By Dan Kervick
My fellow NEP blogger Joe Firestone wrote recently about House Resolution 807, the Full Faith and Credit Act, which was passed on May 9th by the US House of Representatives. The supposed purpose of the act is to prevent default on the public debt as a result of the debt ceiling. Many have described the act as a measure that prioritizes the financial obligations of the US government, and authorizes the Secretary of the Treasury to meet only the highest priority obligations when at the debt ceiling. Indeed, that is how the act is described by its own authors, since the head of the resolution contains the description, “A bill to require that the Government prioritize all obligations on the debt held by the public in the event that the debt limit is reached.”
Now that the bill has been passed, the words “a bill” in that description have been replaced by “an act.” The act seems to have been designed to provide the Secretary of the Treasury with an alternative mechanism for paying off public debt and meeting Social Security obligations once the government has reached the statutory debt limit. But the new mechanism cannot be applied directly to other government spending commitments, and so Congress would still apparently have the ability use the debt ceiling as a tool for shutting down other government payments and forcing the executive branch to accept further spending cuts.
Such might have been the authors’ intentions. But if I am not mistaken, this act would provide the Secretary of the Treasury with the power to meet all US spending obligations, and effectively eliminate the debt ceiling as a serious political and operational consideration going forward.
To see how the Full Faith and Credit Act might have the unintentional effect of eliminating the efficacy of the statutory debt ceiling altogether, we need to look at the text of the act. It is quite short. Here is the key provision:
SEC. 2. PAYMENT OF PRINCIPAL AND INTEREST ON PUBLIC
DEBT AND SOCIAL SECURITY TRUST FUNDS.
(a) IN GENERAL.—In the event that the debt of the United States Government, as defined in section 3101 of title 31, United States Code, reaches the statutory limit, the Secretary of the Treasury shall, in addition to any other authority provided by law, issue obligations under chapter 31 of title 31, United States Code, to pay with legal tender, and solely for the purpose of paying, the principal and interest on obligations of the United States described in subsection (b) after the date of the enactment of this Act.
The act thus authorizes the Treasurer to issue a new kind of obligation in order to pay off other obligations. So what are these latter obligations, the “obligations described in subsection (b)”? Here they are:
(b) OBLIGATIONS DESCRIBED. For purposes of this subsection, obligations described in this subsection are obligations which are—
(1) held by the public, or
(2) held by the Old-Age and Survivors Insurance Trust Fund and Disability Insurance Trust Fund.
Note that Section 2 of the H.R. 807 is significantly different from the original version of the bill that was put forward back in 2011. That original version was a bit more complicated. It directed the Treasurer to prioritize government payments once at the debt ceiling and to “pay with legal tender” the interest and principle on public debt obligations to the extent that the Treasury’s funds were sufficient for doing so, and then to extend the maturities of debts that could not be so paid. If all public debt obligations could be paid from available funds, the Treasurer would then be required to prioritize all other spending obligations and pay them off “in that order the Secretary considers advisable and in the public interest.”
But the version of the act that was actually passed on May 9th authorizes the Treasurer to issue “obligations … to pay with legal tender”, the principal and interest on the obligations described in subsection 2(b). Now, an obligation is just another debt instrument. So the act basically permits the Treasurer to issue IOUs to pay the principal and interest on public debt. It permits the Treasurer to redeem conventional government debt obligations – all of the usual bills, notes and bonds the government issues, and that count against the debt subject to the debt limit – with a new kind of debt obligation.
Call these new types of obligations “807-obligations”. The Full Faith and Credit Act then says the Secretary of the Treasury can issue an 807-obligation whenever it has reached the debt ceiling, and use it to pay off public debt. If you have a T-bill with a $10,000 face value that matures on June 1st, and the government is at the debt limit, then on June 1st the Treasurer is authorized to give you an IOU for $10,000.
Now here are a couple of important facts about 807-obligations:
1. 807-obligations do not count against the debt ceiling, once the debt ceiling has been reached.
This is made plain by section 2(d) of the act itself:
(d) OBLIGATIONS EXEMPT FROM PUBLIC DEBT LIMIT.—Obligations issued under subsection (a) shall not be taken into account in applying the limitation in section 3101(b) of title 31, United States Code, to the extent that such obligation would otherwise cause the limitation in section 3101(b) of title 31, United States Code, to be exceeded.
2. 807-obligations, once issued, would themselves be obligations held by the public.
This is obvious from the plain language of the act, as well as from the fact that section 2(a) of the act specifies that these new obligations are to be issued under chapter 31 of title 31 of the US Code, which is all about public debt.
It thus follows, according to subsection 2(b) of the Full Faith and Credit Act, that 807-obligations can always be issued to pay off other 807-obligations once the debt ceiling has been reached. In effect, then, the bill gives the Secretary of the Treasury unlimited authority to pay off conventional debt with a new kind of debt which does not count against the debt limit, and to roll that total debt over perpetually. Usually, when people speak of “rolling over the public debt”, they mean that the government can sell new debt and use the funds raised to pay off old debt. But the Full Faith and Credit Act provides a way for the Treasurer to roll the debt over at the debt limit by issuing a kind of money-substitute, and by using this substitute to pay the creditor.
But, one might counter, this new mechanism only applies to public debt obligations and Social Security, and still doesn’t give the Treasurer the ability to issue IOUs to pay other kinds of bills. So Congress can still force a default or suspension of payments on all of those other government spending commitments and plans.
