On Thursday, Senate leaders struck a bipartisan deal to temporarily raise the federal borrowing limit, punting a showdown about further increases to December. The agreement narrowly averts a crisis that Harvard Law School Professor Howell E. Jackson J.D./M.B.A. ’82 says would hurt Social Security recipients, government employees, and members of the military; undermine the dollar abroad; and could even precipitate a recession. While Senator Minority Leader Mitch McConnell reluctantly agreed to the short-term increase, he also signaled that Democrats should not rely on Republican cooperation for further increases this winter.
Harvard Law Today recently spoke with Jackson — an expert in financial regulation and federal budget policy, and author of a paper analyzing a previous standoff “The 2001 Debt Ceiling Impasse Revisited” — about what could happen if the United States defaults on its debts for the first time in history.
Harvard Law Today: Can you explain what the debt ceiling is, how it started, and why it matters?
Howell Jackson: The debt ceiling exists because Congress has the authority not just to spend, but to control borrowing. Rather than give the government carte blanche to borrow, Congress has traditionally set limits on how much could be borrowed. And when we’re running deficits, as we are now, the debt increases over time and eventually approaches the debt ceiling. Occasionally, the debt ceiling is suspended, which is what actually happened the last time the debt ceiling was adjusted. We technically hit the debt ceiling when that suspension expired in August. During the first phase of a debt ceiling crisis, the government can take what are known as extraordinary measures — authorized ways in which the government can play with its debt capacity by drawing down its bank account with the Federal Reserve Bank or by fiddling around with different inter-governmental accounts — to gain extra latitude. But those measures eventually run out, at which point, if nothing happens, there would be a huge crisis that we’ve never experienced before.
HLT: I’ve heard this situation compared to paying off a credit card. Is that an apt analogy?
Jackson: The way I would characterize it is that Congress, with the president signing the legislation, has authorized expenditures, and has also set taxes and other revenue sources. Because we’re in a deficit mode, we are spending more each month than we take in. For every dollar we’re projected to spend in the coming fiscal year, we’re bringing in something like 80 cents of revenue. So, 20 cents of every dollar of federal spending needs to be borrowed. Congress has authorized the spending, but the checks go out in the future. The dilemma of the debt crisis is that the ceiling limits the capacity of the government to borrow. You’re hitting the credit card limit. And at that point, the question that comes up is who gets paid?
HLT: Right. So, who does get paid?
Jackson: The government can’t pay everyone, and the received wisdom is that we would not just pay 80 cents on the dollar. It’s usually thought we would do one of two things. First, the government could pay the bills as they come in. And as the days go on, everyone’s payments would be delayed, and we would technically be in default on the national debt, Social Security payments, COVID relief, and everything else. Alternatively, we could prioritize certain payments, such as the debt payments. And then we don’t pay Social Security until we have the cash. Or, we could put Social Security first and not pay the debt. It’s generally thought that if you don’t pay the debt, the financial markets will have a very bad reaction. But even if we do pay the debt, and we’re defaulting on other claims, that probably would be a pretty bad situation for the capital markets as well. So, there’s not a great way to prioritize, but the alternatives would affect the economy and people very differently.
HLT: How bad would the short-term impact be?
Jackson: I think you would see a massive amount of confusion in the financial markets, because Treasury bills are taken to be the safe asset and everything else is built off of that. If Treasuries suddenly become riskier — and I think that there will be a perception that they were riskier if we defaulted — interest rates for them and other financial assets would go up. And it’s generally expected that there would be chaos.
One thing that’s a bit different in this crisis is we now know a little bit more about what the Federal Reserve might do if there were a debt crisis. Minutes from a Federal Open Market Committee meeting back in 2013 are now available and explain in some detail about what the Fed’s plans would have been back then when we almost got to a debt crisis. Undoubtedly, senior leadership at the Fed is having similar conversations today.
“I would be very worried if members of Congress got the idea that failing to raise the debt ceiling is like a government shutdown, that they could just miss the date by a couple of days, and that it would be no big deal. No one really knows what will happen.”
In the old transcripts, there’s a discussion about how the Fed doesn’t want to say what it’s going to do, because it doesn’t want to spook the markets, or make Congress think that failing to raise the debt ceiling is a problem that the Fed can handle. Chairman Powell came forward last week and tried to reiterate that he thought the Fed couldn’t mitigate a debt ceiling crisis. But he’s also on the record in these old transcripts, so it’s clear there are contingency plans.
