Gyroscopic Investing

In Washington today, congress is debating a 1985 GAO ruling that was written to inform then-Senator Bob Packwood that, technically, the Treasury has the right to prioritize interest payments (to avoid a default) over other spending obligations even if Congress fails to raise the debt ceiling.

http://redbook.gao.gov/14/fl0065142.php

B-138524, OCT 9, 1985

TREASURY DEPARTMENT - SECRETARY OF TREASURY - AUTHORITY - PAYMENT OF OBLIGATIONS DIGEST: THE SECRETARY OF THE TREASURY HAS THE AUTHORITY TO DETERMINE THE ORDER IN WHICH OBLIGATIONS ARE TO BE PAID SHOULD THE CONGRESS FAIL TO RAISE THE STATUTORY DEBT CEILING AND REVENUES ARE INADEQUATE TO COVER ALL REQUIRED PAYMENTS. THERE IS NO STATUTE OR ANY OTHER BASIS FOR CONCLUDING THAT THE TREASURY MUST PAY OUTSTANDING OBLIGATIONS IN THE ORDER THEY ARE PRESENTED FOR PAYMENT. TREASURY IS FREE TO LIQUIDATE OBLIGATIONS IN ANY ORDER IT DETERMINES WILL BEST SERVE THE INTERESTS OF THE UNITED STATES.

THE HONORABLE BOB PACKWOOD:

CHAIRMAN, COMMITTEE ON FINANCE

UNITED STATES SENATE

YOU HAVE REQUESTED OUR VIEWS ON WHETHER THE SECRETARY OF THE TREASURY HAS AUTHORITY TO DETERMINE THE ORDER IN WHICH OBLIGATIONS ARE TO BE PAID SHOULD THE CONGRESS FAIL TO RAISE THE STATUTORY LIMIT ON THE PUBLIC DEBT OR WHETHER TREASURY WOULD BE FORCED TO OPERATE ON A FIRST IN-FIRST-OUT BASIS. BECAUSE OF YOUR NEED FOR AN IMMEDIATE ANSWER, OUR CONCLUSIONS MUST, OF NECESSITY, BE TENTATIVE, BEING BASED ON THE LIMITED RESEARCH WE HAVE BEEN ABLE TO DO. IT IS OUR CONCLUSION THAT THE SECRETARY OF THE TREASURY DOES HAVE THE AUTHORITY TO CHOOSE THE ORDER IN WHICH TO PAY OBLIGATIONS OF THE UNITED STATES.

ON A DAILY BASIS THE TREASURY DEPARTMENT RECEIVES A NORMAL FLOW OF REVENUES FROM TAXES AND OTHER SOURCES. AS THEY BECOME AVAILABLE IN THE OPERATING CASH BALANCE, TREASURY MAY USE THESE FUNDS TO PAY OBLIGATIONS OF THE GOVERNMENT AND TO REISSUE EXISTING DEBT AS IT MATURES. SEE GENERALLY H.R. REPT. NO. 31, 96TH CONG., 1ST SESS. 9-10 (1979).

WE ARE AWARE OF NO STATUTE OR ANY OTHER BASIS FOR CONCLUDING THAT TREASURY IS REQUIRED TO PAY OUTSTANDING OBLIGATIONS IN THE ORDER IN WHICH THEY ARE PRESENTED FOR PAYMENT UNLESS IT CHOOSES TO DO SO. TREASURY IS FREE TO LIQUIDATE OBLIGATIONS IN ANY ORDER IT FINDS WILL BEST SERVE THE INTERESTS OF THE UNITED STATES.

UNLESS IT IS RELEASED EARLIER OR WE HEAR OTHERWISE FROM YOU, THIS LETTER WILL BE AVAILABLE FOR RELEASE TO THE PUBLIC 30 DAYS FROM TODAY.

The US missing an interest payment would be incredibly bad. They would have a tough time getting cheap funding for any other spending. So yes they better make the payment and not pay on other obligations if they know what is good for them (and they do).

The debt ceiling debate is a farce. This happens every few years and they always raise it.

Thanks, Gumby.  I've long wondered why there wasn't a simple rule to prioritize interest payments above all other expenditures.  It seems like it had the benefit of making default essentially impossible and at least providing a veneer of fiscal discipline.  If politicians can't keep going back to this, "We have to take on more debt or we're all going to die!" threat, there'd be even less support than there already is for raising the debt ceiling.

If this ruling is correct (and it is of course tentative), then it sounds like Treasury can do exactly that.  That would be a good thing.

It kind of puts this whole charade of acting extremely offended at large deficits while meanwhile proposing legislation every year that increases these deficits in perspective.

Kind of like how politicians love to complain about earmarks and "bridges to nowhere" when in truth, earmarks are only 3% of the budget.

Sometime this morning, the Treasury Department will auction off the last legally permissible U.S. government debt to the public...

With Government Set to Hit Debt Limit, Tensions Rise First in Washington

We just hit the Debt Celing...

Treasury.gov: As US Reaches Debt Limit, Geithner Implements Additional Extraordinary Measures to Allow Continued Funding of Government Obligations

(The emergency measures will float us until August 2nd)

Long term US treasuries seem to be doing fine...

In a few years, this event will look sort of silly (if not sooner).

As long as the people spending the money also have the power to determine the debt ceiling, it will always be raised.

Adam1226 wrote: Long term US treasuries seem to be doing fine...

My favorite quote about the bond market:

"I like the bond market because it’s smarter, bigger, and faster than the stock market.  It’s like the older brother who graduated top of his class at Yale and was captain of the crew team and now leads the M&A department at a major bank.  He’s little unapproachable to the average investor.  He’s austere, academic, and aloof.  But he knows his stuff and is usually the first one to do anything about anything.  The investor at home prefers to watch the stock market.  That’s the colorful younger brother who dropped out of school to join the Poker tour and sells car insurance at the local strip mall.  He’s charismatic — if a little manic depressive — and easier for the average investor to share a beer with.  He’s what people talk about on TV." — Jeffrey Dow Jones

The bond market isn't easily distracted by political games or wild speculation. It just seems to follow the money.

Good quote, Gumby.  I find bonds much more interesting than stocks in many ways.  Stocks have so many moving pieces that they aren't as efficient at telling you a "story" as bonds are.  With bonds, the yield curve, and moreso yield spreads, tell you a lot about the economy in very easy-to-read ways.

That isn't to say that it's perfect, obviously given the mortgage crisis, but still, it really comes down to inflation risk, default risk, and "opportunity cost" of not investing in the stock market or some non-bond instrument.