Oct 4, 2021

Chris Russo on the 2021 Debt Limit Fight, Its Potential Impacts, and Solutions for Reform

The ongoing congressional fight over the debt limit poses many economic dangers, but there are a number of possible solutions that the government could consider.
David Beckworth Senior Research Fellow , Christopher Russo Post-Graduate Research Fellow

Hosted by David Beckworth of the Mercatus Center, Macro Musings is a new podcast which pulls back the curtain on the important macroeconomic issues of the past, present, and future.

Chris Russo is a post-graduate research fellow in the Monetary Policy Program of the Mercatus Center at George Mason University and is a former economist at the New York Federal Reserve Bank. He re-joins Macro Musings to talk about the growing concerns over the US debt ceiling, what it could mean for the economy, and how to fix the issue.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to macromusings@mercatus.gmu.edu.

David Beckworth: Chris, welcome back to the show.

Chris Russo: David, thanks for having me again, it's going to be a lot of fun.

Beckworth: It is. So you've been working on this debt ceiling issue, you've written multiple pieces, we'll have links to them in the show notes, but this is becoming a growing area interest, of concern, as I mentioned, and looking back over history it seems to be reoccurring ordeal we go through. We've put this straitjacket on our public finances and it seems to pop up every few years.

Beckworth: I want to begin our conversation about this by reading the first paragraph from a recent article you wrote in The Hill and this is what you say, "Our nation risks another self-inflicted wound when the debt limit suspension expires on July 31st. Allowing expiration exposes the nation to emergencies, harms our public credit and financial stability, and does not solve the federal government's long term budget problems. Congress and the president should marry a permanent suspension of the debt limit with real economic reforms. Time is running out." So Chris, how is time running out? Why should we care about this problem? Why is it a big deal?

Time is Running Out: Why is the Debt Limit a Big Deal?

Russo: Time's running out in the following sense, the government's budget runs massive deficits. As a consequence of those deficits, the government has to issue more and more debt to repay the government's obligations, but there's a debt limit that Congress imposes on the Treasury, which limits how much debt they could issue. It's separate from the budget process, again the budget sets spending and taxes at a deficit, but separate from that there's a debt limit that constrains how much Treasury can issue. Eventually you've got a situation in which Treasury legally has to meet the government's obligations, has to pay social security, has to pay for national defense, so on and so forth, but they're also legally restricted from doing so and that's why we require either the debt limit to be raised or re suspended, so they can continue to meet those obligations.

Beckworth: Okay. And today, as I mentioned this is September 28th, news came out, Secretary Janet Yellen of the Treasury said that the drop-dead date for when they really get into cash constraints, cash problems, funding problems at the Treasury is the 18th. Is that right? Of October.

Russo: Yes, although it's very uncertain. The government's cash flows are notoriously uncertain with the ongoing pandemic and the uncertainty about President Biden's legislative package. We're not quite sure frankly when this constraint will be binding. As I write in the piece and your listeners may have heard elsewhere, the government gives the Treasury some options even when it's at the debt limit to try to manage around that constraint, these are the extraordinary measures.

Russo: Essentially, and I'm simplifying here just a bit, the government has internal IOUs, it uses these IOUs to keep track of how much money's coming in for certain programs and how much has been paid out for those programs. It can manipulate these IOUs in a way that's loophole intentional in the law, so they can continue to issue debt for time up to a certain amount. Secretary Yellen's point is that based on the Treasury's best forecast those measures will run out on October 18th.

Beckworth: So Chris, let's talk about the immediate harm or potential harm that could come from this and then maybe we'll get into the more dark scenarios where things could get really catastrophic. So what I've seen is that the immediate pain or problems could emerge from payments that the federal government does to employees, to pensioners, to the military, so maybe walk us through that. Why should we be concerned about those developments?

Russo: Sure. Even if you disagree with the stuff the government's spending money on, whether it be what they spend on national defense, where they spend on certain social programs, so far and so forth, people expect these payments to be made. For them not to be made I suspect would cause, at least in the near term, significant economic dysfunction, both with respect to the payments not being made and with respect to the uncertainty about whether they would be made. I only see downside there, I don't see upside, as much as I and others might argue that in a more perfect world we would have a different budget in front of us, or in front of Congress.

Russo: Beyond that I would say that even flirting with default here, whether it be on Treasury debt in and of itself or the other government obligations that it has, I think that weakens our credit quite dramatically in a way that would lead to higher yields on Treasury securities, the higher cost of financing in the government, and that bleeds into the rest of our financial markets. As we've talked about a few times on the show, we had an episode in 2019, in September, where the interest rate on government securities and other overnight money market loans spiked to several percent in some cases, even up to 8% or 9% and that caused significant market dysfunction, because Treasury securities are used as collateral for the rest of the financial market, whether it be at banks, which have to meet their regulatory ratios or in derivatives contracts. So there are ripple effects here even beyond the immediate loss of funds for households, firms, and other organizations awaiting payment from the government. It's not a near term thing either, even if the government doesn't default, the blow to our credibility going forward, both just narrowly with respect to our government finances, but also us as a country and as a nation I think would be quite damaging.

People expect these payments to be made. For them not to be made I suspect would cause, at least in the near term, significant economic dysfunction, both with respect to the payments not being made and with respect to the uncertainty about whether they would be made...even if the government doesn't default, the blow to our credibility going forward, both just narrowly with respect to our government finances, but also us as a country and as a nation I think would be quite damaging.

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Beckworth: Yeah, so it's slowly eroding our institutional capability and we'll walk through some of these challenges in a minute. But you've alluded to the fact that if we don't make payment on our debt, that's a huge shock to the financial system because treasuries are the cornerstone of so much of what the financial market is. I've heard several stories, I'd like to get your take on this, surrounding how the Treasury market will respond.

Beckworth: One story says if you're holding in treasuries that are coming due around this time people will want to sell them or not buy them as much. I understand there is actually some evidence that yields are going up on treasuries that are coming due about that time. On the other hand, if we veered into a severe recession, financial crisis, might people run to treasuries, longer term treasuries at least, since it's the safe asset?

