On the Road to U.S. Government Debt Default, August 2nd Judgement Day
Interest-Rates / US Debt
A great default is behind us. The public is unaware of this. If you read this report, you will no longer be unaware of it.
The ease with which this default took place should serve as a warning: there will be additional, much larger defaults. Again, the public does not understand this. The main one will be Social Security. The program is now in the red: more money going out than comiomng in. But most people still cannot believe that the program really will go belly-up. That’s why I produced a video on this.
What? Would the government really break its retirement promises? Of course. It has already been done. Bear with me. You need to know how the game is played in Washington.
Legally, the Federal government is a month away from bankruptcy. The government, under the direction of Treasury Secretary Geithner, is borrowing money from Federal employees’ pension funds to keep the doors open.
It’s an accounting trick. First, the Federal government funds the pension funds with money. Second, the funds buy Treasury bonds. Third, the government immediately spends the money. It’s like Social Security, whose Trust Fund is a pile of IOUs from the government.
In mid-May, the government unilaterally defaulted on those Federal pension fund IOUs. That action wiped the obligations off the books. That in turn has allowed the government to operate legally. That is because its total debt is now lower than it was before the default.
Here is an analysis by the Federal Times. There are two funds involved: the Civil Service Retirement and Disability Fund and the Thrift Savings Plan’s Government Securities Investment Fund, known as the G Fund.
Both are invested in government bonds, which count as borrowing against the national debt ceiling. Under the Treasury Department’s strategy, the government trims the two funds’ holdings in those bonds. For the 2½-month period from mid-May until Aug. 2, that’s supposed to free up about $214 billion in “headroom” against the debt ceiling, thus allowing the government to borrow a similar amount of money from other sources to keep paying its bills.
“Federal retirees and employees will be unaffected by these actions,” Geithner wrote in a letter to lawmakers earlier this week. By law, those accounts must eventually be made whole. The department took similar “extraordinary measures” in 2002, 2003, 2004 and 2006; each time, the G Fund and the CSRDF were made whole with back interest once the ceiling was raised.
No one is using the D-word: default, but this is what the procedure really is. This has gone on so often in the past that no one in Washington blinks an eye. It’s business as usual. The government pretends that the legal IOUs that it has been presenting to the funds in exchange for real money have been wiped off the books. This is solvency, Washington style.
The public does not understand any of this. It also does not understand that the Social Security Trust Fund is a pile of IOUs from the government. Even worse, these IOUs are not counted as on-budget. They are off-budget.
What makes the two Federal pension funds different from Social Security is that they are on-budget; hence, by wiping them off the books, the government ducked the debt ceiling bullet.
Naturally, new payments are being postponed. That means that the government is spending the money owed to the funds without bothering to issue any IOUs. This saves the government a few million. Every penny counts!
This concealed default, when coupled with a reallocation of the monthly “contributions” to the two funds, is all that stands between government spending and the debt ceiling. If that crash takes place in August, there will be a far greater reallocation of government revenues.
JUDGMENT DAY ON AUGUST 2
Geithner says that the government will hit the legal debt limit in early August. Nobody knows if he is bluffing. He may have a few other rabbits in his hat, but if so, they are new. The tried-and-true rabbit of defaulting temporarily on Federal pensions has been pulled out of the hat.
He says that, once the crisis is behind us, meaning after the Republican House has voted to increase the debt ceiling, that the government will replace the missing pension fund IOUs. If he really believes this scenario, then he is admitting that the politicians are involved in a grand charade. It’s all for show. There will be a deal. Geithner is saying that the temporary accounting games the government is playing with the Federal pension funds is part of a political charade.
But if the deal cannot be worked out in August, then the Federal government will stop paying more of its bills. We have not been told which ones will not be paid. There will not be an overnight shutdown of the government, but some people who think they have guaranteed salaries or who think they have contracts with the government will find that these promises – these IOUs – are not worth the paper they are written on . . . until the Republican House quits stalling and does what everyone in Washington knows is inevitable. Until then, the contracts will not count when the government is over its spending limit.
