Treasury says debt payments could be prioritized in default scenario

LOS ANGELES (Reuters) - The Treasury Department has admitted for the first time that the government is technically capable of prioritizing payments if Congress triggers a default crisis by failing to raise the country’s borrowing authority.

U.S. Treasury Secretary Jack Lew testifies before the Senate Budget Committee about the President's 2015 Budget on Capitol Hill in Washington, in this March 12, 2014 file photo. REUTERS/Kevin Lamarque/files

In a letter to Republican Congressman Jeb Hensarling, a senior aide to Treasury Secretary Jack Lew said the New York Federal Reserve, which pays the principal and interest on government debt, would be “technically capable” of continuing to make those payments while Treasury halted other payments if the United States was unable to borrow more money. The official stressed, however, that such a system is untested.

Lew and other Treasury officials insisted during last October’s debt limit crisis, when the U.S. came close to defaulting on some government obligations, that “prioritization” - a contingency strategy where bond payments are made while other outlays such as Social Security payments are halted - was not feasible.

In testimony to Congress, Lew said last October the government’s payment systems weren’t designed to decide who gets paid and who doesn’t. “It would be chaos,” Lew told Congress.

During the debt ceiling crisis last year, when House Republicans threatened not to extend the country’s borrowing authority, Obama administration officials were at pains to dismiss the idea of any contingencies, lest that encouraged enough lawmakers to take the country over the brink and into default.

Yet lawmakers and analysts have long suspected that in the event of a default, Treasury and Fed officials would seek to keep current on bond payments to keep investors from panicking, while halting other payments as cash reserves ran out.

In the May 7 letter to Hensarling, the Republican Chairman of the House Financial Services Committee, Treasury Assistant Secretary Alistair Fitzpayne wrote: “If the debt limit were not raised, and assuming Treasury had sufficient cash on hand, the New York Fed’s systems would be technologically capable of continuing to make principal and interest payments while Treasury was not making other kinds of payments.”

But, Fitzpayne added, “this approach would be entirely experimental and create unacceptable risk to both domestic and global financial markets. As we have repeatedly stated, this would mean that the United States would default on its obligations, including to senior citizens, veterans, and members of the military.”

Mick Mulvaney, a Republican member of the House Financial Services Committee, said on Friday he believed the letter proves payments can be prioritized if the debt ceiling is not raised, and that a financial meltdown would not occur.

“I’ve thought from the very beginning that the administration has been stoking fear in what they say would happen if the debt limit is not raised,” Mulvaney told Reuters.

Congress extended the government’s borrowing authority in October, ending the crisis, and again in February, when it extended it through March 2015.

Reporting by Tim Reid; Editing by Diane Craft