Remember the last debt ceiling crisis? Congressional Republicans (prudently) decided not to put themselves through that again when the debt ceiling was in sight a few days ago. The possibility of a future crisis is not moot, however.
At the time of the last standoff, as weeks and then days ticked down, my old friend Steve Schwarcz, law professor at Duke University, sent me the draft of an article on how an administration could avoid a default. In the midst of all the political maneuvering of the moment, I wasn’t able to get attention to it from journalists or policy analysts – it was not a moment when folks deep in the political trenches in Washington would even read the title of an academic law review article, even one as provocative and ingenious as this one. Meanwhile, Professor Schwarcz has completed a revised draft, available at SSRN as a free, downloadable pdf if you would like to read it: “Bypassing Congress on Federal Debt: Executive Branch Options to Avoid Default” (forthcoming 2014, Yale Journal of Regulation).
Professor Schwarcz believes firmly that a debt default would an disaster for the the United States – for taxpayers in terms of increases in borrowing costs over time and for the real economy in multiple ways. I agree with him. This is not because I’m unsympathetic to restraining the growth of federal expenditures; on the contrary, I’m a fiscal conservative. It’s just that I don’t think you can have that political fight at the moment of being at risk of a debt default. It has to come earlier, when the spending is being debated. Yes, I appreciate the frustration fiscal conservatives often express at being held hostage to having to simply approve and approve periodic incremental increases because their only political tool is to threaten the nuclear option. I share it. Yet I also appreciate that the argument can be put the other way around, and that those on the other side equally feel it’s they who are being unreasonably held hostage.
This mostly suggests to me, however, that if each side feels (reasonably, in my view) that it’s being held hostage by the other in successive debt ceiling standoffs – well, the problem lies partly in the mismatch of the incremental debt increases (reflecting incremental increases of expenditures) with the disastrous consequences that a default, in my estimation, would very likely bring. And in locating the show-down not in the spending decision debate, nor even strictly at the point of agreeing to borrow the funds to pay for the things agreed to (for better or worse) and raise the debt ceiling to do it. Rather, the problem lies in locating the showdown at the moment that threatens not to repay debt that has already been agreed-to, borrowed, spent – and is now due. True, it is also about taking on future debt obligations, and it is indirectly about forcing down government expenditures in order to have cash flow from which to pay current obligations, but those are indirect effects of the threat of default. This default risk runs principally to short term refunding and is thus not directly about expenditures, but about obligatory repayments to third party creditors who hold Treasury paper.
That’s by way of background on the substantive political arguments over debt ceiling standoffs. But that question is not the fundamental point of Professor Schwarcz’s article. Rather, the article asks if there might be an emergency, discretionary, executive-alone option for a president to avoid a looming debt default, independent of the underlying political and policy questions leading up to it. Professor Schwarcz proposes a quite radical, highly provocative solution: securitize future tax revenues to pay immediately maturing federal debt. Create a “special purpose entity” that is politically off balance sheet, and so bypass Congress:
Even a “technical” default by the United States on its debt, such as a delay in paying principal or interest due to Congress’s failure to raise the federal debt ceiling, could have serious systemic consequences, destroying financial markets and undermining job creation, consumer spending, and economic growth. The ongoing political gamesmanship between Congress and the Executive Branch has been threatening — and even if temporarily resolved, almost certainly will continue to threaten — such a default. The various options discussed in the media for averting a default have not been legally and pragmatically viable.
This article proposes new options for avoiding default, arguing that although the Executive Branch lacks authority to directly issue Treasury securities above the debt ceiling, it has the power to raise financing by monetizing future tax revenues. In each of the proposed options, a non-governmental special-purpose entity (SPE) would issue securities in amounts needed to repay maturing federal debt. Depending on the option, the SPE would either on-lend the proceeds of its issued securities to the Treasury Department on a non-recourse basis, secured by future tax revenues; or the SPE would use the proceeds of its issued securities to purchase rights to future tax revenues from the Treasury Department. In each case, therefore, future tax revenues would form the basis of repayment to investors.
These options should be legally valid and constitutional, notwithstanding the debt ceiling: neither involves the issuance of general-obligation or full-faith-and-credit government debt, and indeed the second option doesn’t involve the issuance of any government debt. Furthermore, based on the similarities of these options to successful financing transactions that are widely used in the United States and abroad, the securities issued there under should receive high credit ratings and also be attractive to investors. Because of provisions in foreign treaties, those securities should be especially attractive to foreign investors — who already purchase half of all Treasury securities.
These options are not intended to be standard financing structures. Being riskier than full-faith-and-credit Treasury securities, the securities issued under these options would almost certainly have to pay a higher interest rate than Treasury securities. The options should therefore be viewed, and this article presents them, as viable emergency measures, if needed, to avoid a U.S. debt default.
This is provocative partly, of course, for its suggestion that the executive branch could act without the need for Congressional action – yet again. And there’s the element that UCLA law professor Steve Bainbridge highlighted in his own post on Professor Schwarcz’s article: “I must confess,” says Professor Bainbridge, “I would find it most amusing if Obama had to resort to securitizing future tax revenues in order to keep the government open after all the calumny he has heaped on securitization over the years.”
Those for whom this article’s proposals are simply anathema – on grounds of executive branch overreach and unbridled executive power, for example – nonetheless ought to read it closely, to identify the precise steps it lays out and where they might think, for example, that it’s vulnerable on Constitutional grounds. I’m not enough of a constitutional law scholar to say much, but it does point up that, alongside other areas in which the administration says it can bypass Congress and act from executive authority alone, constitutional debates that have been mostly about national security and civil liberties in the last dozen years are shifting toward debates over the “economic constitution.” The extent of executive discretion is a core part of this argument, of course.
By the same token, however, those who might find this proposal attractive in its technical ingenuity – a temporary, merely technical default matched by a temporary, merely technical emergency funding solution to avoid it that takes Congress out of the loop – ought to read what it says equally closely. Although this might seem to some like a lawyer’s political permission slip to the executive, it’s not an economically free lunch. It’s off balance sheet. It’s not full faith and credit. It’s not an obligation of the US government. It’s a SPE, for heaven’s sake.
Professor Schwarcz’s deeply held view is that an emergency measure such as this is better than a US government default, even one that some would shrug and say, merely temporary, just roll-over debt. On that question, I agree with Professor Schwarcz, but that’s because I share his views on the long term harms of even a “temporary,” technical default – loss of confidence in the funding markets terrifies me, frankly. It’s also that I place the proper political debate over expenditure restraint at the point at which they are agreed to, not the moment when you have to pay back what you already borrowed, especially if it is 100% certain that you have to borrow more – now.
Professor Schwarcz warns many times that securitizing tax revenues to pay off currently maturing debt is an emergency measure, a technical fix, and that it can’t become a standard financing tool of government. But of course, this also says something very scary about the parlous state of our governance institutions. On the one hand, if one draws upon the techniques of securitization (especially if one resorts to them time and time again), well, the history of securitization shows that purchasers of a SPE’s securities can gradually forget just who issued them and what exactly stands behind them. That usually won’t end well for someone. On the other hand, if ordinary governance mechanisms to address expenditure and the federal budget gradually fall into desuetude in favor of supposedly standby, supposedly emergency measures, well, what can’t go on, sooner or later won’t go on.