The Debt Limit and the Downsides of Avoiding Disaster
As a way of getting around the debt ceiling threat, Matt Levine has pointed out that Treasury can actually safely ignore the debt ceiling by issuing what might be called “Premium Bonds“. The idea is, in short, that the statutory debt ceiling refers only to the principal outstanding, not the amount of money raised. So Treasury could, if they were so inclined, sell a bond with a $100 face value for $275. Instead of the standard 2.6% interest, you’d use a 23% coupon as a way to actually pay this back…and then when redemption time comes around, it is redeemed for the $100 of face value.
The Premium Bond Solution has the benefit of not provoking a constitutional crisis like simply blowing through the debt ceiling, and unlike the platinum coin solution is unquestionably legal and not completely goofy. Moreover, the debt in question is on unshakeable legal ground – there’s no reason for investors to believe that the debt is being issued in contravention of the law and it seems basically certain that an auction would proceed without problems.
This seems like such a clear way to proceed that I have to believe this is the White House’s first option in the event of a debt-ceiling breach. It defuses the debt ceiling permanently as a method of hostage-taking, it doesn’t create a constitutional crisis, and it produces debt the legality of which should be unimpeachable. Unlike the President, who might very well be impeached by the House. But an impeachment movement that goes nowhere seems pretty manageable compared to the horrors of a default on US debt for no particular reason.
The downside of the Premium Bond Solution is mainly relative to a theoretical negotiated solution. Premium Bonds will no doubt poll poorly and be perceived as something vaguely shady on the part of the White House. Since people don’t judge these things against the counterfactuals of financial or constitutional crises, I expect it will be a move met with general disapproval. We would expect to see an uptick in unfavorables for President Obama, and most likely an uptick in support for the GOP in the short term. This will likely encourage them to keep the government shutdown going, which will continue to harm the economy in general and federal workers in particular.
There’s this notion in game theory called the “Best Alternative to a Negotiated Agreement“. It is when two parties (in the sense of people/groups, not political parties) are attempting to negotiate an agreement, like, for example, not defaulting on the US debt. Parties won’t accept a negotiated outcome worse than their BATNA. Unfortunately, a solid backup plan like Premium Bonds makes a crisis much more likely. The Democrats need to not concede anything on the debt limit lest this become a pattern. The Republicans want them to concede something for the same reason. Neither wants to cause an economic catastrophe. If the Democrats have a way to avoid economic catastrophe, and the Republicans both suspect it and hope to make hay out of it…well, there’s not much hope for a negotiated agreement then, is there?