The Broader Market

by Jordan Eizenga

Pennsylvania Senator Pat Toomey’s proposal won’t prevent the U.S. from defaulting on its debt if the debt ceiling is not raised.  At present, the United States is approximately $200 billion away from reaching its debt ceiling.  The U.S. Treasury Department estimates that this will be reached by as early as April 5th and as a late as May, depending on tax receipts.  

Toomey, along with other Republicans, has implicitly threatened to deny increasing the debt limit.  

The concern is that failing to lift the debt ceiling will mean that the U.S. defaults on its debt obligations and damaged the full faith and credit of the U.S. federal government. Toomey claims that his legislation will prevent the U.S. from defaulting on its debt without the debt ceiling increased by simply prioritizing payments on the debt to ensure that Treasury bondholders get the interest and principal payments they deserve.

The problem with this logic is that the U.S. has more than one financial obligation. Perhaps, no one makes that point better than Treasury Secretary Tim Geithner in a strongly worded letter to the Senator:

We understand that you define default narrowly in this context to apply only to debt service payments. But the term is equally applicable to the broad failure contemplated in your legislation to meet other important U.S. obligations. That is how it would be regarded by global markets.  A simple analogy may help illustrate the problem:

A homeowner could decide to ‘prioritize’ and continue paying monthly mortgage payments, while opting to cease paying other obligations, such as car payments, insurance premiums, student loan and credit card payments, utilities and so forth. Although the mortgage would be paid, the damage to that homeowner’s creditworthiness would be severe.

Prioritizing debt payments does not avoid default.  The debt ceiling must be raised.