Creative accounting has a bad reputation. Just ask the people who invested in Bernie Madoff. Or the Congress that paid for a new healthcare law by promising ten years of tax increases and six years of higher spending. Failing to honor obligations has consequences.
However, a little creativity in accounting, although not a long term solution, can help a country through a rough patch. At least thats what Treasury Secretary Timothy Geithner is banking on with his latest sleight of hand on the debt limit.
Our national debt limit of $14.3 trillion was reached earlier this week. But the world did not end. The dollar still trades roughly where it was last week. Banks still trade American government securities. The federal government did not shut down. What happened?
Mr. Geithner and his advisers noticed that over $4 trillion of our $14.3 trillion of debt consists of intragovernmental borrowing, money the government owes to itself. This includes checks owed to future Social Security and Medicare beneficiaries, payments owed to future federal retirees, and amounts on Federal Reserve balance sheets.
In contrast, money that Americans and foreigners have lent the Treasury totals about $10 trillion. America cannot default on this debt. But, according to Mr. Geithner, we can let intragovernmental borrowing slide for a few months.
Mr. Geithner is creatively dealing with the debt limit by reorganizing our intragovernmental debt. He has just announced temporary suspension of payments to federal employee pension funds in the Civil Service Retirement and Disability Fund in order to delay hitting the debt ceiling until August.
Mr. Geithner is also holding in cash employee and agency contributions for retirement savings, instead of investing these contributions in the Government Securities Investment Fund.
In doing this, Mr. Geithner is creating a temporary unfunded federal pension liability to free up room below the debt ceiling. His actions effectively reduce the amount of outstanding debt instruments that count toward the ceiling.
Those expecting government pensions in the future need not be chagrined, because the Treasury will eventually repay the money it borrowed from itself. But the creative accounting gives Congress a little extra time to work out a way to raise the debt ceiling.
In a fact sheet released Monday and found here, the Treasury explains that suspending payments to pension funds frees about $84 billion of headroom from the deficit ceiling. The sheltered cash can be used to pay other government bills, avoiding the need to issue debt that would push above the ceiling. Such actions are expected to keep the government from default until August, even if the debt ceiling is not raised.
The special debt instruments referenced in the Treasury statement about redemptions from the pension funds are IOUs that the government writes to itself. In that sense they are not really outstanding debt. They are the means by which the government appears to have fully funded its pension obligations-which of course it has not. What Mr. Geithner just did to postpone the debt ceiling issue was to cancel a few of those IOUs to the government itself and to postpone writing some others.
These special debt instruments are not the same as debt instruments held by external parties-banks, ordinary citizens, and foreign individuals or governments. If these special debt instruments were not included in the computation of debt relative to the debt limit, then the difference between the computed debt and the debt limit would be sizable. This is especially so if the special debt instruments represented by the Social Security and Medicare Trust funds were excluded from the computation. These currently amount to $2.95 trillion.
Removing these items from our definition of debt for debt ceiling purposes would merely be admitting that we have a large unfunded liability for employee and Social Security pensions and retiree health insurance plans - which is the situation facing many states and some big corporations.
Creative accounting does not have to end with civil service pensions, Social Security, and Medicare. Another item that could be excluded from the computation of outstanding debt is the amount of Treasury debt instruments held on the balance sheet of the Federal Reserve System. These debt instruments represent the basis of the money supply. The Federal Reserve creates money when it buys Treasury debt. It would be reasonable to distinguish these debt instruments from those that are held by external investors. The Fed currently holds over $1 trillion in Treasury debt instruments.
By removing intragovernmental debt from our definition of debt, we could leave the stated debt limit at $14 trillion, and report that outstanding debt, defined as government debt owed to persons and entities other than the government itself, is only $10 trillion.
This is useful in the short run while Congress and the administration spar on spending, but creative accounting only lasts so long. Eventually, reality catches up with it. Thats what will happen to Congresss promises to pay for the new healthcare law. Thats what happens to presidential budgets, which show disappearing deficits only in the out years. And thats what will happen sooner or later to creative accounting of the national debt.
Congress must use real accounting, not creative accounting, to lower future deficits and outstanding debt by cutting spending. And Congress must reduce unfunded government employee pensions and Social Security and Medicare obligations liabilities by either providing real funding instead of phony IOUs, or changing benefit promises that cannot be kept.
Were using creative accounting to avoid hitting the debt ceiling and defaulting on our obligations to domestic and foreign investors. But it shouldnt be a long term strategy.
Original Source: http://www.realclearmarkets.com/articles/2011/05/19/how_to_address_the_debt_ceiling_99030.html