One Way or Another, Wall Street Will Be the Republicans' Hostage in the Debt Ceiling Madness

-- Posted by Neil H. Buchanan

In my Dorf on Law post last Friday, I described the Prompt Payment Act (PPA) and its requirement that the federal government pay interest on any unpaid obligations to contractors who do business with the federal government.  More broadly, I noted that the President cannot legally "prioritize" payments to obligees, because he is required to pay each obligation on the day that it comes due, so long as there is money available on that day, no matter what obligations might be coming up the next day.

Suppose, counter-factually, that I were wrong about how the PPA works, or that there were no PPA-equivalent legal requirement that the President pay obligations to non-contractors (e.g., Social Security recipients) on their due dates.  That would not change the fact that any non-payment would clearly constitute the nation's first-ever default, but it might change the analysis of whether the President can prioritize who will be the victims of that default.  Or, perhaps more to the point, if the President is already forced into violating the appropriations laws, maybe he will decide that it is prudent to ignore anti-prioritization laws as well, to minimize the damage.

The Treasury says that the logistics of prioritization are simply impossible.  Millions of payments are made every year, and the ability to pull out the ones that are designated for special treatment is not part of the processing system that is in place at Treasury.  Again, however, let us put that inconvenient fact aside and simply assume (like the good economist that I am, sort of) that there is a way for the Treasury to implement a prioritization plan.  Will that make a government default less problematic?

Republicans are saying that the President should prioritize interest payments on Treasury's debt securities (bonds, bills, and notes), so that the financial markets will not lose trust in the full faith and credit of the United States.  Earlier this year, I wrote a Verdict column in which I noted the ridiculously bad politics involved in "paying the rich and the foreigners first."  For the moment, however, let us also assume away the political toxicity of prioritizing interest payments.  Would Republicans then be right that there is no problem with a default, that the world will keep spinning, so long as the default does not touch the bondholders?

Another way to ask that question is whether Wall Street would care if the federal government began to stiff other people.  I have argued many times that the financial markets would care deeply, because they would see that they could be next.  Seeing one's debtors defaulting on other debts hardly gives a creditor confidence that he will be paid in full and on time.

That argument, however, might require that Wall Street view a progression of defaults as inevitable.  (Wall Street would actually be more likely to worry about the toxic politics, but I have already set that aside here.)  Some Republicans note that the interest on the debt is only a small part of total spending, and that tax revenues will always be enough to cover that amount.  So, if Wall Street is last in the line of potential victims, financial players could possibly imagine that the sequence of defaults will never reach their doors.

Certainly, this is an argument that some Tea Partiers have offered.  One back-bencher from Louisiana said recently that "nothing happens" if the debt ceiling is reached.  Which raises two related questions.

First, if nothing happens when the debt ceiling is reached, then how is refusing to raise the debt ceiling a bargaining chip?  "Hey, either you do what we say, or we will do something that sounds bad but that really won't do anything!"  At best, this would mean that refusing to raise the debt ceiling is no different from a government shutdown, because it would simply be another matter of House Republicans refusing to pass legislation that is needed to authorize payments of various kinds.  Even though the debt ceiling would prevent payments that were authorized by Congress, this line of thinking has already designated those obligations as "not debt" and therefore not a default.  Therefore, under this theory, the debt ceiling is no better or worse than a shutdown as a bargaining chip.

I find that entire line of reasoning bizarre, of course.  But even if one were to accept the idea that protecting bondholders is all that is needed to turn a default into a non-default, the lack of political bite would paradoxically make it all the more likely that Republicans would eventually insist on putting Wall Street in front of the firing squad.  Why?  Precisely because, if one accepts Republicans' logic, they would otherwise get nothing out of refusing to raise the debt ceiling.

In other words, if it were technically possible to prioritize payments, and if it is numerically possible to pay all interest due with incoming tax revenue, and if everyone would yawn when non-interest obligations go unpaid, Republicans would need to find a real pressure point.  And, by their own arguments, the only pressure point is payments owed to financial market players who hold U.S. Treasury securities.  In order to have a credible threat, therefore, Republicans would have to hold Wall Street hostage, because (by hypothesis) Wall Streeters are the only people whom the rest of us would not want Republicans to shoot.

The logic on Wall Street, then, should not be: "There's always enough money at least to pay us, and we'll always receive special treatment."  It should be: "Econo-terrorists have taken over the building, and they're about to figure out that we're their best hostages.  In fact, threatening us is their only plausible strategy."

It is true that, in the real world, Wall Streeters would be confident that they can buy their way out of that kind of hostage deal.  But if we are moving the argument back to the real world, then all of the assumptions that I was willing to make for the sake of argument in this blog post go away.  The logistics of prioritization are iffy, at best.  The politics of paying Wall Streeters while the country suffers are impossible.  Default (correctly defined) would destroy the credibility of U.S. commitments, and markets would collapse.  Financial market players really would see the writing on the wall, long before the Tea Partiers actually figured out who they need to target.

But even in the fevered minds of those who claim that "nothing happens" if the debt ceiling is not increased, the unavoidable fact is that their strategy only works if Wall Street feels truly threatened and worries that something bad will happen.  One would hope that the people who bought Congress are smarter than the monsters that they created, and that they still have the power to stop those monsters from doing irreparable damage.