within the relevant time frame. It’s more likely they could kludge a system that made sure one thing (like bond debt) got paid before anything else, but not something that could draw fine distinctions between other programs.

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I don’t think the bond traders are assuming that other will get stiffed so they can be paid. They’re wagering that the issue will be resolved in the next 4-5 months and everyone will get paid. After all, that’s how things have gone down in the past. Push it to the deadline. Fund things for another week or two at a time until a deal gets reached. At worst, cut off a bunch of services (parks for example, which would be especially painful just as schools get out and National Parks become a popular vacation stop) so those payments can stop and others - including Treasury debt holders - can get paid.

Then, finally, the back room deal is made, everyone gets a tiny bit of what they wanted for political purposes, and the government is back to routine business. Except, of course, for all those Parks employees who didn’t work for a couple of weeks and will lose out on some of their annual pay.

My absolute worst case is that because of the lack of ability to prioritize payments noted by albaby, no one gets paid for a few days - perhaps a week - and some bonds and notes actually default. But all of those missed payments will eventually get made - even if they are a week or so late. Because even if history rhymes, it doesn’t repeat exactly. We might go a bit further than we have before.

–Peter

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Since this is all about leverage, which the people that are going to create the default think they have some, why doesn’t the government just choose to not pay the people that support such people first? If that was to happen we could sit back and watch a bunch more of fruitless investigations that try to prove who is right and wrong.

:popcorn: :popcorn:

Andy

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I mean, maybe. The same problem still applies. The government doesn’t have a system for prioritizing payments when there’s not enough money in the bank account. It certainly doesn’t have a system for keeping track of the payments it misses because there isn’t enough money in the bank account.

So what you describe could be a fustercluck of epic proportions. The government pays out one or two billion dollars per day - to millions of people and other governmental bodies and companies and whoever else. If a few million transactions get cancelled because of insufficient funds, the amount of work involved to have those missed payments “eventually get made” can be enormous.

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Certainly they have something that keeps track of what is due and when it is scheduled to be paid.

I would envision something more akin to stopping all payments - kind of like what happens every weekend or holiday. Nothing is scheduled, nothing happens. Every day becomes Sunday. “Monday” doesn’t roll around until the President signs the bill Congress passes. Or like a maintenance period, assuming they have some kind of maintenance windows when everything stops for a bit. Open a maintenance period and don’t close it until the ink is dry on the President’s signature.

So when they can start “mailing” checks again, they just start the system back up. (He says as if starting things back up is trivial - which I’m sure it’s not, but it likely easier than picking and choosing who to pay and not pay, or creating a system to track who has been paid and who hasn’t.)

–Peter

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No doubt. But that doesn’t mean they have a system for keeping track of instances when things aren’t paid when they’re scheduled to be paid.

The federal government isn’t like a household budget. They’ve got literally millions and millions of people and entities they pay money to, and countless different payment systems and accounting processes for the legions of different federal agencies that make those payments. There’s no guarantee - at all - that those processes are set up in a way that allows the government to track instances where a bill is attempted to be paid but the payment doesn’t clear because there are insufficient funds.

From the limited stuff I’ve read on the subject, these systems just aren’t set up to accommodate the possibility that the government might not have enough money in the bank account to pay the bills. That’s why no one is confident that the government has the tools to prioritize payments - all of these systems are set up so that if a payment is authorized, the check gets cut and sent out. There’s no step in the process for double-checking the bank account balance before payment, or a place to step in and stop the actual payment if the request for payment is valid.

That makes me think that these systems just aren’t set up to keep track of instances where a payment is attempted to be made, but the fulfillment breaks because of lack of funds. It’s not something that they’ve been programmed to do; not a report that they’ve been programmed to generate.

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They can’t “prioritize” payments to honor some obligations, and default on others, but they can shut departments down, so they can’t spend. Shut the Department of Education down, for instance, and $89B/yr of spending stops. But Treasury stays open, so can pay interest on the debt. Shut down the DoJ’s “COPS” program, and $139M/year in subsidies to local law enforcement stop. Shut down the Dept of Housing’s blight clearance program, and hundreds of millions more in spending stops. Michigan just received another $188M under that program. If the states and cities cry about losing their Federal subsidy, they get a lecture on “person responsibility”.

Steve

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OK. So you have to stop authorizing payment. That would keep the bill from being paid, while still tracking the need to make the payment eventually.

Again, probably not easy, but if a human is in the process somewhere, they can be told to stop doing whatever it is that will lead to a payment being made. I’m sure that a great many things are close to fully automated. But I’m sure some are not and have a human in the chain somewhere along the way.

Every system has some way to hack it (in a white-hat hacking kind of way) to accomplish a goal. Some are easy, some are not. But with the lead time we have, there is still time to figure out some way to work around the system without breaking it, while also allowing it to recover in some non-disastrous way.

–Peter

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Sounds something like Y2K all over again :wink:
'38Packard

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Yes bond holders will be paid first but the others wont be stiffed.

The printing press enters as the elephant in the room. Just at the same time US paper starts to go down the tubes instead inflation will take off.

Inflation means the US paper does go down the tubes and no one really gets paid what they were getting paid bond holders or the others.

In other words not raising the debt limit is an inflationary action. It is worse than inflation in its effect on the USD.

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What happened with the markets a few / several years back with the last “debt limit crisis”?

If nothing else it will become a short term trading opportunity - short first due to the incalculable idiocy of Congress, then long after oh a month or so.

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As I recall, even though they didn’t work for a couple of weeks, they were still paid in full at the end.

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Yep my comment is the seniors, disabled and the medical bills will still be paid by the printing press.

The radio news discussions are trying to explore how this ends. There is no end to it…yet. That was not true in 2013, the sequester was on the table immediately.

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Sold off rather significant prior and then rebounded fully (but slower) once over.

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