Congressman Ron Paul is one of the few original thinkers on Capitol Hill. Sometimes he has great ideas, although at other times he might sound a little daft. He recently grabbed some headlines by expressing the view that the United States “should declare bankruptcy”. A June 28 CNN report focused on Paul’s agreement with the contention that if bankruptcy is the cure for Greece, it is also the cure for the United States. However, as most economists will point out, the situation in Greece is not at all relevant to our situation because the United States issues its own currency and Greece is stuck with the euro, under the regime of the European Central Bank. Anyone who can’t grasp that concept should read this posting by Cullen Roche at the Seeking Alpha website.
Nevertheless, economist Dean Baker picked up on one of Congressman Paul’s points, which – if followed through to its logical conclusion – could actually solve the debt ceiling impasse. The remark by Ron Paul which inspired Dean Baker was a gripe about the $1.6 trillion in Treasury securities that the Federal Reserve now holds as a result of two quantitative easing programs:
“We owe, like, $1.6 trillion because the Federal Reserve bought that debt, so we have to work hard to pay the interest to the Federal Reserve,” Paul said. “We don’t, I mean, they’re nobody; why do we have to pay them off?”
In an article for The New Republic, Dr. Baker commended Dr. Paul for his creativity and agreed that having the Federal Reserve Board destroy the $1.6 trillion in government bonds it now holds as a result of quantitative easing “is actually a very reasonable way to deal with the crisis”. Baker provided this explanation:
Last year the Fed refunded almost $80 billion to the Treasury. In this sense, the bonds held by the Fed are literally money that the government owes to itself.
Unlike the debt held by Social Security, the debt held by the Fed is not tied to any specific obligations. The bonds held by the Fed are assets of the Fed. It has no obligations that it must use these assets to meet. There is no one who loses their retirement income if the Fed doesn’t have its bonds. In fact, there is no direct loss of income to anyone associated with the Fed’s destruction of its bonds. This means that if Congress told the Fed to burn the bonds, it would in effect just be destroying a liability that the government had to itself, but it would still reduce the debt subject to the debt ceiling by $1.6 trillion. This would buy the country considerable breathing room before the debt ceiling had to be raised again. President Obama and the Republican congressional leadership could have close to two years to talk about potential spending cuts or tax increases. Maybe they could even talk a little about jobs.
Unfortunately, the next passage of Dr. Baker’s essay exposed the reason why this simple, logical solution would never become implemented:
As it stands now, the Fed plans to sell off its bond holdings over the next few years. This means that the interest paid on these bonds would go to banks, corporations, pension funds, and individual investors who purchase them from the Fed.
And therein lies the rub: The infamous “too-big-to-fail” banks could buy those bonds with money borrowed from the Fed at a fractional interest rate, and then collect the yield on those bonds – entirely at the expense of American taxpayers! Not only would the American people lose money by loaning the bond purchase money to the banks almost free of charge – we would lose even more money by paying those banks interest on the money we just loaned to those same banks – nearly free of charge. (This is nothing new. It’s been ongoing since the inception of “zero interest rate policy” or ZIRP on December 16, 2008.) President Obama would never allow his patrons on Wall Street to have such an opportunity “stolen” from them by the American taxpayers. Banking industry lobbyists would start swarming all over Capitol Hill carrying briefcases filled with money if any serious effort to undertake such a plan reached the discussion stage. At this point, you might suspect that the grifters on the Hill could have a scheme underway: Make a few noises about following Baker’s suggestion and wait for the lobbyists to start sharing the love.
In the mean time, the rest of us will be left to suffer the consequences of our government’s failure to raise the debt ceiling.