Russo: I think we're seeing evidence of both phenomena, so they're not usually inconsistent. On the one hand we see yields on Treasury bills due around the X date rising. I should be clear that the increases in these yields in absolute sense are not dramatic, we're talking a few basis points or a few tenths of basis points, whereas short term Treasury bills are yielding right now at around 0%, but in terms of a relative change that's dramatic.

Beckworth: That's huge, yeah.

Russo: At the same time we have other government debt, other Treasury securities that aren't subject to this X date uncertainty about of whether the coupons or the principal will be paid, those have yields that are falling. So I think both stories are consistent. And particularly if there was a default, frankly I'm uncertain what would happen in that case. I think there's a great amount of uncertainty here. I'm on the show and I agree with many of your arguments here in talking about the dollar and then the US Treasury again as the safe asset of the world.

Russo: We talked a few times and we've talked many times on the show about them not being an option to run to. I think that's correct in many senses, but I am also concerned that there's nothing in the laws of nature, much less the laws of economics that suggest there has to be a safe asset. I can also imagine a world in which the US defaults or even close to defaulting, the world reexamines the risk of Treasury securities and a dollar denominated debt and they say, "You know, maybe there's not a safe asset after all," and instead what they use as the quote-unquote "safe asset" is some combination of sovereign issuer bonds and similar sorts of things that as a portfolio lead to an asset with a low risk.

Beckworth: Using a sports analogy, there's no need of have an unforced error here, no need to have that self-inflicted wound from failing to act.

Russo: David, just to build off that for a second. If we were to default or even close to defaulting, this is not a problem we can solve just by fiscal discipline or renewed promise to be good in the next few or next 10 years. We've been building our credit as a nation since the founding. There are letters from John Adams, for example, going around Europe during the Revolutionary War trying to secure financing from France and then from the Netherlands. And we were looked at, because we were a new nation frankly still fighting a war of independence, like we were a terrible credit. Who in their right mind would lend money to us?

Russo: Of course when we won that war the Dutch say the next few days, "Oh, actually we think you're a good credit after all. Here's a loan for five million," of whatever the currency was, "at 5%." So there's a whole history here. Then Hamilton's plan of the assuming the war debt and financing that by issuing treasuries, 200, 250 years of us building up our credit. We could destroy that in a day, we could destroy that in an instant, it's not something we can rebuild.

If we were to default or even close to defaulting, this is not a problem we can solve just by fiscal discipline or renewed promise to be good in the next few or next 10 years. We've been building our credit as a nation since the founding.

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Beckworth: Yeah, absolutely. And again, US Treasury securities are the foundation of the global financial system, not just the US. So we don't want to undermine the global economy because that will come back to bite us in rear further exacerbating the challenge. So we've talked about the potential for a financial crisis if there's a debt default and the many challenges that will emerge from that, but I want to go back again to the more mundane maybe, if I can say that, maybe it's not mundane, but the more maybe immediate effects that would emerge from this. So just making a list here, if this happened, if the Treasury did not have sufficient funds to meet its obligations, just off the bat here's some things that would happen.

Beckworth: There'd be no payments to individuals, so social security, Medicare, veteran's benefits. There's Republicans and Democrats in that list, both sides will be adversely affected. Federal government employees would also be harmed and maybe some might have less sympathy for them, but they too have debt and obligations they've got to meet. State governments, they get federal unemployment, there's Medicaid payments, those things will be disrupted. And then finally the military, the military depends immensely on this. Some people joke that the US government is basically a big insurance organization with an army and most of the dollars flow to those two categories. So there would be a lot of people that you and I know, that the average person knows, that would be adversely affected by this. Chris, correct me if I'm wrong, my understanding is if we got to that point and the Treasury said, "Okay, we've got to prioritize certain groups over the others," they would have a hard time doing that. The system's not set up to pick and choose. They're run on different systems, it's not like a clean computer where you can press the key and voila you've got it.

Russo: That's exactly right, David. So here I need to be a little bit careful because unfortunately I don't think a lot of this stuff is public. But at a high level, let me say the following, the Federal Reserve runs the nation's payment system in large part and it helps Treasury make all these different payments which you've just described, as well as to issue its debt and to make principal and interest payments on that debt. There is a very, very complicated process that runs overnight in order to make all those payments happen.

Russo: And effectively, if the Treasury wants to intervene in any part of that automated process, it has to do so by specific points in the night. They've got to call the Fed and say ... I'm making up a time here, I don't remember exactly what it was, but like 8:00 PM, if they want to stop payments is when they need to make the decision by, so someone can actually figuratively put their finger in the machine to stop it from moving. And from my knowledge it's not clear at all that they could prioritize payments in the way that's been described or proposed by some of the media. We have transcripts from the Federal Open Market Committee back in 2013 that suggests that they could and would do certain things to help facilitate the principal and interest payments on Treasury securities, but aside from P&I, principal and interest, it's not clear at all to me that they could prioritize, say, social security, Medicare over defense spending or aid to states or whatever else is on the list.

Beckworth: Yeah, that's what I read too is that the Fed could step in and help bond holders, but it'd be very difficult to address social security holders, veterans, the military. And I just imagine the political blow back if we have this crisis and it's just the bond holders who are protected. Just imagine the populist rage that would emerge when it's these wealthy bond holders who are getting saved and everyone else is getting hammered. Okay. Well, let's move on from the potential dangers and worst case scenarios. Hopefully we don't get to that, hopefully there's a resolution reached in the next few weeks. But how did we get to this point? So here we are in this year, 2021, the last time we had this occur is in 2019. Is 2019 what set us up for what's happening today?

From my knowledge it's not clear at all that they could prioritize payments in the way that's been described or proposed by some of the media...it's not clear at all to me that they could prioritize, say, social security, Medicare over defense spending or aid to states or whatever else is on the list.

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The Debt Limit: How Did We Get Here?

Russo: Yes, 2019 was the last debt limit fight we had. I was actually still with the New York Fed and at that time I was running the trading desk forecast of this X date when Treasury would default if there isn't an increase or suspension of the debt limit. I was advising various officials of the Fed about my forecast here. That deal in August of 2019 set us up for today because it suspended the debt limit for a period of two years. And so I remember at the time telling my colleagues, "It's going to come back around again. It's going to be a big deal," and I'm sorry to say that has come to pass and we're going-

Beckworth: So you're a great forecaster then?

