Notes on US shutdown & debt ceiling

1)   There are two processes ongoing at the same time

a)    Budget resolution – cause of current shutdown

b)    Debt ceiling – potential leading to US default

2)   The two sides have reached an impasse

a)    Republicans believe they can get concessions from Obama and the Democrats; defund/delay Obamacare and further cut to projected spending

b)    Democrats and the President has changed tactics; “we will not negotiate until Republicans end shutdown AND raise debt ceiling”

c)     Compromise may be a short-term increase in debt ceiling while negotiations take place; say 1 – 3 months.

d)    Alternative I: put a clean CR vote / debt ceiling bill on the floor expecting 17 Republicans to join the Democrats. (R: 234, D:201, T:435). This violates the unwritten “Hastert rule” which says the Speaker shall not bring a bill to the floor without party majority! That said, the Hastert rule is often broken, but on an important issue like this, Boehner will probably end his career as Speaker!

e)    Alternative II: Republicans refuse to back down on shut-down, but agree to a clean debt ceiling bill.

3)   Dates to note; budget

a)    US FY runs from October 1st to September 30th.

b)    No budget nor continuing resolution bill was passed by start of FY14 – government must shut down all “non-essential discretionary spending”

c)     This has happened 17 times before with an average of 6.47 days. In 1995 – 1996 with Clinton President and both Senate and House Republican government was shut down for 5 days + 21 days. Note; budget was later balanced!

d)    Economic impact of “non-essential shutdown discretionary spending” is limited, but obviously grows for each day.

e)    This could therefore go on for a long time

4)   Dates to note; debt ceiling

a)    Debt ceiling was actually reached on May 18th 2013, but Treasury can resort to emergency funding under a so-called debt issuance suspension period (DISP) in order to postpone the day of reckoning.

i)       Divesting the Civil Service Retirement and Disability Fund

ii)    Suspend reinvestment of Government Securities Investment Fund

iii)  Re-allocate debt NOT subject to debt limit and debt subject to limit

iv)  In addition, Treasury got a massive injection of dividends from the bailed-out GSEs which gave them more leeway

b)    Treasury have publicly said October 17th is the day when they cannot operate safely

c)     However, by that date they will still have $30bn in cash, so Congress and President may want to continue the standoff

d)    Between October 22nd and November 1st ALL cash will be spent and some form of default will take place unless debt ceiling is raised.

5)   What happened during and after debt ceiling debate in 2011?

a)    Congress (House of Representatives) and the White House experienced the same situation in summer/fall of 2011

b)    The resulting compromise then was the Budget Control Act signed into law August 2nd 2011

i)       The act would allow a three-step increase in the debt ceiling provided certain milestones in deficit reduction was reached

ii)    A bi-partisan “super-committee” – A Joint Select Committee on Deficit Reduction – was established that would agree on reasonable deficit reductions.

iii)  If the committee could not agree, an automatic across the board sequester would take place on January 1st 2013

iv)  The committee did not agree and the sequester did take place (albeit delayed), leading to approximately $100bn annual reduction in projected spending

c)     Given the political wrangling over a serious issue like the debt ceiling, S&P downgraded US debt from AAA to AA+ (S&P was later investigated for misconduct during the financial crisis, Moody`s was not).

d)    US yields fell on the news, as investors still think US treasury debt is risk-free.

6)   What if no one gives in leading to the consequent default?

a)    First of all, this is relatively uncharted territory and no one knows for sure.

b)    In 1790 the US defaulted on debt, but managed to repay by early 1800.

c)     In 1979 a technical glitch caused a delay in interest payments with severe, but far from catastrophic, consequences. All debt, with interest was repaid shortly after.

d)    However, the world is different today and the most notable change is the emergence of shadow-banking that fund itself through collateral chains.

e)    When Lehman Brothers went bankrupt, a cascading chain of defaults occurred because one link in a highly complex chain of promissory notes was no longer eligible as collateral for funding.

i)       Estimated $2.8 trillion worth of Treasuries are used daily in the repurchase agreement market.

ii)    If these were by any instance rated “D” they would no longer be eligible for repo and financial funding would dry up – credit crush

iii)  In addition, sophisticated financial firms (criminals) re-hypothecate repos. In other words, they lend the treasury bonds received in repos to other market participants that repo them anew – credit crunch ^2

iv)  The Federal Reserve could no longer legally receive treasuries in their reverse repo activities. The Fed discount window would shut down

v)    Money market funds, active in these markets, would by mandate be obliged to sell

f)      Needless to say, this would put upward pressure on interest rates and drag down the phony economy with it.

7)   Other alternatives?

a)    Could the Treasury prioritize payments? For example delay social security checks and still pay bond holders?

b)    The Treasury pays on average 4 million bills every day and it will be fiendishly hard to prioritize between various creditors, not to mention the legal issue of Treasury making such judgments

c)     However, the bond market is operated on a separate system than the rest, and could probably be prioritized if need be

d)    Another alternative is for the Treasury to wait until it has enough cash for one full day worth of payments and pay it, and then start to accumulate cash again. Problem is that November is a high deficit month and this would soon mean days or weeks delay.

e)    Treasury could call it a “technical default” based on willingness to pay, NOT ability. This could give MMF, the Fed and possible the Repo-market an excuse to continue as nothing has happened. Or alternatively prompt the rating agencies to maintain current rating (highly unlikely).

f)      Platinum coin or the 14th amendment to the Constitution has been dismissed and if resorted to would lead to even more uncertainty in the future.

g)    If all other measures are exhausted, the Treasury must balance its books which are extra hard as FY Q4 is a high deficit period.

i)       We would probably see a 40 per cent reduction in government outlays and with GDP measuring consumption (GDC), its growth rate in Q4 would be massively impacted

ii)    1 week full shutdown; – 2 per cent in annualized GDC (-0.5 per cent quarter on quarter)

iii)   1 month full shutdown; – 8.4 per cent annualized (-2.16 quarter on quarter)

Update: We were just made aware of yet another alternative; Treasury could issue super-premium bonds – say a bond with price $275 and use the proceeds to fund government or alternatively retire old debt. The trick is based on the fact that the debt ceiling only counts debt at par value! More on another can-kicking devious scheme here; Kudos to Mr.Koutsomitis!

What does the market think about the whole thing? 

T-bill greater Libor

T-bill greater Note

Quiz: Who said this?

Was it Tea-party darling Ted Cruz, Libertarian Ron Paul, his less radical son Rand Paul or maybe someone else?


President, I rise today to talk about America’s debt problem.

The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the U.S. Government can’t pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance our Government’s reckless fiscal policies.

Over the past 5 years, our federal debt has increased by $3.5 trillion to $8.6 trillion. That is “trillion” with a “T.” That is money that we have borrowed from the Social Security trust fund, borrowed from China and Japan, borrowed from American taxpayers. And over the next 5 years, between now and 20XX, the President’s budget will increase the debt by almost another $3.5 trillion.

Our debt also matters internationally. My friend, the ranking member of the Senate Budget Committee, likes to remind us that it took 42 Presidents 224 years to run up only $1 trillion of foreign-held debt. This administration did more than that in just 5 years. Now, there is nothing wrong with borrowing from foreign countries. But we must remember that the more we depend on foreign nations to lend us money, the more our economic security is tied to the whims of foreign leaders whose interests might not be aligned with ours.

Increasing America’s debt weakens us domestically and internationally. Leadership means that “the buck stops here.” Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better.

I therefore intend to oppose the effort to increase America’s debt limit.



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