Thursday, January 10, 2013

The "IOU" proposal for handling the debt ceiling: Social Security recipients should be wary

There is indeed a new idea to give President Obama ammunition in the debt crisis. The government would issue “registered warrants” or “IOU’s” to claimants.  They will not pay interest because they are not loans, and do not violate the debt ceiling.  Paul Kurgman has called them “moral obligation bonds”. 

Recipients of the IOU’s would probably be able to redeem them for a percentage of face value, and then the purchaser (probably a bank) would collect in full when the Treasury deemed itself able to pay them.

There is another proposal, for the treasury to mint a trillion dollar coin.  Of course, this “Weimar” measure could add to inflation and weaken net worth in another way.  But it might protect social security recipients better (although the inflation would still hurt).

Let’s also mention that the Obama administration has suggested that, in the event of default, it would pay existing bills in the order they came due, without preferences.  Many of us have thought that the Treasury really can prioritize based on the legal strength of the claimant.  It does seem probably that the Treasury would pay interest due on bonds first. 

I do have a big problem with the IOU idea as it affects Social Security recipients.  First, one drawback is obvious.  A recipient who gets script and lives “benefit check to benefit check” would have to negotiate the IOU immediately at the bank and lose part of the payment permanently, and still have the same bills (while the bank gets the “profit”).  This hardly sounds like an acceptable practice.
A better-off recipient who did not need the money immediately could seemingly keep the script until the crisis “resolves”.  But there could occur another risk.  The government might say that the recipient has shown other means and no longer has a legal claim, based on the reasoning in the 1960 Supreme Court opinion (Flemming v. Nestor) and deny reimbursement after some period, maybe 30 days. 
California used the IOU mechanism in 2009, but the federal government has never needed it.
Brett LoGiuarto has a story in Business Insider here.

Reuters Video has a 4-minute presentation on the Debt Ceiling.

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