Russo: I try to be-

Beckworth: You've got your forecast.

Russo: ... but it's in the law, it was like two years and then we're done.

Beckworth: Okay.

Russo: As much as I want to take credit for that, it was more of a political prognostication of they're not going to solve it in this time.

Beckworth: Yeah, fair enough.

Russo: And as much as I was advocating for them to do so back in the spring of this year with the new Congress having been set, they could've taken care of this months ago, but unfortunately they just haven't.

Beckworth: All right, so my understanding of that agreement in 2019, as you mentioned, ended at the end of July, July 31st. So they've been working through those challenges since then with meeting the bills, but the prior limit was 22 trillion and then that debt limit suspension raised it to 28.5 [tr]illion, so now we've reached that number, and so we've got to raise it even more. And so here's a question I had and I put this on Twitter to some reporters and they didn't know, and I don't expect you to know this, Chris, I don't think I prepared you to answer this question.

Beckworth: But that 28.5 trillion includes a sizeable amount of Treasury debt that's being held by the federal government, so the public's not holding it, it's not being traded. And in my mind what really matters is being able to make the interest payments and the principal payments on the debt held by the public, the marketable debt that people hold outside the government. So why does the law require us to look at the total amount, the total 28.5 trillion versus ... I believe the actual amount's closer to 21 trillion, 22 trillion right now. Why take all that into consideration?

Russo: That's a great question and I really can't speak to the legislative intent of Congress. My sense is that this language was codified back in 1917 or whatever it was when the debt limit was established in the first place. One key thing here, which I can't answer on the podcast but is an important thing to think about, is what do we mean by actual debt? Is non marketable debt held by government agencies, is that real, economically, or is it not real, economically? My guess is, is that's real economically. So I'll give you an important example, social security.

Russo: Social security is run by a trust fund and there are specific taxes levied on payrolls to fund social security. So for many decades now, really since the founding of the program in the Great Depression, those revenues have come in and they've been greater than the amount that's been paid out to social security benefits. Now sometimes politicians and others talk about the lock box for social security, that puts the wrong impression in at least my mind and in the minds of the public where they're speaking as though, well, those net revenues from social security, we put them aside somewhere, maybe we've invested them and they're there for when we need them.

Russo: Well, in truth that's not quite what's happened. In fact, those social security revenues come into the Treasury's checking account at the Fed like all other revenues and they're spent on everything and anything that the federal government spends money on. The way that Treasury and the Social Security Administration keep track of this, how much has been coming in from the tax revenue for social security and how much has gone out as a result of social security benefits are these non marketable debt instruments. And there's an accounting sense in which if there is net in-flows today and maybe net out-flows 10 years from now, the money in the meantime is earning some, quote-unquote "interest" so it's improving the financial position of social security. So are those non marketable debt instruments real, economically? I'd say yes, they're real, because they represent real economic obligations of the US Treasury for some point in the future.

Russo: So from a legal perspective, why is it helpful maybe to count those in the overall debt limit? And I think that gets to the purpose of the debt limit in the first place. The debt limit as we might go into was created by Congress initially as a way of constraining the US Treasury. And if you're worried about Treasury's fiscal liberalness for lack of a better word coming to mind, making sure that Congress retains the power of the purse, not the Treasury, it might make sense to try to consider both types of debt as equally economically valid.

Beckworth: That makes sense because you could imagine a scenario where if that weren't the case that Treasury might on a regular basis do some funny accounting and incur more and more non marketable debt into the social security, right? I can see your point. It's a way of imposing discipline overall, so you'd want to be careful.

The debt limit as we might go into was created by Congress initially as a way of constraining the US Treasury. And if you're worried about Treasury's fiscal liberalness...making sure that Congress retains the power of the purse, not the Treasury, it might make sense to try to consider both types of debt as equally economically valid.

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Russo: That's what extraordinary measures are, that's exactly what extraordinary measures are. They're intentional loopholes I should emphasize created by Congress for Treasury to utilize when it's at the debt limit. They have this additional time to try to solve the problem. Social security's not on that list of extraordinary measures, by the way, these are other things, for example, the G Fund. We've talked about federal employees a few times. Federal employees have a defined contribution retirement benefit system and they can invest in government securities. The government securities, this G Fund investment are non marketable, so they're able to, for sake of the debt loan, pretend those obligations don't exist. You need to issue debt up until the debt limit is suspended or raised.

Beckworth: Okay. So we don't want the government to be doing these unusual moves on a regular basis and it's one reason we have a broadly defined debt ceiling law. Okay, so back to why this has emerged. We talked about 2019 being the last time this happened. I want to maybe zero in on Republicans and look at the Democrats, but Republicans have played a role in this too and I guess what's interesting to me, Chris, is Republicans were willing to move in 2019 and suspend the debt limit for two years and it went from 22 to 28.5 trillion, that's a sizeable increase. They were happy, they were content with this. Some Democrats might also point out that Republicans have their finger prints on some of those obligations that needed to be funded right now with the debt limit going up. So some of the tax cuts, some of the spending during the pandemic, those things have to be financed and refinanced and Republicans as well Democrats are responsible for that. So they've helped put us into this situation.

Beckworth: The final, I guess, observation is that the Republicans have been intentional in this specific case of not wanting to help the Democrats. As you know there was a bill the Democrats put out where they're going to ... two different actions. One is to provide some stop gap funding to December, and then a suspension married to that in a bill, but the Republicans said, "No way, we're not going to do that, we're going to filibuster it." So it's not going to make it through the House, through the Senate. Well, it made it through the House, but it wouldn't make it through the Senate. So now they have to go back to the budget reconciliation process and there's a three and a half trillion dollar bill being discussed there. It's a much more complicated mess. I'm going to ask you another question, Chris, related to this, why are the Republicans doing this? Why are they not wanting to cooperate now when they were so eager for cooperation in 2019?

