WASHINGTON (Reuters) - Treasury Secretary Timothy Geithner warned on Wednesday that "prioritizing" government payments to avoid a debt default would spur deep cuts in other disbursements and still cause investors to shun Treasury securities.
In a letter to senior Republican senators, Geithner said their proposal to keep the debt limit at the current level while ensuring payment of interest on the federal debt is unworkable.
"Ultimately, the notion of 'prioritizing' payments is futile because the debt limit must be increased regardless of which spending path is adopted," Geithner wrote. "There is no credible budget plan under which a debt limit increase can be avoided."
Geithner said that because the United States now borrows roughly 40 cents of every dollar it spends, prioritizing payments with no debt limit increase would require cutting 40 percent of all government expenditures.
This "would have painful implications for people in every walk of American life," from military families and veterans to Social Security recipients and government employees, he wrote.
Continuing interest payments while defaulting on other obligations would not address how the United States would replace maturing Treasury debt, Geithner noted. Normally, investors would reinvest principal from maturing Treasuries in newly issued debt, allowing the repayment of debt principal.
Geithner said more than $500 billion in Treasuries will mature in August, the month in which the Treasury has said it will no longer be able to pay all the nation's bills without an increase in the $14.3 trillion debt cap.
"There is no guarantee that investors would continue to re-invest in new Treasury securities" if the United States defaults on non-debt obligations, Geithner wrote. "In fact, some market participants have already indicated that they would be disinclined to do so."
He noted that one rating agency has said that failure to pay no-debt obligations would signal severe financial distress and an imminent threat of default.
Reporting by David Lawder; Editing by Dan Grebler