TOPICS > Politics

On the Verge of Default?

November 16, 1995 at 12:00 AM EDT


MARGARET WARNER: To help us understand the actions taken by the Treasury Department this week, I’m joined by two people from Wall Street investment firms. Robert Hormats is vice chairman of Goldman Sachs International. He served in a variety of economic policy positions in four administrations. And Douglas Schindewolf is an economist with Smith Barney. Welcome, gentlemen. Okay, Bob Hormats, let me start with you. Help us understand this. A week ago, Treasury Sec. Rubin and many others were warning that the U.S. Government was on the verge of default. Yesterday he was able to do something to put that off at least till the end of December. What exactly did he do?

ROBERT HORMATS, Investment Banker: (New York) Well, what he did was an accounting maneuver which actually enabled the government to avoid a default. The Treasury Department and the trust funds that are under the government’s control have what’s called non-negotiable treasury securities that they hold.

MARGARET WARNER: Okay. And just for a minute, these are retirement trust funds, is that right?

MR. HORMATS: These are two retirement trust funds, which are quite large, and what the government essentially did was take those non-negotiable securities which are interest-bearing securities and convert them into, in effect, non-interest-bearing obligations of the federal government, therefore, they don’t qualify as outstanding Treasury debt. That, in effect, freed up the Treasury to be able to borrow in capital markets an amount of money, roughly $61 billion, which it can use to finance the federal government and pay interest. It’s as if you had an account in the bank and instead of your CD, which bears interest, that was converted into a checking account which does not bear interest and, therefore, doesn’t qualify as a debt. At the end of this, however, that checking account will be given interest when this whole thing is over, so all the people who have retirement funds in these accounts will ultimately be made whole.

MARGARET WARNER: Okay. Doug Schindewolf, that–explain to us those, those non-interest–that interest- bearing securities that were transferred out, were they sold? What actually happened to them and what happened to that money? Because as Bob Hormats just said, that money, itself, wasn’t used to pay a government obligation. Treasury Sec. Rubin’s not going to go out and borrow more. What happened to that $60 billion they took out of these accounts?

DOUGLAS SCHINDEWOLF, Wall Street Economist: (New York) Well, the fact is those non-marketable securities in the first place are simply book entry accounting gimmicks in a sense. They don’t represent physical securities. So the act of disinvesting or underinvesting those securities does not involve selling physical securities into the markets. It is just basically moving them around within the government’s books, but as Bob indicated, even though those are only book-entry securities, they do count against the official debt ceiling, just like a real Treasury bill or a real Treasury note would. So by lowering the amount of those trust fund assets, that gives the Treasury some room to come to the market with marketable debt that does raise real money and allows them to pay off maturing principal and make interest payments.

MARGARET WARNER: Because what you’re saying is that $60 billion worth of securities were essentially converted into IOU’s.


MARGARET WARNER: Which somehow–for some reason don’t count against the debt limit.

MR. SCHINDEWOLF: That’s correct.

MARGARET WARNER: Okay. Bob Hormats, if I were a government worker and this represented my retirement, why shouldn’t I be nervous?

MR. HORMATS: Well, you shouldn’t be nervous because this is an accounting device. The Treasury still owes that money, that $61 billion, to these retirement funds. When this is all over in a few weeks or a couple of months, whenever it’s all over, the Treasury will get the money and the Treasury will reinstate the interest payments in addition to the principal it owes to those two accounts, so the average worker should not worry at all. You shouldn’t lose any sleep over this. The interest will be paid. The principal will be put back on the books.

MARGARET WARNER: Doug Schindewolf, do you agree there’s absolutely no risk here to people whose money this represents, or whose retirement this represents?

MR. SCHINDEWOLF: Yes, I do agree with that.

MARGARET WARNER: But then, Bob Hormats, why has the administration been very careful to say we don’t do this with the Social Security Trust Fund?