Partisan Perspectives in the Debt Limit Fight

Russo: David, there are politics coming from each and every angle on this issue, whether it's 2021, 2019, all the way back. I think that both parties, wherever possible, use the debt limit for political advantage. So both in my article in The Hill from earlier this year and really in all the work I do, I try not to do finger wagging because I just don't think it's all that productive. Like I'm not going to wag my finger at no, Republicans, you should raise the debt limit, or, oh Democrats, whether you should raise the debt limit or do structural reforms I don't think it's particularly really helpful. My principle here, personally, is that it is the responsibility of the party in power to raise or suspend the debt limit. In the case where you have a divided government, you have to work together, but in the case where there's one party in charge it is their obligation as the governing party to take the lead here. And again, there can be as much back and forth brinkmanship as you like, it's Washington DC, it's something we're all used to. But at the end of the day, if you're in power, this is your responsibility.

My principle here, personally, is that it is the responsibility of the party in power to raise or suspend the debt limit. In the case where you have a divided government, you have to work together, but in the case where there's one party in charge it is their obligation as the governing party to take the lead here.

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Beckworth: Well, Chris, I'm glad you're objective and you don't wag your finger. I'll do a little bit of that myself right here as the host, so you won't be in trouble, I'll be in trouble. I think what the Republicans are doing are setting themselves up for a great marketing ploy for next year's House elections. They're going to say the Democrats are the ones raising the debt, the Democrats are the ones being reckless, fiscally. I just think it's ironic because they were so eager in 2019 to get the same thing done and the Democrats did agree with them.

Beckworth: Now, let's move to the Democrats. The Democrats also have some role to play in this as you mentioned, they're the party in power, of course very narrowly, right? They don't have a true majority in the Senate, they've got to have the vice president step in for a 51-50 vote and they've got a party that's divided too. So there's internal considerations to think about. And again, the budget reconciliation process, that is such a tough act and we'll come back to this, but I think there's some challenges in that, that may make it very hard for the Democrats themselves to get it through. So let's step back though from the here and the now and let's talk about the history of this a little bit. You alluded to it earlier, 1917. So what happened in 1917 that started off this debt ceiling limit law? According to Wall Street Journal, 98 times it's been raised since then. What's the story behind that?

The History Behind the Debt Limit

Russo: David, just very briefly to clarify my previous answer. No, I don't wag the finger just for sake of that because I don't think it's super productive for me personally, but I agree with everything you just said there. So for example, when the Republicans had unifying control under President Trump, they should have solved this problem. They could've, but they didn't.

Beckworth: Yes.

Russo: So to your question what happened in 1917, 1917, and forgive me if that date's a little bit wrong here, it was the start of the First World War and a massive increase in government spending. Prior to World War One, and again I'm simplifying here a bit, this is approximately accurate, Congress had to authorize each and every single debt security issued by the Treasury. So there was some spending, for example, Congress wanted to spend money on the Panama Canal. They would finance that by cash revenue and debt and Congress would work with Treasury to set the terms of that debt instrument and pass a law to authorize it with the specific terms and offering amounts. That makes sense while we were still a developing country and did not have such large levels of debt. That changed with World War One.

Russo: Now of course, Congress just didn't want Treasury to have the power of the purse, that's an important power given to Congress alone by the Constitution, so they put constraints on the Treasury at the start of World War One. They said, "Treasury, you've got the real expertise here to be actually doing the day to day finances of the government, this is why we created you back at the start of the country, but we still need to constrain how much you're issuing. So you're still just going to borrow what you need to in order to meet the obligations we have in our budget, the net spending over taxes, in order to make sure that you're constrained to do that, we'll put a limit on the total amount that you can borrow."  Actually at first it was several debt limits that applied to different types of government borrowing. Today, this is not the terms they used back then, but you could imagine one limit for Treasury bills, another limit for Treasury bonds. And then subsequently to that, I believe it was 1939, World War Two, those were consolidated into today's single statutory debt limit.

Beckworth: Okay, so the law that we operate under now is a product of World War Two, though the history goes back to World War One. So again, 98 times this debt ceiling has been amended in some form. I want to go back to some ones more recently, ones in my lifetime that I remember vividly, so I'll reveal something about my age here, Chris. But I vividly remember 1995, Speaker Newt Gingrich, President Bill Clinton, it was kind of a big deal. I remember the Republicans had this Contract with America that they had rode to victory in 1994, and so that was an interesting moment. And then even more recent than that, 2011 and 2013, we had President Obama, Speaker John Boehner. 2013 was the fiscal cliff moment, but even 2011 had some tense moments. So this is something that's been reoccurring. And then those ones were I think highly eventful, very dramatic, but then 2019 comes along and it was kind of like no biggie, kind of a ho-hum deal. So do you have any sense on why 2019 was such a low energy change in the ceiling versus those previous ones?

Russo: That is an excellent question. I really don't know. I mean, if I was to speculate it's probably because there wasn't any political advantage in it for either Republicans and Democrats, as you alluded to. I don't think Democrats were going to go through pain on Republicans raising the debt limits, and of course at the time I think it was a Republican presidency and a Republican Senate, but Democrat controlled House, so there was not the reconciliation option for them to raise the debt limit that way, just on a party line vote.

Russo: Today of course, when Democrats have narrow control of both houses of Congress and control of the presidency it is theoretically possible for them to do it on a party line vote and bypass the Senate's filibuster. But yeah, this time it was quite bad. My memory here might be off, but I think 2011 was the really bad one that's kicked off the decade of these debt limit fights where we were actually downgraded by the S&P. As I recall it was a few hours potentially when we got a deal up before we could have defaulted, so it was a close call.

Beckworth: Yeah, 2011 there was some stock market turbulence as a result of that. The GAO did a report that said that this delay in raising in the debt ceiling actually increased the borrowing cost to government by 1.3 billion in 2011 and then the Bipartisan Policy Center extended their analysis and said it'd amount to 18.9 billion over 10 years. So there was some thought back then to avoid this going forward beginning with the 2013 famous fiscal cliff, and then 2019, here we are in 2021. So 2019 was uneventful, but we do live in a very polarized country, very partisan. Some are making the claim that the debt ceiling or deals are getting more intense over time, again 2019 being the exception.

