A Debt is a Debt is a Debt: Exotic Bonds are No More Legal than Jumbo Coins or Refusing to Pay Our Obligations

Posted in: Tax and Economics

The constitutional crisis caused by the Republicans’ attempts at extortion via the debt ceiling has now increased from a simmer to a boil. Within a matter of only a few weeks (as early as June 1), President Joe Biden could be left with no course of action that is legal—including “doing nothing,” which is in fact its own kind of illegal action, as we will explain shortly.

In the face of such high stakes, with nothing short of economic Armageddon being very much a possibility, it is understandable that people would want to find a workaround that would allow this Democratic President finally to stop the radicalized Republican Party from continuing to put us through these dangerous hostage crises. It would, indeed, be wonderful if there were an option that is “perfectly legal” and thus could finally neutralize Republicans’ nihilistic tactics. If only.

As sympathetic as we are to those who wish to find an escape hatch, none exists. If the debt ceiling is not increased before the Treasury has exhausted all of the “extraordinary measures” that have staved off the crisis thus far, the White House will have nothing but illegal options from which to choose.

We emphasize here that our own preferred course of action for the President, which we will summarize below, is indeed one of those illegal options. That is why we have continually referred to it as the least-bad or least unconstitutional option. But being the lesser (or least) of evils does not make it good.

Our main contribution in this column, however, is to explain why none of the options—exotic or banal—that anyone has offered will achieve the supposed goal of the entire exercise: preventing the US government from exceeding the debt ceiling. To put it bluntly, unless House Republicans blink (or President Biden does, thus incentivizing perennial debt-ceiling terrorism), the federal debt will exceed the current legal limit on or about June 2, full stop. No cleverly designed financial instruments, no coins, no “prioritization,” nothing will stop that from happening. Laws that have already been passed guarantee it.

And because that is true, Republicans cannot in fact prevent the debt from rising above the ceiling. They would only guarantee that some people would be needlessly harmed, the entire economy weakened, and the financial markets turned upside down—all while failing to notice that the debt ceiling did not in fact put a limit on debt in the first place.

Financial Cleverness Does Not Turn Debt Into Not-Debt

In our two most recent co-authored Verdict columns (here and here), we explained why one of the oddball stratagems that has become popular among a small but loud group of people on the political left (with whom we frequently agree on many other matters of policy) is not the “perfectly legal” genius move that its backers claim it to be. The supposed loophole that they want to exploit, having the government mint one or more platinum coins of arbitrarily large values (in the trillions of dollars), simply does not exist.

More to our current point, we also noted that the platinum coin gambit simply does not work as a matter of preventing the government from exceeding the debt ceiling. Indeed, even the most prominent advocate of the gambit, New York Times columnist and star economist Paul Krugman, inadvertently admitted as much when he recently wrote that minting platinum coins “would in effect simply be borrowing through the back door.” This is because the Treasury would deposit the coins with the Federal Reserve, and the Fed would only accept them on the condition that the government replace them with standard Treasury securities after the crisis is resolved. The coins thus create an obligation on the government, which is what debt is, both as a matter of common sense and as defined by the debt ceiling statute.

The platinum coin is not the only idea being sold as debt ceiling kryptonite. Pundits have come out of the woodwork over the years with various versions of a plan to have the Treasury use some kind of new or special-use security, which would supposedly allow the government to continue to pay the bills (a good thing, of course) but to do so by pretending that the new securities are not debt. Again, no dice.

Because financial engineering allows for endless tinkering with arcane details, there are a number of variations on what we might call Magic Bonds, which have been offered to serve the same role that the platinum coin is supposed to play: borrowing money in a different form, sidestepping the debt ceiling statute, and supposedly saving the day. We will focus on only one of those variations, because it is both the least complicated to explain and shares the same fatal flaw as all the others.