I would be very worried if members of Congress got the idea that failing to raise the debt ceiling is like a government shutdown, that they could just miss the date by a couple of days, and that it would be no big deal. No one really knows what will happen but it can’t be good. Hitting the debt ceiling will probably push up the government’s borrowing costs in the short term and maybe also in the long term. With the huge debt overhang we have today, that’s something that would be really disadvantageous to everybody.
HLT: You’ve spoken about financial markets, but how would this impact average Americans?
Jackson: For individuals, two things would happen. One, and this would be tragic, is that there would be an interruption in Social Security payments and the new child care tax credit. Many of our elderly are entirely dependent upon their monthly Social Security checks and lots of family are now counting on the child care credits. Of course, there’s also COVID relief payments and paychecks for government employees and the military. And if there were a financial turmoil of the sort that we had in 2008 or in March 2020 with the pandemic, there would be many knock-on effects, such as a precipitous decline in equity markets and 401(k) balances. A genuine debt ceiling crisis could precipitate a recession or worse. And the economy is not totally recovered from the pandemic. It’s just not the kind of thing that you want to roll the dice on. In almost any scenario, individuals would be adversely affected, because if there had to be prioritization, many individual government benefits would be held up, unless the Biden administration were willing to try some fairly extravagant legal strategies that have been discussed.
“In almost any scenario, individuals would be adversely affected, because if there had to be prioritization, many individual government benefits would be held up.”
HLT: Let’s talk about some of those extravagant legal strategies. I’ve read people discussing the 14th Amendment in this context.
Jackson: Yes, the 14th amendment does say that the public debt shall not be questioned. And then it goes on to say something else about veteran pensions, because it was put in place after the Civil War to ensure that the federal debt and veterans’ pensions would be honored. When I was a young lawyer in Washington, there was an old guy who would march around Lafayette Park with a poster saying, “I question the public debt.” And it was sort of amusing that he could be violating the Constitution for doing that. But whatever questioning the public debt means, there has been scant Supreme Court discussion of it. One argument is that the debt ceiling questions the public debt, and it’s unconstitutional. Or some see in the 14th Amendment an authorization for the president to say that the spending and tax decisions of Congress are of primary importance and the debt limit is secondary. Under this view, the president could unilaterally continue to issue debt. But that’s not exactly what the 14th Amendment says; it’s a creative extrapolation. And if you’re a capital market investor, and someone is trying to sell you debt under that theory, are you happy to buy it?
Another strategy that’s been advanced, which has a certain visual appeal, is that the Treasury should use its authority to mint money to create a platinum coin worth a trillion dollars, then roll it down Constitution Avenue to the Fed, and deposit it there. Then all of a sudden, the Treasury’s bank account at the Fed has a trillion more dollars, and the government can start writing checks. Now, again, that’s not what the minting authority was contemplated to be. And Congress did set a debt ceiling and issuing the coin is supposed to be a way of issuing a kind of debt that is not covered by the debt ceiling. It’s an amusing idea, but if you were Janet Yellen, could you get up in front of the press corps and hold up this platinum coin and hand it over to Jay Powell, and think that that you were solving the problem? If I were Secretary of the Treasury, I might be reluctant to play that kind of a game.
HLT: What kinds of international impacts would we likely see?
Jackson: There is no doubt that foreigners look at our fiscal shenanigans and are, at best, bemused that our federal government periodically shuts down. Hitting the debt ceiling would be much worse. It would threaten the dollar. And even if we don’t ultimately hit the debt ceiling, simply having this conversation is not a good thing for an already fragile world economy. In addition, the dollar is the world reserve currency. That’s a huge benefit for us financially and in terms of prestige, national security, and global leadership. But there are countries and other interests around the world who would like to move away from the dollar. This kind of amateurish treatment of our financial system aids forces that are already looking for alternatives to the dollar.
“Even if we don’t ultimately hit the debt ceiling, simply having this conversation is not a good thing for an already fragile world economy.”
HLT: You described what’s happening as shenanigans. But we’ve seen these types of situations several times before. So, what good does the debt ceiling achieve?
Jackson: I’ll stick with shenanigans, because the debt ceiling has been a kabuki dance where politicians of both parties have postured in the past. The dangerous thing is that members of Congress might miscalculate or misunderstand the implications of missing the deadline by a day or two. Does the debt ceiling do anything besides create nervous-making headaches for the Treasury Department every couple of years? Well, the case in favor of a debt limit is that offers an episodic opportunity for the country to ask itself whether we are we running our fiscal affairs in a sensible way or whether the accumulated public debt is getting too large. The problem is that the way debt ceiling crises now unfold, those serious conversations don’t happen. So, while I think there is an argument for having national debates about our fiscal challenges, the current way we’re doing it is clearly not productive.