Today's Economist: Bruce Bartlett: The Politics of the 14th Amendment and the Debt Limit

Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of “The Benefit and the Burden: Tax Reform – Why We Need It and What It Will Take.”

In 2011, Republicans in Congress drove the nation to the very brink of defaulting on the national debt. During that debate, a number of conservatives argued that default was no big deal — that the debt was so terrible that default was a reasonable option to be considered. Although few Republicans agreed with this position, probably all agreed with Senator Mitch McConnell of Kentucky, the Senate minority leader, that the debt limit was a hostage worth ransoming to force President Obama to surrender to their demands.

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The most recent debt-limit extension was enacted in January and expires on May 19. On March 12, Senator McConnell signaled that he again planned to hold it hostage to Republican demands that programs to aid the poor and elderly be slashed.

In a March 13 interview with the radio host Sean Hannity, the House speaker, John A. Boehner of Ohio, said repeal of the Affordable Care Act might be the ransom that will have to be paid for raising the debt limit. “Do you want to risk the full faith and credit of the United States government over Obamacare?” he said. “That’s a very tough argument to make.”

In 2011, a number of respected legal scholars asserted that a little-known provision of the 14th Amendment to the Constitution essentially invalidated the debt limit. That provision states:

Sec. 4. The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void.

Other scholars contended that this constitutional provision was archaic, that it related to factors specific to the post-Civil War period and had no present-day relevance. On the contrary, I believe a careful review of the circumstances surrounding enactment of the 14th Amendment shows a great deal of similarity to those today.

Such a review was recently done by Franklin Noll, a historian who is a consultant to the Treasury Department’s Bureau of Engraving and Printing, and posted on the Web site of the Social Science Research Network.

Mr. Noll points out that there was strong support for repudiating the Civil War debt among Democrats, who were closely aligned with the Confederate South. They were angered that Congress had explicitly repudiated all the Confederate debt, and had refused to compensate slave owners for freeing their valuable slaves, and Southerners had no desire to help pay the Union’s debts.

One problem for Republicans was that the 13th Amendment abolished the clause in the Constitution that counted slaves as three-fifths of a man for the purpose of apportioning seats in the House of Representatives. The ironic result was to increase the South’s representation in the House. The 11 states of the Confederacy saw their representatives rise to 73 in 1870 from 61 in 1860. They would also have 22 of the Senate’s 74 seats.

It was feared that readmission of the Southern states, together with Democrats from the north, would provide enough votes to prevent passage of legislation to fund the debt. Hence Republicans believed it was essential to have constitutional protection for the national debt.

The forces of repudiation found strong support in the departing President Andrew Johnson, a Democrat from Tennessee whom Abraham Lincoln put on the Republican ticket in 1864 in a spirit of unity to save the Union. In his last State of the Union address, on Dec. 9, 1868, Johnson contended that the cost of the debt was so high that repudiation was justified. He declared:

This vast debt, if permitted to become permanent and increasing, must eventually be gathered into the hands of a few, and enable them to exert a dangerous and controlling power in the affairs of the government. The borrowers would become servants to the lenders, the lenders the masters of the people. We now pride ourselves upon having given freedom to 4,000,000 of the colored race; it will then be our shame that 40,000,000 of people, by their own toleration of usurpation and profligacy, have suffered themselves to become enslaved, and merely exchanged slave owners for new taskmasters in the shape of bondholders and tax gatherers.

Johnson proposed that the Treasury cease paying interest on a large portion of the debt and instead use that money to retire the debt. “The lessons of the past admonish the lender that it is not well to be over-anxious in exacting from the borrower rigid compliance with the letter of the bond,” he said.

Supporters of repudiation, however, had two big political problems to overcome. First, much of the Civil War debt was owned by average people. Historically, financial institutions had bought almost all the Treasury’s bonds, but the amount of bonds needed to be sold during the war required creation of a mass market for Treasury securities.

Second, the debt was closely identified in the public mind with the war itself. As Mr. Noll explains: “The wartime debt became inextricably entwined with the patriotism and moral purpose of the Civil War. To attack the public debt was therefore an attack on the wartime sacrifices and the righteousness of the war to preserve the Union and abolish slavery.”

For this reason, people were willing to bear a much heavier burden of taxation than existed before the war, making the promises of tax relief from debt repudiation fall on deaf ears.

The purpose of the debt provision of the 14th Amendment was to say that national debt was beyond the realm of politics. In the words Jack Balkin, a Yale law professor: “It was stated in broad terms in order to prevent future majorities in Congress from repudiating the federal debt to gain political advantage, to seek political revenge or to try to disavow previous financial obligations because of changed policy priorities.”

