Janet Yellen Had Better Have a Secret Plan for the Debt Limit

It's happened before: In 1985, Treasury Secretary James Baker had more than one such plan, and his use of them prevented economic disaster.

Dear readers,

In the fall of 1985, there was a debt limit crisis not too dissimilar from the one we’re going through right now. Not only did we run up close to breaching the borrowing cap, the negotiation over raising the borrowing cap was tied to a negotiation over a multi-year agreement for deficit reduction. All the while, the Reagan administration was issuing warnings about what would happen if the Treasury Department ran out of room to borrow, which it expected to happen at any moment.

I am kind of obsessed with the 1985 crisis because I think the way it played out contains a number of lessons that are important today. The main lesson I want to focus on today is: Actually failing to make debt payments is unlikely ever to be the best option available to the Treasury Department. This is why Reagan’s Treasury repeatedly threatened to miss payments, but never actually did so. Whenever a default deadline would hit, they always found a way to keep the funds flowing.

Check out how the warnings changed over time. Here’s The New York Times on October 8, 1985:

The Treasury Department, trying to put pressure on Congress to raise the Government's debt ceiling and pass a companion bill calling for a balanced budget by 1991, said today that as early as [today] the Government would order banks not to honor its own checks…

[Treasury Department spokesman Arthur Siddon] acknowledged that the Treasury had changed its approach from Sunday, when Mr. Siddon said the Government would not issue checks if it it did not have the funds. Today Mr. Siddon said the position was changed because the Treasury found it could not determine at what point to stop issuing checks.

He said when the cash is exhausted, the Treasury would tell the Federal Reserve Board ''to notify the banking system not to honor any Goverment checks or electronic funds transfers.''

He went on to say that there was no way to distinguish among checks and payments, so that all of them, including Social Security checks, payments to military contractors and interest on Government securities would not be honored.

But three days later, Treasury had discovered its checks could still be honored, because of One Weird Trick:

The Treasury Department insisted today that a novel financing technique it used Wednesday to borrow $5 billion did not lift the federal debt above the statutory ceiling…

''I think they're going to have a big credibility problem when they send their next daily 'tremble' letter up here,'' [Senate Majority Leader Bob] Dole said, referring to a series of default warnings by Secretary James A. Baker 3d and Deputy Secretary Richard G. Darman.

A Treasury spokesman said the department had no response to Mr. Dole's criticism.

One of the pieces of conflicting information involved the timing of a novel securities swap the Treasury was forced to make — redemption of Treasury securities held by the Civil Service Retirement and Disability Fund and the substitution of new securities issued by the Federal Financing Bank. The obligations of the bank, a bookkeeping affiliate of the Treasury, are not subject to the debt ceiling…

Treasury considered the retirement fund a public offering and thus left the Federal Financing Bank able to issue only $10 billion more, which would provide operating cash for the government for about two weeks.

Then, when that $10 billion of borrowing capacity had been used up, Reagan’s Treasury found another way to keep borrowing. The Times reported on November 2:

The Treasury on Friday night canceled $13 billion of Government securities held by the Social Security trust funds to prevent the Federal debt from exceeding the statutory limit.

The action became necessary at midnight because Congress could not agree on legislation to raise the debt ceiling above its current level of $1.848 trillion.

The maneuver will enable the Government to cover Federal benefit checks that went out on Friday and others that will go out on Monday, and, according to Treasury officials, will leave the Government with sufficient cash to meet expenses until Nov. 15.

Canceling the bonds issued to the Social Security trust funds allowed the Government to borrow an equivalent amount in private markets while staying below the debt ceiling. The extra borrowing was needed to provide the cash necessary to meet Government obligations.

Later in November 1985, Congress passed and the president signed an interim increase in the debt limit, and in December they made a longer-term deal that included significant and binding targets for deficit reduction.¹ The accounting gimmicks didn’t obviate the need to raise the debt limit eventually, or the need to enact substantial policy changes along with the increase, but they did ensure that we didn’t have an economic calamity on the way to making the deal.

I wrote last week about the four different outcomes that can arise when the debt limit is reached. Repeatedly, Reagan’s Treasury threatened some form of what I call Option 1 — an indiscriminate failure to honor payments due, potentially including interest payments on government bonds. And yet, when push came to shove, they repeatedly chose what I labeled Option 3: using accounting techniques to continue borrowing without technically violating the debt limit law. Say what you will about these technicalities — as the Times described at the time, a lot of members of Congress were none too pleased about the moves — they were obviously preferable to allowing checks from the Treasury to be dishonored.

