Uncertain Debt Management: Treasury Markets and Financial Institutions

House Committee on Financial Services

Uncertain Debt Management: Treasury Markets and Financial Institutions

Tuesday, June 6, 2023

Topline

• Republicans discussed the impacts of inflation and high interest rates, as well as the need to reduce federal spending to lower the debt.
• Democrats highlighted how Republican tax cuts have added to the debt.

Witnesses

• Grant Driessen, Specialist in Public Finance, Congressional Research Service
• Jeff Arkin, Director, Strategic Issues Team, Government Accountability Office

 

Opening Statements

Subcommittee Chairman Andy Barr (R-Ky.)

In his opening statement, Barr said that markets for Treasury securities are integral to the functioning of financial institutions and the products they provide. He added that trillions of dollars of Treasury trades occur each day, which help support provisions of financial services, and they depend on a highly liquid, deep, and stable market. Barr also pointed out that Treasury securities holdings at financial institutions recently came to the forefront in the form of bank runs and failures, and that high interest rates placed many Treasury security holdings underwater. He said that this was at the heart of SVB’s failure. Barr also stated that instability in Treasuries markets arose given uncertainty around the debt limit. Finally, the Chair mentioned discussion drafts of bills aimed at additional information provisions and transparency about Treasury’s debt management and surrounding issues.

 

Subcommittee Ranking Member Bill Foster (D-Ill.)

In his opening, Foster said that the U.S. is almost alone in the world in having a debt limit. He added that this problem should be solved at the budget negotiations level, and not by the artificial rule that Congress made up for itself through the debt limit. He argued that it is a frivolous and dangerous rule that has been ineffective at reducing the national debt. Finally, Foster said that comparing debt to GDP does not make sense, and that if debt is instead compared to wealth, the U.S is far from bankrupt.

 

Witness Statements

Mr. Grant Driessen, Specialist in Public Finance, Congressional Research Service

In his opening statement, Driessen explained that extraordinary measures have been invoked in recent years to delay a binding debt limit by a period of a few weeks to a few months. He also highlighted the extraordinary measures used in 2023, including: suspension of investment in the G Fund of the federal employee’s retirement system; suspension of invested balances in the Exchange Stabilization Fund; declaration of a Debt Issuance Suspension Period; suspensions of state and local government securities; exchanging Treasury securities for obligations in the Federal Financing Bank; and higher net federal deficits which will lead to faster increases in debt subject to limit.

Driessen pointed out that the government has never failed to enact a modification before a debt limit bind. He concluded by noting that the effects of an anticipated or an actual binding debt limit could include the direct effect of missed/late federal payments, financial markets effects, and indirect effects on borrowing and general economic confidence.

 

Mr. Jeff Arkin, Director, Strategic Issues Team, Government Accountability Office

In his opening statement, Arkin said that the federal government faces an unsustainable fiscal future, as debt held by the public is projected to grow faster than the economy. He noted that publicly held debt as a share of GDP grew during three of the last four economic expansions, and the level of publicly held debt is estimated to reach a historical high of 106% of GDP within ten years absent changes to revenue and spending policy. He added that deficits are expected to grow as expected revenues fail to keep pace with expected growth in program spending, particularly in programs like Social Security and Medicare, and that net interest spending is projected to increase steadily over the next 30 years.

Arkin also explained that failing to raise the debt limit could force Treasury to delay payments on securities and interest, which would have devastating effects on the US and global economies. He said that even without a default a debt limit impasse can be costly. Finally, he discussed GAO’s suggestion that Congress develop a plan to address the country’s long term fiscal outlook and promote fiscal sustainability. He noted that part of that could include alternative approaches to the debt limit like linking action on the debt limit to the budget resolution, or fiscal rules that manage debt by controlling factors such as revenue and spending to meet a specific deficit target.