Republican threats to hold the debt limit hostage to their agenda today present precisely the sort of political situation contemplated by the authors of the 14th Amendment.

Rating Agencies Watching Debt Ceiling Limit Again

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On Capitol Hill, Fiscal Talks Now Turn to U.S. Borrowing Limit

According to the Treasury Department, the government is about $66 billion below its $16.4 trillion debt ceiling, a legal borrowing limit that is set and periodically raised by Congress. When the country hits the ceiling — sometime toward the end of December, analysts estimate — it would start a countdown clock that would end with Washington running out of money to pay its bills.

That event might hobble the government, ruin the country’s credit and send markets into an outright panic, analysts predict. But despite — or because of — the debt ceiling’s potential to disrupt the economy, members of Congress are refusing to raise it as a matter of course, instead using it as a potent political football to extract concessions from the other side.

“I will not raise the debt ceiling ever again until we get significant entitlement reforms, because if we don’t reform entitlements, we’re going to become Greece,” Senator Lindsey Graham, Republican of South Carolina, said on CNN this week. If President Obama “doesn’t lead, there’s going to be one hell of a fight over raising the debt ceiling.”

The White House has pushed back by warning Republicans away from the ceiling in strong terms. “We cannot play this game, because while it might be satisfying to those with highly partisan and ideological agendas, it’s not satisfying to the American people and is punishing to the American economy,” said Jay Carney, the White House spokesman, this week. “We cannot do it.”

Some Democrats have in recent weeks urged the White House to mount a legal challenge to the ceiling itself. The White House has ruled out such measures. But in its initial proposal to avert the worst of the year-end tax increases and spending cuts, the so-called fiscal cliff, the Obama administration asked Congress to grant it more authority over the ceiling.

The White House’s plan — based on a proposal initially made by Senator Mitch McConnell of Kentucky, the Republican leader — would allow it to request an increase to the debt limit. Congress could pass a resolution blocking the increase, though such a resolution could be killed with a presidential veto.

Republicans immediately rejected the proposal. But it stems from the Obama administration’s deep frustration with Capitol Hill’s use of the ceiling as a source of political leverage, both last year and this year.

Mr. Boehner and Mr. Obama tried and failed to strike a long-term debt package before raising the debt ceiling, but not before scaring the markets and leading to the first-ever downgrade of the country’s credit rating.

This time, the ceiling is complicating the renewed negotiations on a long-term debt deal. Republicans are considering a plan to preserve the tax cuts on income up to $250,000 that Mr. Obama has requested, and then in the new year refuse to raise the debt ceiling unless the Obama administration concedes to cost reductions for Social Security, Medicaid and Medicare and possibly other programs.

When the country hits the ceiling, the Treasury would stop issuing new debt and start a series of “extraordinary measures,” technical maneuvers to leave it with enough money to pay all its obligations. But such extraordinary measures would buy the government only about six to 10 weeks, analysts estimate.

Eventually, its spending obligations would overwhelm incoming receipts, and the government would not be able to pay its bills. That would leave the Treasury in the position of choosing whether to pay bondholders or soldiers, the elderly or states.

Last summer, “Treasury considered asset sales; imposing across-the-board payment reductions; various ways of attempting to prioritize payments; and various ways of delaying payments,” a department report said. “Treasury reached the same conclusion that other administrations had reached about these options — none of them could reasonably protect the full faith and credit of the U.S., the American economy, or individual citizens from very serious harm.”

Knowing exactly when the Treasury would reach that point is an exercise in guesswork. The Bipartisan Policy Center estimates the date would fall sometime in February.

If Congress failed to address any of the year-end spending cuts or tax increases, the government’s revenue would rise and spending obligations would fall. But analysts say they do not think that would delay the need to raise the debt ceiling for more than a few days.

“I’ve been here in 40 years this coming January, and I have never seen this many consequential spending and tax problems descend at the same time,” said Steve Bell, senior director of economic policy at the Bipartisan Policy Center, and a former Republican Hill staff member.

“There might be a variation of a day or two or four,” he guessed. But by sometime in March, Congress would have needed to raise the ceiling or the country might have entered another financial crisis — or even another recession.

On Capitol Hill, Fiscal Talks Now Turn to U.S. Borrowing Limit

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DealBook: Fed Governor's Plan to Limit Bank Size Fuels Debate

Michael Reynolds/European Pressphoto AgencyDaniel Tarullo of the Federal Reserve has suggested a simple tool that could be applied to individual institutions.

Since the financial crisis, academics, politicians and even former bank chieftains have called for the nation’s banking behemoths to be broken up or shrunk — calls that appear to have fallen largely on deaf ears among Washington’s policy makers.

