Congress’ latest slow-motion chicken play on the nation’s debt ceiling, when the government is set to run out of money by mid-October, raises the terrible specter of the D-word.
Fault. In several recent deadlocks on the cap, including the one in 2011 that led to ratings downgrades, we’ve found a way to pay the bills before cash runs out. It would be unprecedented for the United States to default on its obligations, numerous media and governments have said.
Or almost unprecedented. In a poorly covered episode in 1979, the Treasury stiffened a group of investors in $ 122 million Treasuries. At least he failed to get the money back to holders on time amid an IT backlog. Eventually, all were reimbursed, with interest, some waiting more than 10 days for their checks to arrive.
Technically, a default and, although small, this brief non-payment would have consequences. “The delays resulted in a flood of complaints to federal district reserve banks,” wrote Edward P. Foldessy, The Wall Street JournalLongtime market reporter who revealed the story on May 9, 1979. Foldessy noted that this was “particularly embarrassing because US Treasury securities are considered the safest and most liquid investments in the world. “.
Foldessy’s article was not a bombshell. It unfolded on page 8 and treated the episode as something unique, the result of “an embarrassing back office crunch.” The word “default” does not appear. The Journal published only one follow-up article (more details below). The New York Times‘the only mention was a four paragraph chuckle on May 20, titled “Back-Office Snarl”. Barron never wrote about it.
It could have gone even more unnoticed without a trial, and 10 years later a university study that determined the defect resulted in “a one-time, permanent increase in yields.”
What would happen today if the United States defaulted? This episode kind of provides an answer, and Foldessy got right to the point. “I have lost confidence in buying directly” treasury bills, said Daniel Beck, an unpaid Detroit investor. the journalist of the Journal. “I could use my money in another area, like corporate paper. “
Confidence was already scarce in 1979, with soaring inflation plunging the United States into recession and Congress just starting a now familiar battle for the debt ceiling. This mini-default only added to the negative outlook, even though it is a bureaucratic slippage and not the debt ceiling deadlock itself: A new IT system has been overwhelmed by strong demand, with the three-month T-bill yielding over 9% compared to the standard deposit account offering of 5.25%.
The victims were mostly small investors, who had to be paid with actual paper checks – wire transfers were used for large financial institutions – but the checks just weren’t processed on time.
“For a $ 10,000 investor,” the Times calculated, “the potential loss of income at current interest rates for 11 days is about $ 30.”
Not a lot of money, but enough to wake up Claire G. Barton. Represented by her husband-lawyer Sidney – the retired couple lived in Encino, Calif., At the foot of the Santa Monica Mountains – Ms. Barton, 71, has filed a class action lawsuit against the United States in federal court.
The lawsuit alleged that the delay in payments “constituted unjustified enrichment” of the government “at the expense, loss and expense of the plaintiffs,” the Journal wrote on May 29. He claimed damages in addition to the interest payments.
This small investor revolt caught the attention of Washington, where Representative Richard Gephart sponsored a resolution to compensate all victims of late payments, and the class action lawsuit was dismissed.
The plaintiffs were cured, “but the default apparently warned investors that Treasury issues were not completely risk-free,” wrote Terry L. Zivney and Richard D. Marcus in their 1989 article. They argue that this loss of confidence “resulted in a 60 basis point increase in Treasury bill rates” and was permanent.
Gephart then got to the bottom of the problem by proposing to eliminate the debt ceiling vote, which after all simply allows the government to fund existing bonds; it does not authorize new spending.
His solution was simple, according to economist Alan S. Blinder, writing in the Journal in August: “When Congress passes a budget, it is deemed to have authorized any borrowing involved in that budget.
Thus was born Gephardt’s Rule, which eliminated the need for a vote to raise the cap, and peace reigned for 16 years. Then came Newt Gingrich.
The Republican House Speaker suspended the rule in 1995, “and raising the debt ceiling has become an integral part of budget battles” between Republicans and President Bill Clinton, wrote Blinder, who was at the time. Vice Chairman of the Federal Reserve and is now in favor of a return to Gephardt’s rule.
In 2011, Republicans used the cap again as a club, and “the threat of default seemed real enough that the stock market collapsed and the unthinkable actually happened: Standard & Poor’s downgraded debt from the US government, ”Blinder wrote.
And so, 10 years later, the United States is at a similar stage, looking at the prospect of an unprecedented default.
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