 

Question & Answer

Monetary Policy and Interest Rates

Barr asked how recent changes in monetary policy, compounded with the Fed’s decision to operate at near zero interest rates for too long, have impacted the Treasury market. Driessen said that interest rates determine net interest costs, which is a huge factor in the future of federal budgeting. He said that an unstable market for any reason would be more dangerous during a debt limit episode. Barr asked if a precipitous rise in interest rates makes it harder for banks to manage interest rate risk and examiners to supervise that risk. Arkin said it can certainly increase risks for banks and was a factor in SVB’s failure. Finally, Barr asked if the Fed continuing to “park dollars at the Fed instead of at banks where money can fund lending” will result in market distortions. Arkin said he would get back to the committee with an answer. Barr said that this needs to be investigated, because the reverse repo facility is now used as a monetary policy tool but could be another source of instability in the banking sector as deposit migration continues.

Rep. Blaine Luetkemeyer (R-Mo.) asked if issuing another trillion dollars of Treasury bills would exacerbate liquidity problems due to the increased costs of the rates on those bills. Driessen said that a sudden change after 15 years of consistent interest rates at any level, low or high, will lead to economic disruption.

Rep. Brad Sherman (D-Calif.) asked if interest rates are going to be higher over the next several years because the U.S came so close to default. Arkin said that he does not know if there is an immediate impact on interest rates because of the impasse. In general, he said that interest rates are expected to increase in the future, certainly from where they were a few years ago.

 

Transparency at the Treasury Department

Barr also said that the Treasury was opaque about how it arrived at the conclusion of when the US would no longer be able to pay its obligations, and he added that Congress needs all the information necessary to raise the debt ceiling and introduce solutions to create lasting changes to our debt trajectory.

Rep. John Rose (R-Tenn.) asked if Treasury should be more transparent about debt, cash balances, forecasts on how long extraordinary measures would help keep debt below the limit, forecasts of near-term receipts, revenues, and cash, or forecasts about the x-date. Arkin replied that the Treasury has a responsibility to share information with Congress. He noted, however, that the Department balances some of that with information provided to the market since it’s a sensitive topic.

 

Causes/Solutions to Growing Federal Debt

Foster said that the ultimate solution to this issue is to get rid of the debt limit. He said that long term deficits are being driven by Medicare, Social Security, etc., and that a large part of the inability to pay is because of boomers accumulating wealth. Foster noted that over $80 trillion of wealth is going to be passed to the next generation over the next 20 years, and that a third of that would be enough to retire the debt. Finally, the Ranking Member recommended returning to the tax policies that made the U.S. great by getting rid of things like the basis step-up and charging higher rates in several areas, particularly when wealth is passed to the next generation.

Rep. Barry Loudermilk (R-Ga.) said that he will be reintroducing his balanced budget amendment legislation again this week or next. He also noted that Congress passes budgets that balance in ten years, but never decreases from that initial ten. Arkin said that there should be a target plan to look at revenue and spending and have those be more balanced to avoid driving deficits that grow debt faster than GDP.

Rep. William Timmons (R-S.C.) said that the U.S. has created a system that is unsustainable, but the largest drivers are off limits. He added that there is a health care problem and a workforce problem, neither of which were addressed in recent budget negotiations. He also pointed out that Social Security will be insolvent in 7-10 years and added that these three drivers were preemptively removed from discussion by our leaders. He concluded by stating that the U.S. needs to fix entitlement programs because they are going to fail if Congress do not address them, and every year they get harder to fix.

Rep. Scott Fitzgerald (R-Wisc.) said that Medicaid is still the ultimate driver of the debt. He asked if it is accurate to lump Social Security and Medicaid together. Arkin said that the biggest drivers, looking into the future in terms of increases in spending, are federal health care programs.

Rep. Al Green (D-Texas) said that Republicans believe the rich need more to do more, and the poor can do more with less. He said that poor people need Medicaid and working people need Social Security. Green also said that if the wealthy fail to pay their fair share of taxes, this decreases the amount of revenue that can be used to pay debts. He concluded by stating that cutting the IRS agents to catch the wealthy who are cheating was not a good idea.

Rep. Sean Casten (D-Ill.) said that it is a legitimate problem when revenues fall under expenses, but there is a completely imaginary problem created by the debt limit. He noted that Republicans have proven capable of turning imaginary problems into real problems.

 

Impacts of Defaulting or Nearing Default

Luetkemeyer asked how much money extraordinary measures cost the taxpayers in direct costs. Arkin replied that when the GAO looked back at 2011, it was in the range of tens of millions of dollars. He said that the factors in play then were similar to now.