Now, a powerful insider has suggested a simple tool that could place a tight limit on the size of individual banks. Daniel K. Tarullo, a Federal Reserve governor who oversees bank regulation, said in a speech last week that an important part of a bank’s balance sheet could be capped at a set percentage of the nation’s gross domestic product.

That a regulator at the Fed — the most powerful of the banking industry’s overseers — would say that such a structural overhaul of the financial system might be considered, was a sign that the policy debate over what to do about “too big to fail” might be shifting.

Mr. Tarullo’s “statements mark a significant — perhaps even dramatic — shift in thinking at the central bank,” Simon Johnson wrote in a recent column for Bloomberg News. Mr. Johnson, a professor at the Massachusetts Institute of Technology, has been a leading voice in the movement to limit the size of large banks.

It’s not just that the Fed governor’s words provided comfort to supporters of breaking up the banks. They also come at a moment in the debate over the Dodd-Frank Act, when both Republicans and Democrats might be able find common ground.

Mitt Romney and other Republicans have criticized Dodd-Frank, contending that it is overly complex and protects “too big to fail” institutions. Some Republicans looking to repeal Dodd-Frank say they still want to constrain large banks. Their concern is that the law may lead the market to believe that the government protects large banks. In turn, investors might then provide cheap loans to the biggest banks, fueling even more growth in the banks’ balance sheets. As a result, some Republicans may warm to the simple cap on bank size outlined in Mr. Tarullo’s speech.

“I am completely open to the proposal because of my similar concern about the growing size of institutions that are too big to fail,” said Senator David Vitter, a Republican of Louisiana. “Beyond this specific proposal, there is a growing nonpartisan consensus to do a lot more to limit the size of the megabanks.”

Any shift at the Federal Reserve would be notable. The central bank, mindful of the stability of the financial system, has avoided giving strong backing to measures that could have a direct impact on bank size.

Mr. Tarullo did not give an unequivocal, personal backing to a cap on size of banks. But he said that if size were to become a big issue, Congress should take it up, so the effects of a cap could be debated. Mr. Tarullo then detailed a type of cap that he said seemed to have “the most promise.”

His proposed limit would focus on something called “nondeposit liabilities.” These are the borrowings that banks do to finance themselves, excluding deposits.

For example, at the end of June, JPMorgan Chase had $1.24 trillion of nondeposit liabilities, a figure that excludes deposits in the United States, but includes international deposits.

That $1.24 trillion is equivalent to 8 percent of G.D.P. Any legislation would have to decide whether to set a percentage that would immediately force a bank like JPMorgan to shrink. If it were set at 5 percent, JPMorgan would have to shed the excess borrowings, which in turn would lead it to cut its overall size.

Senator Sherrod Brown, Democrat of Ohio, introduced legislation earlier this year that proposed the cap be set at 2 percent of G.D.P., which would force several of the largest banks, including Citigroup, Bank of America and Goldman Sachs, to shrink aggressively. (That bill has not advanced.)

Alternatively, the cap could be set at a percentage of G.D.P. that allows banks to stay at close to their current size. In that case, it would just constrain future growth.

Dodd-Frank has a provision that sets out to limit the relative size of banks. It stipulates that banks cannot have liabilities that exceed 10 percent of the total financial system’s liabilities. But this may not cap bank growth if the whole system is ballooning, as happened in the last decade. From 1999 to 2007, the Goldman Sachs balance sheet grew by 346 percent. But it would have increased by only 48 percent if its growth had been strictly tied to G.D.P. growth in that period.

The cap has its critics.

One drawback is that it might deter banks from issuing longer-term debt, which can act as a stable source of financing in a crisis. Hal S. Scott, a professor in Harvard Law School, said it would be preferable to limit short-term borrowings by banks, since that is more vulnerable to bank runs.

Others say that the economy needs both large and small banks and growth could be harmed by efforts to dictate bank size.

“The costs to society would outweigh the benefits,” said Phillip L. Swagel, a professor at the School of Public Policy at the University of Maryland. “But I realize that the idea of setting limits on large banks is gaining popularity across the political spectrum.”

Others fear that an inordinate focus on one tool to deal with financial stability could backfire. They think that the multifaceted approach of Dodd-Frank is better at catching and moderating the risks in the banking system.

“I think it’s a mistake to think there’s some sort of silver bullet here,” said Michael S. Barr, professor at the University of Michigan Law School. Mr. Barr worked on Dodd-Frank as an assistant secretary at the Treasury Department. He also says he thinks that going back right now and undoing parts of Dodd-Frank would most likely only dilute the overhaul.

“If Congress took up reform, it would only be in the direction of weakening it, not strengthening it,” he said.