Conservatives: The threat of default is a myth

January 15, 2013

President Obama on Monday accused Republicans of holding "a gun at the head of the American people" by using the debt-ceiling to force spending cuts. "Even the threat of default hurts our economy," he explained. 

(Source: Mark Lennihan / AP)
(Source: Mark Lennihan / AP)

A growing number of conservatives say this just isn't so: If we breach the debt ceiling next month, the Treasury Department could simply prioritize outstanding bond payments to avoid stiffing investors and prompting a financial meltdown. The government would have to hold off on paying for domestic programs, the argument goes, but that would be a temporary inconvenience. 

"The debt ceiling does not equal default," says Rep. Mick Mulvaney (R-S.C.). "We can continue to refinance the principal all the time. As long as you pay the interest, you're fine, you have plenty of money on an annualized basis."

The South Carolina Republican accused the president of using "hyperbole" to scare the American people and criticized Democrats for equating a breach of the debt-ceiling with default. "Democrats trying to expand the definition of default— if we don't open the national park service one day, that would mean default. We will not default," Mulvaney said, advising against "this crisis mentality, this 'Oh my god, the world is going to end' mentality."

The White House has long maintained that it might not be possible to prioritize payments if the debt ceiling were breached, and others have raised the possibility of legal complications, as my colleague Brad Plumer explained yesterday. But conservatives both on and off the Hill are uniting behind the argument that default is a myth, regardless of whether we breach the debt ceiling or not. 

"The only way the federal government would default on its debt in the event the debt ceiling remains unchanged is for the Treasury to choose to default—an utterly implausible eventuality," wrote Heritage analyst JD Foster. He elaborated his case in a longer report: "Whether Treasury is required as a matter of law to prioritize incoming receipts to pay interest costs first is an open question, but there appears to be little doubt Treasury would do so. There is, therefore, no real question that Treasury would take the actions necessary to preserve the full faith and credit of the U.S. government and avoid defaulting on debts due."

The Cato Institute's Michael Tanner makes a similar argument in the National Review, though he acknowledges that there are still some risks and market disruption involved, even if Treasury prioritizes its interest payments as predicted. He predicts that about $500 billion in debt would mature between Feb 15. and March 1, when we're expected to hit the debt ceiling, and believes that Treasury could still pay the principal on this debt by issuing new securities.

"Theoretically, there could be a problem if no one is willing to buy the new securities," he writes, though he believes this is unlikely. "More likely is the possibility that Treasury might have to offer higher interest rates on this rolled-over debt, a not insubstantial concern: A one-percentage-point increase in interest rates could cost taxpayers more than $100 billion per year." But, ultimately, Tanner believes the economic consequences of failing to cut spending would be much greater. "None of this would be worse than a failure to take meaningful action to reduce the debt, federal spending, and the growth of government," he concludes.

The argument assumes that prioritizing bond and principal payments would be enough to ward off potentially calamitous market disruptions, and that postponing government payments to everyone other than investors would have legal standing, which analysts like Bipartisan Policy Center's Steve Bell have raised major concerns about. Democrats, for their part, have already primed their counterargument.“This proposal to prioritize payments to foreign creditors over those to seniors, families, and veterans is the wrong way to go and it’s an absolute nonstarter in the Senate,” said Senate Budget Committee Chairman Patty Murray (D-WA) told TPM.

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Sarah Kliff · January 15, 2013