Oct 14, 2013

    US shouldn't prioritise bills

    The New York Times

    THE threat of hitting the debt ceiling remains, especially if the politics of the shutdown continues to go against the GOP.

    So what are the choices if we do hit the ceiling? As you might guess, they're all bad, so the question is which bad choice would do the least harm.

    What would a general default look like? A report last year from the Treasury Department suggested that hitting the debt ceiling would lead to a "delayed payment regime": Bills, including those for interest due on federal debt, would be paid in the order received, as cash became available.

    Since the bills coming in each day would exceed cash receipts, this would mean falling further and further behind. And this could create an immediate financial crisis, because United States debt - heretofore considered the ultimate safe asset - would be reclassified as an asset in default, possibly forcing financial institutions to sell off their US bonds and seek other forms of collateral.

    That's a scary prospect. So many people - especially, but not only, Republican-leaning economists - have suggested that the Treasury Department could instead "prioritise": It could pay off bonds in full, so that the whole burden of the cash shortage fell on other things.

    And by "other things", they largely mean Social Security, Medicare and Medicaid, which account for the majority of federal spending other than defence and interest.

    Some advocates of prioritisation seem to believe that everything will be okay as long as we keep making our interest payments.

    Let me give four reasons that they're wrong.

    First, the US government would still be going into default, failing to meet its legal obligations to pay.

    You may say that things like Social Security cheques aren't the same as interest due on bonds because Congress can't repudiate debt but, it can, if it chooses to, pass a law reducing benefits. But Congress hasn't passed such a law.

    Second, prioritising interest payments would reinforce the terrible precedent we set after the 2008 crisis, when Wall Street was bailed out, but distressed workers and homeowners got little or nothing.

    Third, the spending cuts would create great hardship if they go on for any length of time. Think Medicare recipients turned away from hospitals because the government isn't paying claims.

    Finally, while prioritising might avoid an immediate financial crisis, it would still have devastating economic effects.

    We'd be looking at an immediate spending cut roughly comparable to the plunge in housing investment after the bubble burst, a plunge that was the most important cause of the Great Recession of 2007-2009.

    That by itself would surely be enough to push us into recession.

    And it wouldn't end there. So, even if we avoid a Lehman Brothers-style financial meltdown, we could still be looking at a slump worse than the Great Recession.