Latest debt ceiling fix-it: IOUs

By Jeanne Sahadi | CNNMoney.com – Thu, Jan 10, 2013 4:43 PM EST

The list of sorry ways to address the unthinkable is growing. Call the latest debt ceiling work-around the IOU Plan.

Edward Kleinbard, a tax and legal scholar, has offered up a contingency plan he thinks President Obama could adopt without causing a constitutional crisis if Congress pushes the country to the brink of default: Issue IOUs that can be sold and traded in private markets.

As everyone but Congress seems to understand, if the debt ceiling isn't raised soon, the government would no longer be permitted to borrow new money. That means it won't have enough funds to meet all its financial obligations in full and on time.

Enter the IOU Plan. Here's how it would work:

To avert the potentially catastrophic result of defaulting on U.S. bonds, the Treasury Department would continuing paying all interest owed on the federal debt in full and on time.

But other people and companies owed money by the government would be paid partly in cash and partly with IOUs called "scrip." The IOUs, or registered warrants, would be paid as soon as Treasury had enough funds on hand to do so.

Who might be offered the IOUs? Federal contractors large and small. Social Security recipients. Medicare and Medicaid providers. Federal workers. Tax filers due refunds. Government programs. You name it.

Related: What you need to know about the debt ceiling

If holders of the IOUs need their money sooner than the government can pay it, they could sell it at a discount to a financial institution such as a bank or potentially even on an online marketplace like craigslist.

"Claim holders will be able to 'monetize' their claims through private sector sales, even while the government is precluded from borrowing money to pay them directly," Kleinbard explained in an email.

The holder of the claim would take a haircut by selling it at a discount, and the buyer would be paid the full face value when Treasury is able to pay it off.

The idea is not exactly new. California -- during its budget crises of the past few years -- also issued IOUs to those owed money by the state.

Kleinbard hopes his IOU plan will never have to be put in place. He does think it offers a credible back-up to support Obama's oft-repeated assertion that he "will not have another debate" with Congress over raising the debt ceiling in order to pay the country's bills.

"Congress and the country need to know before we reach the breach point ... that he has a plausible plan to work around the debt ceiling," Kleinbard wrote in a New York Times opinion piece Thursday where he first introduced his idea.

Translation: The more that people who are owed money by Uncle Sam know they won't be paid in full, the more they'll pressure Congress to raise the debt ceiling pronto.

"Would a federal scrip program be a painless way of resolving a debt ceiling crisis? Hardly. But it would be the least awful way ... and one that would not permanently damage America's fiscal standing in the world," Kleinbard wrote.