US weighing payment priorities if default comes

WASHINGTON – If the government can't pay all its bills come Wednesday, odds are it will pay bondholders. Social Security and Medicare recipients will be high on the must-pay list, too. Likely losers: federal workers in jobs deemed non-essential, private contractors and state and local governments.

It seems politically certain that active-duty members of the military would be paid, but there are no guarantees as the government decides which of its 80 million monthly payments to make and which to set aside.

Since the U.S. now borrows slightly over 40 cents for every dollar it spends, a failure by Congress to increase the debt ceiling above the $14.3 trillion limit suggests the government could renege on more than 40 percent of its current obligations.

Just five days before the Treasury begins running out of cash to pay all its bills, Congress remained deadlocked over plans to both raise the debt limit and trim federal spending. President Barack Obama warned anew that the credit status and financial credibility of the United States stand in severe jeopardy.

"There are plenty of ways out of this mess, but we are almost out of time," Obama said, noting the Tuesday deadline.

Treasury, working with the White House budget office, has sketched out a priority plan for payments. So far, officials have refused to provide details, knowing it could touch off a firestorm. They're hoping for a compromise soon so it won't be necessary. But White House spokesman Jay Carney said Treasury would release some details on payment priorities as the Aug. 2 deadline approached, perhaps over the weekend.

There is wide agreement that the government would take pains to avoid an actual default on its debt by putting interest payments to bondholders at the top of the payment priority list.

"Most people in the bond market feel the bonds will be paid off, that they will get priority in payment" said David Wyss, former chief economist at Standard & Poor's. "This is not like when you shut down the government. You can still spend money up to the amount of revenue you're bringing in. You just can't borrow."

Of today's $14.3 trillion national debt — the accumulation of decades of deficit spending — some $9.7 trillion is financed through the sale of Treasury bonds, bills and notes to the public. Holders of these securities range from individuals to pension funds, corporations, and foreign governments.

The remaining $4.6 trillion in debt represents "intergovernmental holdings," money one governmental entity owes to another, including assets held in the Social Security Trust Fund.

According to Treasury figures, the government will take in $172.4 billion from Aug. 3 to Aug. 31, but is scheduled to pay out $306.7 billion, suggesting a shortfall of over $134 billion.

The Bipartisan Policy Center — founded by former Republican Sens. Howard Baker and Bob Dole and former Democratic Sens. Tom Daschle and George Mitchell — did a speculative rundown on how the government might spend that $172.4 billion absent a debt-limit deal.

Topping its list was the $29 billion due in interest on Treasury securities. That would keep the U.S. out of technical default.

Then, the center suggested, might come $49.2 billion for Social Security payments, some $23 billion of them due to go out on Aug. 3; $50 billion in Medicare and Medicaid payments, $31.7 billion for high-priority defense-vendor obligations, and $12.8 billion in unemployment insurance benefits.

But, that would be about it.

The center says there would be no money left even for active-duty military pay, despite its political popularity.

Also on the center's hypothetical hit list: many other defense-related expenses, federal salaries and benefits, funds for the Departments of Labor, Justice, Energy and Interior; for the Federal Highway Administration, the Environmental Protection Agency, Health and Human Services grants, the Federal Transit Administration and the Centers for Disease Control.

A default or even near-default would push up interest rates across a wide swath of the economy, from mortgages and business borrowing to student, auto loans and credit cards. But how much is open to debate, since many rates remain near historic lows and it is not clear whether major holders of Treasury securities — such as China and Japan — would rush to sell.

However, if the standoff lasts long enough, it could trigger a global stampede.

The three major rating agencies have already warned that the government's coveted triple-A credit rating could be downgraded in the absence of a suitable debt-limit deal. That would undermine the status of Treasury securities as the world's safest investment.

But the practical effects are also questionable, since there's not a lot of appealing other safe-haven options right now.

In addition to $23 billion in Social Security payments due to go out Aug. 3, the government is also scheduled to pay $2.2 billion in Medicare and Medicaid payments. Also, over $4 billion in scheduled federal salaries are to be paid over the first week in August.

Some $87 billion in federal debt is due to be rolled over into new bonds on Aug. 4. Also, Treasury is scheduled to make a $29 billion interest payment to bondholders on Aug. 15.

Some economists suggest the government could get by for a week or more beyond the Aug. 2 deadline, noting Treasury's unusually high daily cash balance in recent days of over $80 billion, about twice the norm. However, Treasury argues that, despite this cash on hand, next Tuesday is still when it will run out of accounting maneuvers.

It has been clearing headroom for additional borrowing since hitting the $14.29 borrowing limit on May 16, primarily by removing investments from government employee pension accounts.

Obama and congressional leaders of both parties are still predicting a default-avoiding deal — although they're a bit sketchy on just how to reach it.

Meanwhile, state and local governments still reeling from the recession and housing bust, corporate America and big investors have stepped up their demands for a resolution.

California borrowed $5.4 billion from private investors this week as a hedge against a possible federal default. Moody's Investors Service warned the governments of Maryland, New Mexico, South Carolina, Tennessee and Virginia they were also in danger of losing their triple-A ratings, along with the federal government, because of their close ties to Washington.

Business groups have also mobilized despite a hesitancy to take sides. "Political brinksmanship is no longer an acceptable strategy for either the White House or congressional leaders," said Bruce Josten, executive vice president for the U.S. Chamber of Commerce. And CEOs of the nation's largest banks wrote to Congress and Obama urging a quick settlement.

Allen Sinai, chief global economist at Boston-based Decision Economics, said he remains optimistic that the conflict will be resolved "one way or the other in the next two weeks."

But while he's optimistic for a deal, dysfunction sometimes rules the day in Washington. "In talking to those I advise and clients, I explain that I hope for the best, but that realistically in terms of investments and money decisions, we should expect the worst."

"I think a downgrade is highly likely in any scenario," Sinai added.

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Associated Press Economic Writer Martin Crutsinger contributed to this report.