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posted on 30 July 2015

What Went Wrong According to GAO

Written by , GEI Associate

Recent Debt Limit Impasses Resulted in Increased Borrowing Costs, Decreased Demand for Treasury Securities, and Constrained Treasury Cash Management.
- Government Accountability Office

Had it not been for timidity in raising the debt limit in 2013, the government could have prevented unnecessary significant costs according to a new report by the United States Government Accountability Office (GAO).

The GAO says the Government needs to be more daring, by scrapping previous-not-bearing-fruit policies; more trustful, by delegating more borrowing power to Treasury; and more multitasking by tying decisions about the debt limit to spending and revenue decisions.

Figure 1: "Fall 2015: Debt ceiling must be raised" (CRFB)

The debt limit - which implies there is a ceiling above which the government can't borrow - has been recalculated several times during recent decades. In suspension since February 2014, the debt limit was raised to $18.113 trillion in March 2015.

Figure 2: The debt as of July (TreasuryDirect)

Date

Total public debt outstanding

07/16/2015

18.1 trillion

The following is a rundown of points were made in the GOA report.

Subject To The Debt Limit . . .

. . . Public debt, which mainly "consists of marketable Treasury securities". Treasury securities - "viewed as one of the safest assets in the world" - represent the government's debt obligations.

(1) Individuals purchase securities in the form of bills, bonds etc., (mainly) hold them in "pension or mutual funds" (cf. with institutions or central banks using them in daily transactions), and anticipate profits on them. There are two forms of Treasury securities: marketable (purchased from the government and can be resold in the second market) and non-marketable (can't be marketed in the second market; e.g. savings bonds). Marketable Treasury securities held by the public are expected to slightly increase in proportion to an increase in government debt - see Figure 3. GAO specified: "as of January 31, 2015, roughly 99.8 percent of public debt was subject to the debt limit."

Figure 3:

(2) The intra-governmental debt, which is particularly sensitive as it relates to Medicare and Social Security trust funds, predicted to be hit by a severe tempest, partly because "spending will grow faster" (CBO) than the economy overall. Already, recipients feel the 'bad weather'.

Figure 4: Extract From A Gallup Survey Table Indicating Feelings About The Social Security And Medicare systems

Year

Very satisfied

Somewhat satisfied

Somewhat dissatisfied

Very dissatisfied

No opinion

2015

11%

26%

27%

29%

7%

37% positive

56% negative

GAO Insists On . . .

. . . Decisions timelessness. Indeed, decisions about borrowing are made first-- about the debt next. Decisions on the debt limit also come after "lengthy" congressional debates. GAO insists that this pause is the source of Congress's 'meek' compliance as it limits options to "effect an immediate change to federal debt."

About The Treasury . . .

Treasury responsibility is to ensure there is "enough cash on hand to pay government obligations as they come due." This 'cash on hand' at the Federal Reserve, and as the debt limit is close this cash dwindles, voluntarily reduced by Treasury to actually be able to "make payments without increasing the amount of debt subject to the limit." To avoid "breaching the limit" when there are delays in raising the debt limit, Treasury veers to the left: not conforming to its established rules - temporarily applying "extraordinary measures."

Treasury temporarily can make needed payments when there is delay increasing the debt limit. The extraordinary measures, however, are just a puny, survival kit - not meant, nor effective, for the long term. Raising the debt limit is vital. Because when the apparatus of extraordinary measures fade away - with spending cuts, suspended investments and securities disinvestments - the Treasury "could eventually be forced to default."

About The Financial Sector . . .

The financial sector is not separate from the economy: it makes waves when, to investors, its prospects look dim. GAO said:

"disruptions in the financial sector [...] could ultimately result in the increased costs for providing credit in the economy, either through increases in interest rates or in transaction costs. Consequently, lending in the economy may be reduced, and loans may become more costly. Reducing availability of capital may translate into lower levels of economic activity and growth. "

About Investors Reactions . . .

In their quest to spare themselves, investors play a crucial role in stabilizing the economy, which is why America needs to nurture their confidence. That said, even though investors love Treasury securities (as they are a safe investment,) they substitute for Treasury securities when they feel their love is doomed to be unrequited (when they fell at-risk securities are unlikely to bring profit.) During a debt limit impasse, indeed, market participants (broker-dealers, investors etc.) avoid at-risk Treasury securities or get rid of them (sell them) to replace them with bank deposits, agency discount notes, and commercial papers; or, (very) safe securities.

