That’s the question – for Treasury Secretary Jacob Lew and Fed Chairman Ben Bernanke during the debt-ceiling charade because it seems they’re boxed into a contradictory situation where one of them will have to break one of the laws, whether they want to or not, writes Vincent Reinhart, managing director at Morgan Stanley and former head of the Federal Reserve’s monetary division.
On October 17, the government’s out-of-money date, Lew will be in a quandary if he can’t find more “extraordinary measures,” which the Treasury used to fund the government until now whereby it scrounged up some money elsewhere. He will have to choose which of these three laws to break because, according to Reinhart, he (or Bernanke) will end up breaking one of them, whether they want to or not:
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, which holds that the debt of the United States government, lawfully issued, will not be questioned.
It’s just a question of which one. “At the end of the day, officials will avoid violating the Constitution by indicating that they have been given inconsistent instructions and are obeying the one with the most important precedent,” Reinhard writes. In each case, it would open a different can of worms.
If Lew violates No. 1 and the Treasury issues Treasury securities beyond the debt ceiling, that debt would not be “lawfully issued” and may not have the constitutional protection against default (No. 3, 14th Amendment). Presumably, the market could figure out how to price that risk into the securities, hoping that they’d be exchanged for “legal” paper once the debt ceiling is raised.
Or they – they? – could decide that the situation should be solved by having Chairman Ben Bernanke violate No. 2 and print money and lend it directly to the Treasury – by allowing the Treasury’s accounts at the Fed to be overdrawn – in violation of the Federal Reserve Act.
Either option might be less bad than violating the Constitution, option No. 3, which would be the ultimate result if neither of the other two options is chosen.
This is the sort of surrealistic logic Congress forces these hapless officials to think through. Brains are presumably already smoking over the issue. Lew and Bernanke have to weigh these options “by precedent, punishment as specified in the law, and standing as to who can claim a violation of the law,” Reinhard explains.
But by violating one of those laws, either Lew or Bernanke “saves the global financial system and, at most, risks being impeached or fired. That seems to be a reasonable risk and reward trade-off.” A Kafkaesque entanglement brought on by our heroes in Congress.
Meanwhile, “As political theater, the debt ceiling is not a useful threat, because politicians are basically threatening to shoot themselves,” Reinhart points out. They’ll get blamed for the global economic consequences of a US default. Watch for new record lows in Congressional approval ratings – in the single digits.
Wall Street is convinced the government shutdown won’t hurt unless it drags out too long. It’s even more convinced that Congress would never be crazy enough to refuse to raise the debt ceiling in time and send the mighty and sole superpower, biggest debtor of all times, into default. That risk hasn’t been priced in. But a majority of Republicans begs to differ. Read…. Wall Street Brushes Off Debt-Ceiling, Republicans Beg To Differ, But Default Would be “Catastrophic,” And Nothing Is Priced In
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.