Government Default, Risk-Taking, and Knowing What You're Getting Into
-- Posted by Neil H. Buchanan
In my Verdict column today, I suggest a way that President Obama could act now to defuse future debt ceiling crises. Yes, it obviously involves invoking the Buchanan-Dorf trilemma analysis, but the question is how the President could act on our argument. I recently concluded that "most of the debt ceiling debate is obviously about framing the issues," so I have been thinking about the supposedly "practical" objection to the notion of issuing debt in excess of the debt ceiling.
To get to that point, however, I spend the bulk of today's column arguing that President Obama's stare-down strategy for dealing with the Republicans in the last two iterations of the debt ceiling standoff has not permanently scared the Tea Partiers away from future standoffs. Some people claim that the specter of the mid-term elections in November of next year will stop the Republicans from using the February 7 return of the debt ceiling to try to extract concessions from the President.
I am willing to believe that they will not shut the government down again, but there is every reason to believe that they view the debt ceiling issue as a political necessity. As one report recently put it: "Surrounded by a hostile White House and Senate, and with few legislative avenues beyond borrowing and spending bills to impose their agenda, Republicans said capitulating to Obama would cede to Democrats the only institutional authority Republicans possess." They are delusional enough to think that putting the President in a trilemma is not only completely acceptable, but that negotiating over borrowing and spending bills is insufficient "institutional authority" to get their way.
If I am wrong about that, then the debt ceiling will be forever dormant, returning to its former status as an occasional annoyance that allows member of Congress to make unctuous speeches about fiscal rectitude. If I am right, however, then sometime soon (probably in only a few months) we will be back where we were barely a week ago, trying to figure out what the President can do.
My argument in today's column expands on a point that I have made in a few places recently, which is that the stare-down strategy requires nerve-wracking photo finishes, whereas the best strategy would be to get in front of this issue months in advance. How, then, could a President announce months in advance that he is putting in place plans to issue debt in excess of the debt ceiling (which Professor Dorf and I have referred to as Presidential Bonds), if it comes to that? My answer: By framing it as a matter of personal choice, and the morality of making people pay for consequences that they could not have reasonably anticipated.
Essentially, the argument relies on a comparison of who might get hurt under different strategies, and assessing who should bear the risks and burdens of a possible default on federal obligations. I argue that potential victims of default -- people with checks coming from Social Security, businesses who are to be paid for work performed under government contracts, holders of Treasury securities expecting scheduled interest payments, and so on -- would be forced by a default to become involuntary creditors of the federal government, waiting to be paid while hoping that the impasse is resolved quickly.
By contrast, who would potentially be hurt by issuing debt in excess of the statutory ceiling? When commentators (and President Obama himself, as I point out in the column) argue that nobody would be willing to buy that debt, my response to date has been, in essence, "Rational investors buy junk bonds, don't they?" My argument today extends that point, to say that this is a matter of people deciding in advance whether they want to engage in a contract with the federal government, knowing that the contract is of uncertain enforceability.
This is, in other words, a question of just deserts. Those who might be the victims of default were told in advance that they would be paid in full, on time, and they had two hundred years of history backing up their belief that they could rely on that legal commitment by the United States. If they were to suffer, it would be through no fault of their own, because a default would occur when it would be too late for them to defend themselves. People who would buy risky bonds, by contrast, would know that they might lose that lottery, and they could bid on the debt accordingly.
One trivial response to this argument might be that there are no guarantees in life, and so people who rely on the federal government should not start crying if they do not receive payment. Even if one were to credit that reductio ad absurdum argument, of course, it misses the comparative point: the likelihood, ex ante, that the federal government will default is much lower than the argument, ex ante, that the Presidential Bonds will not be honored.
And even if one argues that the "new normal" since the Tea Party ate the Republicans' brains should have put potential victims on notice that there might be a default (at least, for those whose obligations arose after early 2011), that still does not respond to the reality that the potential buyers of Presidential Bonds would be better positioned to be aware of the risks involved. Moreover, potential buyers are exactly the people who buy and sell risky assets for a living.
The notion of "knowing what you're getting into," of course, comes up all the time in life, and therefore in the law. The doctrine of reliance interests in contract law, for example, requires comparing relative degrees of reasonableness when people claim that the actions of other parties have harmed them.
On last night's "The Daily Show with Jon Stewart," they ran a segment showing the Wall Street cheerleaders on the TV business channels expressing outrage at the idea that JPMorganChase will be paying a $13 billion fine, a chunk of it for the wrongdoings of Bear Stearns and Washington Mutual, two companies whose misdeeds occurred before they were bought (at fire-sale prices) by JPMorgan.
