May 15, 2023 - Economy

When a default is not a default

Illustration: Sarah Grillo/Axios

As we get closer to the x-date when the U.S. runs out of money to pay its bills, the broad consensus among economists and politicians alike is that a debt default would be catastrophic. When they use the word "default," however, they mean different things.

Why it matters: The Treasury Department has an idiosyncratic definition of default — which means that when Treasury officials talk about the consequences of default, they're not talking about exactly the same thing that's keeping bankers and economists up at night.

  • That raises the possibility that the U.S. might default — by Treasury's definition — without that default being quite as catastrophic as many fear.

The big picture: Broadly speaking, there are two categories of U.S. government spending: debt service, and everything else.

  • Financiers think of default as being a missed payment on debt service — Treasury bondholders not receiving their principal and interest payments as they come due.
  • Treasury thinks of default as being any missed payment — “Not paying any of our bills is default,” Yellen said in March — but that’s if (and only if) that missed payment is caused by the government running out of money.

How it works: If a missed payment is caused by a lapse in appropriations or a government shutdown, as happened in 2013, that's not default in the eyes of Treasury. (According to Janet Yellen, default is "something America hasn’t done since 1789.")

Between the lines: In the financial markets, why a payment is missed doesn't matter. It could be because of a debt repudiation, it could be because the debtor ran out of money, it could be because the payment was blocked by a judge.

  • For Treasury, however, the why is crucial. When federal payrolls were interrupted in 2013, neither markets nor politicians considered that a default. But their reasons were different.
  • Markets didn't consider 2013 to be a default because debt servicing on Treasury bonds was uninterrupted. Politicians, on the other hand, didn't consider 2013 to be a default because the cause of the missed payments was "a lapse in appropriations" rather than an inability to raise the necessary funds.

Where it stands: During the last major debt ceiling crisis, Treasury put together a plan to stay current on Treasury bonds while missing other government payments. As Yellen said on Friday, that plan "was never presented to the president and never approved." She has more recently said that such "prioritization" is not even possible.

  • Be smart: If Treasury ever admitted that it had a prioritization plan, Republicans would be even more comfortable pushing us past the x-date, and more likely to believe former President Trump's claims that the consequences of default "could be maybe nothing."

The bottom line: If prioritization were both possible and implemented, the consequences for financial markets and the global economy would be much milder — at least in the short term — than if there was a fully-fledged debt default. After all, in terms of actual missed payments, that outcome would be very similar to what we already went through in 2013.

  • Until the x-date arrives, however, we won't know for sure whether prioritization is even possible, or whether President Biden would ultimately decide to try to implement it.
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