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Moral Obligation Coupons Won't Work Either

Monday, 7 Jan 2013 | 5:58 PM ET
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It's amazing how much innovative thinking has gone into avoiding the debt ceiling. You're familiar by now with the trillion dollar platinum coin. But have you heard about zero face-value Treasury bonds or moral obligation bonds?

Let's start with zero face-value Treasury bonds. The idea was first proposed last April by the commenter called "beowulf" on the Monetary Realism site. (Yes, he's the same guy credited with first proposing the trillion dollar coin.) Modeled on a British financial instrument known as a consul, the Zero Treasury Bond would have no scheduled maturity and no face-value. It would be a perpetual bond with no amount of guaranteed principal. It would pay a coupon, however, which is why it would be attractive to investors.

In a new post today on Monetary Realism, beowulf explains why he thinks issuing this type of bond wouldn't violate the debt ceiling.

My thesis is simple, there's a kind of debt that according to the Department of the Treasury itself shouldn't even be counted as debt under the debt ceiling statute.

"The face amount of obligations issued under this chapter and the face amount of obligations whose principal and interest are guaranteed by the United States Government (except guaranteed obligations held by theSecretary of the Treasury) may not be more than…"

The clue that this isn't as iron-clad as is generally assumed is the aside about "whose principal and interest are guaranteed". The face amount of an interest-bearing bond is the sum of principal that is guaranteed repayment at a fixed maturity date. This creates an interesting question, what would happen if interest is guaranteed by Tsy but the principalis not? Arguably, if Tsy issued interest-bearing bonds (discount bonds andT-bills are handled differently) that guarantees interest but not principal,then by the legal arguments Tsy has used in court successfully in nearly a century of tax cases, the obligations created should not count against the debt ceiling.

Paul Krugman proposes something very similar on his blog:

Don't like the platinum coin option? Here's a functionally equivalent alternative: have the Treasury sell pieces of paper labeled "moral obligation coupons", which declare the intention of the government to redeem these coupons at face value in one year.

It should be clearly stated on the coupons that the government has no, repeat no, legal obligation to pay anything at all; you see,they're not debt, and therefore don't count against the debt limit. But that shouldn't keep them from having substantial market value. Consider, for example, the fact that the government has no legal responsibility for guaranteeing the debt of Fannie and Freddie; nonetheless, it is widely believed that there is an implicit guarantee (because there is!), and this is very much reflected in the price of that debt.

So the government should have no trouble raising a lot of money by selling MOCs.

Unfortunately for advocates of Zero Treasury Bonds and Moral Obligation Coupons, this won't work under the debt ceiling statute. These things would still count as debt. Because what matters isn't the amount guaranteed or the face amount. It's the amount paid for the instrument.

Here's what the law, codified as 31 USC 3101, actually says about what counts toward the limit:

(a) In this section, the current redemption value of an obligation issued on a discount basis and redeemable before maturity at the option of its holder is deemed to be the face amount of the obligation.

(b) The face amount of obligations issued under this chapter and the face amount of obligations whose principal and interest are guaranteed by the United States Government (except guaranteed obligations held by the Secretary of the Treasury) may not be more than $14,294,000,000,000,outstanding at one time, subject to changes periodically made in that amount as provided by law through the congressional budget process described in Rule XLIX [1] of the Rules of the House of Representatives or as provided by section 3101A or otherwise.

(c) For purposes of this section, the face amount, for any month, of any obligation issued on a discount basis that is not redeemable before maturity at the option of the holder of the obligation is an amount equal to the sum of—

(1) the original issue price of the obligation, plus

(2) the portion of the discount on the obligation attributable to periods before the beginning of such month (as determined under the principles of section 1272(a) of the Internal Revenue Code of 1986 without regard to any exceptions contained in paragraph (2) of such section).

It's Section (c) (1) that trips up the Zeros and the MOCs. The instruments would not be redeemable before maturity—they have no maturity—so their face value would be equal to the original issue price. Clever thought though.

Follow me on Twitter @Carney

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