Benefit recipient? Disruptions may be coming

If the day comes — whether next Tuesday or later — when the government reaches its legal borrowing limit, it will be forced to make a 40 percent cut in outlays.

Congressional Republicans would finally have gotten their wish: Spending cuts of a historic magnitude, at least for a few days. But the cutting would be sudden and potentially haphazard, with ripple effects that are hard to foresee.

Yet some House Republicans believe that such an outcome would force the government to make choices, and “then we can see what's really important and what isn't,” as Rep. Lee Terry, R-Neb., put it Wednesday.

Forcing choices on whom to pay
If unable to borrow more, the government would rely on its daily cash influx, mostly from tax payments.

Treasury Secretary Tim Geithner told Congress last month that he cannot “renege on existing legal commitments.” But which commitments would come first?

If the borrowing were brought to a halt, the ‘D’ word would not necessarily be "default," it would be “disruption.”

The Obama administration would face policy questions — do unemployment insurance benefits get priority over national parks? — as well as nitty-gitty management headaches, perhaps requiring a kind of “manual override” of an automated payment system that sends out tens of billions of dollars a day.

Bloomberg News, citing as its source an Obama administration official who requested to not be identified by name, reported Thursday that the Treasury will give priority to making interest payments to Treasury bond holders if no agreement is clinched on raising the debt limit.

David Beers, global head of sovereign ratings at the bond rating firm Standard & Poor’s, told CNBC’s Larry Kudlow on Tuesday night that reaching the debt limit “would not be default so long as the government is continuing to pay its debt as it matures and its interest payments.”

But the government being unable to borrow and the resulting cut in outlays would be, Beers said, “a very sudden fiscal shock that, the longer it lasted, would filter powerfully through the system ... Potentially that would be deeply disruptive to the economy.”

Among the categories of people and industries affected if the government found itself unable to borrow:

Social Security recipients
According to an analysis by the Bipartisan Policy Center, next Wednesday the government is scheduled to make $23 billion in Social Security payments to the program’s 54 million recipients.

With retired people, the disabled, widows, and children of deceased workers counting on that money to pay rent and buy food, it would be left to administration officials to decide how soon they'd get their benefits.

In his speech Monday night, President Barack Obama specifically cited Social Security checks, veterans’ benefits, and government contracts as items the government would not have sufficient money to pay if no deal were reached on raising the $14.3 trillion debt limit.

Sen. Pat Toomey, R-Pa., has offered a bill to instruct the Treasury secretary, if the debt ceiling isn’t raised, to give priority to three types of payments:

  • Interest on the debt, “so that we will not default on our debt and not plunge our economy into chaos,” Toomey said;
  • Paychecks for active duty military personnel;
  • Social Security payments.

Federal workers
Even if Toomey’s bill were enacted into law, non-military federal employees could be forced to wait before getting their pay.

Back in February Toomey previewed his bill by telling Geithner during Senate testimony, “You're telling us that if we have to delay a payment to the guys who mow the lawn around the Mall, that would have the same kind of impact and cause the same kind of financial crisis that would result if we failed to make an interest payment on a Treasury security.”

But “that's just not true,” Toomey contended.

It’s not just “the guys who mow the lawn.” The household budgets of more than two million federal workers would feel the impact of a 40 percent cut, or a partial delay, in federal outlays.

"We're very concerned about our members' paychecks being interrupted," said John Gage, president of the American Federation of Government Employees, the labor union which represents some 600,000 federal workers. "Many of them make $35,000 or $40,000, and missing paychecks is not something you really plan on, or can just absorb."

Gage said his members are also worried that federal workers' retirement benefits will be cut as part of any deficit-reduction agreement between Obama and congressional leaders.

Medicare providers and other government vendors
More than 47 million people have their care paid for by Medicare, so an interruption in reimbursements to hospitals and other providers would disrupt the cash flow of a significant sector of the economy.

In the week which ended on Friday, the Treasury sent out an average of $1.3 billion a day to hospices, hospitals, and other Medicare providers.

Eric Zimmerman, a lawyer-lobbyist with McDermott Will & Emery in Washington, D.C., who represents hospitals and health care providers, said millions of claims come in to the federal government every day from health care providers for surgery, therapy and other services for Medicare beneficiaries.

“It is possible that that could get suspended or disrupted in the event there are choices that have to be made about how limited federal dollars are going to go out,” Zimmerman said.

He added, “Every day that there is a disruption caused by the debt limit crisis, that’s a cash flow problem for hospitals, physicians and nursing homes, anyone who furnishes services to Medicare beneficiaries.”

Rural hospitals at risk
One group of 195 rural hospitals, defined in federal law as Medicare Dependent Hospitals, would be particularly at risk, Zimmerman said. As Medicare Dependent Hospitals, they get enhanced payments from the federal government.

More than 60 percent of their patients are Medicare recipients and the hospitals are located in rural areas where they’re a big engine of the local economy.

Case in point: Tiny (64-bed), not-for-profit Waynesboro Hospital in Waynesboro, Pa., 85 miles north of Washington D.C., which gets $18 million a year in payments from Medicare.

In the short term, the hospital could manage without a disruption in service, said Patrick O'Donnell, the senior vice president of Summit Health, which owns and operates it. But a longer payment interruption or ending the Medicare Dependent Hospital program (one deficit reduction possibility) would jeopardize the facility and others like it.

Interruption of payments isn’t unprecedented.

Zimmerman said there have been occasions when Medicare payments to doctors have been put on hold while Congress wrestled with the issue of whether to make cuts mandated by the 1997 budget law. For the past several years Congress has postponed those cuts and eventually allowed full payments to go to doctors serving Medicare patients.

Investment fund managers
It was clear from comments this week by major Wall Street firms and individual money managers and analysts that there’s no consensus on how pension and other investment fund managers might react to a disruption in government payments, or if Standard & Poor’s and other rating agencies downgrade Treasuries from their AAA rating.

“We find virtually no evidence that asset managers would be forced to sell U.S. Treasuries in the event of a downgrade,” Wall Street firm J.P. Morgan said in a report Monday. “In a survey of our asset manager clients, less than 5 percent responded that they would be required to sell U.S. Treasuries in the event of a downgrade and that was by ‘a modest amount.’”

It added, “Most investment managers hold assets that are linked to certain indices or reference a particular asset class (governments) and a downgrade to AA doesn’t remove them from their reference/benchmark portfolio.”

Treasury yields move inversely to price: as investors sell bonds and they drop in price, yields rise. A spike in yields indicates a sovereign debt crisis.

The J.P. Morgan report said the impact on Treasury yields from a downgrade to AA would be “quite modest and on the order of 5-10 bp”  that is, basis points, or hundredths of a percentage point. In other words, a bond that had yielded 3 percent would rise to a yield of 3.05 percent to 3.1 percent.

But investment advisor Richard Bernstein said on CNBC Wednesday that a downgrade of Treasuries to AA would lead to a 50- to 150-basis point increase in yields in the short term. “I don’t think right now the U.S. economy is strong enough to withstand, say, a 100 or a 150 basis point increase in the ten-year (Treasury) rate,” he said.