Whose Fault Default?

We need a little clarity: Default occurs when a debtor fails to meet a legal obligation.  Or to put it more simply: when you fail to pay a bill.  Now, the federal government has a host of bills: bills owed to a host of contractors for things (from desks and pencils to bombers and aircraft carriers), for services (from janitorial service to building maintenance to tippy top secret stuff people are doing for the CIA), and for money (the borrowing that everyone talks of, amounting to more than $17 billion.)

In addition to these debts, the federal government pays out a great deal of money to what are euphemistically known as entitlements, that is, those receiving it are ‘entitled’ to them, without providing any goods or services.  Strictly speaking, many of these are not debts.  Failure to provide aid to unwed mothers may seem unsavory, but if the US Government did so, it would not constitute default in the financial sense.

Further, there is a legal hierarchy for debt.  At the top of that hierarchy are outside debtors.  Thus, no company can refuse to pay a mortgage based on the claim that they must pay their workers first.  The bank that owns the mortgage comes before the employees.  So, with the US in debt to the tune of $17 billion, total annual payments to service that debt come before any other payments.  For the year 2013 total interest is a bit short of $416 billion.  This works out to about $35 billion per month. Thus, the US need only pay that amount, plus the payoffs for the various Treasury notes – some 20 and some 30 year notes – that will come due (mature) each year; so, we add perhaps another $700 billion, or $58 billion per month.  Thus, for some $95 billion per month the US will not default.

Does the US have $95 billion per month?  Absolutely.  US tax revenue will total about $2.6 trillion for 2013, or about $215 billion per month.  So, we – the US – can pay our debts and still have $120 billion per month to spend on critical issues.  No default.

Repeat that: no default.

So, how could we default?  For the near term (the next few years), there are only two ways we could default:

1)    The Treasury / IRS stop collecting taxes. How that would happen is a mystery, but I suppose it is possible, perhaps UFOs land on the Mall and the aliens take control.  Short of that, it seems pretty unlikely, in as much as the federal withholding tax process has a stranglehold on everyone’s income.

2)    The Treasury decides to stop paying the debt as it comes due.

It should be noted that #2 above is illegal.  It would require a willful act on the part of the Secretary of Treasury, he would have to make the decision to pay out money into other programs before he paid money to service debt.  That is illegal under US law.  I have to assume the Secretary of Treasury knows this, as does, I assume, the President.

Which leads to simple question: Why did both Secretary Lew and President Obama both say that the current tempest in Washington risked pushing the nation into a default?  Is it possible that President Obama and the Secretary Lew don’t know that most basic of laws: that debtors must be serviced first?  Secretary Lew and President Obama are both lawyers.  Certainly they know the law.  Secretary Lew has worked both at the Office of Management and Budget and at CitiGroup.  I suspect he knows fairly well the law as it pertains to debt and bonds.  President Obama is a Constitutional scholar.  And he has regularly commented on the law as it pertains to debt and in particular the national debt.  In March 2006, when US debt was $8 trillion (less than half of where it now stands), one  senator commented:

"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 US Government cannot 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.  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."

That was the then junior senator from Illinois, Barack Obama.  Presumably, then Senator Obama was not advocating default, he was simply saying that the US should live within an $8 trillion debt.  Since then US debt has doubled, 7 of the 9 trillion coming at the hands of President Obama; and it promises to increase at nearly $1 trillion per year for the next 10 years – if we adhere to President Obama’s spending plans.

So, how is it that then senator Obama felt that the right thing to do was oppose a debt increase and now President Obama says that to do so risks default?  Is it that he no longer understands the issue, that such an act cannot precipitate default unless the government actually decides not to pay?  Or is it that he is fear mongering?  Whatever the reason, one thing is certain, it certainly doesn’t constitute the leadership he spoke of 6 years ago.

For the record, the US has defaulted in the past.  As recently as April and May of 1979 the US Treasury failed to make payment on time – it was an internal bookkeeping mistake.  They later made up the payments, but there was a default.  We have also in fact defaulted a number of times via de-linking the dollar from gold and letting it float – thereby reducing the value of all debts (1971); or by changing the value of the dollar such as when FDR restated the value of a dollar as 1/35^th of an ounce of gold (1933).  In short, this has happened before.  It is not an over the edge catastrophe, it is a gradual, corrosive event that undermines the whole society.  John Adams – and others – stated that at the heart of Western thought lie two ideas, inextricably tied together: the contract, and personal property.  The concept of contract means that we can individually bind ourselves, that we can make an agreement with someone else and having done so we must comply with the terms of our agreement (with all the normal exceptions – you must be competent, it must not be an illegal act, etc.)  And, there must also be personal property, that is, there must be something of ours – land, equipment, ideas, money, our labor – that are the things that are exchanged.  Undermine either one of these concepts and you threaten all the rest of the huge structure that is Western political thought.  And that, it would seem, is what the President is playing with.