Plenty of Fear to Go Around If America Defaults on Debt
WASHINGTON – Here’s the scariest thing about the looming deadline to raise the U.S. government’s borrowing limit: No one knows precisely what will happen if the limit is breached.
It’s never happened before.
The possible consequences are dizzyingly complex.
But they’re all bad. Most ominously, the government might fail to make interest payments on its debt. Any missed payment would trigger a default.
Financial markets would sink. Banks would slash lending. Social Security checks would be delayed.
Eventually, the economy would almost surely slip into another financial crisis and recession.
Even if the government managed to make its interest payments, fears about a default would likely cause investors to dump Treasurys and send U.S. borrowing rates soaring.
The financial world is holding out hope that that grim scenario will compel Congress to raise the debt limit and avert a default.
Here are questions and answers about the government’s borrowing limit:
Q. What exactly is it?
A. The borrowing limit is a cap on how much debt the government can accumulate to pay its bills. The government borrows by issuing debt in the form of Treasurys, which investors buy. The government must constantly borrow because its spending has long exceeded its revenue. The first borrowing limit was enacted in 1917. Since 1962, Congress has raised the borrowing limit 77 times. It now stands at $16.7 trillion.
Q. How close are we to the limit?
A. The national debt actually reached the limit in May. Since then, Treasury Secretary Jacob Lew has made accounting moves to continue financing the government without further borrowing. But Lew says those measures will be exhausted by Oct. 17. The government will then have to pay all its bills from its cash on hand – an estimated $30 billion – and tax revenue. The cash and tax revenue aren’t likely to be enough. Lew has said the government’s daily spending can run as high as $60 billion.
Q. What happens after Oct. 17?
A. The government could pay all its bills for a few days, according to the nonpartisan Congressional Budget Office. But sometime between Oct. 22 and Oct. 31, the $30 billion would run out. The date isn’t exact because it’s impossible to foresee precisely how much revenue the government will receive and when.
Q. When it runs out of cash, does the government default?
A. No, not right away. A default would occur if the government fails to make a principal or interest payment on any of its Treasurys. A $6 billion interest payment is due Oct. 31.
Many experts think that to avoid a default, Treasury would make payments on the debt its top priority. The House has approved a bill to require such “prioritization.” The Senate hasn’t passed it, though. And President Barack Obama has threatened to veto it.
In any case, making some payments and not others is harder than it might sound. Treasury makes roughly 100 million payments a month. Nearly all are automated. Without any cash in reserve, a minor glitch could cause Treasury to miss a debt payment – and default.
“Treasury would do everything in their power to not miss a debt payment,” says Donald Marron, an economist at the Urban Institute and a former economic adviser to President George W. Bush. “But when you’re in untested waters under a great deal of stress, bad things happen.”
Even if the government managed to stay current on its debts, it would fall behind on other bills. These include Social Security benefits, federal employees’ pay and payments to contractors.
There are legal and political obstacles, too. The government is legally obligated to pay contractors. If not, they could sue for non-payment. And how long would members of Congress stand by as bondholders in China and Japan were paid interest, while Social Security and veterans’ benefits were delayed?
Q. Couldn’t the government just print more money?
A. No. The Federal Reserve, an independent agency, is responsible for creating money. The government funds itself through tax revenue and borrowing.
Q. Could the president just ignore the debt limit?
A. Some experts say he could. The 14th Amendment to the Constitution says, “The validity of the public debt of the United States, authorized by law … shall not be questioned.” But the White House has said its own lawyers don’t think he has the authority to do so. Nor is it clear that many investors would buy bonds issued without congressional approval.
Q. What would the economic impact of all this be?
A. Many foresee a nightmare. No longer able to borrow, the government could spend only from its revenue from taxes and fees. This would force an immediate spending cut of 32 percent, the Bipartisan Policy Center estimates.
If the debt limit wasn’t raised through November, Goldman Sachs estimates that government spending would be cut $175 billion. That’s equivalent to about 1 percent of the economy.
On top of that, stock markets would likely fall. Household wealth would shrink. Consumer confidence could plunge. Americans would cut back on spending. Higher rates on government debt would raise other borrowing costs, including mortgage rates.
Q. Why is it potentially catastrophic for the government to miss a payment on its debt and default?
A. In part because the repercussions would be felt worldwide by a global economy that still isn’t at full health.
Banks in the United States and overseas use Treasurys as collateral when they borrow from each other. If Treasurys were no longer seen as risk-free, it would disrupt borrowing and jolt credit markets. A financial crisis like the one in 2008 could follow.
Banks also hold much of their capital reserves in Treasurys. If they fell in value after a default, banks would have to cut back on lending.