Perhaps I’ve missed the discussion of what might happen if the U.S. fails to meet its debt obligations because the TV hasn’t been on that often, but it does feel as though the preponderance of the analysis has concerned the political ramifications of defaulting, and not on what a default would mean to most Americans.
The following information has been inserted in other posts, but if the impression that this hasn’t received the kind of media coverage is accurate, then there’s a good reason for revisiting the topic with a more select focus.
Here are the highly likely results of a debt default:
#1. “First, foreign investors, who hold nearly half of outstanding Treasury debt, could reduce their purchases of Treasuries on a permanent basis, and potentially even sell some of their existing holdings.”
So what? If foreign investors start to divest their portfolios of U.S. Treasuries then Treasury rates, and Treasury borrowing costs will increase. The prediction? “A sustained 50 basis point increase in Treasury rates would eventually cost U.S. taxpayers an additional $75 billion each year.” [TBAC] Therefore, if it’s thought that the national debt is “too expensive” now — wait and see what it costs taxpayers AFTER the United States defaults.
#2. “Second, a default by the U.S. Treasury, or even an extended delay in raising the debt ceiling, could lead to a downgrade of the U.S. sovereign credit rating. ”
What would this mean? One distinct possibility is that for every one-notch downgrade in the U.S. credit rating there would be a 1% increase in Treasury rates. If a 50 basis point (0.5%) increase would cost American taxpayers $75 billion annually, then imagine increasing the borrowing costs by 100 basis points (1%)? The arithmetic is simple, it could cost us another $150 billion annually. The Congressional Budget Office predicts we could incur approximately $130 billion in increased costs. [CBO]
#3. “Third, the financial crisis […] could trigger a run on money market funds..”
It’s a fact of financial life that money fund investors are singularly focused on “overnight liquidity” and there is a better than even chance that funds in a run will “break the buck.” Breaking the buck is financial sector jargon for what happens when the net asset value of a money market fund falls below $1, and the operating expenses and investment losses are higher than the fund’s revenue.
Oh, come on…what could go wrong with a little “technical default” wherein the U.S. missed a deadline and then went back to paying its obligations? We’ve seen this movie before. When Lehman Brothers went south in 2008 the run on the money funds was prodigious, and very expensive. It was so expensive the Bush Administration resorted to the TARP model to bail out the U.S. financial sector.
If words don’t get the message across, let’s look at a picture: [Business Insider]
We might want to remind ourselves that on September 15, 2008, the day Lehman Brothers Holding declared bankruptcy, the Dow was at 10,917.51 and by October 15, 2008 it had dropped to 8,557.91. [YahooFin]
#4. “…a Treasury default could severely disrupt the $4 trillion Treasury financing market, which could sharply raise borrowing rates for some market participants and possibly lead to another acute deleveraging event.”
There are two pieces of bad news in this prediction. The first is that disrupting the financing market (where capital lenders and capital borrowers meet) is a messy matter at best, and as we saw after the Lehman collapse it can create a Credit Crunch. If the demise of one major investment house can wreak havoc on the financing market, imagine the impact of having the United States of America default?
And, rates would go up, yielding the second phase in the Bad News realm. Who might be those “some market participants?” Banks. If the cost of borrowing goes up for the banks then the cost of borrowing goes up for everyone else — right down to the credit cards in our wallets. Up goes the cost of student loans, auto loans, home mortgages, commercial lines of credit, revolving credit, and down goes the consumer and small business capacity to get credit.
What happens during a Credit Crunch? We’ve already seen this play out as well. “Deleveraging” is a lovely term of art to describe what happens when businesses and individuals are so busy trying to pay down debt that there’s nothing left over to purchase new goods and services. Main Street still hasn’t fully recovered from the last round of “deleveraging” and if the U.S. defaults it will no doubt be hit with another Whammy.
#5. “…the rise in borrowing costs and contraction of credit that would occur as a result of this deleveraging event would have damaging consequences for the still-fragile recovery of our economy.”
And, here comes that second Whammy. In the wake of the 2008 financial debacle there was a 1.5% increase in mortgage spreads created by increasingly tight credit. Mortgage rates went up for consumers, and down went the housing market even further. The housing market still hasn’t fully recovered, there is still excess inventory on the market, some home owners are still Upside-Down, and as if this sector of the economy needed another blow — a default would certainly provide one.
What makes the housing market so touchy is that it is positioned “midstream,” meaning that events which impact the housing sector ripple down to primary industries (timber, mineral mining, etc.), ripple out to secondary economic activities like wholesaling, and outward to tertiary sectors including brokers, banking, and professional services. If one is looking to strike a body blow which will adversely effect primary, secondary, and tertiary sectors of the economy, then Housing is the place to hit. If it’s the worst target, then it follows that this is the sector we most need to protect, and precipitating yet another Credit Crunch is definitely not protective.
#6. A default will have a negative effect on the Social Security Trust Funds. Unfortunately for all the drivel about allowing the U.S. to default, and then “prioritize” its repayments, there is no real plan in place to do the “prioritization.” [CRS pdf] In this uncharted territory we find those Special Issue Securities, the Social Security surplus funds invested in Treasuries that are not available to the commercial markets, and which comprise a significant portion of the Social Security Administration’s revenue stream. These are the result of our payment of payroll taxes, which are invested in U.S. Treasuries, and from which we fully expect to earn interest — which we won’t if the U.S. defaults.
We can easily summarize the effects of a U.S. default as (1) excessively expensive, (2) economically perilous, and (3) counter-productive to our national and societal interests. So, why would anyone be foolish enough to suggest we “Cut It and Shut It?’
Perhaps the answer lies with the Tea Party radicals in the Republican Party, who unlike Wall Street hate their own government more than they detest the level of national indebtedness. Robert Reich explains, “Tea Partiers hate government more than they hate the national debt. They refuse to reduce that debt with tax increases, even with tax increases on the wealthy, because a tax increase doesn’t reduce the size of government. The Tea Partiers’ real aim is to shrink the government.” [Reich, CSM] For all the palaver about “The Debt Crisis,” the Drown Our Own Government In The Bath Tub crowd is promoting a course of action that will make government more expensive, imperil the free market economy they claim to espouse, and jeopardize the Social Security program upon which many of them may depend.
This doesn’t make any sense, but then hysteria rarely does.
Desert Beacon 