It’s fortunate President Obama and House Republicans appeared to be moving closer to an agreement to at least temporarily raise the debt ceiling, which would postpone a scenario that most analysts agree would be catastrophic for the US and global economies.
Without such a deal, the federal government would hit its current borrowing limit around Thursday, risking the first debt default in US history while potentially throwing financial markets into turmoil and pushing the US economy into yet another recession.
“The economic risks to the average American if the government defaults on its debt are so great I find it hard [to believe] policy makers would ever allow it to happen,” said Gautam Mukunda, a Harvard Business School assistant professor who studies how government and business interact. “The entire crisis is entirely unnecessary and avoidable.”
Here’s a quick primer on the dangers of debt ceiling politics. Keep in mind economists don’t entirely agree on the exact sequence and magnitude of what could occur.
‘Everything is going to be worth less. In the worst-case scenario, think: 2008.’
If the government blows past its debt ceiling deadline, what would I first see happen?
Keep an eye on interest rates on all sorts of loan products — government bonds, mortgages, credit cards, and auto and student loans.
Most economists agree that interest-rate increases are highly likely, if not inevitable, in the first few hours and days after the government hits its debt ceiling. How fast and high interest rates rise is anyone’s guess.
“It will make lenders reluctant to loan money with so much uncertainty,” said Doug Handler, chief economist at IHS, an economic research firm in Lexington. “Just how high rates go depends on how long the impasse lasts. It could disappear in a day if [lawmakers] reach a quick settlement. It could go on longer.”
Economists believe nervous investors would quickly start selling short-term Treasury bills and demand higher interest on bonds they suddenly view as riskier investments. Last week, for example, debt ceiling concerns led to a spike in short-term Treasury rates.
Many business and consumer loan rates are tied to Treasurys, so the cost of mortgages, car loans, and other financial products would rise.
Is my 401(k) account going to get hit if a debt ceiling agreement isn't reached?
There’s general agreement markets will be thrown into turmoil. One analyst at Deutsche Bank estimated that the US stock market could lose 45 percent of its value if the government misses a payment on the interest of outstanding bonds.
Mark Zandi, chief economist at Moody’s Analytics, is convinced markets would start going into convulsions almost immediately after a debt ceiling deadline passed. And the longer policy makers go without raising the debt ceiling, the more severe the pain, he said.
“Any investor, including those with 401(k) accounts, is going to get creamed,” he said of a prolonged fight without a debt deal. “Everything is going to be worth less. In the worst-case scenario, think: 2008. That’s your case study for this.”
William Cheney, chief economist at John Hancock Financial in Boston, agrees that 401(k), IRA, and other savings accounts would take hits. The value of existing short-term government bonds would fall because few will want them, while stock markets would be spooked by fears of all the economic unknowns ahead, he said.
Large public pension systems and nonprofit endowment funds will also get hit, as they were five years ago after Lehman Brothers collapsed in September 2008 and stock markets tanked, Cheney warned.
“We just don’t know by how much they might go down,” he said of the markets. “This [debt ceiling impasse] has never happened before. All financial markets will drop. Assets will go down. Yet it’s not clear by how much.”
Would the US government stop paying individual Social Security recipients and Medicare providers if it can’t borrow money?
Initially, no. Eventually, probably yes.
Zandi said the Treasury Department has a cash reserve, estimated at about $30 billion as of late last week, that would allow it to pay for government programs for a short period of time after a debt ceiling deadline is passed.
The current estimate is that Treasury would burn through its cash reserve before Nov. 1, if a deal isn’t reached by Thursday, Zandi said.
At that point, the Treasury Department could rely only on taxes and other revenues streaming into government coffers on a daily basis from taxpayers, since it couldn’t borrow money. Tax collections cover less than 70 percent of operations, so spending would have to plunge more than 30 percent, according to the Bipartisan Policy Center, a Washington think tank.
That, in turn, would require the government to start juggling what bills it pays on a daily basis, based on how much money is coming in from taxes and other revenues.
Zandi said the estimated financial shortfall, without borrowing, for November alone is about $130 billion — so Treasury simply can’t pay all its bills on time. Delayed payments, including to Social Security recipients, would become inevitable, he said.
The Treasury Department also would have to juggle payments for government workers’ salaries, veterans benefits, funds distributed to state and local governments, and other obligations, economists say.
“There must be some point when the cash box is empty,” agreed Doug Snow, associate professor of public service at Suffolk University’s Sawyer School of Business.
Are we talking about another recession here?
In a word: Y es.
Zandi and Cheney say a recession is all but assured if the debt ceiling deadline is missed for even a few days. There would be just too much market turmoil and uncertainty for the economy to stay on an even keel — and it would get worse every day that went by without the government being able to pay bills on time.
To make his point, Zandi said the estimated $130 million shortfall for November represents about 9 percent of the gross national product for that month.
“That means the economy would contract by that much,” said Zandi.
In the worst quarter of the last recession, the economy contracted 8.3 percent, according to the Commerce Department. If the debt ceiling fight goes on for the full month and the nation enters recession, Zandi said he could see the nation’s unemployment rate reaching 12 percent from its current 7.3 percent rate.
Robert Murphy, an economist at Boston College, said consumers and businesses would lose confidence and start to pull back on spending. “That’s perhaps the biggest effect and fear,” he said.
Harvard Business School’s Mukunda said there are “so many imponderables involved” with a possible government default, it’s hard to fathom how hard the US economy and average Americans could be hit.
“There’d be a chain reaction,” he said. “Yet there are a lot of chains connected and we don’t know how or where they’re connected.
“No one really knew how bad a Lehman collapse would be, otherwise regulators wouldn’t have let it collapse. But it did collapse and look what happened — the Great Recession. Is this going to be another Lehman Brothers? Is it going to be something less? We don’t know. But the risks are there.”