Rollover Risk: Ideating a U.S. Debt Default

INTRODUCTIONAlthough many would agree that "an eventual default [by the United States government] on [its] Treasury debt [is] a conceivable, although unlikely, outcome," concern is growing.1 When the U.S. Secretary of the Treasury met recently with a group of Chinese students, they laughed contemptuously at the assertion that U.S. government bonds are "safe" investments.2 The expanding international market in credit-default swaps on U.S. debt echoes this concern.3Whatever might be the likelihood of a U.S. debt default, its harm could be devastating.4 Furthermore, as this Article explains, certain types of U.S. debt defaults are actually quite realistic.5 It is therefore important to think through how a U.S. debt default might occur, how it could be avoided, its potential consequences if it is not avoided, and how those consequences could be mitigated.Part I of this Article examines how the United States might default on its debt, differentiating defaults caused by insolvency from temporary defaults caused by illiquidity.6 The latter, which are potentiated by rollover risk,7 are not only plausible but have occurred in the past.8 Moreover, the ongoing controversy over the federal debt ceiling and the rise of the shadow-banking system make these types of defaults even more likely today.9Part II examines how a U.S. debt default could be avoided, discussing steps-such as monetizing its debt and printing money to pay maturing debt-that the government can take to facilitate debt repayment.10 Part II also examines the limits on the government's ability to avoid defaulting.11Part III of this Article analyzes the consequences of a U.S. debt default.12 Any such default, even one that is temporary, would have severe economic and systemic consequences, significantly raising the cost of borrowing and causing securities markets to plummet.13 A U.S. debt default also would raise a host of legal issues, including questions of first impression under the Fourteenth Amendment of the U.S. Constitution.14Finally, Part IV explores how the negative consequences of a default might be mitigated, potentially through bilateral or unilateral debt restructuring or even through a possible International Monetary Fund (IMF) bailout.15 The Article concludes, however, that neither a debt restructuring nor an IMF bailout would likely be successful in effectively mitigating those consequences. It therefore may be more prudent to try to minimize rollover risk ab initio, such as by better managing the issuance of short-term government debt and considering austerity measures that would reasonably limit the government's need to borrow.I. HOW MIGHT THE UNITED STATES DEFAULT ON ITS NATIONAL DEBT?The classic view is that a national debt default, meaning a "hard default" on the debt, which includes non-payment of debt when due, ultimately depends on the country's expenditures exceeding taxes and new borrowings.16 That view, however, does not adequately differentiate between insolvency and illiquidity. Insolvency occurs when total liabilities exceed the value of total assets, whereas illiquidity occurs when liquid assets-for example, cash, short-term securities, and other assets readily convertible to cash-are insufficient to pay current liabilities as they become due.17 It is possible for a nation to be solvent but illiquid, causing the nation to default on its debt.18This Article assumes that the United States is unlikely to become insolvent soon.19 Nonetheless, there is a real risk that the United States could become illiquid.20 The most likely cause of illiquidity is rollover risk: the government's temporary inability to borrow sufficient funds to repay or refinance its maturing debt.21A. Rollover Risk and IlliquidityRollover risk is not merely theoretical. A former Under Secretary of the Treasury for Domestic Finance recently observed that "[i]f you ask [U.S.] Treasury . . . officials responsible for debt management 'What keeps you up at night? …