While this claim is technically true, it seems to me that if this act takes effect there will no longer be any obstacle to the Treasurer meeting all government spending commitments, even if it has reached the formal debt limit. Suppose the Treasury needs $10 million dollars to pay some building contractors, but the debt held by the public is at the statutory debt limit and so Treasury can’t sell any more bills, notes or bonds. Building contractors are not one of the types of obligation covered under subsection 2(b) so the Secretary can’t pay the contractors with 807-obligations. However, the Treasurer can issue a bunch of 807-obligations to pay off some conventional short-term debt obligations, which then gives the Secretary more space to issue conventional debt. Since these new 807-obligations don’t themselves count against the debt limit, then once they have been issued and used to redeem T-bills, that brings the public debt down $10 million below the debt ceiling. Treasury can then sell $10 million worth of new securities to raise the cash, and pay the contractor with the cash.
The law thus allows the Treasurer to continually extend US borrowing beyond the debt limit by swapping in, whenever necessary, debt that is not subject to the limit for debt that is subject to the limit.
But what if the public doesn’t really want to hold these 807-obligations? After all, if the government is no longer guaranteeing that it will always make the principle and interest payments on its securities with dollars, and if the buyers of public debt know they might end up getting IOUs instead of money when the obligations come due, won’t those buyers decide Treasury securities are now more risky than they were before? Won’t they as a result bid up the yields on these securities and raise the government’s borrowing costs?
I don’t think this is really a serious concern. For one thing, the Fed can always guarantee a market for whatever kind of debt obligation the government wants to sell, at whatever price, by standing ready to repurchase the debt at a price that is profitable to the purchaser. But even if we imagine that some future debt-hawking Fed chair adopts an uncooperative stance toward the extension of public debt, here are a few other salient factors to consider:
First, the Full Faith and Credit Act contains no directions pertaining to the maturities of the new kind of obligations it permits the Treasury to issue. Presumably that decision is left by omission to the discretion of the Secretary of the Treasury, especially given that Chapter 31, Title 31 of the US Code, which is specifically referenced, gives the Secretary broad discretion to decide on the maturities of other government obligations.
The US code also gives the Treasurer the option of prescribing conditions for redeeming T-bills before maturity. So, if the Treasury maintains an abundant stock of short-term debt, redeemable before maturity, it should always have the ability and flexibility to work around any formal debt ceiling constraints by using 807-obligations, all while satisfying market demands for dollar redemption of securities. Suppose the Treasurer wants to issue a bunch of 90-day T-bills with a total value of $500 million, and do so in such a way that the purchasers are guaranteed to be paid the face value in cash at exactly 90 days. It could sell 89-day T-bills, redeem them with 1-day 807-obligations on day 89, bringing the debt down $500 million below the debt limit. It could then sell $500 million more in conventional securities, and on day 90 redeem all of the 807-obligations it issued on the previous day. If the creditors want dollars, Treasury can get them the dollars.
Of course, such complex operations will probably never be required to get the public to be fully confident in the new 807-obligations, and treat them as something close to money. Like other obligations of the Treasury, 807-obligations would be negotiable. One assumes that once issued they would be highly liquid. Perhaps the Treasury could even issue the paper versions of these obligations in roughly the shape and size of a Federal Reserve Note, and encourage their use as money in ordinary transactions. In principle they are no different than other forms of money. After all, a Federal Reserve Note is also an obligation of the US government, but can’t really be redeemed for anything besides other obligations of the US government. If you have an 807-obligation that might only be redeemable for other 807-obligations, how is that different from what the Fed does?
Finally, even if statutes require that people pay their taxes in dollars, and can’t use 807-obligations, the Treasury could set up special tax processing accounts that allow people to deposit their 807-obligations. Each day, by redeeming ordinary debt subject to limit with new 807-obligations, the Treasurer could create space to issue more conventional debt to raise dollars sufficient to redeem all of the 807-obligations in the tax processing accounts. The holders of those accounts, or their agents, could then use to pay the tax obligations. As far as the public is concerned, anything you can use to pay your taxes is as good as money, and should be willingly accepted as such.
ADDENDUM RAISED FROM COMMENTS:
In the original piece above, I parsed this phrase from HR 807:
“the Secretary of the Treasury shall … issue obligations … to pay with legal tender, and solely for the purpose of paying, the principal and interest on obligations of the United States described in subsection (b) etc.”
“the Secretary of the Treasury shall issue obligations to pay with legal tender, and use those obligations solely for the purpose of paying the principal and interest on obligations of the United States described in subsection (b) etc.”
That is I took the bill to be authorizing some new kind of California-style IOUs. But others have suggested to me it more likely means:
“the Secretary of the Treasury shall issue and sell obligations to obtain legal tender, and then use that legal tender solely for the purpose of paying the principal and interest on obligations of the United States described in subsection (b) etc.”
Yet I think the general point of the piece still stands, since whether the new 807-obligations are sold for dollars which are then used to pay of debt, or are a new kind of IOU used to pay off debt themselves, the Treasurer can still undertake the manipulations I described in the piece. The Treasurer can sell the 807-obligations to retire old conventional debt, and then sell new conventional debt to carry out other kinds of spending. This wouldn’t violate the law, because the dollars raised from the sales of 807-obligations wouldn’t be used to carry out the kinds of spending not specified in section 2(b). Those dollars would come from regular debt issuance after debt retired via sales of 807-obligations opens up room under the debt ceiling for more ordinary debt.
So, then, suppose Congress says there are two kinds of debt:
1. Regular debt, the funds raised from which can be used to carry out any authorized spending, and
2. Special debt, the funds from which can be used to retire regular debt.
And suppose it imposes a nominal limit on regular debt, but says special debt can be issued whenever regular debt is at the nominal limit. Then there is no practical debt limit so long as there is always regular debt available to be retired. The Treasurer can always issue regular debt up to the nominal limit, then swap in special debt for the nominal debt, which creates more room for regular debt.