Here’s How to Bypass the Debt Limit

Michael Santoli

Thu, Oct 3, 2013, 7:54 AM

Desperate times invite desperate measures and necessity sparks invention. So the dire prospect of a U.S. debt default has prompted a predictably extreme and creative set of proposed maneuvers to let the Treasury pay the bills should Congress fail to raise the debt ceiling before cash runs out.

Dismiss them as gimmicks, deride them as red herrings or laud them as ingenious work-arounds – the ideas for skirting Congressional authority to forestall default keep circulating among economic commentators.

Several months ago an improbable amount of momentum built behind the notion that the Treasury mint a platinum coin with a $1 trillion face value, deposit it with the Federal Reserve and draw on that to cover deficit spending. The idea arose from an obscure and ambiguous law apparently intended to allow the Treasury to meet demand for physical coins from collectors and savers. The Obama administration in January went so far as to publicly rule out the prospect in January before a debt-limit deal was ultimately reached in Congress.

Now a somewhat less bizarre scenario is being floated: Treasury, in theory, could issue bonds with an extraordinarily high “coupon,” or interest rate, which would sell at a large premium to their face value.

The proceeds of such a debt sale would far exceed the stated principal amount of the bonds, and provide the government with enough cash to roll over maturing debt and pay government expenses without violating the debt ceiling. That ceiling, by the way, applies only to the principal value of the debt.

The way bond pricing works is that the issuer sets the coupon and the market prices the bond in line with the level of prevailing interest rates. A bond with $100 par value and a 5% coupon pays $5 in interest a year. If rates fall to 2.5% --half of 5%--the bond would double in price to $200. The $5 in interest would account for 2.5% of the bond's price.

The idea, as detailed by Bloomberg View columnist Matt Levine, is that Treasury could offer, say, a 20%-coupon bond that would sell at far above par value, giving the government a financial cushion and avoiding technical default until Congress raises the debt limit. Some Twitter commentators have rallied to the cause, even suggesting they be called “Lew Bonds” for Treasury Secretary Jack Lew.

As discussed with Yahoo Finance Editor-in-Chief Aaron Task and Daily ticker host Lauren Lyster in the attached video, there is no evidence that the Treasury is seriously contemplating such a move. And the market acceptance of such a ploy could not be taken for granted.

It appears that only the Treasury’s bond-auction rules would stand in the way of this plan, and those presumably could be changed without Congressional input.

The Treasury has estimated that it will run out of borrowing authority in two weeks, though such a date could extend toward November depending on tax receipts, given a lack of large Treasury maturities in coming weeks. As the government shutdown drags into a third day, the tactical calculations of House Republicans seem to be moving toward mingling the fiscal budget talks with a debt-ceiling vote – a prospect that Wall Street dreads.

Commentators ranging from former Clinton-era White House chief of staff Erskine Bowles to Pimco bond-fund chief Bill Gross have characterized even a technical government default as anywhere from unthinkable to catastrophic for the markets, for which Treasury securities act as collateral for the entire banking and capital-markets system.

Morgan Stanley economist Vincent Reinhart offers that if the debt-limit isn’t lifted, the Treasury will face the prospect of violating one of three laws: The World War I-era statute that created the debt limit, the ban on direct lending to the Treasury from the Federal Reserve or the 14^th Amendment declaring that the legitimacy of U.S. debt must go unquestioned.

All the proposed evasive actions, far-fetched or not, serve to point out the arbitrary, anomalous and unnecessary debt-limit convention itself. It is a vestige of Congressional action a century ago, not a Constitutional requirement, and (as the President never tires of pointing out) amounts to forcing Congress to vote separately on letting the Treasury to pay for spending that Congress has already mandated.

One unknowable question is whether the very discussion of these backdoor plans to get around the debt ceiling is draining some urgency from the Congressional debate over authorizing a higher borrowing limit. By some accounts, when the Administration in January took the platinum coin option off the table and ruled out invoking the 14^th Amendment, the need to vote for the limit increase was more sharply felt.

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