IS U.S. GOVERNMENT DEBT DIFFERENT? i IS U.S. GOVERNMENT DEBT DIFFERENT? ii iii IS U.S. GOVERNMENT DEBT DIFFERENT? EDITED BY Franklin Allen Anna Gelpern Charles Mooney David Skeel AUTHORS Donald S. Bernstein William W. Bratton Peter R. Fisher Richard J. Herring James R. Hines Jr. Howell E. Jackson Jeremy Kreisberg James Kwak Deborah Lucas Michael W. McConnell Jim Millstein Charles W. Mooney Jr. Kelley O’Mara Zoltan Pozsar Steven L. Schwarcz Richard Squire Richard Sylla FIC Press Philadelphia, USA iv Published by FIC Press 2405 Steinberg Hall - Dietrich Hall 3620 Locust Walk Philadelphia, PA 19104-6367 USA First Published 2012 ISBN 978-0-9836469-9-0 (paperback) ISBN 978-0-9836469-8-3 (e-book version) Cover artwork, design and layout by Christopher Trollen v Contents The Contributors ix Acknowledgments xxi PREFACE xxiii by Anna Gelpern 1 U.S. Government Debt Has Always Been Different! 1 Richard Sylla 2 A World Without Treasuries? 13 William W. Bratton 3 Default and the International Role of the Dollar 21 Richard J. Herring 4 A Macro View of Shadow Banking: Do T-Bill Shortages Pose a New Triffin Dilemma? 35 Zoltan Pozsar 5 Origins of the Fiscal Constitution 45 Michael W. McConnell 6 The 2011 ebtD Ceiling Impasse Revisited 55 Howell E. Jackson 7 A Market for End-of-the-World Insurance? Credit Default Swaps on US Government Debt 69 Richard Squire vi Contents 8 Thoughts on ebtD Sustainability: Supply and Demand Keynote Remarks 87 Peter R. Fisher 9 The ederalF Debt: Assessing the Capacity to Pay 101 Deborah Lucas 10 TheTax Revenue Capacity of the U.S. Economy 113 James R. Hines Jr. 11 Can the United States Achieve Fiscal Sustainability? Will We? 129 James Kwak 12 Burning the Furniture to Heat the House – The otentialP Role of Asset Sales in Funding the Federal Government’s Deficits 151 Jim Millstein 13 United States Sovereign Debt: A Thought xperimentE On Default and Restructuring 169 Charles W. Mooney, Jr. 14 A Comment on Professor Mooney’s Thought xperiment:E Can U.S. Debt Be Restructured? 237 Donald S. Bernstein 15 Direct and Indirect U.S.Government Debt 245 Steven L. Schwarcz Contents vii Appendix The 2011 ebtD Limit Impasse: Treasury’s Actions & The Counterfactual – What Might Have Happened if the National Debt Hit the Statutory Limit 255 Jeremy Kreisberg & Kelley O’Mara (Under the Supervision of Professor Howell Jackson) viii Contents ix The Contributors Franklin Allen University of Pennsylvania Franklin Allen is the Nippon Life Professor of Finance and Professor of Economics at the Wharton School of the University of Pennsyl- vania. He has been on the faculty since 1980. He is currently Co- Director of the Wharton Financial Institutions Center. He was for- merly Vice Dean and Director of Wharton Doctoral Programs and Executive Editor of the Review of Financial Studies, one of the lead- ing academic finance journals. He is a past President of the American Finance Association, the Western Finance Association, the Society for Financial Studies, and the Financial Intermediation Research So- ciety, and a Fellow of the Econometric Society. He received his doc- torate from Oxford University. Dr. Allen’s main areas of interest are corporate finance, asset pricing, financial innovation, comparative financial systems, and financial crises. He is a co-author with Richard Brealey and Stewart Myers of the eighth through tenth editions of the textbook Principles of Corporate Finance. Donald Bernstein Davis Polk & Wardwell LLP Donald Bernstein, who heads the Insolvency and Restructuring Practice at the international law firm Davis Polk & Wardwell LLP, is recognized as one of the world’s leading insolvency lawyers. He has received numerous honors, including being elected Chair of the Na- tional Bankruptcy Conference, a non-partisan organization of lead- ing academics, lawyers and judges seeking to improve bankruptcy law and administration in the United States. Mr. Bernstein’s practice x The Contributors includes representing debtors, creditors, liquidators, receivers and ac- quirers in major corporate restructurings and insolvency proceed- ings, as well as advising financial institutions and other clients re- garding bank insolvency and resolution planning and the credit risks involved in derivatives, securities transactions, and other domestic and international financial transactions. William Bratton University of Pennsylvania William Bratton is recognized internationally as a leading writer on business law. He brings an interdisciplinary perspective to a wide range of subject matters that encompass corporate governance, cor- porate finance, accounting, corporate legal history, and compara- tive corporate law. His work has appeared in the Cornell, Michigan, Northwestern, Pennsylvania, Stanford, and Virginia law reviews, and the Duke and Georgetown law journals, along with the Amer- ican Journal of Comparative Law and the Common Market Law Review. His book, Corporate Finance: Cases and Materials (Foun- dation Press, 7th ed. 2012), is the leading law school text on the