Beckworth: So Jim Tankersley had an article in The New York Times this week and let me just read what he says in the first few paragraphs, "For nearly two decades lawmakers in Washington have waged an escalating display of brinkmanship over the federal government's ability to borrow money to pay its bills. They have forced administrations of both parties to take evasive actions, pushing the nation dangerously close to economic calamity, but they have never actually tipped the US into default. The dance is repeating this fall, but this time the dynamics are different and the threat of default is greater than ever." Very sobering words. So is the dance different this time? Have we gone from a nice ballroom dance with the debt ceiling to something really radical, something more dangerous. What's going on here?

Dangers of the Debt Fight and Degrading Institutions

Russo: I would say that we are today in the most danger of default since that 2011 episode.

Beckworth: Okay.

Russo: We've got about three weeks until the X date, although there is a lot of uncertainty around that date. It's possible that something happens, a terror attack or a natural disaster that pushes that date up quite dramatically. But with the exception 2011, I can't think of a single time where we've been closer to default until today. So in that sense we are in a danger zone. I'm honestly not sure if it's not more dangerous over time, ex ante. Certainly as things stand now, we're almost in as much danger as we've ever been in with respect to government finances.

I would say that we are today in the most danger of default since that 2011 episode...But with the exception 2011, I can't think of a single time where we've been closer to default until today. So in that sense we are in a danger zone

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Beckworth: So I wonder along those lines, the Republicans are not cooperating this time with the Democrats, so let's say the Republicans are in power in the future, then the Democrats have no incentive to come back and cooperate the next time this happens when the Republicans are in power. So it just seems like you're swinging that pendulum one side to the other and it's getting a little more intense. And going back to the point made earlier, the institutions are degrading, the quality of governance are degrading, and so this is getting trickier. I agree here, I think it's getting trickier, I think Jim Tankersley is right.

Beckworth: And the fact that it now has to go through a budget reconciliation process tied to a huge bill, that's controversial, makes it even more concerning. And I've read several pieces that have commented on this, what's going to happen now that it gets tied to a budget reconciliation bill. Well, one observation is it will take too long to go through the House, the Senate again, to get approved, to somehow find a middle ground between the progressive Democrats and the moderates. This is going to take time, time that we don't have before we've run out of cash. You think that's a fair concern?

Russo: I think that is a fair concern. Again, I'm not an expert here on the legality or the parliamentary [inaudible] that gets used to get budget reconciliation through, and to my knowledge there's even some frictions around bypassing the filibuster, which is another concern, although maybe less than budget reconciliation. There is a concern that these parliamentary frictions will stop a speedy increase in the debt limit. I should mention also that, again, in the case of a natural disaster or a terror attack or something along those lines, it might be too late. Even if Congress was to immediately raise the debt limit in such an instance it could be a circumstance in which Treasury loses access to debt markets. In that case, even if the debt limit is raised, if Treasury can't access markets, they can't raise more funds.

Beckworth: Yeah. So it's worth mentioning to listeners, I'm sure many know this already, but they can pass with the budget reconciliation, a 51 vote that would carry this forward as opposed to the typical bills that need more than that, they need to have some Republicans voting and join them, that's the filibuster. One thing I wonder is do events like this push us closer to getting rid of the filibuster altogether? So the budget reconciliation is one area where the filibuster's gone, the Supreme Court I believe is another one, but we're slowly walking down this path to getting rid of the filibuster altogether. I know there's Democrats in the Senate who say, "No, no, we'll keep it," but if we get to a point where we have something close to a debt default or some financial crisis, I wonder if this gives some folks pause, we should have gotten rid of the filibuster, we should have done this more efficiently.

Russo: Honestly I would say it's even deeper than that. The potential loss of the filibuster as you said reflects a real degrading of our institutions. We've talked a lot about the economy and I'm recalling now the words of the founders in the declaration, they mutually pledged their lives, their fortunes and their sacred honors, what matters here most importantly is our honor. And this is in my view, what is ultimately at risk. The loss of the filibuster ... I think if we were to default on the debt more than the loss of the filibuster, it would be a bad reflection on the potential American democracy and republicanism. We are an experiment as a nation and it's an experiment whose result we do not yet know and I think that would portend very poor things for the future of our self-governance and we should avoid that outcome at all costs.

The potential loss of the filibuster as you said reflects a real degrading of our institutions.

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Beckworth: Yes. So another observation that's been made about using the budget reconciliation process is that the parliamentarian of the Senate may not accept this added part being added to the bill itself. So having the debt ceiling raised to the budget reconciliation may not be something the parliamentarian approves. In that case what would happen is the president of the Senate, the vice president, Kamala Harris will step in and overrule the parliamentarian. She can do that legally, but it would be a precedent that hasn't happened in a long time, if ever. So it would be another example of having to break the norms, this degrading of institutions, if push comes to shove.

Russo: Yeah, and again this where my own knowledge is a little bit lacking, but my understanding is there's something called the Byrd rule I think due to Senator Robert Byrd from a few decades ago when the budget reconciliation was adopted by Congress. It was a relatively new invention in our country's history and the Byrd rule basically outlines what is and is not appropriate for budget reconciliation. So there are things in there like you can't change social security, but the three main categories you can do, you can change spending, you can change taxes, and you can change the debt limit, which I suppose means raise or hypothetically lower.

Russo: So I don't know specifically why the parliamentarian might have a problem with that, I think more controversially would be including a suspension of the debt limit, which is what's been done more typically in the last decade. The suspension is for a period of time and when that suspension expires the debt limit is automatically raised to account for all the issuance that's taken place by Treasury in the suspension period.

Beckworth: Yeah, that was a third observation about why this is trickier, more challenging this time is the nature of the fix. So you just said the suspension is what's been done in the past. Is that right?

Russo: Yes, suspension's been typically done, forgive me I don't have the exact years here, but roughly in the last decade at least they've opted for a suspension rather than raising the limit.

Beckworth: And so what would have to happen to make this through budget reconciliation is actually raising the debt limit, not just having a suspension?

