Steven L. Schwarcz from Duke Law argues that President Obama might have new options if there’s another constitutional showdown with Congress over raising the debt ceiling.
Under the U.S. Constitution, Congress has exclusive authority to issue debt “on the credit of the United States.” Congress has long delegated some of that power to the Treasury Department. To avoid having to micromanage the Treasury Department’s debt issuances, Congress created the public debt limit—colloquially known as the “debt ceiling”—within which the Treasury Department has virtually unfettered debt-issuance authority.
As government costs increase, the debt ceiling may need to be raised to finance those costs. The biggest component of U.S. government costs is the need to pay debt service—principal and interest—on maturing Treasury securities. Congress thus can threaten a default by refusing to raise the debt ceiling, creating the potential for a debt-ceiling showdown between Congress and the Executive Branch.
Such a showdown will loom large, for example, if Congress and the President are at loggerheads on spending and Congress uses the debt ceiling as leverage to try to extract spending cuts—a scenario that has occurred many times over the years, including during the Clinton Administration and more recently, during the Obama Administration. This type of showdown can occur frequently because the federal government, like most governments worldwide, routinely depends on borrowing new money—often above the debt limit—to repay (i.e., refinance) its maturing debt.
In October 2013, the Obama Administration thus warned that if the debt limit were not raised, the United States would shortly default on its debt. Congress agreed to a temporary increase, but the issue will arise again in February 2014. And the problem is not limited to that date. As mentioned, the risk that a debt-ceiling showdown could trigger a debt default has been historically significant. It will continue to be significant, even if Congress and the President manage to agree in February on an appropriate debt-ceiling increase, because the rising federal government debt load will inevitably make future debt-ceiling increases necessary.
So what happens if Congress fails, due to political paralysis, political gamesmanship, procedural voting impediments, or any other reason other than a clear desire to force the nation to default on its debt, to raise the debt ceiling? Such an action would cause more U.S. debt coming due than can be refinanced under the applicable debt limit, leading the Executive Branch to search for ways to avoid a debt default.
Even a “technical” default by the United States on its debt, such as a delay in paying principal or interest due to Congress’s failure to raise the debt ceiling, could have serious systemic consequences, destroying financial markets and undermining job creation, consumer spending, and economic growth. The ongoing political gamesmanship between Congress and the Executive Branch has been threatening — and even if temporarily resolved, almost certainly will continue to threaten — such a default.
It therefore is critical that any such default be averted. The various options discussed in the media for accomplishing that, such as the notion that the President has implicit authority under the 14th Amendment to the Constitution to borrow in order to avoid such a default or that the Executive Branch could prioritize payments, paying its maturing debt first, in order to avoid default, are not legally and pragmatically viable. Other discussed options, such as the $1 trillion platinum coin proposal, have been even more fanciful. Some legal scholars have observed, for example, that it fails as a pragmatically viable solution because it is so “cartoonish and desperate that it could undermine faith in the government’s ability to repay its obligations” and would create market uncertainty.
Because of these legal and practical impediments, there are possible alternative options for avoiding default. These options attempt to bypass traditional borrowing limitations by applying structured finance modeling to federal debt.
Structured finance is an essential basis of corporate finance, and an increasingly important basis of state and municipal finance. Its use in federal public finance has heretofore been minimal, however, probably because Treasury securities already bear extremely low interest rates.
Although the Executive Branch lacks authority to directly issue Treasury securities above the debt ceiling, it has the power to raise financing by monetizing future tax revenues. In each of his proposed options, a non-governmental special-purpose entity (SPE) would issue securities in amounts needed to repay maturing federal debt.
Depending on the option, the SPE would either on-lend the proceeds of its issued securities to the Treasury Department on a non-recourse basis, secured by specified future tax revenues; or the SPE would use the proceeds of its issued securities to purchase rights to future tax revenues from the Treasury Department. In each case, therefore, specified future tax revenues would form the basis of repayment to investors.
These options should be legally valid and constitutional, notwithstanding the debt ceiling: neither involves the issuance of general-obligation or full-faith-and-credit government debt, and indeed the second option doesn’t involve the issuance of any government debt. Furthermore, based on the similarities of these options to successful financing transactions that are widely used in the United States and abroad, the securities issued thereunder should receive high credit ratings and also be attractive to investors. Because of provisions in foreign treaties, those securities should be especially attractive to foreign investors — who already purchase half of all Treasury securities.
These options are not intended to be standard financing structures. Being riskier than full-faith-and-credit Treasury securities, the securities issued under these options would almost certainly have to pay a higher interest rate than Treasury securities. The options should therefore be viewed, as my research presents them, as viable emergency measures, if needed, to avoid a U.S. debt default.
Steven L. Schwarcz is the Stanley A. Star Professor of Law & Business at Duke University and Founding Director of Duke’s interdisciplinary Global Capital Markets Center (now renamed the Global Financial Markets Center). His full research on this subject is available on the Social Science Research Network, and forthcoming as a “Feature” article in the Yale Journal On Regulation.
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