The debt ceiling: can the US avert a disastrous default?

The US government is hurtling towards an unprecedented debt default in roughly two weeks’ time if lawmakers do not act to raise the federal limit on borrowing and enable the Treasury department to pay government commitments already approved by Congress.

Treasury secretary Janet Yellen has warned that a failure to service these obligations would result in a “catastrophe”, igniting a painful economic recession and disastrous financial collapse as borrowing costs spike and the creditworthiness of the US takes a hit.

Chuck Schumer, the Senate majority leader, told Democratic lawmakers on Monday that they must deliver a bill to raise the debt ceiling to the president’s desk by the end of the week. But it remains unclear how that will be done, given Mitch McConnell, the Republican Senate minority leader, remains steadfastly opposed to lifting the borrowing limit.

With the spectre of a US sovereign debt crisis looming, here is a guide to how a resolution could still be reached and possible contingency plans if the default happens.

What legislative options are left for Congress?

The Democrat-controlled House of Representatives passed a measure last week in a party-line vote that would raise the debt ceiling and avert default. But Republicans in the Senate have used the filibuster — a mechanism that in effect requires legislation to have the support of at least 10 Republican senators — to prevent Democrats from passing the same bill by a simple majority in the upper chamber of Congress.

Instead, Republicans have argued that Democrats should use reconciliation, a more complicated and time-consuming process, to circumvent the 60-vote threshold. But Democrats on Capitol Hill and in the White House say that reconciliation is not an option. That has left lawmakers in a dangerous staredown, with both parties hoping the other side will blink.

A more radical option would be to abolish the debt ceiling altogether, something Yellen told lawmakers last week she would support. It is a view shared by other prominent economists, including several former Treasury secretaries, though most congressional experts believe doing so would require the approval of both chambers of Congress, including a filibuster-proof 60-plus senators.

Is there anything Biden can do on his own?

The 14th amendment to the US constitution, adopted in 1868 in the wake of the civil war, includes a clause pertaining to the public debt, saying: “The validity of the public debt of the United States, authorised by law . . . shall not be questioned.”

Some legal scholars have interpreted this to argue that the president could raise the debt ceiling on his own. But other constitutional experts disagree, and previous presidents, including Barack Obama, have ruled out such an unprecedented step.

If Joe Biden were to act unilaterally, he could open his White House up to a spate of legal challenges.

Should Yellen mint a $1tn coin?

Another controversial option to avert default is for the Treasury to issue a $1tn platinum coin, deposit it at the Treasury’s account at the Federal Reserve and then use the money to service its obligations, all without adding to debt levels.

US law does give Yellen the scope to do this and several lawmakers and leading economists have said they would support such a move. But the unusualness of the idea has concerned many politicians. Plus, there are worries about the precedent it would set if the government was able to spend money without borrowing via the Treasury market or through taxation.

The $1tn coin also does not appear to have the backing of the Treasury secretary.

When asked about it at a hearing with members of the House of Representatives last week, she said: “I believe that the only way to handle the debt ceiling is for Congress to raise it and show the world, the financial markets and the public that we are a country that will pay our bills when we incur them.”

What could the Treasury do if lawmakers don’t raise the debt ceiling?

If Congress fails to act and the debt ceiling cannot be raised, the Treasury will be forced to decide how to deal with pending payments.

The department has already enacted a series of “extraordinary measures” to buy lawmakers time to forge a deal, including pausing investments in certain federal retirement and health funds.

A default could push the Treasury to take a step further, prioritising some payments over others — a task the Bipartisan Policy Center said would be “logistically excruciating”.

This could mean choosing to pay for social security, Medicare or defence-related expenses, for instance, while delaying salaries for federal employees.

“Such a strategy would entail sorting and choosing from hundreds of millions of monthly payments, stretching the limits of the Treasury department’s financial technology systems and forcing executive branch officials to pick winners and losers from among the programmes that lawmakers have authorised,” the Washington-based think-tank said in a recent report.

One proposition is for the Treasury to prioritise principal and interest payments on the federal debt in order to mitigate the impact on financial markets. However the delay to payments for other obligations would probably spark legal challenges, according to Wendy Edelberg and Louise Sheiner at the Brookings Institution.

What’s in the Fed’s emergency playbook?

While Fed chair Jay Powell recently said the US central bank would be limited in its ability to “fully protect” financial markets or the economy from the damage caused by a default, transcripts of meetings around previous debt-limit crises in 2011 and 2013 show the Fed contemplating a series of measures to cushion the fallout.

Officials at the time broadly supported the Fed accepting defaulted Treasuries as part of its broader quantitative-easing programme of asset purchases and allowing market participants to post defaulted securities as collateral for lending activities. Repurchase operations were also discussed to help alleviate strains on money market funds.

One thornier idea involving the Fed simultaneously purchasing defaulted securities and selling those it owned drew criticism from officials in 2013. Then-governor Powell called that option “loathsome”.

“The institutional risk would be huge,” he said during the October 2013 meeting. “The economics of it are right, but you’d be stepping into this difficult political world and looking like you are making the problem go away.”

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