Russo: Actually yeah, they have to pick a number. And so I'm not the parliamentarian, but they could say we're raising it to 30 million, they could say we're raising to 40 million, they could say I guess hypothetically we're raising it to infinity or infinity minus one, like pick something, but it has to be a number.

Beckworth: Yes, this is good because this goes back to the point I was making earlier. So suspension is not likely to pass, that's where the parliamentarian would say no, but raising the debt limit is also going to be very tough, because if you raise the debt limit enough to cover the bills, you already have contention among Democrats among the size of the bill itself, three and a half trillion. So the debt limit, using that approach may be tough and then if you resort to the suspension the parliamentarian may say no. So you're really up in a roadblock facing these two obstacles here. And again, what will happen, we don't know. Hopefully this will be done in a manner that doesn't create more concerns.

Beckworth: Well, let's talk about some solutions to this, Chris. We've been talking about the challenges this poses and there is some standard solutions and I want to get to your solution. Your solution marries two different fixes for public finance, but we already touched on the two main ones, suspension or raising the debt ceiling, but those really aren't in the cards yet, they may be in the next few weeks. So let's talk about, for fun, some more radical solutions, all right? And maybe you can just comment on what it is and why you think it's not going to happen. In fact, we know it's not going to happen because Secretary Janet Yellen said that the list of items I'm about to share with you are not on the table.

Beckworth: Chris, let's start with mint the coin, the platinum coin that apparently there's a legal loophole that the Treasury can mint this coin, deposit it at the Fed and instantly get a trillion dollars, two trillion dollars, thoughts on that?

Creative Debt Limit Solutions

Russo: Before I comment on that specifically I should just say that people who come up with this stuff are really clever and I mean that sincerely. There's something about the American spirit where we've got this really difficult problem about raising or re-suspending the debt limit and people look to laws about minting commemorative coins for the solution. Sincerely, there's something really clever about that.

Russo: As you've described, the idea here basically is using some law, again not a lawyer, basically, supposedly, maybe authorizes the Treasury to mint a commemorative platinum coin at whatever face value it wants, maybe a trillion dollars, maybe 10 trillion dollars, whatever they choose, and for them to deposit that coin with the Fed where they have their Treasury general account. The idea being is that that coin and the corresponding money created at the Fed doesn't count to the debt limit, and so we've figured out a solution around the debt limit in a way that doesn't require Congress to get its act together. With respect, I think that's a gimmick, I think, again, a really clever gimmick, but this does not solve the fundamental problem that we have in a representative democracy where you have the real levers of power here for the budget in Congress, in the legislative branch, and they need to figure out what budget they want to accept and how to finance it.

This does not solve the fundamental problem that we have in a representative democracy where you have the real levers of power here for the budget in Congress, in the legislative branch, and they need to figure out what budget they want to accept and how to finance it.

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Russo: And I think very wisely, since really Tim Geithner was Treasury secretary I think back in the Obama administration writing letters to Congress about this, he said, "Look, there's things that we can do, these extraordinary measures, these tools Congress has given us to work around the debt limit for a time while you figure out what you're going to do. We'll use those measures to the best of our ability to give you as much time as possible."

Russo: But there are these more radical gimmicks that Geithner and Treasury secretaries after him have affirmed they're not going to use. So at the time, for example, there were Republicans saying you should sell off government assets or you should selectively default on the debt, default to China. All of these things I think would have the same economic consequences, or approximately the same in terms of being really, really bad and fundamentally don't solve the problem. So again, platinum coin, super clever. I know some of our friends of the show have talked about this, even in a joking way. In comments that they've made I think they're just trying to make fun of the debt limits, in their view show how absurd it is, but it's not a realistic solution.

Beckworth: Okay. Another suggestion is to invoke the 14th Amendment which says that nothing should impair US public debt, so nothing should get in the way of it being functional, being used in markets. Again, another gimmick in your view?

Russo: Yeah. I hesitate to call any amendment to the US Constitution a gimmick, but in this case I think its use would be gimmicky for the same reason. In many respects I'm a legal realist which roughly means we write the law down, it means something when we write it down, the plain language of law means something, but in reality when interpreted by courts it's also an exercise of political power. My view is that if the Biden administration and the Democratic Congress have the political power to do the platinum coin or to do the 14th Amendment or anything else, they have the political power to just raise the debt limit using budget reconciliation. And again, in my view it is a principle of mine that as the governing party they have the responsibility to do that.

Beckworth: Right. Another suggestion and I think less radical than the first two I've mentioned is have the Treasury issue perpetuity. So these would be securities that never expire, they just make interest payments, there's no face value on them, and the argument made by John Cochrane is that by law the Treasury determines its debt stock based on the face value, not the interest payments it makes. So if you eliminate the face value and just pay interest forever, a perpetuity, there you go, it's solved, problem solved.

My view is that if the Biden administration and the Democratic Congress have the political power to do the platinum coin or to do the 14th Amendment or anything else, they have the political power to just raise the debt limit using budget reconciliation.

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Russo: Yeah, I've got to be painfully consistent here because I like perpetuities, I think perpetuities are great. In an op-ed I said something similar where he's giving his favorite solution to a new problem.

Beckworth: Ah, that's funny.

Russo: But again let's go back to at least the economics here. The fact that a perpetuity may have no face value or may have a low face value, you could have a face value of a dollar and pay an interest rate of 100% if you wanted to have each security pay one dollar per year, you can structure these things however you like, and it just would have pushed down the face value of the debt, it doesn't mean that it has lower economic value. The actual economic value of a perpetuity is a real thing, it's certainly not zero.

Russo: And so in so far as again the debt limit's purpose is to be a way for Congress to discipline the executive branch, particularly to discipline the Treasury, economically it doesn't make sense to me why this debt shouldn't count towards the debt limit. But again this gets back to the question of the way the law's written, in my view, in a lot of respects. For a sentence like this in particular what the court to decide here is an exercise of political power, what they themselves exercise, what they think that they could get the rest of the government to go along with.

Beckworth: Yeah, so even if perpetuities could be done it violates the spirit of the debt ceiling law, which is your point.

