With The Government Out Of Money, Who Won’t Be Paid?

Contrary to popular belief, October 17 is not the day that the federal government exhausts its authority to borrow. That happened in May. What happens on October 17 is that the Treasury runs out of options (“extraordinary measures”) for avoiding the consequences of not borrowing. Beginning on Thursday, the only money available to pay federal bills is about $30 billion in cash already on hand, plus whatever new tax payments and other federal income are received.

This being a relatively slow time of the year for tax receipts, the government will have to curtail about a third of its spending until the debt ceiling — meaning the borrowing limit — is raised. If Congress has any sense at all, it will raise the limit before cash on hand is exhausted sometime later this month. Until that happens, though, the Treasury will have to figure out who gets paid and who doesn’t, because there won’t be enough money to cover all the government’s bills. Secretary of the Treasury Jack Lew has been saying that his department lacks the mechanisms and authorities to prioritize payments, but faced with the prospect of financial collapse, I’m going to guess he finds a way.

That solution has to begin with paying holders of federal debt, because even the hint of default on those obligations would raise rates as the market adjusted to higher levels of risk associated with lending to the government. Higher rates would greatly increase the burden of federal debt service and destroy the economic recovery, because interest rates for other types of debt are closely tied to the interest that Treasuries are paying. Any increase in the interest rates on federal debt thus could put mortgages, car loans and new business investment beyond the reach of enough borrowers so that our anemic growth rate would flatline.

So federal bondholders get paid first. But then what? Who has to wait, maybe for a long time, to get the money they are owed by Washington? According to the Bipartisan Policy Center, the biggest bills the government has to pay over the next four weeks — through November 15 — are Medicare/Medicaid ($69 billion), Social Security ($49 billion), interest on the federal debt ($35 billion), defense vendor payments ($28 billion), and federal salaries & benefits ($24 billion). That latter expense assumes the government shutdown has ended.

These bills can be paid from current cashflow if the government stops funding everything else from food stamps to military pay to IRS tax refunds, but this is a political system so once debt service is covered money will go to the claimants with the most electoral clout. That means Social Security, Medicare and military pay ($10 billion over the next month). But what about everybody else in line behind the old folks and warfighters? Let’s hope that the Treasury never has to actually answer that question, because it will be the most divisive debate Washington has seen in modern times. It’s time for everybody on Capitol Hill to come together and raise the debt limit before the wheels come off the cart.