Calculating the Probabilities of a U.S. Default

An argument has been making the rounds that there’s really no danger of default if the U.S. runs up against the debt ceiling — the president could simply make sure that all debt payments are made on time, even as other government bills go unpaid. I’ve heard it from economist Thomas Sowell, investor and big-time political donor Foster Friess, and pundit George Will. It’s even been made right here on by Tufts University accounting professor Lawrence Weiss.

The Treasury Department has been saying all along that it can’t do this; it makes 80 million payments a month, and it’s simply not technically capable of sorting out which ones to make on time and which ones to hold off on. I don’t know if this is true, and there may be an element of political posturing in such statements. On the other hand, it is the Treasury Department that has to pay the bills. If they say they’re worried, I can’t help but worry too. When Tony Fratto, who worked in the Treasury Department in the Bush Administration, seconds this concern, I worry even more. Not to mention that this has happened before, in the mini-default of 1979, when Treasury systems went on the fritz in the wake of a brief Congressional standoff over  —  you guessed it — raising the debt ceiling.

Then there’s the question of legality. The second the President or the Treasury Secretary starts choosing which bills to pay, he usurps the spending authority that the U.S. Constitution grants Congress. The Constitution states, in the 14th Amendment, that the U.S. will pay its debts. But there is no clear path to honoring this commitment in the face of a breached debt ceiling. Writing in the Columbia Law Review last year, Neil H. Buchanan of George Washington University Law School and Michael C. Dorf of Cornell University Law School concluded that as every realistic option faced by the president violated the Constitution in some way, the “least unconstitutional” thing to do would not be to stop making some payments but to ignore the debt ceiling. That’s because, in comparison with unilaterally raising taxes or cutting spending to enable the U.S. to continue making its debt payments under the current ceiling, ignoring the debt limit would “minimize the unconstitutional assumption of power, minimize sub-constitutional harm, and preserve, to the extent possible, the ability of other actors to undo or remedy constitutional violations.” And even this option, Buchanan and Dorf acknowledge, is fraught with risk: financial markets might shun the new bonds issued under presidential fiat as “radioactive.”

So assigning a 0% probability to the possibility that running into the debt ceiling will lead to some kind of default doesn’t sound reasonable. What is reasonable? Let’s say 25%, although really that’s just a guess. The likelihood that hitting the ceiling will result in sustained higher interest rates for the U.S. is higher (maybe  50%?) and the likelihood that it will temporarily raise short-term rates is something like 99.99%, since those rates have already been rising.

It’s the kind of thing that makes you wish Nate Silver weren’t too busy hiring people for the new, Disneyfied to focus on. At this point even Silver would have to resort to guesswork — this is a mostly unprecedented situation we’re dealing with here.  But the updating of his predictions as new information came in would be fascinating to watch, and might even add some calm sanity to the discussion.

Updating is what the Bayesian approach to statistics that Silver swears by is all about. Reasonable people can start out with differing opinions about the likelihood that something will happen, but as new information comes in they should all be using the same formula (Bayes’ formula) to update their predictions, and in the process their views should move closer together. “The role of statistics is not to discover truth,” the late, great Bayesian Leonard “Jimmie” Savage used to say. “The role of statistics is to resolve disagreements among people.” (At least, that’s how his friend Milton Friedman remembered it; the quote is from the book Two Lucky People.)

I tread lightly here, because I’m one of those idiots who never took a statistics class in college, so don’t expect me to be any help on Bayesian methods. But as a philosophy, I think it can be expressed something like this: You’re entitled to your opinion. You’re even entitled to your opinion as to how much weight to give new information as it comes in.  But you need to be explicit about your predictions and weightings, and willing to change your opinion if Bayes theorem tells you to. A political environment where that was the dominant approach would be pretty swell, no?

Not that it would resolve everything. Some Republicans have been making the very Bayesian argument that, after dire predictions about the consequences of the sequester and the government shutdown failed to come true, the argument that a debt ceiling breach would be disastrous has become less credible. As a matter of politics, they have a point: the White House clearly oversold the potential economic consequences of both sequester and shutdown. But I never took those dire claims about the sequester and shutdown seriously, so my views on the dangers associated with hitting the debt ceiling haven’t changed much at all. And while I’m confident that my view is more reasonable than that of the debt-ceiling Pollyannas, I don’t see how I can use Bayesian statistics to convince them of that, or how they can use it to sway me. Until we hit the debt limit.

Update: And now Nate Silver has written something! Conclusion: “there’s a lot we don’t know.”

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