Russo: It violates the same norms that I think the platinum coin violates, that the use of the 14th Amendment in that way violates. It's a degradation of our country's institutions and it self-reflects poorly on the credit of the United States.

Beckworth: Okay, last solution, and this maybe is more of a backstop solution, it's not like something that the government's going to try off the bat, but that is the Treasury being backstopped by the Federal Reserve. So you have an article titled *Inside the Fed's Playbook for a Dollar Default*, and we'll have a link to that. You walk through what the Fed has discussed it would do and recently it's been brought to life, this 2013 FOMC meeting in October, you alluded to it earlier. Jay Powell has a nice long discussion. He was just a governor back then, but it sheds some light on what the chair of the Fed could be thinking in terms of worst case scenario, they step in to backstop the Treasury market. But what are your thoughts on that?

Federal Reserve Solutions to the Debt Limit Issue

Russo: I hesitate to use the word backstop because to say that the Fed is backstopping the Treasury market or backstopping the US government suggests that, almost like a baseball game, if the ball gets past the pitcher, well, at least there's the backstop to stop it. It's not really the same situation. In the case of a Treasury default, the Fed can do some things to mitigate the harm around the edges, but there is ... It's hard to put numbers on this, but let me try to put it this way. There is very little the Fed could do on the whole to mitigate the fallout from a default on US Treasury debt or even US government obligations. These were a set of options that were put together by the Federal Open Market Committee, the committee that runs monetary policy for the Federal Reserve back in 2013 when they're again facing a similar type of situation. It's options that they would take in order to try to keep financial markets functioning the best they can, to keep the economy chugging ahead in line with its dual mandate. But frankly, I'm concerned and skeptical even about whether the Fed could at least in the near term achieve those objectives in the event of a default.

There is very little the Fed could do on the whole to mitigate the fallout from a default on US Treasury debt or even US government obligations.

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Beckworth: Okay. So it wouldn't be like a repeat of March 2020 where the Treasury market was having problems and the Fed stepped in, provided liquidity, provided support, got it through that moment? This would be a fundamentally different experience if it was attempted?

Russo: That's my opinion. Of course, we've not seen a US default before, it the reason why this would be a big deal, so it's hard to say with any certainty or any sort of quantitative accuracy. But to draw a distinction between the two, September 2019, what happened roughly, there's a lot of causes here, but one way to think about it is there was a tremendous increase in the issuance of Treasury debt following the debt limit episode, there was a corresponding decrease in the supply of dollars in the financial system, reserves held by banks at the Fed, for example.

Russo: So at the same time we have these banks needing to finance greater issuance, they have less cash to do it. Something about the financial regulations, which we don't really have to go into, probably made it more difficult for banks to step in to provide that extra liquidity in a market where interest rates were rising. As a consequence of that and some other factors, rates rose quite dramatically, 4%, 5%, 6%, 7%, 8%, 9% for overnight rates.

Russo: The Fed stepped in, they provided more dollars to the system. They did in fact backstop the banks, this is why they had the discount window so that in the event of say a run on bank deposits or similar sorts of things in the shadow banking system there will be enough dollars there to pay out depositors or to pay our short term liability holders. In that sense the Fed is backstopping those systems.  Here, what would a default be? Well, the Fed wouldn't be paying the government's bills and the Fed can't do anything to restore the credibility of the US Treasury, the United States Congress. So in that sense monetary policy is quite powerful, but it's not [inaudible].

Beckworth: So it wouldn't be able to pay the ongoing bills to retirees, social security, veteran's benefits, things like that, but it could step into the Treasury market? But that's only one piece of the puzzle I think is what you're saying. So I guess the one observation I would make, Chris, is that fundamentally this is not a question of solvency, this is a question of a law that's tied the hands of the Treasury department, but your counterpoint is that nonetheless it's a big mess, the big puzzle piece, there's many pieces in that puzzle and the Fed at best could maybe put a few of those pieces back together, but the rest of the puzzle's still going to be spread out on the table?

Russo: Yeah. Maybe to make it more concrete for the listeners, if we have a few minutes can I run us through specifically-

Beckworth: Yes, please do.

Russo: So there were a few things here that were discussed in 2013 by a few different officials from the board of governors, again given to the top policymakers of the Fed. The first had to do with payments. So one big takeaway from those 2013 transcripts is that if Treasury makes the payment it won't be rescinded. So if you're a social security beneficiary and you get a social security check, don't worry, it's not going to be charged back a day later because the Treasury decides they need the money for something else. So in that sense people get a little bit of comfort, if you get a payment from Treasury don't think it's going to then be taken away.

Russo: There is also, as we discussed before, the issue of principal and interest payments. There's again a complicated system run by the Federal Reserve called Fedwire Securities, which helps the financial system manage where different securities are in the financial system. So if I have a Treasury security, and again not actually literally me and you but suppose we're large financial institutions, if I have a Treasury security and I'm giving it to David, trading him for some cash, that settlement takes place on the Fed's books in many cases through Fedwire Securities.

Russo: Because this system is a legacy system and it's difficult to use there is a thing where once the security settles, once it actually matures, it can't be traded anymore. So if we've got a Treasury bill that matures around the X date and the Treasury isn't able to make that virtual payment what the Fed will do is it will stop that security from technically maturing in its system. The bottom line here is that it allows these defaulted, or "delayed payment securities" to continue trading. So if you've got a Treasury security and Treasury has a delayed payment, frankly I think that's a euphemism, I'll just say if Treasury defaults, you will still be able to trade that security to somebody else who maybe is willing to wait for Treasury to make that payment. So those are the two things to do with payments and I think that's important.

Russo: Another thing is to do with financial regulation. The Fed would instruct its examiners and its regulators to not treat Treasury securities adversely in this situation. So again, if you're a bank and you're holding treasuries for your liquidity ratios or other things, your capital ratios, you won't be marked down because there was some delayed payment going on. And then the big that thing I think listeners might be most interested is what the Fed would actually do in the case of default in terms of the securities in its portfolio and its big open market operations. And here the Fed outlines three different sets of options in growing level of displeasure. The first and second groups of options the Fed policymakers have all pretty unanimously agreed these are things we can do, the third option which I'll get to were called loathsome by I think President John Williams were called other things by their policymakers that were not good.

