Debt Ceiling Debacle: Who Gets Paid First?

If Congress does not vote to extend the debt ceiling by the U.S. Treasury's August 2 deadline, the United States may not be able to pay all its bills. In fact, the Bipartisan Policy Center estimates the Treasury will default on nearly half its financial obligations. Jay Powell, the former Under Secretary to the Treasury under President George H.W. Bush and current visiting scholar at the Bipartisan Policy Center, talked with CBS MoneyWatch about what will happen -- and who will get paid first -- if Congress cannot agree on a plan.

MoneyWatch: What happens if there is no agreement by August 2?
Jay Powell: If the debt ceiling is not increased by August 2, then the federal government will wake up on August 3 and find itself far short of the amount of cash it needs to pay all of its bills. And if that happens, for the month of August, we estimate that the federal government will default on 44 percent of its legal spending obligations. We do not believe there will be a debt default, but there will not be enough cash to pay the other obligations. The federal government will be faced with a series of impossible choices over what not to pay.

MW: So who gets paid first?
JP: Interest on the debt will have the highest priority. It is unthinkable that we would fail to do so. Beyond that there's really no way to know. There are an almost infinite number of alternatives. It is possible to pay all the safety net payments out of income and cash flow. If you do that, though, you don't have a dollar for the national defense and you don't have any money to run the justice department, so the FBI doesn't operate, the courts don't operate, and the federal prisons close down. You open up the doors and let everybody go. That can't happen. The government has to pay for the defense establishment, the justice department and all these other departments. These are not trivial activities of government. But any way you play the game, you can't cut spending by 44 percent overnight without cutting very popular and important programs.

MW: What's the long-term solution to this problem?
JP: We have to reduce our deficits by between 4 and 5 trillion dollars over the next 10 years to restore our fiscal path to one that is sustainable. Right now we're borrowing a trillion dollars plus every year and that's not even going to change when the economy recovers. The system is out of whack. Spending is way too high for the amount of revenues we take in, and if we don't address it, we're going to hand the country over to future generations in a substantially reduced state. If we can't do that with this one package right now, we have to come back to it in a year and do it again. It's going to take sacrifice, but it's something as a country we really have no choice but to do.

MW: President Obama says he won't sign a stopgap bill. If push comes to shove and that is the only option he has on August 2, should he sign it?
JP: Yes, and it's something I predict he will reconsider. Many presidents have issued such statements and wound up signing something. I think all of the leadership both in the White House and on the Hill understand that it's a really unattractive option to go past August 2 without a debt ceiling increase. We're going to do the best we can. If the best we can is a short term increase, it's probably the right thing to do in the short run. But, we've got to keep working on this problem until we solve it.

MW: If there is no agreement, how will it affect the average citizen?
JP: If we pass August 2 without a debt ceiling increase, it's very likely there will be significant negative effects on the economy from the precipitous drop in government spending. It's going to be very concerning and confusing to foreign debtors who do not understand quite what is going on. Some of them will opt not to take part in our Treasury bill and bond auctions. And when they do that, interest rates will have to go up to attract bidders during this period of so-called prioritization. Interest rates in the Treasury market are what fundamentally set the level of interest rates in the private sector, so you can expect that as Treasury rates go up, mortgage rates would go up, business interest payments would go up, municipal interest would go up and that would both increase the deficit and create a drag on the economy.

MW: Do you have confidence that the White House, Congress and the Treasury will be able to overcome this crisis?
JP: I want to believe, I want to be an optimist. Some days it's not easy.