Stewart rightly mocked the talking heads, who were actually trying to argue that JPMorgan should not be punished for the wrongdoing of others. The larger point (and, of course, Stewart's staff had damning video clips from the relevant time period) is that JPMorgan knew in advance that the law clearly requires buyers of such firms to assume the liabilities that might arise from the companies' prior actions. Indeed, this is such a bedrock concept in American law that it is laughable that the pro-Wall Street hacks on CNBC and Fox Business would even try to suggest that it was somehow morally shocking. It turns out that JPMorgan, like any organization with an even mildly competent legal staff, set aside funds to deal with the potential losses for which the firm might ultimately be found liable. This is easy stuff.
Another area in which people misunderstand this is when they complain about institutional liability for college sports programs. Whenever a university is hit with sanctions for past misbehavior by coaches, alums, boosters, or some other miscreant, the cry is almost always heard that (especially if the coach or player has since left the school) it is wrong to hold the institution responsible. Beyond the goal of setting appropriate incentives for institutions to control their employees, this argument is absurd simply as a matter of considering who is taking risks, and with what kind of prior knowledge.
The most sympathetic version of the argument is that "the kids there right now didn't do anything wrong, so why are you taking something away from innocent victims?" The fact, however, is that everyone knows that big-time programs can be hit with these types of sanctions, such that this is a known risk of joining any such program. When, as in this week's sanctions against the University of Miami, the punishment follows a multi-year investigation, that risk was even more obviously both knowable and known.
Moreover, saying that "these kids didn't do anything wrong, so it's wrong to make them suffer with the institution," ignores the flip side: "These kids didn't have anything to do with turning the institution into the global brand that it is today." When a high school senior excitedly signs up with Notre Dame, or USC, or Oklahoma, they are signing up to enjoy the perks that come with being part of an institution that provides things they cannot get elsewhere.
Admittedly, this example is far afield (no pun intended) from the debt ceiling and Presidential Bonds. The broad point is that there are plenty of situations in life in which people have to assess the possibility of things going wrong, before entering into situations that entail making sacrifices in return for promises of future benefits. There are close cases, and there are easy cases.
It should be easy for a properly motivated President to make the case, based on morality, that defaulting on federal obligations falls well outside the acceptable range of "making people pay for what they should have known they were getting into" -- especially when there is an alternative group of people who could be brought into the situation with full knowledge of the risks that they would be facing.
This President shows no sign of being motivated to do so, but that merely means that he is willing to risk another default crisis, because he is too timid to take even the risk of saying: "Given the choice between stiffing people who would be blindsided, or possibly stiffing people who volunteered to take the risk, my decision is easy."
In my Verdict column today, I suggest a way that President Obama could act now to defuse future debt ceiling crises. Yes, it obviously involves invoking the Buchanan-Dorf trilemma analysis, but the question is how the President could act on our argument. I recently concluded that "most of the debt ceiling debate is obviously about framing the issues," so I have been thinking about the supposedly "practical" objection to the notion of issuing debt in excess of the debt ceiling.
To get to that point, however, I spend the bulk of today's column arguing that President Obama's stare-down strategy for dealing with the Republicans in the last two iterations of the debt ceiling standoff has not permanently scared the Tea Partiers away from future standoffs. Some people claim that the specter of the mid-term elections in November of next year will stop the Republicans from using the February 7 return of the debt ceiling to try to extract concessions from the President.
I am willing to believe that they will not shut the government down again, but there is every reason to believe that they view the debt ceiling issue as a political necessity. As one report recently put it: "Surrounded by a hostile White House and Senate, and with few legislative avenues beyond borrowing and spending bills to impose their agenda, Republicans said capitulating to Obama would cede to Democrats the only institutional authority Republicans possess." They are delusional enough to think that putting the President in a trilemma is not only completely acceptable, but that negotiating over borrowing and spending bills is insufficient "institutional authority" to get their way.
If I am wrong about that, then the debt ceiling will be forever dormant, returning to its former status as an occasional annoyance that allows member of Congress to make unctuous speeches about fiscal rectitude. If I am right, however, then sometime soon (probably in only a few months) we will be back where we were barely a week ago, trying to figure out what the President can do.
My argument in today's column expands on a point that I have made in a few places recently, which is that the stare-down strategy requires nerve-wracking photo finishes, whereas the best strategy would be to get in front of this issue months in advance. How, then, could a President announce months in advance that he is putting in place plans to issue debt in excess of the debt ceiling (which Professor Dorf and I have referred to as Presidential Bonds), if it comes to that? My answer: By framing it as a matter of personal choice, and the morality of making people pay for consequences that they could not have reasonably anticipated.
Essentially, the argument relies on a comparison of who might get hurt under different strategies, and assessing who should bear the risks and burdens of a possible default on federal obligations. I argue that potential victims of default -- people with checks coming from Social Security, businesses who are to be paid for work performed under government contracts, holders of Treasury securities expecting scheduled interest payments, and so on -- would be forced by a default to become involuntary creditors of the federal government, waiting to be paid while hoping that the impasse is resolved quickly.