Russo: So the first set of options basically says in the event that a payment on Treasury securities is delayed they will continue to treat treasuries equivalently. So if they're going out and they're buying their 120 billion dollars a month of treasuries and mortgaged backed securities, they're not going to differentiate between a security with a delayed payment and a security without a delayed payment. And similarly the other [of the] Fed’s operations, things like securities, lending, repo, reverse repo, all of that will treat Treasury securities as equivalent with no respect to whether a payment is delayed. The second set of options is to do more with the repo market, and David I think this is what you were getting at where there are spikes in repo rates or every sort of overnight short-term interest rate, the Fed would step in to use its tools to try to bring those interest rates back down in line with their target range.

Russo: The third set of options which are the "loathsome ones" are the ones that would have the Fed very intentionally purchase those delayed payment securities, either outright purchase or I think they even discussed the options of doing swaps. And they are clear on the transcripts to say that this is an option they would take only in the event that it was, and I'm going to paraphrase here but in my article I have the exact language, they're fairly certain that payments will be made in short order. This is my interpretation, not something they have in the transcript, but my interpretation is that payments were expected in a few days, it's something that they could do. If payments were expected in a year, to me that doesn't sound like short order. Again just to emphasize, there's all these things they would do. I think it's important for them to do it in this really bad state of the world. But I hope these, actually policies, make clear it's not something that can fix the situation.

Just to emphasize, there's all these things they would do. I think it's important for them to do it in this really bad state of the world. But I hope these, actually policies, make clear it's not something that can fix the situation.

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Beckworth: Yeah, that's a great account of those suggestions they had. I would note that that was done in 2013, that discussion took place in 2013. Here we are in 2021, the amount of public debt has just ballooned since then, and as you know, Chris, there has been challenges for the banking system in terms of all the reserves that have been injected. There's a limited amount of bank balance sheet space, so we see developments to the overnight repurchase facility at the Fed.

Beckworth: And the reason I bring this is up is imagine we have this scenario where they actually have to do some of these measures you just outlined. So treasuries would be sold en masse to the Fed and the Fed would in turn provide reserves. Where would all those reserves go? We already have huge banks and their balance sheets are stuffed full of reserves. So there would be these secondary effects spilling over into the banking system, in financial markets. So even the Fed's best efforts, there'd be many complications I think.

Russo: I think that's right and that's an asymmetry that's not often appreciated between repo and reverse repo. So in the Fed's repo operations they're growing the size of their balance sheet with an increase on the asset side and there's a corresponding increase in their liabilities. Typically, we think about it as increasing reserves, but as we've discussed previously on the podcast there's a limit right now as to how much banks can absorb additional reserves. So those dollars actually flow into that shadow banking system, which is why we're seeing that large increase in the overnight reverse repurchase agreement facility, whereas typically we think about then ONRRP, that overnight reverse repurchase agreement facility as a substitute for reserves. So it's not always the case that an increase in ONRRP reflect an increase of assets on the Fed's balance sheet. That could be a substitution between the banking system and the shadow banking system where individuals choose to hold their dollars.

Beckworth: So we need to avoid this altogether so we don't have deal with these situations. And you have a proposal to do just that. So in the time we have left, walk us through your recommendation for Congress.

Reform Recommendations for Congress

Russo: Sure. To be clear, I don't think this is something they can do and I know this is something they can't do in this current fight. I proposed this back in spring of this year and we're long past the time period where we can actually get that done before the impending X date. My suggestion is if we're going to have representative democracy where Congress, our elected officials, choose the budget and they finance that with taxes and revenue, then a change to the debt limit, practically speaking, has to be able to pass with a majority, has to pass both with Republican support and with Democratic support. I should mention here of course I'm talking about suspending the debt limit aside from the budget reconciliation options we had discussed before.

My suggestion is if we're going to have representative democracy where Congress, our elected officials, choose the budget and they finance that with taxes and revenue, then a change to the debt limit, practically speaking, has to be able to pass with a majority, has to pass both with Republican support and with Democratic support.

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Russo: In an event where we're looking to either suspend the debt limit for a long period of time, or in my view and I propose in the article permanently suspending it, it has to be paired with things that bring a super majority in the Senate on board. So I don't know what Republicans would ask for in that case, I would suggest that we have reforms to the budget in the long term that puts the budget on a sustainable path. There's pretty wide agreement among economists, both Republican and Democrat, whatever [inaudible] happen to be, that the path the budget's been on in the last decade, two decades has been unsustainable. That's not to say we shouldn't have a deficit or that we shouldn't have lots of debt being used by the world and deny ourselves the privileges that brings, but to put the budget on a sustainable path I think is a fundamental thing our country will have to do at some point.

Russo: And then of course, in addition to that, I would also suggest we do structural reforms. Again, our program at Mercatus is correctly very much behind the Fed's use of monetary policy to get us price stability and full employment. We don't need to rehash that here, but in normal times, it's my view that the Fed can't do all that much to raise the upward potential of the economy to raise maximum employment. They can do it by having good monetary policy as a second or third order effect through long expansions and having tight labor markets, but if we really want a higher level of maximum employment and similar things like higher productivity growth there needs to be structural reforms. Those can be only done by Congress.

If we really want a higher level of maximum employment and similar things like higher productivity growth there needs to be structural reforms. Those can be only done by Congress.

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Russo: So the combination of these three things, a permanent suspension of the debt limits, so we don't have these fights every two years where we almost fall of the fiscal cliff, combined with long term budget solutions that I think makes a large segment of the population, including many economists, more comfortable with the direction of our economy and our country, and third, structural reforms to grow the size of the economic pie… I think that's a package that again, if we're committed to getting this done via the traditional institution of this country, might be able to actually work.

Beckworth: Okay. Well, on that upbeat outlook, Chris, our time is up. So our guest today has been Chris Russo. Chris, thank you for coming back on the show.

Russo: Thanks a lot, David.

Photo by Andrew Caballero-Reynolds via Getty Images

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