A Brief History of U.S. Defaults
Does the United States have a stellar credit record — or is it a nation of deadbeats?
January 16, 2013
By the end of February or early March, a U.S. default on Treasury bills and notes will become a distinct possibility. As a confused world scratches its head about the United States’ self-inflicted political chaos, President Obama has made it clear that the United States is not — in his words — a deadbeat nation.
Well, not so fast. America has, in fact, defaulted on several occasions.
The 1790 default episode
The country’s first default occurred soon after its founding, when President George Washington signed the Funding Act of 1790. Through this act, the new federal government of the United States assumed the war debt of its constituent states, which they had accrued during the Revolutionary War.
While creditors were ultimately better off due to this measure (because the states were in no position to make timely payments), the act also deferred interest payments on this debt until 1801. By most estimates, this was a default — as timeliness of payments of principal and interest is at the core of creditworthiness.
The 1861 default episode
Moving right along to the beginning of the Civil War, the U.S. federal government created the so-called greenbacks (in essence today’s dollars) in 1861. These were demand notes that could be redeemed at a specified conversion rate into gold.
However, before you could say “I want my gold back,” the federal government refused, in January 1862, to redeem them. After that, the greenbacks became “legal tender” that would not be redeemable on demand.
These legal tender laws, first implemented in February 1862, were retroactive — and hence were tested in the Supreme Court. In 1869, the Court decided in Hepburn v. Griswold that the application of the legal tender laws to debt that had existed before these laws were enacted was indeed unconstitutional.
This decision so enraged then-President Ulysses S. Grant that he appointed two new justices to the Supreme Court in 1870 who willingly took up the cases of Knox v. Lee and Parker v. Davis.
As a result, the Supreme Court ruled in December 1870 that the legal tender laws were in fact constitutional, overturning the one-year old decision of Hepburn v. Griswold. So much for the rule of law.
The 1933 default episode
This takes us to Franklin D. Roosevelt in 1933. Much like President Obama, Roosevelt found the economy in shambles. He, too, had to take a lot of emergency actions, some orthodox, others not so much.
One of the more unorthodox actions related to U.S. government bonds issued many years earlier. In 1917, after entering World War I, the U.S. Congress passed the First and Second Liberty Bond Acts.
In fact, it is the Second Liberty Bond Act that is widely considered the legislative root of today’s debt ceiling. This measure allowed the U.S. Treasury to issue long-term and short-term debt up to a certain limit — rather than seeking, as was previously required, specific Congressional authorization for each borrowing transaction.
These Liberty Bonds (more were issued in 1918 to prosecute the war) also included a gold clause. This clause required that redemptions of these bonds were to be made in gold. However, outstanding Liberty Bonds were far in excess of the country’s gold reserves.
Upon President Roosevelt’s request, Congress passed a “Joint Resolution to Assure Uniform Value to the Coins and Currencies of the United States.” This had the net effect on reneging on the government’s obligation to make payment on Liberty Bonds in gold.
Such subsequent restructuring of a contractual debt agreement would constitute a default by today’s definition. In fact, four legal cases made it to the Supreme Court.
In February 1935, the Supreme Court deemed the congressional resolution as constitutional in a 5-4 decision. Chief Justice Charles Evans Hughes, who wrote the majority opinion, described the resolution as “immoral” but legal.
The 1979 default episode
The story of U.S. defaults does not end there. On May 9, 1979 the Wall Street Journal reported that the U.S. Treasury had failed to make timely payments redeeming Treasury bills for two reasons.
The first reason was a disruptive relocation of the offices issuing the checks. The second reason — hold on to your seats — was “the postponement of several securities auctions because of Congressional debate over the national debt ceiling.”
Over a period of three weeks in 1979, the U.S. Treasury Department failed to send checks out on time, for an amount totaling $122 million. Again, by all modern definitions this constitutes a default, even if it was somewhat technical in nature.
Once again, lawsuits ensued. Their very nature and context tied it all together. The class action suit of Claire G. Barton v. United States demanded that the United States government pay interest (which was high in 1979) for the period during which it failed to send out redemption checks.
The U.S. Treasury thought it had no liability, relying on the Supreme Court decision in Smyth v. United States (1937), which was another case to reach the Supreme Court on the gold clause issue. In that particular case, the court held that “interest does not run upon claims against the government even though there has been a default in the payment of principal.”
In fact, the 1937 decision even referred back to the Public Credit Act of 1869, which had attempted to revert back to binding the government to make its debt payments in gold. The Act was never fully implemented. Ultimately, following the 1979 default, the government settled out of court.
The 2013 default episode?
Back to the present, in the year of 2013. The hardened political stance of Congressional Republicans will push the issue of a possible debt default to the very edge.
Practically, the United States has already pierced the debt ceiling. However, certain Treasury operations are able to stave off default until the end of February or possibly early March.
So, what are the options? Of course, the U.S. Congress can lift the debt ceiling, as the President has demanded. However, this is unlikely unless President Obama commits to very severe spending cuts for future budgets. The President has noted that he will not negotiate on debt that has already been accrued.
Alternatively, it has been suggested that the President could invoke the 14th Amendment. This hardly-known Amendment has a clause that states that “the validity of the public debt of the United States, authorized by law…shall not be questioned.”
On this basis, the President could declare the U.S. debt ceiling to be unconstitutional and authorize the Treasury Department to raise debt in excess of it. President Obama has rejected this option.
While it is politically unwise for Barack Obama to show his hand, he probably is constitutionally accurate. The real purpose of the 14th Amendment was to prevent Southern states from returning to the U.S. Congress after the Civil War to pass a law that might declare the debt they accumulated during the Civil War as invalid — or to pass it on to the federal government.
That is the reason why the 14th Amendment continues: “But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States.”
Finally, there are options for the U.S. Treasury to remain current on the government’s Treasury bills and notes. This could be done by failing to pay Social Security beneficiaries and military personnel. This, in fact, is the most likely outcome of the current round of political theater.
Once the Treasury runs out of movable cash, it will shut down parts of the government and stop making payments on entitlement programs. This will be an enormous shock to the system. The political cost to the Republicans will be huge.
If this situation were to last any longer than a week or two, the President could then — against his earlier constitutional judgment — still invoke the 14th Amendment.
Would the Supreme Court stand for it? Clearly, the Court has taken some liberty in interpreting the Constitution, most recently on the Second Amendment in 2008 and its Citizens United decision on campaign finance in 2010. In the latter case, it stretched itself to consider a corporation a natural person as envisioned by the Founding Fathers.
President Obama would be regarded as a hero by invoking the 14th Amendment if he did it for the purpose of resuming the issuance of Social Security checks. Republicans would be angered and likely begin impeachment proceedings against him.
While Congress might impeach the President, the Senate would fail to convict him. (Of course, Obama’s second term would be wasted.) However, history may look kindly on President Obama, like it does on President Clinton, even in light of a failed impeachment.
But the plight of the American people will not be altered by a political process that is focused too much on serving various factions’ political legacy, rather than the interests of the American people.
America defaulted on several occasions. The country's first default occurred in 1790.
Other U.S. default episodes occurred in 1861, 1933 and 1979.
President Obama's rejection of the 14th Amendment option was probably politically unwise, but constitutionally accurate.
If the United States defaults for longer than a week or two, Obama could still invoke the 14th Amendment — against his earlier constitutional judgment.
The Congress might impeach Obama, but the Senate would not convict him. Of course, his second term would be wasted.