MR. HORMATS: Well, the Social Security Trust Fund, first of all, is a very sensitive thing with an awful lot of people. They want to be sure their money is available when they need it. Second, they’ve said that they wouldn’t use the Social Security Trust Fund to finance other aspects of the federal government, that is to say to pay interest on normal bonds, or to do other things that the federal government has to do. When it comes to the point that the federal government has to pay off Social Security recipients, it will find a way as it normally does to utilize money in the Social Security Trust Fund and will be able to raise money in the markets that will enable them to come up with the cash that the recipients would ordinarily get. So there’s really no threat that the Social Security Trust Fund will be used for purposes other than to pay off Social Security recipients when the time comes.

MARGARET WARNER: And what you’re saying is they’re staying away from that, in fact, because it’s just politically too risky to–

MR. HORMATS: Well, it’s politically very risky to use Social Security money for other purposes, and second of all, the normal course of drawing on the Social Security Trust Fund, in effect, is to disinvest it in a way to enable the government to borrow to raise capital, to raise money, in effect, which it uses to pay the check. So that is a self-contained operation.


MR. HORMATS: It will be done just as it normally is done, particularly in early January, when a lot of payments are due. The federal government will do it, and recipients should not worry. Neither the Congress nor the Executive Branch wants to tamper with that. That is very sensitive and will go just the way it normally would have gone.

MARGARET WARNER: Okay. Doug Schindewolf, what happens–Sec. Rubin said that what he did yesterday would basically take care of the borrowing needs of the government until the end of December. What if this impasse continues? Can he just go back to this well again? How long can he continue doing this?

MR. SCHINDEWOLF: It’s not clear to me why the Treasury Secretary indicated that the end of December made any significance, because in theory or conceivably this emergency financing mechanism could last quite some time, because in the aggregate there are several of these government trust funds, and they do hold over $1 trillion worth of these non-marketable securities, so that represents quite a deep pocket or well to dip into if this does become protracted. It’s not clear to me why he marked the end of December as a critical date.

MARGARET WARNER: There’s no legal–and Bob Hormats weigh in on this if you want–there’s no legal restriction on how often he can do this, or how much of this he can–

MR. HORMATS: There’s a complicated problem here, and that is each of these trust funds has its own legal status. It was quite clear that these two trust funds–in fact, under legislation asked for by the Reagan administration, give the President a lot of flexibility to the Secretary of the Treasury, a lot of flexibility to disinvest. Some of the others are much more limited in how the Treasury Secretary can draw on them.


MR. HORMATS: And there is a lot of money, as Doug’s indicated, but different funds have different legal provisions, and the lawyers of the Treasury are right now working through how much the President and the Secretary of the Treasury can draw on those. That’s why I think the longer this–the impasse lasts, if it goes into January or February, heaven forbid, then the markets are going to begin to worry how long it will last and is there sufficient money to finance the government and to repay interest into the Spring of next year. Then it becomes a little more problematic for legal reasons that have to do with the limits on the ability to draw on these funds.

MARGARET WARNER: And Doug Schindewolf, what has been the market’s reaction till now, to this move?

MR. SCHINDEWOLF: Well, to this move, the reaction has been very favorable. Toward the end of last week, there were a couple of days where the bond market was starting to weaken to a modest extent because of the fear of default, but when Monday came and it was clear that the Treasury would resort to this emergency financing mechanism and that they would avoid default, the markets had settled down and recovered all of that lost ground.

MARGARET WARNER: And so if this was always available, Bob Hormats, let met end with you, if this was always available as a gimmick, why did we hear all these warnings about default?

MR. SCHINDEWOLF: Well, I think on one level, they were trying to illustrate the point that this was an extraordinary kind of action. This kind of action has never been taken before. Second, I think that they were trying to figure out ways of doing this. It wasn’t altogether clear how much authority they had to disinvest these funds, and I think they were working it through in their own minds how far they could go, what the legal provisions were. This is a very poor way to finance the federal government of the United States. And I think there is a lot of concern in Washington about using this. It’s an extraordinary measure, but if it continues to be used on into next year, then it becomes questionable how much they can draw on these things, and then markets do become much more concerned about whether the government will down the road be able to pay their debts. But for the moment, as Doug said, the markets don’t think it’s a problem. But it is a problem in the long run, and it looks bad to Americans, and it certainly looks bad to foreigners, who hold a trillion dollars worth of Treasury securities. We shouldn’t forget that.

MARGARET WARNER: Well, thank you both very much for shedding some light on this complicated subject.