WASHINGTON -- Deep within the Treasury Department sits a once-secret plan written by the Obama administration that could lead to the first-ever default on U.S. debt. Bond traders are worried that Donald Trump's Treasury secretary may have to use it.
The U.S. government will reach its statutory limit on borrowing some time in October, the Congressional Budget Office estimates. The Trump administration has asked Congress to raise the ceiling before then, but it is running into the same complications the Obama White House encountered: lawmakers, mostly Republicans, who want to use the debt limit as leverage for controversial policy changes.
Treasury Secretary Steven Mnuchin has said there are "plans and backup plans" to keep the government solvent through September. Bond traders suspect he is referring to preparations made in 2011 in case the Obama administration had to prioritize payments on government securities over other obligations. The Treasury chief got fresh hope that Congress may raise the debt limit before leaving for its August recess after Senate Majority Leader Mitch McConnell delayed the break by two weeks.
When the nation almost breached its debt ceiling six years ago, the Federal Reserve and Treasury drew up contingency plans that were kept secret until January, when transcripts of an Aug. 1, 2011 conference call at the central bank were released after a customary five-year lag.
One day before protracted negotiations concluded with Congress raising the debt ceiling, Fed officials were briefed about how its staff and Treasury officials had worked together to develop a plan to handle debt payments in the event they had to be "prioritized or at least not fully paid," the transcripts say.
Under the contingency plan, holders of U.S. debt and recipients of Social Security, veterans benefits and other entitlements would be paid first. Everyone else, such as government contractors and federal employees, would be at risk of payment delays or partial payments.
Though the scenario nominally protects holders of U.S. debt by prioritizing the payments they are due, it raises fears that the value of their underlying assets could suddenly decline if the U.S. government's reputation for creditworthiness is damaged.
"I'm assuming that prioritization is the fallback," said Lou Crandall, chief economist at Wrightson ICAP LLC. The acknowledgment in the Fed transcripts of the existence of a backup plan to pay interest first makes it more plausible, he said, calling it a "truly terrible idea."
It was in 2011 that U.S. debt was downgraded for the first time by S&P Global Ratings. If the secret debt prioritization plan has to be used by the Trump administration, the nation's credit rating may well be downgraded again, some analysts say.
Even the existence of the 2011 backup plan is contested. Some former Treasury officials who worked at the department at the time say that by design there was no plan. The agency may have used a legal distinction to avoid appearing to have created a backstop by never asking its general counsel if prioritization was legal, one former Treasury official said.