Consols could avert another debt-ceiling crisis

November 14, 2013

James Leitner is president of Falcon Management based in Wyckoff, N.J. Ian Shapiro is a professor of political science at Yale.

At the height of last month’s debt-ceiling crisis, Standard and Poor’s came within hours of downgrading U.S. federal debt to its rock-bottom classification of “selective default.” This would have been much costlier than S&P’s slap on the wrist in 2011, when political brinkmanship over the debt ceiling led it to cut the U.S. credit rating a notch, from AAA to AA-plus. Had the debt ceiling been breached, the damage to the U.S. and world economies could have been measured in trillions of dollars.

When this issue returns in February, things might unfold more harshly. The midterm elections will be five months closer and President Obama five months deeper into lame-duckdom. House Speaker John Boehner (R-Ohio) is still running scared of his right wing. Senate Republican leader Mitch McConnell (Ky.) faces a tea-party-sponsored primary opponent. Many House Republicans fear they will face similar challenges if they are portrayed as caving to the RINO (“Republicans in name only”) establishment.

It is appalling that a small minority of extremists in Congress can hold the nation hostage by threatening to drive the economy over a cliff if the administration does not agree to the repeal of laws that they dislike.

There is a way to stop them. Treasury Secretary Jack Lew should declare it to be administration policy that the U.S. government will not default on its debt. To that end, he should prepare to issue consols, should Congress refuse to enact timely increases in the debt ceiling.

Consols are bonds that pay interest but have no set maturity date, so the principal is never repaid. In effect, they are perpetual annuities. In the 18th century, the British began issuing gilts, or bonds, that could be redeemed by the government but did not need to be. When various types of bonds were later consolidated, they were dubbed consols. They are still traded in London capital markets and remain a small part of the British government’s portfolio.

Consols issued by the U.S. Treasury would not fall within the scope of the debt ceiling because there is no principal that is an obligation of the U.S. Treasury. If no principal ever comes due, there is no addition to the U.S. debt as defined by the debt-limit legislation.

The Treasury should announce a pilot program to issue consols. This would involve determining the size of the potential market at different rates of return so that officials would know what the offering should be if Republicans threaten another debt-ceiling crisis.

Consols would not be issued unless the debt ceiling was about to be breached. At that point, they could be sold daily in whatever amount is needed to allow the Treasury to continue meeting the nation’s financial obligations.

The administration could pledge to publicize a ticker showing exactly what the refusal to raise the debt ceiling would cost taxpayers. If consols have to be issued at 6 percent, the cost would be the difference between that rate and the normal rate of issuing government securities. Alternatively, consols could be auctioned at some spread over the nominal growth rate of gross domestic product, instead of being issued at a specified interest rate.

In either case, the president should promise to veto any congressional attempt, in debt-ceiling legislation or elsewhere, to ban consols.

Some will dismiss these preemptive measures as overblown. After all, the markets did not tank during last month’s crisis. The Dow Jones Industrial Average shed only a few hundred points as the prospect of default loomed. Investors evidently assumed — correctly, as it turned out — that the United States would not default. With markets already surpassing their pre-crisis highs, the episode seems to be disappearing in the rearview mirror.

But recall that the markets once believed the federal government wouldn’t let Lehman Brothers fail — not least because it had bailed out Bear Stearns six months earlier. Some elected officials believe, as Rep. Ted Yoho (R-Fla.) put it last month, that refusing to raise the debt ceiling “would bring stability to the world markets.” Sen. Ted Cruz (R-Tex.) maintains that the crisis was a good thing because it got people talking about the debt.

It would be foolish to write off the possibility of a default when there are members of Congress who believe such things.

Our country should not have a debt ceiling. If Congress does not want to increase the nation’s debt, it should raise taxes to cover the spending that it authorizes. But because the debt ceiling does exist, consols would be an effective arrow in the Treasury’s quiver to prevent rogue minorities in Congress from undermining the full faith and credit of the United States.

Time is of the essence. Establishing a working group on consols, including the Treasury, primary securities dealers and investors, is the necessary next step to show that U.S. credit cannot be held hostage by minorities in Washington.

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