We are witnessing kabuki theater in a pre-election year. This is why there has been no deal among Obama, the Democrat-controlled Senate, and the Republican-controlled House. They are doing a kind of mating dance about how they are ready to deal, just so long as the others want to deal. But the only thing between official bankruptcy and today is the on-going raid on the pension funds.
Think about this. Government workers spent years contributing to these funds – taking IOUs – and Geithner is treating the funds as convenient cookie jars. He has assured the victims of this contract-breaking, crisis-delaying theft of $214 billion of IOUs that the government will replenish the cookie jars just as soon as the crisis is over.
ROBBING PETER TO PAY PAUL
Until such time that the debt ceiling is legally raised, Washington will continue to rob Peter to pay Paul. Of course, this is the premise of Washington politics at all times, but this time, the victimized Peters are government employees.
This is the sweet fiscal irony of the budget impasse. The middlemen in the great Peter-to-Paul wealth transfer programs are finding that they have become the targets of the senior administrators of the great heist. Instead of taxpayers coming up with the money to finance the transfers, the middlemen are. Civil-Service-protected, salaried employees of the government are now on the paying side of the wealth-transfer process. It could not have happened to a more deserving bunch.
Here is what impresses me most. First, the default on $214 billion of Treasury debt did not get a headline on the front pages of America’s press. This was not a prime-time story on the evening news shows.
Second, the arcane nature of the retirement fund programs remains arcane. The public does not understand that the great heist is long behind us. It has been going on since 1937. Political deception is part of the American way of life. It is right up there with mom and apple pie. In fact, it’s way above mom and apple pie. The tell-all biographies of the children of famous celebrities have long-since undermined mom, and the food police are after apple pie. But nobody writes a best-selling book called Franklin Dearest on the origins of Social Security.
Third, there are no legal repercussions of a default on $214 billion of government debt. There are no class-action lawsuits. How could there be? The Federal government is legally sovereign. It cannot be sued in any Federal court unless it consents to the lawsuit.
This should send a message to anyone who is alert to what is going on. The U.S. government can default at any time. It is not bound by law. If, in order to obey one law, such as the debt ceiling, senior officials think it should violate another law, such as keeping pension fund obligations on the books, someone is going to get stiffed. Politics will decide who gets stiffed.
We are on the road to default. Who has sounded a warning? Not the nation’s economists.
Economists are dumb. I don’t mean stupid. I mean mute.
They are smart. They have Ph.Ds. They can write unreadable articles filled with equations. They get paid lots of money, at least the ones we read about in the media. Yet, as a profession, or guild, or special-interest group, they are remarkably silent.
With the exception of Austrian School economists, university economists are not going on the Web, let alone national television, to sound the alarm. No academic economist is as forthright and as rhetorically inflammatory as David Walker, the former Comptroller General of the United States. He has been sounding the alarm for years. In early 2008, he went on the CBS “60 Minutes” show to give one last shout as a government employee. The next month, he resigned. He was hired by Peter G. Peterson to be the spokesman for Peterson’s new foundation which is dedicated to sounding the alarm. That interview is still worth watching, even though the huge deficits that began in 2008 had not begun. I have posted it here.
There was a mild warning in March issued by ten former chairmen of the President’s Council of Economic Advisors. I suppose we should be grateful for small blessings. Their press release got very little attention. It was posted on the Politico site, which is not an economics site. It did get picked up, but not by the mainstream media, as a search on Google will reveal.
