US Treasury "Rises Above" The Debt Ceiling - Now What?
When Tim Geithner announced an hour ago that the US debt ceiling will officially be "risen above" on December 31, he stated that there are approximately two months in which the Treasury can take emergency measures to delay the actual debt ceiling breach, a moment in time which we believe will take place some time in March. Upon further reflection, with the automatic spending cuts and tax hikes that will take place on January 1, the irony is that the debt ceiling extension may last materially longer due to a substantial reduction in the US budget deficit, potentially pushing the final threshold to as late April or even May which means the political theater is going to last for even longer than we expected - something which both parties now appear set to capitalize on as much as possible. So the question now is what are the options before Tim Geithner and what are the "emergency measures" the Treasury take to delay the inevitable moment when one of three things happens: i) the US hikes its ceiling, ii) the US begins living within its means, iii) the US defaults on its debt.
Since the third, and certainly second are impossible, and since the debt ceiling theater is something we all lived through as recently as 2011, here is the article we penned in January 2011, when that long ago debt ceiling of a mere $14.3 trillion was about to be breached, and whose ultimate rise required a 20% market plunge together with an S&P downgrade of the then pristine US AAA rating (an event which Tim Geithner had said shortly prior there is no risk of ever occuring), answering precisely this question.
(just replace the numbers that were relevant in January 2011 with the appropriate numbers now, all of which are just over $2 billion greater.)
The Treasury's Options as the Debt Ceiling Approaches
- The US Treasury is approaching the $14.294 trillion (trn) statutory ceiling on its outstanding debt. In fact, last week the agency invoked the first of several options—running down the Supplemental Financing Program (SFP)—to buy several weeks of additional time against what otherwise would likely be an exhaustion of net borrowing authority by early spring.
- Although a new limit will surely be approved eventually, the process of reaching agreement is apt to be contentious. Market participants should therefore expect a period of uncertainty lasting several weeks—perhaps even a few months—before this situation is resolved.
- As this situation unfolds, Treasury has numerous options to create more headroom, which we estimate could yield almost $420bn in one-off relief, including $195bn from the SFP rundown, plus about $10bn per month—far more than the $299bn the Treasury expects to borrow during the April-June quarter. Some of these options involve accounting maneuvers that rearrange internal accounts within the government, while others affect the Treasury’s external liabilities.
The US Treasury is approaching the $14.294 trillion (trn) statutory ceiling on its outstanding debt. As of Friday, the debt subject to this limit, which covers almost all Treasury obligations—including those owed to other government agencies—was $14.004trn, or $290bn below the limit. Absent maneuvers to create more headroom under this limit, the Treasury would likely reach it by about the end of the first quarter.
A new limit will eventually be approved, as few if any members of Congress will want to risk the Treasury’s defaulting on debt obligations. However, the process of reaching agreement is apt to be contentious given the divided control of the US government and the pronounced differences that exist between Republicans and Democrats on fiscal priorities. For example, some influential Republican congressmen have vowed to vote against an increase in the debt ceiling unless it is packaged with significant cuts in spending, an approach Democrats are apt to resist. Thus, the potential exists for a period of at least several weeks of uncertainty about the government’s ability to maintain its current borrowing schedule and ultimately to pay its obligations, comparable to earlier episodes in 1995-96 and in 2003. In fact, the uncertainty could last for a few months given that the Treasury’s cash flow is usually fairly firm—and its borrowing needs are therefore a bit lighter—during the second quarter, when the ceiling will start to impinge on its operations.
Given the potential for a protracted period of unease on this issue, we devote this daily comment to the options Treasury officials have available to them to create additional headroom under the debt ceiling, many of which were on display during the earlier crises. We divide them into two groups: (1) moves that change only the internal accounting of liabilities with no effect outside of the government’s balance sheet, and (2) moves that have an external effect, which include one measure that has already been invoked to buy a few weeks’ time—running down the Supplemental Financing Program (SFP). For each option, we include the rough amount of debt issuance the Treasury could forego by using that strategy. Altogether, they amount to one-off options to create almost $420bn of relief, including $195bn from the SFP operation, plus about $10bn per month. This is far more than the $299bn the Treasury has announced as its preliminary borrowing need for the April-June quarter. The options are as follows:
1. Internal rearrangement of liabilities
a. Disinvestment of the Civil Service Fund ($72 billion (bn) up front, plus another $2bn per month): In order to avoid breaching the debt limit, the Treasury’s authority over the Civil Service Retirement and Disability Fund (CSRDF) allows it to (i) redeem Treasury obligations of the fund as they mature and (ii) to suspend the investments of amounts coming into the fund, which are mandated to be invested in nonmarketable Treasury debt or other debt backed by the full faith and credit of the US government. Both strategies amount to exchanging liabilities of the Treasury that count toward the debt limit for those that do not. The CSRDF balance is likely to be around $790bn by March 2011, comprised almost entirely of Treasury securities. The fund is expected to receive $101bn in revenues this fiscal year, and is expected to pay out $72 billion, leaving a surplus of $29bn this year.