In this case, the “new” idea is not truly a matter of creating a never-before-seen type of financial instrument. It is new-ish, however, in that the US government only issued a limited number of such instruments between 1877 and 1930 and has not done so in almost a century. The gimmick in question is called “consol bonds,” which the British government was issuing long before the United States won its independence in the late eighteenth century.

With the sale of a consol bond by a government, the buyer gives that government X dollars in return for the promise to be paid y dollars every year forever. No, the word “forever” in that last sentence is not a mistake. Consols are sometimes called perpetuities, because they are designed so that the government never pays back the principal amount but instead makes annual payments to the holders in perpetuity. When the consol is sold or willed to another person, the payments continue, even if the original owner is long since dead. Indeed, until the British government decided to buy back the last of its consols in 2015 (by purchasing them at market value), it had been making scheduled payments like clockwork since the mid-1700s.

That arrangement is not as weird as it might seem, however, because in substance a consol bond mirrors a plain-vanilla savings account. That is, a person could put $100 into a deposit account with a bank, and if the bank pays three percent interest, the person would be able to withdraw three dollars per year forever. Savings accounts differ in that their interest rates can vary over time and because the saver can withdraw any or all of the principal, but those distinctions are immaterial to the current analysis. The fact is that a person can guarantee future payments in perpetuity simply by depositing money in a bank and leaving it there, withdrawing only the annual yield.

The structure of consol bonds also makes it very easy to determine their value. When one of the current authors (Buchanan) used to teach economics courses at the university level, consols were a favorite hypothetical financial instrument, because the arithmetic for determining their value is shockingly simple. If a consol promises to pay, say, 100 dollars per year, and alternative investments are paying four percent in annual interest, a consol would be worth the annual payment divided by the interest rate, or 2500 dollars.

That means that, even though consols never pay back the original principal that was paid to buy the bond, the infinitely long stream of future payments has a finite value. The claim that we cannot put a value on such bonds because they have no redemption date is simply wrong.

We do not, however, even need to get that far into the financial weeds to understand why issuing consol bonds would not allow the government to evade the debt ceiling. Even if we did not know the equation for valuing such a bond, we would know how much the government sold them for at issue. That is, if the government needed to borrow a trillion dollars by issuing consols, it would set the annual perpetual payment and then start selling the bonds until it had borrowed a trillion dollars. How much would those bonds be worth? Well, how much did the government sell them for? One trillion dollars.

The Debt Ceiling Statute is a Well Written, Bad Law: The Workarounds Do Not Work

Sometimes, however, the underlying economic reality of a transaction is different from what the law recognizes. Congress has, for example, allowed businesses to deduct depreciation expenses far in excess of the true economic costs of depreciation. Financial disclosure laws similarly allow corporations to leave some items “off book” for various purposes.

Is something like that going on here? In other words, even if the platinum coin is debt as (correctly) seen through the eyes of an economist like Krugman, could it nonetheless legally be non-debt? Are consol bonds or any of their cousins not debt in a formal sense, for some obscure legal reason? Again, that does happen at times, but it did not happen here.

The debt ceiling was originally designed to rationalize an utterly chaotic budget process, changing the system so that Congress needed to authorize borrowing only occasionally rather than on a near-daily basis. No one at that time could have foreseen that the law would be twisted in the way that Republicans have abused it in recent years.

In any event, the people who wrote and periodically revised the law were fully aware that it might be possible to evade the debt ceiling statute by engaging in creative legal and financial games. They responded accordingly. The debt ceiling statute is a bad idea, but it was not sloppily drafted.

In its current form, the debt ceiling statute (31 USC § 3101: Public debt limit) in subsection (b) puts an aggregate limit on “[t]he face amount of obligations issued under this chapter and the face amount of obligations whose principal and interest are guaranteed by the United States Government.” Aha! say the people who want to find a way around the debt ceiling, What if we design something that has no face value? No face value, no debt!