Now let’s look at what Treasury Secretary Janet Yellen is saying about what would happen if the debt limit is not raised before the “X-date” — the day, expected to be in early June, when the federal government would run out of the spending capacity it has under the current debt limit with the current set of “extraordinary measures” the Treasury uses to manage its cash.

U.S. Secretary of the Treasury Janet Yellen leaves after speaking during the 2023 Independent Community Bankers of America Capital Summit on May 16, 2023 in Washington, DC. (Photo by Alex Wong/Getty Images)

At a Wall Street Journal conference this morning, Yellen declared: “If Congress doesn’t act to raise the debt ceiling, and if we hit the so-called ‘X-date’ without that occurring, there will be some obligations that we will be unable to pay.” If Yellen is not bluffing, then her statement would foreclose Option 3 (gimmicks) and Option 4 (overt defiance of the debt limit law), since these are both strategies to pay every bill that comes due. She also declared that Option 2 (strategic prioritization of certain payments over others) is technologically infeasible. So her threat is equivalent to the threat the Reagan Treasury was making in early October 1985: if we don’t raise the debt limit, we will fail to pay, and that failure will be indiscriminate.

Yellen went on to note that this would be really bad, saying, “We will default on some obligation, and that's really not an acceptable state of affairs. It threatens the strong recovery that we have in the US economy; it threatens financial markets.”

This last part is obviously true: An indiscriminate payment default would have terrible economic consequences. I would additionally note that it would break the law. Just as there is a law limiting the total face value of government bonds outstanding, there are also a variety of laws (and some constitutional provisions) requiring the Treasury to disburse certain funds. If the Treasury Department fails to pay interest on government bonds, it will be breaking the law. If it fails to disburse funds Congress has instructed it to disburse, like Social Security checks, it will be breaking the law. I understand the government sometimes does things that are illegal — I think the president’s student debt forgiveness plan is illegal — but surely we should expect the Treasury to exhaust its legal options before choosing an illegal one, especially when the illegal option would also be really bad for the economy and the president’s political position.

And this makes me wonder: When Janet Yellen says “there will be some obligations that we will be unable to pay” absent a debt limit increase before the X-date, is she for real? As you can see in the news articles quoted above, when Reagan administration officials made similar claims in October 1985, they were not for real, and Bob Dole got quite grumpy about their dissembling, though that didn’t stop him from being one of the parties to a deal to resolve the debt limit crisis just a few weeks later.

Another thing Janet Yellen said this morning, when pressed on exactly how a default on payments would play out, was: “I'm not going to get into what exactly is possible and what is not possible.” Again, here is a parallel with the Reagan team in 1985: President Biden wants a deal, and if the Treasury Secretary was out there saying she has a plan to keep the markets calm and orderly if a deal isn’t reached, that would reduce the odds that members of Congress (in either party) would actually reach one. And who knows? Maybe the contingency plan she has isn’t very good, and won’t keep the markets in good working order or prevent a severe economic crisis. But if the plan is pretty good, I understand why she wouldn’t tell.

It does seem to me, though, that like in 1985, Treasury ought to have gotten itself into a position where it can push this thing out for a few more weeks without indiscriminate payment default or economic calamity.

I am not making an argument for invoking the 14th Amendment to issue debt in violation of the debt ceiling. Even if you take the 14th Amendment to mean that bonds issued in violation of the debt limit law would necessarily be honored, that interpretation alone does not vitiate the debt limit law. It would still be the case that if Treasury can simultaneously honor the debt limit and comply with its various statutory and constitutional obligations to disburse funds, it must do so.

What I’m arguing for is gimmicks. There is a Washington Post report that Treasury is seeking to have government agencies manage cash, including by delaying certain payments, in a way that could push the X-date past June 15 — because estimated tax payments are due on June 15, getting that far would likely push the X-date well into July. If that doesn’t work, there are several strategies available — including premium bonds, consols, and the platinum coin — that comply with all relevant laws, including the debt limit, while allowing Treasury to make all the payments it owes. While these options are not without political or economic costs — they should not be Plan A — they are significantly less economically and legally troublesome than just failing to pay our bills.

