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Hitting the debt ceiling would be terrible even if we didn’t default

There's a lot of confusion over what will happen if the United States blows past the debt-ceiling deadline on Oct. 17.

(Photo by Scott Eells/Bloomberg) (Scott Eells/Bloomberg)

Many economists are playing up the scary possibility that the United States could default on its debt, triggering a financial crisis. Other analysts and some Republicans, however, think this is overblown. Even if the debt ceiling isn't raised, they say, the Treasury Department can keep making interest payments on the debt. There's no absolutely no reason to default.

Both views are incomplete. Yes, it's possible that the Treasury Department could avoid an outright default on debt payments if the borrowing limit isn't increased before Oct. 17 — though this is far from certain. But a failure to raise the debt ceiling would still be highly disruptive even if we don't default, raising the possibility of delayed Social Security checks and economic havoc.

Can we avoid a debt default? Maybe.

Remember, if the debt ceiling isn't lifted by Oct. 17, then the Treasury Department will only bring in enough tax revenue to pay about 65 percent of the bills that arrive over the next month. And it won't be able to borrow any more money to pay the rest. That means some of the government's bills will go unpaid.

Now, which bills go unpaid? That's the all-important question. Some observers think the Treasury Department will do everything in its power to ensure that the U.S. government continues to pay interest on its debt. After all, huge swathes of the global financial system are structured around the idea that U.S. Treasuries are the safest asset in the world. if that assumption were ever called into question, havoc would ensue.

This is precisely why Moody's thinks that a default on U.S. debt is unlikely, even if we smash into the debt ceiling.

I took a more detailed look here at whether Treasury can actually "prioritize" payments to avoid a debt default. Short answer: There are big legal and technical challenges, but the numbers might work out. Between Oct. 18 and Nov. 15 the government will bring in roughly $222 billion in taxes and owe roughly $328 billion. But it will only need about $35 billion on hand to make interest payments over that time.

So the money to avoid default is there, at least in theory. But that doesn't mean our problems would be over...

The problem with avoiding a debt default

Here's the big problem with prioritization: If the Treasury Department wants to conserve enough cash to keep servicing the debt, then it will have to miss or delay a bunch of other important payments in the weeks ahead.

Again, here's a refresher on the major bills that are coming due in the weeks ahead:

If the Treasury Department wants to save up enough cash to make that $6 billion interest payment on Oct. 31 and that $29 billion interest payment on Nov. 15, then it might have to delay Social Security checks or Medicare payments or even military pay in order to conserve cash.

So, for example, Social Security checks might go out two weeks later than scheduled at the start of November. Here's an illustrative example of what those delays might look like, courtesy of the Bipartisan Policy Center:

delayed payments

Food stamps could get delayed five days. Social Security checks and military pay could get delayed two weeks.

And that's not the end of the story. These delays would be disruptive enough. But a prioritization plan to avoid default would also have major economic impacts. And it could still spook the financial markets.

Case in point: Alec Phillips of Goldman Sachs has estimated these missed and delayed payments would cause the economy to shrink as much as 4.2 percent of GDP in that quarter. Paul Krugman has estimated that the damage could rise to as much as 10 percent of GDP. So have economists at Citi Research. Again, this is in an "optimistic" scenario where we avoid defaulting on the debt.

The same goes for market confidence: In a recent note, David Bianco estimated that any prioritization plan to avoid default would still cause the S&P 500 stock index to lose 10 percent of its value (the orange line below):

(Deutsche Bank)

That's not nearly as bad as outright default — which he thinks would cause a 45 percent wipe-out and a global financial calamity — but it's quite severe.

Note that there's ample room for market panic in the weeks ahead if the ceiling isn't raised. For instance: The Treasury Department has to roll over about $302 billion worth of debt on Oct. 17, Oct. 24, and Oct. 31. If the borrowing limit isn't increased before then, there's a risk that buyers of government debt could either sit out these three Treasury auctions or demand higher interest rates, which would increase the cost of U.S. borrowing.


-- Absolutely everything you need to know about the debt ceiling

-- A very simple timeline for the debt-ceiling crisis.

-- If we hit the debt ceiling, can Obama choose which bills to pay?



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Lydia DePillis · October 14, 2013

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