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Geithner, the debt ceiling, and the 14th Amendment

July 6, 2011: 11:18 AM ET

While Secretary Geithner's strategy of using the 14th Amendment in defending an extension of the debt ceiling appears to have legal precedent, the potential for a Supreme Court showdown between Democrats and Republicans may make the strategy not worth the gamble.

By Daryl G. Jones, Hedgeye

Treasury Secretary Timothy Geithner has heightened the debate over the debt ceiling extension in recent weeks by implying that the President could simply push through an extension of the debt ceiling based on an interpretation of the Fourteenth Amendment of the United States Constitution. While rumors of this defense have been circulating for the last 8 weeks or so, the idea was more officially circulated at a May 25th Politico Playbook breakfast at which Mike Allen was hosting Geithner.

At that breakfast, Allen asked Geithner about a potential default and the debt ceiling debate and Geithner responded with the following:

"I think there are some people who are pretending not to understand it, who think there's leverage for them in threatening a default. I don't understand it as a negotiating position. I mean really think about it, you're going to say that-- can I read you the Fourteenth Amendment?"

Even as President Obama has avoided opining or interpreting the Fourteenth Amendment, Geithner, who presumably is speaking as a representative of the administration, has made it very clear that he believes that Fourteenth Amendment gives a President the legal right to extend the debt ceiling.

As noted, in the same breakfast Geithner then read the following excerpt, Section 4, from the Fourteenth Amendment:

"The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. 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, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void."

In fact, the U.S. Supreme Court has actually ruled on the Fourteenth Amendment in Perry v United States (1935). This case was part of a series of cases brought before the United States Supreme Court that were known as the Gold Clause Cases. The gist of these cases was to question whether the U.S. Congress could change the form by, or terms under which, U.S. debts could be repaid.

The ruling by the Supreme Court in Perry v United States specifically referenced Section 4 in the following excerpt:

"Section 4 of the Fourteenth Amendment, declaring that "The validity of the public debt of the United States, authorized by law, . . . shall not be questioned," is confirmatory of a fundamental principle, applying as well to bonds issued after, as to those issued before, the adoption of the Amendment, and the expression "validity of the public debt" embraces whatever concerns the integrity of the public obligations."

So, in effect, it would appear that there is some precedent for Geither's statements as it seems that the United States Supreme Court has previously ruled that voiding a U.S. government debt is beyond the power of Congress. Here is the ruling.

As is outlined in the following chart, the credit default swap markets on U.S. government debt are signaling that a default on U.S. government is highly unlikely and the odds of such haven't increased much over the last six months, which perhaps also gives credence to Geithner's view. Currently, CDS on 10-year U.S. treasuries are trading at 58bps, which is well off its highs for the year. By way of comparison, German 10-year CDS are trading at 59bps, Greek CDS are trading at 1,550bps, and Spanish CDS are trading at 268bps.

Even if we accept that President Obama has the legal authority to make a unilateral decision on extending the debt ceiling as Geithner has been suggesting and legal precedent appears to support, the question is really whether it is the most practical or best political path to take. Regarding the latter point, it would seem that while President Obama would get a clear win by trumping the Republican Congress with the Fourteenth Amendment, the downside risk to this strategy is a potentially increased credit risk associated with U.S. sovereign debt and a potential Supreme Court showdown between Republicans and Democrats.

So, would the President and the Democratic rank and file actually pursue the Fourteenth Amendment option? While he doesn't necessarily speak for all Democrats, Senator Schumer said on a call to reporters on July 1st when asked about the Fourteenth Amendment responded, "It is certainly worth exploring."

Indeed.

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Hedgeye, a real-time investment research firm founded in 2008 by former Carlyle-Blue Wave portfolio manager Keith McCullough, operates as a virtual hedge fund. Staffed by research analysts from across Wall Street, Hedgeye offers fundamental, macro and sector analysis, present picks in a transparent way to its clients. It has built a stable of subscribers, which includes hedge funds and mutual funds, and recently launched a retail investor product.

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