Don’t take consol in your fears

The chair has four legs… Now, an animal has a one track mind, For instance, the animal is coming after you with the idea of tearing your head off… You put the chair up, and all of a sudden, he has four points of interest. He loses his original train of thought because this agitates him. He can’t comprehend those four points of interest, so what he does he attacks the chair. He takes his wrath out on the chair. His mind now had been completely distracted from his original thought: “Eat the man in the white pants.”
Lion tamer Dave Hoover, interviewed in Fast, Cheap & Out of Control
It seems to me there are three or four different ways the Department of the Treasury could address the debt ceiling hostage situation.
1. Trillion Dollar Coin
2. Trillion Dollar Gift
3. T-bonds “redeemable at the pleasure of the United States” (i.e. consols).
and since a chair should have 4 legs
4. The 14th Amendment argument
You can read much more about 1 and 2 elsewhere on this site and 4 is more of a shield than a sword (e.g. We’re only issuing the TDC because the alternative is violating the Constitution). Its the third option I want to discuss this morning.

My thesis is simple, there’s a kind of debt that according to the Department of the Treasury itself shouldn’t even be counted as debt under the debt ceiling statute.
The face amount of obligations issued under this chapter and the face amount of obligations whose principal and interest are guaranteed by the United States Government (except guaranteed obligations held by the Secretary of the Treasury) may not be more than…”

The clue that this isn’t as iron-clad as is generally assumed is the aside about “whose principal and interest are guaranteed”. The face amount of an interest-bearing bond is the sum of principal that is guaranteed repayment at a fixed maturity date. This creates an interesting question, what would happen if interest is guaranteed by Tsy but the principal is not? Arguably, if Tsy issued interest-bearing bonds (discount bonds and T-bills are handled differently) that guarantees interest but not principal, then by the legal arguments Tsy has used in court successfully in nearly a century of tax cases, the obligations created should not count against the debt ceiling.

The term “the face amount of obligations” has never been litigated in court as a public debt issue per se. However, the Department of the Treasury has been in court an awful lot dealing with the face amount of obligations in tax cases (as well as the odd gold devaluation case). For example:
“The essential feature of the debtor-creditor relation is the presence of a fixed maturity date at which time… [the creditor] bound itself to pay on a fixed and certain date the face amount of the instrument together with all accumulated and/or accrued and unpaid interest at the designated rate.” (emphasis added) Commissioner of Internal Revenue v. HP Hood & Sons, 141 F. 2d 467, 471 (1st Cir. 1944)
“It was held that the payment at maturity, of the face amount of bonds purchased at a premium, was not a sale or exchange resulting in a capital loss.”
Hale v. Helvering, 85 F.2d 819, 822 (DC Cir. 1936)
“The Treasurer refused to comply with that demand, but offered payment of the face amount of the principal in legal tender coin or currency other than gold or gold certificates. Petitioner declined to accept the tender and retained the bond.” Smyth v. United States 302 US 329, 351 (1937)
“In common parlance the bonded indebtedness of a corporation imports the total face of its outstanding bonds, — the amount which must be paid at their maturity. The phrase is not generally used to connote par plus an unreturned proportion of premium. And as respects “interest,” the usual import of the term is the amount which one has contracted to pay for the use of borrowed money… We cannot believe that Congress used the word having in mind any concept other than the usual, ordinary and everyday meaning of the term.” Old Colony R. Co. v. Commissioner, 284 US 552, 561 (1932)

I could go with the cites but, I’ll just state the matter plainly— I cannot believe that Congress used the words “face amount of obligations” having in mind any concept than the usual, ordinary and everyday meaning of the term.

So if Tsy engaged in some do-it-yourself bond stripping and issued a bond that only guaranteed interest, there’d be no maturity date; which means there’d be no face amount of principal; which means there’d be no additional public debt subject to limit. And that’s a good place for Tsy to be. If a bond with no maturity date sounds familiar…
“We note that there have been other debt instruments having no maturity date. One of the best known is the English consol, a bond issued without maturity and perpetually outstanding. The total value of these bonds issued and outstanding is not known but it certainly was very substantial. It is true that these bonds regularly paid interest, but their principal never became due and payable (unless they were called). The United States issued consols having no maturity to finance the Panama Canal. These bonds were eventually called.”
In re Wabash Valley Power Ass’n, 72 F.3d 1305, 1323 (7th Cir.1995).

That’s not precisely true, the Panama Canal bonds mostly matured after 30 years (and in the case of the 1911 series, 50 years). The Court has them confused with the 2% gold Consols of 1930. You can’t fault a late 20th Century Court for the confusion. Even while the bonds were still outstanding, their terms were hard to keep straight. The Federal Reserve Bulletin listed the Consols as as PAYABLE (Tsy duty to pay) in 1930, when actually they were REDEEMABLE (Tsy option to pay) in 1930 with no payable date. That’s a pretty big difference. Of course that was Federal Reserve Bulletin, Volume 2 (1916). I’d wager the Fed has tightened up a bit since then.

The Consols of 1930 were issued in 1900 to consolidate (thus, “Consols”) several older high interest bond series. They were later redeemed by Tsy along with Panama Canal bonds when FDR took us off the domestic gold standard. Even if they were still outstanding, both would be exempt from the debt limit in any event because they were issued prior to 1917. The Consols’ length term was described as “indefinite”. There was no maturity date– the 1930 refers to the date after which Tsy had the option (but not the obligation!) to redeem the bonds. No maturity date meant there was no face amount. Likewise, if Tsy began issue the Consols of 2143 (and 2144, 2145, etc.) series, there’d be no face amount of principal adding to the public debt limit subject to limit. The debt limit would then go the way of the gold standard, kicked to the curb by executive action. Everything I know of the man tells me FDR would approve.

The Gold Standard Act of 1900 which gave the Secretary this perpetual bonding power was actually more restrictive than the bonding power the Secretary has today under 31 USC 3104 (as you’d expect with something called the “Gold Standard Act”). However in both bond statutes, there are no time restrictions on when or IF the bonds must mature. The two important deal terms in the Consols of 1930 were:
“Length of loan, indefinite.”
“and is redeemable at the pleasure of the United States after the first day of April, 1930”

As for which of the options listed above Tsy should use to deal with the debt ceiling hostage situation, I’d go with the plan with the fewest moving parts. Issuing consols would be a textbook example of a permanent solution to a temporary problem. It may be a good idea on its on terms (and it probably is) but Tsy shouldn’t be making that call with its back against the wall. So what I’d suggest is, while everyone is jibber-jabbing about the trillion dollar coin or the 14th Amendment, Tsy should quietly arrange for the Fed to run with the trillion dollar gift.


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16 Comments on "Don’t take consol in your fears"

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4 years 5 months ago

Damn, Krugman wrote about the “gentlemen’s handshake” I mentioned earlier today in email to you!