Republican leaders will need Democratic votes to raise the debt ceiling because a cadre of conservatives argue that the dire picture painted by experts about the consequences of defaulting are overblown and feed into the liberal resistance to enacting necessary spending cuts. They would prefer spending cuts and forcing the government to prioritize making its interest payments over other things before raising the debt limit and will only support a debt ceiling hike if they extract major concessions.
The larger problem is that neither side knows definitively what “defaulting” would entail, since the nation has never truly defaulted.
The debt ceiling traces its legislative roots to 1917 and sets the legal limit the Treasury Department is allowed to borrow to meet its payment obligations and cover the shortfall between expenditures and revenues brought in largely through taxation. Prior to its enactment, all debt issued by the federal government had to be individually legislatively authorized. This act was intended to avoid the voluminous legislation on debt matters, especially in times of war. Since this time the United States has never fully defaulted on its debt obligations, despite a series of technical malfunctions that happened in 1979.
But, during the 1840s, some states fully repudiated their debts, thereby defaulting, and the consequences were drastic. Their default deprived states, the federal government and even private companies of access to international capital, which contributed to a prolonged recession — all of which reveal how dangerous such an action would be for Congress today.
Risky lending practices in the wake of the Panic of 1837 precipitated eight states (Arkansas, Illinois, Indiana, Louisiana, Maryland, Michigan, Mississippi and Pennsylvania) and one territory (the future state of Florida) defaulting. From 1837 to 1839 state debts increased by more than 40 percent with some $100 million worth of state securities hawked in London.
Many Northern states needed funds to finish internal improvement projects while for Southern states the bond issues helped to fund new emerging banks in competition with northern financial powerhouses. The bankruptcy of the Bank of the United States in February 1841, and a general unwillingness on the part of the federal government to bail out state debts led many of these states to default in 1842.
Most of these states viewed their defaults as temporary, but this did little to assuage the concerns of foreign investors. Foreign banks were especially upset by the unwillingness of the defaulting states to make serious inroads to curb spending or raise additional funds via taxation.
The defaults led to a war of words between British banks and American politicians. Gov. Alexander McNutt of Mississippi declared, “the blood of Judas flows” in the veins of the British banking house Rothschild. McNutt further added that the Jewish firm wished for southern states to “mortgage our cotton fields and make serfs of our children” in order to meet debt obligations. Other defenders of repudiation included senator and future president of the Confederacy Jefferson Davis, who defended the actions of his home state of Mississippi.
The defaults sparked a credit crisis throughout the United States. By 1842, American securities became known as “American insecurities” in London damaging the credit of the United States as a whole. London financier (and American expatriate) George Peabody succinctly proclaimed “As long as there is one state in the Union in default no U.S. Government bonds can be negotiated.” American attempts to contract a federal loan abroad in 1842-1843 were firmly rebuffed in London, Paris and Amsterdam. The American representative on the credit mission dejectedly reported to Washington, “The condition of American credit in Europe is a source of deep humiliation to every American who visits that section of the world.”
By 1843, with little assistance from the United States or British governments in the offing, European banks took the matter into their own hands. Six European investment banks earmarked 2,000 pounds to undertake a public campaign in the United States regarding the importance of financial integrity.
Directing their initial focus towards Pennsylvania — a state with $24 million worth of foreign owned debt out of a total obligation of $34 million, this “Committee on State Debts” undertook an extensive lobbying campaign in the American press, state and federal legislatures, and even among the clergy to expose the moral dangers of default. By the middle part of the decade and under increased public pressure, several defaulting states passed legislation addressing their debt and beginning the process of repayment. Even though steps were made in the right direction, it did not stop European firms from selling over a third of their American holdings in the early 1840s.
States like Florida and Mississippi that continued to be in default were unable to procure loans abroad until after the Civil War and even then on less than favorable terms. Such financial handcuffing extended beyond state expenditures, as railroad companies in both of these states found no interest in bond underwriting on trips to London and Amsterdam in 1847.
The state defaults had an especially damaging effect on the American economy — prolonging the recovery from the Panic of 1837. As one historian has noted, foreign capital catapulted the American economy in the 1830s, and the lack of it contributed to the extended recession in the 1840s.
Undoubtedly the financial world has changed drastically since the 1840s. Yet the state default sagas from this period offer an interesting parallel to present considerations. A default in 2017 would likewise lead to market turmoil and lack of credit access from foreign investors — an eerie reminder of the international ramifications of default for U.S. public credit and standing on a global stage. As in the 1840s, the ramifications would be longer lasting and more widespread than currently anticipated, hurting not only the federal government, but states, American companies and other actors — including American citizens.
The 1840s offer a clear warning that default ought to be avoided at all costs, lest the United States trigger a global recession entirely of its own making. This need to avoid default, in turn, provides massive leverage for legislators willing to vote to raise the debt ceiling as the deadline approaches. Come December that will provide a boost to Democrats.