By contrast, who would potentially be hurt by issuing debt in excess of the statutory ceiling? When commentators (and President Obama himself, as I point out in the column) argue that nobody would be willing to buy that debt, my response to date has been, in essence, "Rational investors buy junk bonds, don't they?" My argument today extends that point, to say that this is a matter of people deciding in advance whether they want to engage in a contract with the federal government, knowing that the contract is of uncertain enforceability.
This is, in other words, a question of just deserts. Those who might be the victims of default were told in advance that they would be paid in full, on time, and they had two hundred years of history backing up their belief that they could rely on that legal commitment by the United States. If they were to suffer, it would be through no fault of their own, because a default would occur when it would be too late for them to defend themselves. People who would buy risky bonds, by contrast, would know that they might lose that lottery, and they could bid on the debt accordingly.
One trivial response to this argument might be that there are no guarantees in life, and so people who rely on the federal government should not start crying if they do not receive payment. Even if one were to credit that reductio ad absurdum argument, of course, it misses the comparative point: the likelihood, ex ante, that the federal government will default is much lower than the argument, ex ante, that the Presidential Bonds will not be honored.
And even if one argues that the "new normal" since the Tea Party ate the Republicans' brains should have put potential victims on notice that there might be a default (at least, for those whose obligations arose after early 2011), that still does not respond to the reality that the potential buyers of Presidential Bonds would be better positioned to be aware of the risks involved. Moreover, potential buyers are exactly the people who buy and sell risky assets for a living.
The notion of "knowing what you're getting into," of course, comes up all the time in life, and therefore in the law. The doctrine of reliance interests in contract law, for example, requires comparing relative degrees of reasonableness when people claim that the actions of other parties have harmed them.
On last night's "The Daily Show with Jon Stewart," they ran a segment showing the Wall Street cheerleaders on the TV business channels expressing outrage at the idea that JPMorganChase will be paying a $13 billion fine, a chunk of it for the wrongdoings of Bear Stearns and Washington Mutual, two companies whose misdeeds occurred before they were bought (at fire-sale prices) by JPMorgan.
Stewart rightly mocked the talking heads, who were actually trying to argue that JPMorgan should not be punished for the wrongdoing of others. The larger point (and, of course, Stewart's staff had damning video clips from the relevant time period) is that JPMorgan knew in advance that the law clearly requires buyers of such firms to assume the liabilities that might arise from the companies' prior actions. Indeed, this is such a bedrock concept in American law that it is laughable that the pro-Wall Street hacks on CNBC and Fox Business would even try to suggest that it was somehow morally shocking. It turns out that JPMorgan, like any organization with an even mildly competent legal staff, set aside funds to deal with the potential losses for which the firm might ultimately be found liable. This is easy stuff.
Another area in which people misunderstand this is when they complain about institutional liability for college sports programs. Whenever a university is hit with sanctions for past misbehavior by coaches, alums, boosters, or some other miscreant, the cry is almost always heard that (especially if the coach or player has since left the school) it is wrong to hold the institution responsible. Beyond the goal of setting appropriate incentives for institutions to control their employees, this argument is absurd simply as a matter of considering who is taking risks, and with what kind of prior knowledge.
The most sympathetic version of the argument is that "the kids there right now didn't do anything wrong, so why are you taking something away from innocent victims?" The fact, however, is that everyone knows that big-time programs can be hit with these types of sanctions, such that this is a known risk of joining any such program. When, as in this week's sanctions against the University of Miami, the punishment follows a multi-year investigation, that risk was even more obviously both knowable and known.
Moreover, saying that "these kids didn't do anything wrong, so it's wrong to make them suffer with the institution," ignores the flip side: "These kids didn't have anything to do with turning the institution into the global brand that it is today." When a high school senior excitedly signs up with Notre Dame, or USC, or Oklahoma, they are signing up to enjoy the perks that come with being part of an institution that provides things they cannot get elsewhere.
Admittedly, this example is far afield (no pun intended) from the debt ceiling and Presidential Bonds. The broad point is that there are plenty of situations in life in which people have to assess the possibility of things going wrong, before entering into situations that entail making sacrifices in return for promises of future benefits. There are close cases, and there are easy cases.
It should be easy for a properly motivated President to make the case, based on morality, that defaulting on federal obligations falls well outside the acceptable range of "making people pay for what they should have known they were getting into" -- especially when there is an alternative group of people who could be brought into the situation with full knowledge of the risks that they would be facing.
This President shows no sign of being motivated to do so, but that merely means that he is willing to risk another default crisis, because he is too timid to take even the risk of saying: "Given the choice between stiffing people who would be blindsided, or possibly stiffing people who volunteered to take the risk, my decision is easy."