The press release began with a positive reference to the now-defunct Bowles-Simpson commission: the bipartisan National Commission on Fiscal Responsibility and Reform. It issued a report in December 2010. It had a great title: “The Moment of Truth.” It is a shame that it was filled with convenient deceptions. Here is an example:
Unless we act, these immense demographic changes will bring the Social Security program to its knees. Without action, the benefits currently pledged under Social Security are a promise we cannot keep. Today, the program is spending more on beneficiaries than it is collecting in revenue. Although the system’s revenues and expenditures are expected to return to balance temporarily in 2012, it will begin running deficits again in 2015 if interest from the trust fund is excluded and in 2025 including interest payments. After that point, the system’s trust fund will be drawn down until it is fully exhausted in 2037.
By now, you know what the deception is. The report pretends that the Social Security Trust Fund is filled with assets rather than non-marketable IOUs from the Treasury. We were told that “the system’s revenues and expenditures are expected to return to balance temporarily in 2012.” That means that revenues and expenditures were not in balance in late 2010. The report did not mention that the Trust Fund is broke today, not in 2037.
This is the same old con game that the politicians, the media, and the economists have been running since 1937. It is so widely accepted that it is considered heresy for anyone in authority to tell the truth.
The Commission was also part of the government’s kabuki theater. It was a lead balloon from day one. The rules stipulated that Congress would not have to formally consider its recommendations if there were not a majority vote of 14 out of 18 members. The Commission’s report got 11 votes.
This was also deceptive. It was well known among insiders that some of the members voted for the report because they knew that it would not get 14 votes. This fact was reported by Stan Collender, an old-time Washington observer. He concluded a few days after the December report was issued:
For all the reasons noted above, my guess is that the Bowles-Simpson plan will suffer the same fate as the reports by virtually every other budget-related commission in U.S. history: the online equivalent of gathering dust on a shelf. By early next year, it will seldom be mentioned.
He was correct.
Then came the March 24 press release by the ten ex-chairmen. The members praised the report. They used fairly strong language. But they, like the Commission’s report, ignored the fundamental fact of Washington: politics.
They said of the deficit, “It is a severe threat that calls for serious and prompt attention.” But then they did what almost all economists do: they said the problem is far in the future.
While the actual deficit is likely to shrink over the next few years as the economy continues to recover, the aging of the baby-boom generation and rapidly rising health care costs are likely to create a large and growing gap between spending and revenues. These deficits will take a toll on private investment and economic growth. At some point, bond markets are likely to turn on the United States – leading to a crisis that could dwarf 2008.
This was what Washington loves to hear. This means that Washington can safely ignore the problem. It guarantees another round of kick the can.
“The Moment of Truth” documents that “the problem is real, and the solution will be painful.” It is tempting to act as if the long-run budget imbalance could be fixed by just cutting wasteful government spending or raising taxes on the wealthy. But the facts belie such easy answers. They were correct. There are no easy answers. This guarantees that kick the can will be Washington’s response. Washington is interested in hard answers only after an emergency is upon them. Then Congress spends hundreds of billions to solve it.
They spoke of the Commission’s recommendations. Then they did what most economists do: they said they – members of the ten – could do better.
To be sure, we don’t all support every proposal here. Each one of us could probably come up with a deficit reduction plan we like better. Some of us already have.
Oh, yeah? Then why didn’t the Commission (or anyone else) accept these better provisions? Here is the answer: because it’s all kabuki theater. One list of things that must be done to save the Federal government from default is as easy for Washington to ignore as any other list.
It’s not about solving the deficit problem. It’s about solving the November election in 2012.
We know the measures to deal with the long-run deficit are politically difficult. The only way to accomplish them is for members of both parties to accept the political risks together. That is what the Republicans and Democrats on the commission who voted for the bipartisan proposal did.
Nothing is going to be done. Politically, nothing needs to be done before November 2012. The debt ceiling will be raised. There may be some late-night meetings. There may even be a few days when the government has to rob some Peters on the payroll to pay Pauls with more political influence.
Then they will kick the can. They will send a ceiling-raising bill to Obama, who will sign it.
And we’ll have fun, fun, fun ’till the market takes our T-bills away!