The Default Threat: Rationalization and Obligation, Part III: Premium Bonds, and Asset Sales
In Part I of this six-part series I presented the President’s explanation of why he can’t use alternative options for coping with the default threat arising out of refusal to raise the debt ceiling, a summary of the kinds of difficulties characterizing it, and discussed two of seven options, selective default, and the exploding option, the President has to deal with it, apart from the way he seems to have chosen. In Part II I discussed the next three options, platinum coins, 14th amendment, and consols, and commented on the legal issues related to them. Here, in Part III, I’ll cover two options which have started getting attention most recently.
6. Premium Bonds (See wigwam’s discussion):
“. . . are those whose interest rates are sufficiently high relative to their principal that they are expected to sell at a premium (i.e., negative discount), bringing their full issue price (principal plus premium) to the Treasury while adding only their principal to the national debt.”
Matt Levine explains the idea in more detail here, and here. But what it amounts to is that the debt subject to the limit is the total face value of all the unredeemed fixed maturity date debt instruments of the United States. So, if the Treasury auctions off a bond and sells it for more than its face value, then it gets enough money to not only roll over debt equal to the face value, but also to pay down additional debt, or deficit spend, as well. But, how can it sell a debt instrument by more than its face value? The answer is to offer interest rates higher than the rates offered for conventional bonds.
How high the rates would need to be, and the duration of the premium bonds offered, would need to be determined by how much in additional funds would be needed to stay under the debt ceiling and spend all appropriations. Levine suggests a “. . . 10-year at a 1.836% yield and the 30 at 3.026%” for example. So, interest rates for the premium bonds would not have to be sky high. Nevertheless, there is a problem with the idea of premium bonds:
”Of course then you’d have to pay the interest! This would be a fairly short-term solution; after a year of doing this you’d be incurring an extra $250+ billion in interest payments that you’d have to fund by issuing ever-higher-coupon Treasuries, leading I suppose to a death spiral. If I were doing this on a tabula rasa I’d probably bump the interest rate a bit at the cost of deferring payments for a year or two, making this a breathing-room rather than permanent solution, but obviously the further you get from regular-Treasury-bond structure the weirder this looks.”
And there is another problem too. The Federal Reserve controls interest rates in the United States by targeting its Federal Funds Rate, which is currently very near zero. This rate in turn influences Treasury offering which are only a bit higher for short-term debt instruments, and progressively higher for longer-term instruments. These rates, in turn, percolate throughout the economy and keep interest burdens where the Fed thinks they should be in the current fragile economy. However, if the Treasury begins to offer securities at much higher interest rates, than this will affect other investments throughout the economy that will have to offer rates higher than Treasury premium rates throughout the economy. In short, premium bonds will undermine Fed monetary policy even as they stave off default.
Kevin Drum also offers some negatives to the premium bonds idea after remarking favorably on it. He hints at legal difficulties and wonders about what a judge would say about it. But he has no real legal objection to this. He also remarks on the confidence issue. I’ll take that up below.
Sales of material and cultural assets to the Fed,
7. The last option, sales of material and cultural assets to the Fed, just arose out of a multi-party e-mail exchange about debt ceiling issues. Warren Mosler pointed out:
the coin is about the fed buying an asset from the govt.
they could buy other gov assets as well? national parks? military equipment? spr? etc. etc. any asset sale to the Fed by the gov. works same? legal restrictions?
And L. Randall Wray expanded on the idea and shortly thereafter blogged this piece offering the following proposal, a bit tongue in cheek.
. . . We’ve got museums and national parks shut down. Why not sell them to the Fed? We can find a few trillion dollars of Federal Government assets to sell–and the Treasury can pay down enough debt to postpone hitting the debt limit for years. Heck, if we run out of Parks and Recreation facilities to sell, why not have the Fed start buying up National Defense? How much are our Nukes worth? That should provide enough spending room to keep the Deficit Hawk Republicans and Democrats happy for a decade or two.
This proposal shares with Jack Balkin’s “exploding option” proposal the idea that the Treasury Department can sell assets to the Federal Reserve to raise revenue. I’ve been able to find no prohibition in law that would make this illegal. And, as long as a fair price reflecting likely market value is paid by the Fed, I don’t think such transactions would raise legal problems.
This option is a temporary one. But it might buy enough time for Congress to become Democratic again, whereupon the Democrats could repeal the debt limit legislation, ending debt ceiling crises.
There is a problem with this option relating to who within the Fed system buys Treasury’s assets. The Federal Reserve Board of Governors is a self-funding Federal Agency; but it is nevertheless Federal, so the sale of Government property to it still leaves the assets in the hands of Government. But what happens if the assets are sold to one or more of the regional Fed Banks. These are agents of the Federal Government, but they privately owned. The transfer of Federal assets would surely raise the issue of turnover of federal property to the private sector. Also, if the regional Fed Banks ever sold any of those assets to private organizations that are not agents of the Government, for example, the big banks whose representatives sit on the regional Fed Bank Boards, we would see immediate charges of corruption and private sector looting of Government property. The next post, Part IV, will cover differences among options in their likelihood of having severe legal problems, or seriously undermining loss of public confidence in debt instruments.
(Cross-posted from New Economic Perspectives.)