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Will Trump Use Obama's "Secret Debt Ceiling Plan" To Avoid A U.S. Treasury Default?

After voting to repeal and replace Obamacare 60 times under the Obama administration, Senate Republicans, now that it counts, are locked in a heated civil war over how or if they should even modify the controversial legislation.  As proven time and again, despite sharing a common party, conservative and moderate republicans have very little else in common.

So, while many may think that a repeat of the 16-day government shutdown in 2013 is unlikely while a single a party controls all three branches of government in Washington D.C., we suspect it may not be quite as simple as that.  Without a budget in place that truly balances, conservative republicans will most likely be unwilling to approve debt ceiling increases no matter who is sitting in the White House.

While republicans have attempted to get ahead of the game by passing a debt ceiling increase well in advance of a breach, efforts so far have failed.  And while it may seem far away, the U.S. government will reach its statutory limit on borrowing some time in October.  So how will Mnuchin handle the Treasury Department if Republicans fail to act and Democrats refuse to play ball?  Turns out Obama had a plan for that.  Per Bloomberg:

When the nation almost breached its debt ceiling six years ago, the Federal Reserve and Treasury drew up contingency plans that were kept secret until January, when transcripts of an Aug. 1, 2011 conference call at the central bank were released after a customary five-year lag.

 

Under the contingency plan, holders of U.S. debt and recipients of social security, veterans benefits and other entitlements would be paid first. Everyone else, such as government contractors and federal employees, would be at risk of payment delays or partial payments.

 

Though the scenario nominally protects holders of U.S. debt by prioritizing the payments they are due, it raises fears that the value of their underlying assets could suddenly decline if the U.S. government’s reputation for creditworthiness is damaged.

 

“I’m assuming that prioritization is the fallback,” said Lou Crandall, chief economist at Wrightson ICAP LLC. The acknowledgment in the Fed transcripts of the existence of a backup plan to pay interest first makes it more plausible, he said, calling it a “truly terrible idea.”

 

Under the prioritization plan described in the 2011 transcripts, Treasury would make all semi-annual coupon payments on debts in part by using monies built up by deferring other obligations. The government would auction new debt at regularly scheduled times only to fund old debts that matured.

 

Meanwhile, even though the plan would still make all interest payments on U.S. debt when due, it's unclear whether Obama's prioritization plan would merit further downgrades from the ratings agencies.

Prioritizing U.S. debt is a contentious issue, with no consensus over whether it constitutes a default. Former Treasury Secretary Jacob Lew called it “default by another name” while in office. Fitch Ratings disagrees, but says it would trigger a review of whether the U.S. still warrants a AAA rating.

 

Moody’s Investor Service, which considers it likely that the government would use the plan if the Treasury exhausts extraordinary measures to stay under the ceiling and Congress doesn’t act, seems comfortable with it. The agency says that the economic disruption that could erupt would expedite a political compromise to end the impasse.

Of course, in the long run these shutdowns are just a waste of time as politicians ultimately cave to pressure from a base of constituents who have been whipped into a state of mass hysteria by a barrage of news flow on the damning impacts of a government shutdown.

There is little support for prioritizing debt payments in Congress, with Oklahoma Republican Tom Cole, a member of the House Budget Committee, calling it a “harebrained scheme that is apt to backfire.”

 

“Proposing to pay interest to the Chinese first, while stiffing American businesses and households that are owed payments by Treasury, hardly seems like a winning political strategy,” Wrightson’s Crandall said. “We’re not sure how the market would respond to that kind of payments twilight zone.”

And, in the end, the result is always the same: