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Legal opinion gives Treasury leeway ahead of debt limit fight

Justice Department told Treasury officials during earlier debt fight that they could build up larger rainy day fund

Treasury Secretary Janet L. Yellen testifies before the House Financial Services Committee on Feb. 6.
Treasury Secretary Janet L. Yellen testifies before the House Financial Services Committee on Feb. 6. (Tom Williams/CQ Roll Call)

A newly released 2021 Justice Department legal opinion holds that the Treasury Department has wiggle room to maintain higher cash balances ahead of the statutory debt limit’s reinstatement, a potentially significant development as Congress prepares for another battle over the nation’s borrowing cap next year.

The opinion, which Justice’s Office of Legal Counsel quietly posted on its website Friday, appears to give Treasury some leeway to maintain a cash balance in keeping with what it believes the government’s immediate financing needs are, or at least close to it. 

That’s contrary to past debt ceiling episodes when similar statutory language was in effect barring creation of an excess cash buffer “above normal operating balances in anticipation” of the end of a debt limit suspension period. In those instances, it appeared Treasury officials interpreted the language to require a drastic rundown of that emergency cash balance.

However, the opinion says Treasury told DOJ that the previous spend-downs were based not on its interpretation of the law, but rather an “informal view” that a higher cash balance might be “construed” to suggest Treasury had exceeded its borrowing needs.

“A prudential buffer is a reasonable response to the uncertainties in the government’s expenses that the Department must cover through the end of the suspension period, and we see no basis for concluding that Congress forbade that practice,” according to the the legal opinion that Treasury obtained in 2021.

The document, dated July 8, 2021, was drafted by then-acting Assistant Attorney General Dawn Johnsen, a senior official in the Biden DOJ’s Office of Legal Counsel.

At that time, Treasury and Congress were again bumping up against the debt limit, which lawmakers had last suspended in 2019, until Aug. 1, 2021. With around $130 billion in cash at the time of enactment, market participants assumed that was the roughly the level that Treasury needed to run its balance down to by Aug. 1. 

While the “normal operating balances” stipulation wasn’t included in the 2019 law, typical language was included barring Treasury from issuing debt during the suspension period beyond what was “necessary to fund a commitment incurred pursuant to law by the Federal Government that required payment before” the suspension ended.

That surviving provision on its own has been interpreted to limit Treasury’s flexibility to maintain a higher-than-necessary cash buffer.

[Huge Treasury cash pile might delay debt limit ‘drop dead’ date]

Accordingly, Treasury officials sought legal justification to maintain a cash balance closer to $465 billion. That’s the amount they deemed prudent in light of higher than normal costs due to the COVID-19 pandemic response but “increased slightly to address short-term uncertainties and risks.”

To be extra cautious given the stipulation to avoid incurring any more debt than needed to finance pre-existing obligations, Treasury officials said they wouldn’t issue new debt during the last week of July 2021. 

Johnsen’s memo blesses Treasury’s reasoning, arguing that funding “necessary” commitments does not preclude them from raising “a prudential buffer of funds in order to make good on the federal government’s obligations.”

Treasury ended up with $459 billion in cash on Aug. 1, 2021, which in addition to “extraordinary measures” the agency regularly employs to stave off breaching the debt limit, helping delay the drop-dead date for Congress to act into late that year.

Market uncertainty

In releasing the DOJ memo now, the Biden administration appears to be responding to uncertainty in the marketplace over the size of Treasury’s cash balance and what could happen to it come Jan. 2, 2025, when the debt limit snaps back into place under a law enacted last year that also set discretionary appropriations caps. 

Among the major potential implications: hundreds of billions of extra dollars that could be used to again delay the moment Congress needs to act on the debt limit. That would extend the runway for either a second-term Biden or Trump administration — each with its own challenges depending on the makeup of Congress after November’s elections — to negotiate an off-ramp from a market-rattling standoff next year.

Under a strict reading of the “normal operating balances” language, which was also contained in several prior suspensions, Treasury would need to draw down its cash buffer all the way to $23 billion by Jan. 2. That’s what it sank to just prior to President Joe Biden’s signature on the debt limit law last year, which allowed Treasury to start issuing more debt and building its cash balance back up.

Under Treasury’s current guidelines, roughly $750 billion is what officials are comfortable with and expect to have in the account through the end of June. Treasury’s next quarterly financing update, in which that forecast could fluctuate a bit, is April 29; as of Monday, the account held $729 billion.

That doesn’t mean Treasury is necessarily on solid legal ground to maintain a buffer that high through the end of the current debt limit suspension. It’s possible the law may require a slightly more narrow interpretation of “normal” operating balance; $750 billion is substantially higher than what Treasury estimated would be prudent at 2021 when pandemic-related expenses were greater, for example.

Lou Crandall, chief economist with Wrightson ICAP, a research firm specializing in Fed policy analysis and the Treasury market, said the Justice opinion gives Treasury some flexibility to hold higher cash balances in order to avoid economic disruptions.

“The Treasury may face marginally tighter constraints on its cash balance on December 31 than would be the case in the absence of debt ceiling constraints, but the general philosophy outlined in the DOJ memo suggests there are few risks of really serious distortions,” he said.

In one possible wrinkle, the DOJ opinion notes that the 2019 debt limit suspension, unlike some previous suspensions and the current law, did not contain the “normal operating balances” language. 

But the Justice opinion adds that, even if that restriction had been in place in 2021, the agency would still hold the view that Treasury would not be obligated to spend down its balance to the level in effect before the suspension.

“This is because Treasury does not intend to raise funds ‘for the purpose of increasing the cash balance above normal operating balances.’ Treasury is simply trying to maintain its normal operating balance (which typically increases proportionally with Treasury’s spending),” the memo says.

Don Schneider, deputy head of U.S. policy at Piper Sandler, an investment bank, wrote to clients last week that the practical effect of the debt limit law’s restrictions means Treasury must draw its cash balance down to $23 billion by next January. That’s in keeping with every prior instance of debt limit suspension laws that carried the same restrictions since 2015.

But Schneider, a former House Ways and Means GOP aide who worked on past debt limit bills, allowed that Treasury could simply end up ignoring their prior interpretation of the language. That goes for the 2021 episode as well, when despite omission of the “normal operating balances” provision, the language barring new debt other than to fund “necessary” obligations was in effect.

“To us, this looks like Treasury simply chose not to follow the law but instead reinterpreted it in a way that is not consistent with its prior reading of the law,” Schneider wrote.

After later reading the DOJ opinion, Schneider said Treasury now seems likely to maintain a $750 billion cash balance when the debt limit gets reinstated on Jan. 2 under a “strained” legal rationale and in a break with prior precedent.

He said Treasury would be “ignoring Congress” under that scenario, but there also wouldn’t be any justification for “some half-measure” like a slightly smaller cash buffer.

“Treasury has boxed itself into a no-win position,” Schneider said.

Liquidity infusion

Another potential implication of keeping a larger-than-expected cash balance: avoiding the economic impact of a large drawdown in the Treasury account ahead of the debt limit reset, which would likely begin later this year and possibly be felt ahead of the November elections.

Opinions are divided, but some analysts believe a drawdown could create a temporary windfall for the economy by injecting liquidity into the economy. That’s because money Treasury withdraws from its account at the Federal Reserve goes back onto the balance sheets of banks that also hold assets at the Fed. 

Also, Treasury would be issuing less short-term debt, and thus wouldn’t be soaking up investment that otherwise might go into riskier assets.

“When you have increases in liquidity, it tends to be very positive for stock prices and risk,” Joseph A. LaVorgna, managing director and chief economist for SMBC Nikko Securities, said, adding that the economic impact would be felt quickly, in days or weeks.

But LaVorgna, who served as chief economist for the National Economic Council under Trump, doubts that Treasury will spend down the balance to that degree.

“I don’t think they’ll run it down to $23 billion, is my guess,” he said. LaVorgna anticipates Treasury will keep the balance somewhere around $500 billion.

All of this suggests that Treasury and the Biden administration are gearing up to maintain ample cash reserves rather than seek a quick, debt limit-driven drawdown of its emergency fund to help juice Biden’s reelection prospects.

But once the debt limit is reinstated next year, expect to see that cash buffer drained, as it always is when Treasury is trying to fund all of its expenses without hitting the ceiling.

Peter Cohn contributed to this report.

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