Here’s an important point on the debt ceiling debate by Vincent Reinhart who points out that, if we actually fail to raise the debt ceiling then SOMEONE has to break the law in the USA because the laws that are currently on the books make it impossible not to. He explains:
“If the Treasury is unwilling to stretch the definition of extraordinary measures, on the day that the Federal Reserve predicts that the Treasury will run out of cash in its account and the Treasury is bound by the debt ceiling, it suspends all payments and awaits instructions from the Treasury. As a result, the government’s principal economic officials will face the prospect of violating one of these three laws:
1. The Second Liberty Bond Act of 1917 that establishes the debt ceiling;
2. The Federal Reserve Act that prohibits the Fed from lending directly to the Treasury; or,
3. The 14th Amendment of the Constitution that holds that the debt of the United States government, lawfully issued, will not be questioned.
They have to break a law. “
Basically, someone has to break the law here if the debt ceiling isn’t raised. I don’t know precisely how this would all play out, but my guess is there’d be strength in numbers by having Jack Lew ring up Ben Bernanke and exercise the “exigent circumstances” clause in the Fed act. The Fed would buy new bonds directly from the Treasury which would keep the government from defaulting and would keep the Treasury from breaking the 14th Amendment. The Federal Reserve would come under fire for breaking the Federal Reserve Act, but the exigent circumstances clause would likely give Ben some wiggle room there.
The bottom line is, no matter what happens someone has to break a law so if someone’s going to be an adult and avoid breaking the law PLUS crashing the global financial system I am pretty sure that the obvious choice is to break the law and NOT crash the global financial system.
In other words, by failing to raise the debt ceiling the US Congress puts the US Treasury in an impossible position where someone is forced to act like an adult just because Congress can’t. And that means this inane debate is really an unrealistic and useless waste of time because once push comes to shove the Treasury has to act or get someone else to act because they break the law by not acting. And they will act. Because there’s no realistic alternative.
NB – Oh, and even if Ben Bernanke was found liable of breaking the law here I am pretty sure there’d be a nice phone call before all of this goes down that goes a little bit like this:
Tsy Sec Jack Lew: “Ben, I’m about to break the law here if we don’t do something. Oh, and we’re about to crash the global financial system. How about you enact the exigent circumstances clause and just fund our account?”
Fed Chief Ben Bernanke: “Sure, but I want some guarantees that I am not going to be the only one on the hook here for this.”
Lew: “Sure thing.” [Dials in President Obama]
President Obama: “Hey dudes, how can I help?”
Bernanke: “If I am going to save the world AGAIN, I need some guarantees I won’t go to jail this time around. Can you guarantee that?”
Obama: “Of course. Your stock market rally saved my skin on more than one occasion. I’ll put you at the top of the pardon list.”
Bernanke: “Swell. Oh, and I want lifetime beard groomings also. This thing doesn’t keep itself looking this good all by itself.”
Lew: “Great, now someone phone down to those clowns on the floor of Congress and inform them that their little games are pointless.”
Edit: this post previously stated that Vincent Reinhart had published the Carmen Reinhart paper of the issue of government debt. Sorry for the error.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.