Let's say you're Barack Obama and want to raise the debt ceiling without giving any more away to John Boehner. Usually, analysts say, there are two ways to do it. He could invoke the 14th amendment and declare the debt limit unconstitutional, but press secretary Jay Carney has already taken that option off the table. What's more, it would throw the validity of debt issued after the amendment was invoked into some legal doubt, which could lead interest rates to spike. The more clearly legal option is minting a platinum coin, though that option is not without its detractors, among them our own Ezra Klein.
But Edward Kleinbard, former chief counsel at the Joint Committee on Taxation and a law professor at USC, outlined another option in the New York Times this morning. Once the debt limit is reached, he argues, the United States shouldn't acquire more cash by issuing more debt (as in the 14th Amendment option) or by printing more money (as in the platinum coin case) but by issuing IOUs to various creditors.
Suppose that we normally pay Lockheed Martin $1 billion for fighter jets. Under this plan, we would instead give them a "scrip" redeemable for $1 billion in the future, once the federal government got its act together. Paul Krugman has also floated a version of this plan, calling the scrips "moral obligation coupons."
If this sounds nuts, note that it has actually been tried before, and on a large scale. In 2009, the state of California was in the midst of a budget crisis, and to avoid missing payments it started issuing IOUs known as "registered warrants" to various claimants. They eventually issued 450,000 IOUs, collectively worth $2.5 billion, over the course of three months, after which the scrips became redeemable as the crisis had ended. The deadline for redemption was Nov. 10, 2010, after which the warrants became useless.
The scheme worked. It wasn't exactly popular (one item on the State Controller's FAQ on the program is "Who can I call to complain about this?"), and big banks such as Bank of America, JPMorgan Chase, Wells Fargo and Citigroup stopped accepting deposits of the warrants after a couple of weeks, but credit unions accepted them throughout, and the program kept the state in business for two months. Once the state secured a $1.5 billion loan from, ironically, JPMorgan Chase, it called in the warrants for redemption and the experiment ended.
Could that plan work for the United States as a whole? That's less clear. For one thing, as Kleinbard notes, it would be hard for federal scrips to pay interest. That would make them look suspiciously like bonds, which the debt limit says you can't issue if you're at the ceiling. Part of what made the California program work was that while creditors didn't get cash from the state, they did get a security that paid 3.75 percent annual interest. That's a pretty good deal, especially in July 2009, when other interest rates were at rock bottom. As done by the U.S. as a whole, payments would be delayed but not increased. In nominal terms, they'd get all their money back, but adjusting for inflation, they'd get a little bit less.
The market reaction would make or break the plan, and Nancy Vanden Houten, a bond analyst at Stone & McCarthy Research Associates, thinks the reaction might not be all that bad. "I think if bond holders were persuaded that their principal and interest would be paid, that’s certainly favorable for the bond market," she says. "It would also mean that the Treasury wouldn’t be issuing new debt, as they would still be operating under the debt limit so they couldn’t issue new debt, so you would have less supply of securities than you otherwise would, which would be favorable for interest rates as well."
But Vanden Houten stressed that it would require a lot of prep time to work: "For the bond market to react to something like this favorably, it couldn’t be a last-minute thing. There would have to be some advance notice." Overall, she prefers it to the 14th Amendment option and views it as on a par with the platinum coin, but thinks the sheer amount of political dysfunction that renders such solutions necessary might spur ratings agencies to downgrade U.S. debt. It didn't matter much when S&P downgraded the U.S. in 2011, but second time might be a charm.