Would you buy a bond guaranteed by the full faith and credit of the United States if its existence also breached U.S. law? This seemingly crazy concept might sound ridiculous, but bizarre times may call for bizarre measures. As a result, this week, Citi analyst Brett Rose (via Business Insider) suggested that the Treasury could resort to an unlikely worst-case scenario: it could just issue more Treasury securities in violation of the law.
Could This Really Happen?
This might sound far-fetched, because, well, it is. But John Carney at CNBC's NetNet explains that it wouldn't be totally out of character for the Treasury to disregard the law:
For example, Geithner's Treasury Department ignored the law that explicitly forbid the government from putting conditions on banks that wanted to repay TARP. He forced the banks to show they could issue non-guaranteed debt before he permitted them to repay their TARP funds. This was completely illegal--but he got away with it.
The only retaliation that banks could have taken would have been to sue the U.S. government. As you can imagine, that would not have made for the most flattering headlines at the time.
For another example of the Obama administration picking and choosing the laws it enforces, you can look to the Defense of Marriage Act. A few months ago, the administration announced that the Justice Department would no longer prosecute cases involving the Act. In a similar way, the Obama administration could just say that the Treasury will ignore the debt ceiling.
Carney points out that the only Congress would really have standing to file suit if the Treasury took this route. He imagines only a couple members of Congress, perhaps Rep. Ron Paul (R-TX) or Sen. Rand Paul (R-KY) would go that far. And what judge would force the U.S. into default by ruling in their favor? Indeed, what judge would want to rule on this at all? Instead, they would delay, or kick the case up to higher courts, until a deal had finally be reached, essentially nullifying the case.
This analysis stresses the practicality of the situation. No prominent U.S. officials -- no matter their branch or politics -- want to see the U.S. go into default. Other than through very dramatic cuts starting going into effect almost immediately, raising the debt ceiling is the only way to prevent that ugly fate.
But Would Investors Buy "Illegal" Treasuries?
So we've established that it isn't totally beyond the realm of possibility that the Treasury could issue "illegal" Treasuries. The decision to issue such securities would be meaningless if no one wanted to buy them. Carney addresses this question as well in a separate post. He thinks investors would bite, because any scenario where the Treasury would have to resort to this kind of extreme measure would be very scary, and when people are scared they buy Treasuries. For an example, he refers to the recent rating action by S&P:
When Standard & Poor's warned that it might downgrade the credit rating of the US, bonds actually rallied. That doesn't happen with most other sovereign or corporate issuers--for them, a warning about a downgrade usually triggers a sell-off. But debt of the US Treasury is different.
That's one explanation, but there are others as well. The U.S. Treasury is only considered "different" because the U.S. is historically considered very politically stable. If the government became so hopelessly divided that it essentially forced itself into default, then investors might begin to question that traditional view.
An "illegal" Treasury would be an inherently risky security. What if a judge decides the security should not have been issued and rules that any sold are now worthless? The government might be able to provide a refund, but the situation would be messy. What if the rating agencies responded shortly thereafter officially downgrading U.S. debt? A new crisis would erupt with global investors dumping Treasuries and dollars alike, which could send the U.S. spiraling back into recession and providing the rating agencies with an even more tangible reason to worry about U.S. fiscal health.
If I were an investor, I wouldn't go anywhere near an illegal Treasury. If things got that bad, I'd probably resort to buying gold. And maybe a bunker, some guns, and a year or two's worth of non-perishable food. The idea that the executive branch would issue illegal Treasuries and investors would happily buy them up sounds like something out of an apocalyptic novel. Even if it could happen, it stretches the mind to imagine a world in which it does.
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