This is what would happen if we breach the debt ceiling
Posted by Ezra Klein
on January 7, 2013 at 12:34 pm
Want to make sure your calendar is clear when we hit the debt ceiling? Then don’t schedule anything between Feb. 15 and March 1.
That, according to a new analysis
by the Bipartisan Policy Center, is the likely range for debt-ceiling doomsday: The day when the Treasury Department runs out of room to maneuver and we actually begin to default on obligations. Either Congress figures out the debt ceiling before that date or things get very bad, very fast.
Imagine we hit the debt ceiling Feb. 15. The BPC’s analysis suggests that federal spending over the next month will be about $450 billion. Federal revenues will be nearer to $277 billion. That means that the government will have to default on about 40 percent of its obligations.
The choices it will face quickly become stark. It can cover interest on the debt, Social Security, Medicare, Medicaid, defense spending, education, food stamps and other low-income transfers, and a handful of other programs, but doing all that will mean defaulting on everything — really, everything — else. The FBI will shut down. The people responsible for tracking down loose nukes will lose their jobs. The prisons won’t operate. The biomedical researchers won’t be funded. The court system will close its doors. The tax refunds won’t go out. The Federal Aviation Administration will go offline. The parks will close. Food safety inspections will cease.
This is the difference between a debt-ceiling shutdown and a government shutdown. As Shai Akabas, a research at the Bipartisan Policy Center, puts it, “in a government shutdown, the government is shutting down future obligations. With the debt ceiling, They’ve already obligated the money. They owe these people the payments now, and they can’t make them.”
Then, of course, there’s the financial-market chaos. Trillions of dollars in derivatives and other financial products are based on the interest rate that the federal government pays when borrowing. U.S. government debt is, after all, supposed to be the safest investment in the world, and so it’s used to “benchmark” all other sorts of debt. A spike in the Treasury rate would mean a spike in credit card rates and mortgage rates, not to mention all manner of more esoteric financial derivatives. The damage to the economy would be tremendous, and it would occur at every level, from individuals looking for a loan to buy a house to hedge funders trying to play the markets.
“Think about what we’re talking about here,” says Steve Bell, director of economic policy at the BPC. “We’re talking about the reserve currency of the world. We’re talking about the deepest and most liquid markets in the world. And we’re sitting here wondering if we’ll cover our obligations?”
All of this, amazingly, is something of a best-case scenario. It’s what happens if we breach the debt ceiling in an orderly way. But the federal government needs to make more than 100 million individual payments between Feb. 15 and March 15. Those payments are all computerized and those computer systems aren’t build to stop making half of them, or to prioritize some above others. There’s a real question as to whether the federal government could reprogram its software to seamlessly begin picking and choosing which bills to pay and which to ignore. If there’s a glitch, then it’s possible that after assuring bondholders that they’ll never miss a payment, the government will accidentally fail to pay them, causing widespread confusion about whether the guarantee remains valid, and throwing financial markets into a panic.
Nor does any of this account for public outrage over the spectacle of the U.S. government prioritizing bondholders over everyday Americans. “This could lead to some interesting headlines,” says Bell. “Imagine: ‘America pays Chinese debt instead of Social Security.’ “
Additionally, the easy ways out don’t look so easy. The White House has already said it doesn’t believe that it would be constitutional for the president to invoke the 14th Amendment and simply continue paying our debts. That doesn’t mean, warned Bell, that it won’t happen. But if it does, those payments will go out under a cloud of uncertainty. Interest rates are unlikely to remain unaffected.
The same goes for the “platinum coin” option, in which the Treasury takes advantage of a poorly worded law meant to help coin collectors and mints a trillion-dollar coin with which to pay our debts. Imagine a Japanese bond trader who hears we’re now running our government off of a trillion-dollar coin created through a loophole in the law. Is there any way that trader is going to keep lending to America at near-riskless rates? The result might be better than default, but it won’t be good.
The consequences, meanwhile, will be lasting. We will have done something we told the markets we would never, ever do. The United States will have proven itself a riskier borrower with a more broken political system than anybody thought. The BPC estimates that the last debt-ceiling fight cost us $19 billion in higher borrowing costs over the next decade, and in that case, we didn’t even breach the debt ceiling. If we go further this time, the costs will be much higher, and much longer lasting.
Ironically for those who want to use the debt ceiling as leverage to reduce the deficit, busting through the debt ceiling would make our future deficits far worse. The damage to the economy now would increase the deficit, as spending goes up and tax revenues go down when the economy flags, and the higher borrowing costs later would increase the deficit, as we’d be paying more to service our debt than the Congressional Budget Office expects.