Rep. Maxine Waters (D-Calif.) asked how premium increases cost taxpayers money when debt impasses take place. Arkin replied that on the secondary market there were yields that rose quickly in May from 5-7%. He added that there are broader costs for other kinds of financing that are tied to the Treasury market (mortgages and car loans become more expensive). Waters also mentioned that Brookings has said that compared to 2011 and 2013 when similar brinkmanship over the debt limit occurred, the premium being charged was much higher this time around and increased earlier.

Rep. Bill Posey (R-Fl.) asked how much the interest on the debt is costing taxpayers now and what percent of total federal expenditures it is. Driessen replied that it is about $700 billion this year, about 10% of spending and 2.5% of GDP. Arkin said that at the end of 2022 it was about 8% of total federal spending. He added that over the last 20 years it has been 1.5% of GDP and has gone up a little bit. Based on projections, Arkin said that 30 years from now it will be more like 8.5% of GDP.

Posey also asked if there is any reason why the government could not prioritize payments. Driessen pointed out that there is a difference between making payments on existing securities and making choices with existing spending programs. He said that from a legal standpoint, the Treasury’s mandate to minimize federal borrowing costs might provide support for prioritizing principal and interest on existing securities. From a practical standpoint, they make those payments in a different system than others. He also noted that prioritizing current spending programs has been subject to legal debate for decades.

Rep. Joyce Beatty (D-Ohio) asked what a default would mean for the dollar’s role as the global reserve currency. Arkin said that GAO has not looked into it too much, but if countries start holding other currencies it could have an effect on the dollar’s supremacy in foreign markets. Driessen added that there is a lot of uncertainty about the effect of the dollar losing its status as the preferred reserve currency. He said that there are some estimates that it saves the U.S. a quarter of a percentage point on interest rates ($50 billion per year).

Rep. Young Kim (R-Calif.) also asked about the impact of the debt on the U.S. dollar’s reserve currency status. Driessen said that there is a long-term risk.

Rep. Byron Donalds (R-Fl.) asked how a default would be different from a government shut down scenario. Arkin said that a shutdown means there has been a lapse in appropriations, and federal agencies can still do some things. That is a little different from the scenario of the Treasury not having the funds to make payments to bondholders, interest and principal, or to contracts to other obligations. Driessen added that in a shutdown, Congress and policymakers are controlling what is funded and what is not.

 

The Debt to GDP Ratio

Loudermilk also asked about the effects of a sharp increase in the debt to GDP ratio if Congress does not act to cut spending and reduce the deficit. Arkin replied that risks include a potential fiscal crisis where interest rates would rise quickly. He added that nobody knows how much is too much or at what point it becomes problematic.

Fitzgerald also asked how long the U.S can maintain or keep adding to this level of debt before it experiences a debt crisis like some of the smaller European countries have already faced. Arkin said that it is a bit of an unknown and re-emphasized the importance of a long-term plan.

 

Foreign Held Public Debt

Loudermilk asked about the challenges that high levels of foreign held public debt could create. Arkin said they have not looked specifically at whether there are risks from foreign governments holding shares in terms of growth in that ratio in the future. Driessen added that people who support the idea of allowing foreign institutions to hold the debt would say that it helps lower interest costs, but there is a cost from interest payments leaving the U.S. economy and going into someone else’s. Loudermilk asked if defaulting could create a national security risk due to the foreign held debt. Driessen said that the current risk is low because the debt holdings are pretty dispersed.

 

The Tax Cuts and Jobs Act

Rep. Nydia Velazquez (D-N.Y.) said that when Republicans talk about the debt, they frequently fail to acknowledge the true cause of debt level rise: slashing taxes that primarily benefit the wealthy and profitable corporations over the last 25 years. She said that this has led to a lack of revenue and put the U.S. on a path of uncontrollable debt.

She also noted that CBO has estimated that extending many of the temporary provisions in the TCJA could cost as much as $2.7 trillion and increase the debt as a share of GDP by 2032 to 118%. She asked if it makes sense for Congress to consider another large TCJA 2.0 package extension from a budget perspective. Driessen said there is a structural imbalance with the federal budget. He said that looking at the debt side, most people are relatively impartial as to how the federal government changes its operations—whether its lower spending, higher revenues, or a combination of the two.

 

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