The path of threats from the Reagan team in 1985 reflected a set of conflicting priorities: They wanted the threat of economic disaster to help push Congress toward a deal, but they didn’t actually want to allow an economic disaster. In early October, they claimed the government would stop sending out checks it owed. Then they claimed the government would imminently tell banks to dishonor its checks. Maybe that’s because they hadn’t yet thought up the accounting gimmicks they later decided to use, but I think it’s because they wanted to use the threat of default — and the economic calamities it would entail — to push Congress toward a deal. When that didn’t work, they reached into the drawer of gimmicks they’d previously claimed wasn’t available.

And I sure hope that’s what’s happening today.

If Biden and his economic team really do not believe they have a unilateral strategy to buy additional time on the debt limit, then their overall strategy around the debt limit has been idiotic. If that’s the case, they are backed into a corner: Republicans have little reason to moderate their demands for spending cuts and other policy changes, because they are willing to allow a payment default that would damage the economy in a way that would harm President Biden politically. This would make it nearly impossible for Biden to walk away from a Republican offer. If that’s the case, they should have shoved a debt limit increase through Congress using the budget reconciliation process last fall, even though it would have had significant political costs, taken up lots of floor time in the Senate, and interfered with other legislative priorities like the appropriations laws that are funding the government right now.

But if — like Ronald Reagan and James Baker nearly 40 years ago — the Biden team is bluffing about payment default, then what they are doing makes quite a lot of sense.

Because government spending needs to be reauthorized next year, there needs to be a spending deal with Republicans, and that need would exist even if there were not debt limit law. That spending deal will have to entail spending cuts; this is the consequence of losing an election. So long as Republicans do not really have a gun to the president’s head — if Biden knows he can get through the next few weeks, if necessary, with no debt limit increase law — then the inclusion of the debt limit in the negotiations does not put him or Democrats at any particular disadvantage compared to a more normal budget negotiation. Quite plausibly, Democrats would be in a worse negotiating position right now if they’d used reconciliation to raise the debt limit last year, because moving a debt limit increase through a partisan and time-consuming reconciliation process during last year’s lame duck session might well have interfered with the thing they used that time for instead: a successful bipartisan negotiation of Fiscal Year 2023 spending bills that entailed a substantial spending increase and set the high baseline from which Biden is now negotiating over next year’s spending.

And if you know you have tools available to stave off a payment default through June, that doesn’t necessarily mean you should disclose them in advance. Doing so could undermine a sense of urgency toward a deal that the White House wants to be felt on both sides of the aisle. If a deal isn’t reached promptly, that could force Treasury to use tools that, while better than defaulting on payments, would still cause significant turmoil in financial markets — suddenly dropping a lot of oddly structured bonds into the Treasury markets would be an action with real and negative economic consequences. Such moves would also uncomfortably politicize the Federal Reserve and the Treasury in ways that may not prove necessary if we can push everyone toward a deal this week. And even though Democrats loathe the idea of “negotiating over the debt ceiling,” I can see why they would feel pretty good about resolving the entire fight over spending levels for the rest of Biden's first term within the next few weeks, which is what rolling this negotiation into the debt limit fight may yet allow them to do.

I don’t know exactly what’s going on inside Janet Yellen’s head or her Treasury Department. But allowing yourself to get backed up into a situation where you have mere days to talk Republicans into a debt limit increase or else you’re going to break the financial markets by defaulting on government bonds would be so stupid that I find it very hard to believe that is what has happened. I have to believe that, like James Baker before her, she has some tricks up her sleeve, and that’s why the administration’s moves on debt and spending make any political sense at all.

A statistic I keep hearing — and repeating — as this crisis unfolds, is that the debt limit has been raised 103 times since it was first established in law, and every single time it was raised in time to avoid payment default. Sometimes, as was the case in 1985, this was achieved despite warnings that we might be mere hours away from payment default. And there’s something I’m not sure about. Have we gone 103 for 103 because Congress, despite its dysfunctions, has always gotten its shit together and acted just in the nick of time? Or have we gone 103 for 103 because the deadlines are fundamentally fake — squidgy enough that the Treasury can consistently find a way to move them back when the alternative is a payment default? I think the answer is the latter — but if it’s the former, I guess we’re about to find out.

Very seriously,

Josh

1. Ultimately, the Supreme Court threw out the binding targets as unconstitutional, but the understanding of the parties negotiating the legislative agreement was that the targets would have the force of law.