Category Archives: Politics

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How To Avoid Default Without Raising The Debt Ceiling – Or Doing Anything Else

Welcome back to my lair! I’ve been very inactive, but I hope to write more as my life regains a little clarity.

I’ve been following the debt ceiling debate very closely over the last month, and I’ve been incredibly disappointed. The discussion has focused entirely on spending cuts and tax hikes, as if these are the only two ways to solve the problem. Some magic combination of tax hikes and spending cuts, or maybe just spending cuts, is expected to be a panacea, if only those damn politicians could reach an agreement! Everything is presented as a dichotomy: raise the ceiling or default. An economy crushing tax hike or nothing. Paying entitlements or ending Social Security and Medicare as we know it. The list goes on and on. This method of thinking is inherently flawed, and the lack of nuance will ensure that President Obama does not sign any deal until 11:59 PM on August 1.

But that’s not what I’m here to discuss. I’m here to propose the ultimate compromise – a plan that absolutely no one in the mainstream media has mentioned. A plan that would not raise taxes. A plan that would not cut spending. A plan that would avoid default. A plan that would keep America running beyond the 2012 elections, without even having to raise the debt ceiling one dime.

I’m talking about raiding the Social Security trust fund.

This is a measure that sounds, by all accounts, extreme. Until you understand the economics behind it, of course. The Social Security trust fund is a giant pot of treasury bonds – about $2.6 trillion worth. Those treasury bonds represent decades of surpluses – each year, Social Security collects about $100 billion more in taxes than it pays out in benefits. Instead of putting the extra cash in a pot, the cash is exchanged for treasury bonds, which go in the trust fund. The extra cash is then treated as any other tax revenue, and spent along with the general fund. So the precious trust fund that has become the third rail of American politics is nothing more than a stack of IOUs. But if you think about it, so is cash.

Here’s the key realization. The treasury bonds in the Social Security trust fund are both assets and liabilities. The economists in the room nod their heads, and the rest look up like lost puppies. What exactly does this mean?

-Assets: the bonds, while not money, represent a claim to real money, just like any other bond. Any treasury/municipal/corporate bond can be sold for its face value, discounted by the annual interest rate. Anything that can be exchanged for money is an asset.

-Liabilities: the bonds make up just over one sixth of that $14.3 trillion debt limit we’re approaching. They are money the government owes someone. That someone happens to be itself.

Let’s be realistic. When’s the last time your friends called you up for a night on the town, and you said “Gee, I’d love to, but I just owe myself too much money”? Never. Because owing yourself money doesn’t mean a damn thing in the practical sense. The money isn’t there. Poof! We spent it.

But if the money isn’t there, how can we steal it? One of two ways:

  1. Declare a default on the entire trust fund. This is an actual default, and as such, is bad. It would allow the government to issue $2.6 trillion in new treasuries, which at the current rate of deficit spending, would last about 2 years. No one is really affected, because the money has already been spent. Both the assets and liabilities on the SSTF balance sheet are erased with one stroke of the pencil.
  2. Sell the treasuries in the trust fund. This would not be a default, and as such, is good. By selling the treasuries to the market, the government would turn $2.6 trillion in IOUs into $2.6 trillion worth of actual money, which it could then use to fund some beautiful deficit spending, again for about two years. The downside of this is, while not an actual default, it still floods the market with bonds, pushing interest rates up. But interest rates are the lowest they’ve ever been, barring the depression era. They could use a nudge in the right direction – up. I’ll let Patrick explain this one.

So, if it’s this easy, why haven’t we done it before? First, because the seniors will crucify any politician that tries. Old people are generally stupid and greedy – their love of government handouts blinds them to the fact that the trust fund doesn’t mean a goddamn thing, and defaulting on it won’t change their benefits in any way. The second reason is a little more practical – interest bearing bonds are a better investment than plain cash. But when you realize that the government owns both sides of the balance sheet, the interest rates don’t mean a damn thing either. The interest rate is nothing more than an accounting trick – the government can declare the rate to be whatever it wants, as long as the surplus or the general fund can pay for it. Getting more money sounds awesome – unless you’re also the one paying it.

The third reason is the most practical of all – it’s illegal. Current law forbids Treasury from raiding the Social Security trust fund. (Federal pension funds weren’t so lucky, as Tim Geithner has been raiding them this exact same way since May.) Of course, current law can be changed, but thanks to fallacies 1 and 2, it’s a bit tricky.

As always, there’s a workaround. Public law 104-121 allows the Treasury to pay out Social Security benefits even in the event of a default. The Treasury is allowed to “redeem prior to maturity amounts in any Federal fund which are invested in public debt obligations… [for the purpose of] payment of benefits or administrative expenses.” So raiding the trust fund is OK, as long as the money is used to pay benefits. This is what will have to be done anyway in a few years, when benefits exceed revenues and the trust fund starts losing money. Did I say a few years? I meant now. Thanks for that FICA cut, Obama!

So, what this means is that the government can use the Social Security FICA revenue to pay its deficit, while selling treasuries from the trust fund to pay out benefits.¬†Patrick?¬†Thanks. This would cut the deficit by about $800 billion a year, meaning we would need to cut other spending or raise taxes by $400-500 billion. (Easy enough when spending is $3.7 trillion a year.) But it would also be a better band-aid, lasting 4 years instead of 2. And best of all, no legal wrangling. Every politician can get what they want: full payment of Medicare and Social Security benefits, no tax hikes, no debt ceiling increase. A dealmaker’s dream, if you ask me.