When is a default a ‘default’?

Budget expert Stan Collender sounds a dire warning about the future of the country's fiscal fight. (The Washington Post)
October 9, 2013

Republicans on Capitol Hill are circulating a memo by the credit ratings agency Moody’s that says that if Congress does not raise the debt ceiling by Oct. 17, the nation wouldn’t actually be at risk of default. That’s because the Treasury would still have plenty of revenue to pay interest to owners of U.S. government bonds.

That seems to fly in the face of what President Obama says. The president and his aides have been warning for weeks that if the nation doesn’t raise the debt ceiling, there would be a default in the weeks following — and that could shake the economy and global financial markets.

Why the discrepancy?

It partly reflects word choice — and partly reflects a different assessment of the consequences of failing to raise the debt ceiling.

Let’s start where there’s agreement. Most independent analysts say that after Oct. 17, the Treasury will be unable to borrow additional funds and thus will only have cash on hand, plus incoming tax revenue, to pay the government’s bills. Officials say it’s unclear how long that will be adequate to meet all obligations. It could be a few days or a bit longer, but almost nobody believes it will be enough past Nov. 1, when nearly $60 billion in government payments are due.

If Congress refuses to act, President Obama has three last-minute options he could use to avoid a default on the nation's debt. (The Washington Post)

The question is what happens when the government runs out of money to pay all of its bills. And that’s where there’s disagreement over what a “default” is.

The Obama administration says that a “default” occurs whenever it can’t make any of its required payments. So if the Treasury can pay interest to lenders but not Social Security recipients, it believes it’s “defaulting” on its obligations to seniors.

Financial firms — in particular the credit rating agencies such as Standard & Poor’s and Moody’s — have a more specific definition of default. That definition is missing a payment to a creditor.

Here’s how S&P — which has been harshest on the U.S. credit rating — explained it in a report on the issue last week:

“If the debt ceiling were not raised by the mid-October date, when the stop-gap measures employed in recent months are estimated to be exhausted, the U.S. would not be able to meet all of its obligations. Should the government fail to service a debt obligation, we would lower the sovereign rating to ‘SD’ (selective default). This designation indicates that the issuer, in this case the U.S. government, had failed to meet one or more of its outstanding debt obligations.”

What’s more, anyone that relies on payments from the U.S. government may suffer if the nation can’t meet its obligation. “We may lower our ratings on obligations that depend on payments by the U.S. government,” S&P writes. “Other ratings could be affected, depending upon the severity of the impact on financial markets, the payment and settlement systems, and the real economy, in the U.S. and possibly globally. It is difficult to ascertain the impact at this time, given the unprecedented nature of this event.”

So, according to the credit rating agencies, it’s true that as long as the government debt can be serviced, the United States is unlikely to technically default on its debt. But it is still unlikely to be able to “meet all of its obligations,” as S&P writes. Because federal revenues pay for only about 70 percent of government spending, that means spending will need to be cut by about a third once the government can’t pay all its bills. And many economists say that would cause a recession.

That’s assuming — as Moody’s and others do — that the government can pay interest on the debt, which most inside and outside of government feel is sacrosanct. It’s probably true that Treasury would strive to do that. But given the uncertainty in such a scenario, there’s no guarantee that there wouldn’t be disruptions in debt servicing or the broader financial markets.

Indeed, U.S. short-term borrowing rates have already been getting expensive as investors fear dislocations in the U.S. bond market later this month.

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