Over the past decade, the U.S. federal government has repeatedly run up against its debt limit and neared the point of being unable to fund its commitments. Crossing that ominous threshold has been termed by some as “default by another name.” Meanwhile, others have asserted that the Treasury Department could prioritize certain payments, allowing the government to continue making good on its debt obligations and its most important benefit programs while biding time for policymakers to resolve the impasse. But just how realistic is that scenario? No one really knows, but at a minimum, it would carry profound risks to the American economy, and could damage its prosperity if global markets were to lose confidence in the full faith and credit of the U.S. government.
Following a two-year suspension, the country’s debt limit was once again reinstated on August 1, 2021, at $28.4 trillion—the amount covering all federal borrowing to-date. The Treasury Department was forced to immediately deploy its emergency authority, known as extraordinary measures, to continue paying the nation’s bills. But the clock is ticking; absent congressional action, the Treasury Department’s extraordinary measures and cash on hand will likely run out sometime this fall. At that point—which we call the “X Date”—the federal government will be unable to meet all its obligations in full and on time.
There is no established playbook for the Treasury Department if Congress fails to raise or suspend the debt limit in the coming weeks. Officials have long denied the existence of any Plan B to finance government operations past the X Date. The Treasury Department will not attempt a “fire sale” of financial assets as a way to avoid or delay congressional action on the debt limit. Other previous suggestions—from minting a trillion-dollar coin to deposit at the Federal Reserve, to issuing IOUs that could be sold and traded in private markets, to unilaterally declaring that the Constitution’s 14th Amendment nullifies the debt limit—have been deemed impractical, possibly illegal, and could bring the U.S. government uncomfortably close to the image of a banana republic in the eyes of investors.
The Treasury Department could, in theory, employ one of two untested strategies: making payments in priority order or making full days’ worth of payments once it receives sufficient revenues to cover all of a day’s obligations.
Upon reaching the X Date, the Treasury Department might attempt to prioritize some types of payments over others. Prioritized payments would be made on time, others would not. 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 programs that lawmakers have authorized. Under the best of circumstances, processing all payments on a day-to-day basis for critical government priorities—such as Social Security, Medicare, Medicaid, national defense, and salaries for the military—while at the same time declining others would be a logistically excruciating task.
The Treasury Department may have the technological capability to prioritize interest payments on the federal debt over other obligations, a possibility that reinvigorated the prioritization debate in 2014. Under such a scenario, the New York Federal Reserve would make principal and interest payments, while the Treasury Department would not make any other kinds of payments. In fact, such an idea even led some members of Congress to introduce legislation that would have required the Treasury Department to prioritize debt payments and certain other crucial obligations.
In an alternative scenario, the Treasury Department could wait until enough revenue is deposited to cover an entire day’s obligations and then make all such payments at once. For example, upon reaching the X Date, it might take two days of revenue collections to raise enough cash to make all payments due on Day 1. Thus, the first day’s payments would be made one day late, which would, in turn, delay the second day’s payments, and so on. Delays would grow until the debt limit was extended. Since debt operations—interest and principal payments—are reportedly handled by a separate computer system, these payments could likely still be prioritized under this scenario. During the 2011 debt ceiling crisis, some Treasury Department officials believed this to be the most plausible and least harmful course of action among a variety of perilous options.
When evaluating these scenarios, it is important to remember that crossing the X Date would be an event unparalleled in our nation’s history, so uncertainty and risk abound.
First, under any hypothetical prioritization scenario, the federal government would be failing to meet some of its obligations. There is no legal precedent for choosing to pay certain bills before others. Immediate court battles would likely arise over the legality of paying, for example, foreign bondholders over American citizens. What would be the logical interpretation of a court ruling in favor of a legal claimant? A default on the full faith and credit of the United States?
Second, given the sheer number of daily payments, prioritization of any obligations beyond interest and principal on the debt would require a massive—and potentially impossible—overhaul and reprogramming of the Treasury Department’s computerized payment systems. This would be unlike any prior operation. To believe that the federal government could pull such an effort off seamlessly with limited time for preparation requires a lot of faith in the bureaucracy. Even if prioritization is feasible, errors would be certain, and fingers crossed that debt payments would remain unimpacted.
Third, the current federal budget deficit poses an additional hurdle to any prioritization plan. The gap between expenditures and revenues means that either a large share of bills would go entirely unpaid (until the debt limit was extended) or delayed payments would quickly pile up. What is certain is that millions of households, business owners, and other entities would be stuck waiting on their payments from the federal government. In addition to the direct financial stress they would face, their counterparts—a landlord awaiting rent or another vendor in the supply chain—would quickly feel the impact as delays spread throughout the interconnected U.S. economy.
Finally, perhaps the most critical risk of prioritization relates to the potential discipline imposed by financial markets on the U.S. for what would likely be perceived as an irresponsible outcome driven by politics. In fact, S&P downgraded U.S. debt in 2011 for getting dangerously close to the X Date—not because of any financial degradation but rather because the political system had stooped to a level that was deemed to make timely payment of debts slightly less guaranteed. Consequences at the time were limited, but if a second ratings agency followed suit this year, it could have dramatic implications for investment funds that are only allowed to hold the highest-rated securities.
Another form of market discipline would materialize if investors became nervous about the developing situation and decided against participating in the Treasury Department’s auctions of new securities. At a minimum, this could raise interest rates and the cost to taxpayers for ongoing federal borrowing. More concerning is its potential to disrupt financial markets, as the surefire underpinning of the global economy is called into question. The worst—albeit unlikely—case would be an actual failed Treasury auction, where the U.S. is unable to sell its debt, which allows it to roll over maturing securities.
In short, market participants are unlikely to view prioritization as a practical way for the Treasury Department to manage an economic crisis. Rather, investors would see prioritization for what it is—the first time in modern history that the U.S. fails to pay its bills.
Of course, the least risky path forward—congressional action before the X Date—would obviate the need for speculation about the outcome of prioritization. The two parties, however, remain at odds over how to move forward. Democrats omitted language to address the nation’s ballooning debt from their budget resolution, and Republicans have vowed to oppose any increase of the debt limit through regular order.
Members of Congress must weigh the potential costs of a default—even one managed through prioritization—against any perceived benefits from extending their negotiations beyond the X Date. The fact that such a decision is even on the table, and that we return to it year after year, demonstrates the need for reform. Congress should take the opportunity to de-risk the debt limit once and for all by replacing brinksmanship with an alternative structured process to consider proposals for debt reduction, thereby preventing such post-X Date scenario planning from ever being needed again.