Figure 5: Commercial Paper Outstanding (in Billions of dollars)

Financial

2015

Total

January

-31.2

February

6.2

March

-.6

April

-17.1

May

-6.1

June

31.0

Investors' actions are consequential, permeating various sectors of the economy. During the 2013 debt limit impasse, for example, "interest rates rose and liquidity decreased for at-risk Treasury bills" (because investors avoided them). When investors fidgeted about "Treasury's ability to pay its bills and avoid a delayed payment or a default," their reflex caused interest rates to rise, and liquidity to drop—and "even if temporary", liquidity drops negatively affect the Treasury market.

Changes in Treasury rates

"affect everyone, GAO said, from individuals, whose pension and money market funds invest in these securities, to global financial institutions, whose daily transactions in Treasury securities are vital to the U.S. and global financial markets."

On Repos . . .

GAO's insistence on the importance of "market repurchase agreements--" alias "repos--" springs from the linkage between repurchase agreements and borrowing rates. Repurchase agreements are characterized being for short -—"such as overnight—" periods; "borrowers provide collateral," and are charged relatively low rates. When there is a debt limit impasse, moreover, repos face high - challenging to economic stability - rates. Investors, of course, run from high rates, fearing the guarantee on their securities might - together with support from Treasury itself - vanish.

About When There Is A Delay To Raise The Debt . . .

Market participants were concerned about a delay in raising the debt limit in 2013. Two Treasury auctions held in the fall of 2013 auctioned $35 billion of securities. The first auction was significantly lower than the second, and the GAO claims this was "indicating both an increased cost and a decreased demand for Treasury securities at that time." Would the rate remained constant, "Treasury would have saved more than $1 million in interest."

About Treasury's Cash Balance . . .

Debt limit restrictions do not facilitate Treasury's cash balance management, as they can preclude Treasury "to manage unforeseen risks," such as natural devastations such as extraodinary weather events.

If Treasury Reduces Its Cash . . .

Treasury, which has maintained a high cash balance, will have to reduce its cash so it can "temporarily make payments without further increasing federal debt subject to the limit." As a result, Treasury bills supply may also decrease, disrupting the financial system and increasing borrowing costs.

Three Main Policies GAO proposed . . .

(1) There should be no seguing between actions related to the debt limit and the Budget Resolution (BR.) Besidesimplementation of facilitating decisions, Congress would have more flexibility in altering at-will expenditures and revenue flows. An amending of the 1974 Act is complimentary with (1:) so each Congress will not have to revisit each decision after the House and the Senate makes changes. Because when each Congress has to revisit the decision on implementations of changes on the debt, there are chances of discord—not consensus.

(2) Providing the administration with the authority to propose raisings to the debt limit, subject to a congressional motion of disapproval.

(3) Directly linking spending and revenue decisions to the debt limit by delegating broad authority to the administration to borrow as necessary to fund laws enacted by Congress and the President.

Although these policies aren't unfamiliar to Congress (already used or proposed), their previous use perhaps needs to be reestablished. For example, "linking action on the debt limit to the budget resolution, GAO foreshadows, relies on accurate forecasting of projected debt levels." Congress has passed budget resolutions since 1995; each year, though, accurate debt projections were not a part of the process.

Figure 6: Data extracted from GAO: "Comparison of Projected Debt Subject to the Limit in the Budget Resolution to the Actual Debt Subject to the Limit"

$ Billions

Fiscal year

Difference:

Actual - Projections

2008

455.7

2009

1,646.1

2010

277.6

Like the daughters of Danaus condemned to ever pour water in a broken vessel, America too seems doomed to ever struggle with filling the vault's required debt (resorting to arbitrary spending cuts, etc.) Many experts speak of the "unsustainable" fiscal path of the government. If there is no improvement in budgeting, long-term consequences could put great stress on America. For a start, the government may inspire itself, on matters of dealing with the debt, by looking at countries like Australia, New Zeeland, or the United Kingdom ( cited by GAO).

Figure 7

The full faith and credit of America is at risk:

"The effects of the debt limit on financial markets in the future could be more sudden and severe, giving Treasury and policymakers less time to react."

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