subject. Bratton is a Research Associate of the European Corporate Governance Institute. In 2009, he was installed as the Anton Philips Professor at the Faculty of Law of Tilburg University in The Nether- lands, the fifth American academic to hold the chair. Peter R. Fisher BlackRock Peter R. Fisher, Senior Managing Director, BlackRock, is head of BlackRock’s Fixed Income Portfolio Management Group and a member of the firm’s Global Executive Committee. Prior to joining BlackRock in 2004, Mr. Fisher served as Under Secretary of the U.S. Treasury for Domestic Finance from 2001 to 2003. Before joining the Treasury he worked at the Federal Reserve Bank of New York and at the Bank for International Settlements. He earned a B.A. in history for Harvard College in 1980 and a J.D. from Harvard Law School in 1985. The Contributors xi Anna Gelpern American University Washington College of Law Anna Gelpern is Professor of Law at American University Washing- ton College of Law and Visiting Professor at Georgetown Law. She has published articles on financial integration, government debt, and regulation of financial institutions in law and social science journals, and has co-authored a textbook on International Finance. She has contributed to international initiatives on financial reform and sov- ereign borrowing. Professor Gelpern is a visiting fellow at the Peter G. Peterson Institute for International Economics, a fellow at the George Washington University School of Law Center for Law, Eco- nomics & Finance, and held a visiting appointment at the University of Pennsylvania Law School in Spring 2011. Earlier, she was on the faculty at Rutgers School of Law-Newark and Rutgers University Di- vision of Global Affairs. Between 1996 and 2002, Professor Gelpern served in legal and policy positions at the U.S. Treasury Department. Richard J. Herring University of Pennsylvania Richard J. Herring is Jacob Safra Professor of International Bank- ing and Professor of Finance at The Wharton School, University of Pennsylvania, where he is also founding director of the Whar- ton Financial Institutions Center. From 2000 to 2006, he served as the Director of the Lauder Institute of International Management Studies and from 1995 to 2000, he served as Vice Dean and Direc- tor of Wharton’s Undergraduate Division. During 2006, he was a Professorial Fellow at the Reserve Bank of New Zealand and Vic- toria University and during 2008 he was the Metzler Fellow at Jo- hann Goethe University in Frankfurt. He is the author of more than 100 articles, monographs and books on various topics in financial regulation, international banking, and international finance. His most recent book, The Known, the Unknown & the Unknowable in Financial Risk Management (with F. Diebold and N. Doherty) has just been recognized as the most influential book published on the economics or risk management and insurance by the American Risk and Insurance Association. At various times his research has been funded by grants from the National Science Foundation, the Ford Foundation, the Brookings Institution, the Sloan Foundation, the Council on Foreign Relations, and the Royal Swedish Commis- xii The Contributors sion on Productivity. Outside the university, he is co-chair of the US Shadow Financial Regulatory Committee and Executive Director of the Financial Economist’s Roundtable, a member of the Advisory Board of the European Banking Report in Rome, the Institute for Fi- nancial Studies in Frankfurt, and the International Centre for Finan- cial Regulation in London. In addition, he is a member of the FDIC Systemic Risk Advisory Committee, the Systemic Risk Council and the Stanford University Hoover Institute Working Group on Reso- lution. He served as co-chair of the Multinational Banking seminar from 1992–2004 and was a Fellow of the World Economic Forum in Davos from 1992–95. Currently, he is an independent director of the DWS mutual fund complex, the Daiwa closed-end Funds, the Aberdeen Singapore closed-end fund, and Barclays Bank, Delaware. Herring received his undergraduate degree from Oberlin College in 1968 and his PhD from Princeton University in 1973. He has been a member of the Finance Department since 1972. He is married, with two children, and lives in Bryn Mawr, Pennsylvania. James R. Hines Jr. University of Michigan James R. Hines Jr. is the L. Hart Wright Collegiate Professor of Law and co-director of the Law and Economics Program at the Univer- sity of Michigan Law School. He is also the Richard A. Musgrave Collegiate Professor of Economics in the Department of Econom- ics at Michigan, and serves as the research director of the Office of Tax Policy Research in the Stephen M. Ross School of Business. His research is focused on various aspects of taxation. Hines taught at Princeton and Harvard Universities prior to joining the Michigan faculty in 1997, and has held visiting appointments at Columbia University, the London School of Economics, the University of Cali- fornia, Berkeley, and Harvard Law School.