Even if the drafters of the statute had in fact left the foregoing language as an inviting loophole, that would not be the end of the inquiry, because gap-filling doctrines would still most likely limit how creative one could be in exploiting such a loophole. Here, however, the statute carefully defines the key term, stating in paragraph (c)(1) that the face amount is “the original issue price of the obligation.”

That means that if Treasury were to issue consol bonds or anything else, the amount of money that the government receives from such sale (that is, the price that the buyer paid to the government in exchange for the future payments) is included in the debt. So, we could indeed see Treasury raise any amount of money it chose by selling unusual assets, but all of it would count against the debt limit. And as we noted above, that would also apply to the amount of money that Treasury received from the Fed for depositing a platinum coin. If the Fed credits the government with a trillion dollars, that is a one trillion-dollar addition to the debt, as defined by the debt ceiling statute.

Failing to Pay People Still Leaves the Federal Government With More Debt

All of which brings us to the question of what would happen if, on June 1 (or whenever we truly reach the debt ceiling), President Biden were to follow the conventional wisdom and say something like this: “I wish Republicans had increased the debt ceiling, but they didn’t, and I have to follow the law as it exists, not as I wish it were. So I have no choice but to stop paying people in full and on time, because the law doesn’t allow any other option.”

In an op-ed that was prominently placed in this past Sunday’s New York Times, Professor Laurence Tribe summarizes a series of arguments that we have made over the years, endorsing our conclusion that—because it is also illegal not to pay obligations in full on the dates that they come due—the least unconstitutional option would be for the President to obey the appropriations and tax laws, even though doing so requires violating the debt ceiling. Obviously, we agree.

For current purposes, however, we want to emphasize another of our arguments that Professor Tribe echoed toward the end of his column: “[E]ven if Speaker Kevin McCarthy and those pulling his strings succeed in making some of those creditors wait, it wouldn’t eliminate our debts; it would merely replace them with i.o.u.s. And that’s just debt in another form.”

In other words, regardless of whether or not President Biden has Treasury “prioritize” who will not be stiffed on the relevant due dates, that money will still be owed to people and entities that are stiffed. If a plumbing contractor, for example, was supposed to receive a million dollars in payment for replacing the toilets in the Capitol Building, Biden would not say: “Because we can’t borrow the money to pay you today, we’re never going to pay you.” He would instead say, “We’ll pay you as soon as we can.” That is debt.

We noted this obvious fact in a Columbia Law Review article in 2014 (building on a column from the prior year). And here again, the statutory language that we cited above follows common-sense economics with respect to definitions. It does not limit “debt” narrowly but “obligations” broadly. Therefore, unless the idea would be for the President to commit an even more egregious legal violation by outright repudiating the government’s obligations, that unpaid debt would stand and be added to the gross federal debt.

As a particularly bad direct result, this would mean that rather than finding voluntary lenders by selling Treasury securities on the open market, the government would be forcing people against their will to become creditors to the federal government.

Finally, there is the Prompt Payment Act. That law requires the federal government to pay bills in full and on time, and it states that any obligations that are unpaid are to be treated as “debt” and that those unpaid obligations must be repaid not only in full but with interest.

In the end, and with apologies to Gertrude Stein, a debt is a debt is a debt. No amount of financial legerdemain, invention of loopholes that do not exist, or anything else will give President Biden an out by which he can avoid disaster through legal means. Even if he stiffs people, he will not have avoided exceeding the debt ceiling—which, again, is what the entire exercise is supposed to be about.

The onus is still on House Republicans to pass a clean debt ceiling increase, suspension, or (dare we dream) repeal. If they do not, however, the President will have only illegal options, and none of those options can keep the debt from increasing to the level that our taxing and spending laws require.

If put into that impossible bind, President Biden should minimize the damage and simply issue normal Treasury securities, preventing the United States from becoming a deadbeat nation. Doing so would still leave us in a crisis, but it is the least bad way to limit the damage from Republicans’ irresponsible political posturing.

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