To activate this option, the Treasury must declare a “debt issuance suspension period” (DISP), the length of which how much of these funds the Treasury can use to create room under the limit. The Treasury may suspend investment of new funds during the DISP, and may also redeem before maturity an amount of Treasuries equal to the amount of payments expected to be made by the fund during the period. Since the law does not dictate how the length of a DISP is determined, the Treasury could in theory announce a very lengthy period, which would allow it to redeem a greater amount of Treasury securities and buy more time under the limit. Previously announced DISPs have ranged from a few months to one year.
b. Suspending reinvestment in the “G-Fund” ($116 bn): As with the CSRDF, the Treasury can suspend its issuance to the Government Securities Investment Fund (G-Fund) of the federal Thrift Savings Plan (TSP). As of October 2010, the G-Fund balance was $116bn. The G-Fund is invested in non-marketable Treasury securities that mature daily, so the entire balance of the fund is theoretically available to the Treasury to avoid breaching the debt ceiling.
c. Disinvest Treasury securities held by the Exchange Stabilization Fund ($20bn): The Treasury’s Exchange Stabilization Fund (ESF) was created in 1934 for use by the Treasury to stabilize exchange rates, and the Treasury has wide latitude over how the $105bn in funds in the ESF are invested. The ESF currently holds $20.4bn in non-marketable Treasury securities, which it could disinvest and hold in cash.
d. Exchange Federal Financing Bank (FFB) debt with the CSRDF ($15bn). Although it is part of the Treasury, the FFB is subject to a separate limit on its debt issuance, set at $15bn. The FFB typically issues debt in order to purchase securities issued by other government agencies. The CSRDF has authority to hold debt issued or held by FFB. During debt issuance suspension periods, the Treasury can exchange FFB debt, which does not count against the debt limit, for Treasuries held by the CSRDF, which do count against the limit.
2. External rearrangement of liabilities
a. Run down the Supplemental Financing Program (SFP, $195bn). The SFP was created in September 2008 to help the Federal Reserve expand its balance sheet without increasing the volume of excess reserves in the banking system. Under this program, the Treasury has been issuing special cash management bills (CMBs) and holding the proceeds of this issuance on deposit at the Federal Reserve. At its peak in December 2008, the outstanding volume of SFP bills was $550bn; however, since early 2009 it has been stable most of the time at $200bn in a rotating cycle of 8 56-day CMBs of $25bn apiece. Since this debt counts against the debt ceiling but merely funds a larger-than-needed cash balance, it is an obvious first step to tap this source of funds. In fact, last Thursday the Treasury announced that it would run the SFP balance down to $5bn beginning this week.
b. Suspend issuance of SLGS ($5-10bn/month): The Treasury issues a special State and Local Government Series (SLGS) of securities that state and local governments may purchase to invest the proceeds of tax exempt bond issuance. Suspending SLGS issuance is another of the initial steps the Treasury typically takes as it runs out of headroom under the debt ceiling. As of January 28, $187.2bn was outstanding in SLGS; however, the rate of monthly issuance is fairly low—around $8bn in December. News that this program has been suspended could come as early as the refunding announcement due this coming Wednesday morning.
c. Financial asset sales ($156bn, but unlikely to occur): To our knowledge, the Treasury has never engaged in the sale of financial assets to avoid reaching the debt ceiling. However, for most of its history the Treasury has not hold significant amounts of liquid financial assets. Times are different now. As of December, the Treasury held $155.6bn in GSE mortgage-backed securities purchased in 2008 and 2009 as part of the program to support the agencies. These purchases were funded with Treasury issuance, and sale of these securities would allow the Treasury to forego net issuance for several weeks. However, unlike the accounting maneuvers described above, the sales would be permanent, since the Treasury’s authority to purchase GSE MBS has expired since these securities were acquired. Given the political importance of the housing market and the potential for complicating the upcoming debate on overhauling the GSEs, sale of these securities seems unlikely as anything but a last resort. In theory, sales of assets held by the Troubled Asset Relief Program (TARP) could also be used to create headroom under the debt ceiling; the Treasury seems unlikely to time these sales based on debt ceiling considerations, but sales of stakes in AIG and auto-related holdings could net tens of billions of dollars in proceeds, depending on market conditions.
d. Suspend federal payments: Although we don’t expect the showdown over the debt limit to come to this, if the delay in raising the debt limit were so long that the Treasury exhausted all other options such as those listed above, we would expect a decision to suspend payments to employees, contractors, and potentially to beneficiaries of federal programs, rather than fail to make payments of principal or interest related to Treasury securities. Some congressional Republicans opposed to raising the debt ceiling have introduced legislation to legally prioritize payment of principal and interest over all other obligations incurred by the federal government. This is very unlikely to come into play, but it is worth noting that even assuming the worst case scenario in the congressional debate over a debt ceiling increase, payment of interest and principal would not be at risk.
As noted above, passage of an increase in the debt limit will occur at some point, because the consequences of not enacting an increase are too high. However, it is quite possible that this issue could stretch out over several months, with one or more small increases (e.g., $100bn or $200bn at a time) to buy additional time as lawmakers try to fashion a more lasting solution. And even once this occurs, the issue will recur from time to time until the federal deficit comes down. After all, the last increase—of $1.9trn—lasted barely more than a year. So keep this daily comment handy.