Devastation before default: How debt problems only get worse over time
While a default should be a doomsday scenario that would forever undermine America’s reputation as a reliable borrower, preparing for this critical failure would do its own damage, compounded every day as people potentially miss checks, investors are getting nervous about taking on US debt and the country’s credit rating at risk of an embarrassing downgrade.
Here are our best answers to frequently asked questions about how the coming weeks could unfold, if President Joe Biden and congressional Republicans fail to reach a bipartisan agreement.
How is date X different from ‘default’?
Date X is the day the Treasury Department expects to run out of all available cash and completely exhaust all available “extraordinary measures”, accounting maneuvers that federal officials are authorized to deploy in order to temporarily avoid the default. Secretary Janet Yellen continues to warn that the date is “very likely” to fall in early June if Congress does not act.
Without borrowing authority to make payments of any kind, the Treasury Department would first begin to default on its promises to send money to ordinary Americans, businesses that work for the government, the states and local governments that receive money from federal agencies.
And just like a mortgage or auto loan, non-payment of interest and principal on the national debt would cause the United States to default on its loans.
How would the Treasury handle the inability to make payments?
The Biden administration has previously said that delaying some payments and not others would be unfair to average Americans and likely technically impossible. Instead, the department is preparing a back-up plan in which it could delay all payments for a given day, waiting to make them until there is enough money to do so, the Wall Street Journal.
Such a system will get worse on its own, with the economy and Americans feeling the pain as payments are potentially delayed for longer and longer periods.
When would the economy start to suffer?
Once the Treasury is unable to pay the bills on time, markets will begin to react immediately, Zandi said.
“I think at that point the markets – stock market, bond market, more broadly the forex market – will start to sell off, thinking, well, a recession is ahead,” he said. . “The economy is already very fragile.”
The situation should get exponentially worse over time. “If it’s a one-day violation, that’s one thing,” Zandi said. “If it’s a week, we’re definitely in a recession. If it’s more than a few weeks, it’s a deep slowdown.
When would average Americans start to feel the pinch?
If the Treasury Department completely exhausts its borrowing power before Congress acts, billions of dollars in payments would not go out June 1 and 2 to people who depend on Social Security and Veterans’ benefits, as well as pensions for soldiers or retired civil servants. .
As of the second week of June, the federal government is said to have spent over $100 billion in missed payments. These include SNAP benefits (also called food stamps), education programs and tax refunds, as well as payments to hospitals and health care providers who see people covered by Medicare and Medicaid.
Wages for federal workers and payments to defense contractors would also be suspended. Unlike the government shutdown, even non-emergency workers would still have to do their jobs, but their pay could be delayed for weeks.
Even before the Treasury Department misses payments, ordinary Americans’ retirement accounts and investments would likely take a considerable hit as markets falter. At the same time, interest rates are expected to skyrocket, including for credit cards and mortgages.
When would rating agencies assess the US score?
A credit downgrade could occur before the U.S. actually runs out of cash. Fitch Ratings has previously warned the United States of a possible downgrade of the country’s AAA rating as a reliable borrower, citing “accuracy” around the borrowing limit, among other issues.
“We believe the risks have increased that the debt ceiling will not be raised or suspended by date X and therefore the government may start to miss payments on some of its obligations,” the ratings service said in a statement. a press release this week.
There is also precedent for such degradation before economic disaster actually hit. During the 2011 debt ceiling clash between Republicans and former President Barack Obama, Standard & Poor’s downgraded the United States’ credit rating for the first time, even after the two sides concluded a major budget deal to avoid default, dropping it one notch below the highly prized AAA. rating. The ratings service also cited the “tightrope policy” around the debt ceiling.
But there is a “pretty high bar” for issuing a downgrade, Zandi warned. Moody’s, for example, probably wouldn’t downgrade the United States unless there was indeed a missed payment on federal debt, he said.