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"Treasury would do everything in their power to not miss a debt payment," says Donald Marron, an economist at the Urban Institute and a former economic adviser to President George W. Bush. "But when you’re in untested waters under a great deal of stress, bad things happen."
Q. What other problems might be raised by prioritization?
A. Consider the legal and political obstacles. The government is legally obligated to pay its contractors. If not, the contractors could sue for non-payment. And how long would members of Congress stand by as Treasury holders in China and other nations were paid interest, while payments to U.S. veterans and Social Security recipients were delayed?
Q. How would investors react if the government made its interest payments but fell behind on other obligations?
A. Badly, most economists say. If the government couldn’t pay veterans’ benefits, federal employee salaries or other bills, investors would almost certainly demand higher interest rates at future Treasury auctions. That would drive up the cost to taxpayers of servicing the government’s debt.
A failure to pay any obligation "would severely damage perceptions of our creditworthiness," says David Kelly, chief global strategist at JPMorgan Funds.
Each week, the government issues new short-term debt and uses the proceeds to pay off maturing debt. This step doesn’t increase total debt. So it would still be allowed even if the borrowing limit wasn’t raised. But it’s possible that not enough investors would want to buy the new debt. That would leave the government short of cash to pay off its maturing debt. The result: a default.
Q. What else could Treasury do?
A. It could make its interest payments first — then delay all other payments until it collects enough tax revenue to make a full day’s payments. That would avoid choosing among competing obligations. Treasury officials favored this approach during the last borrowing-limit fight in 2011, according the Treasury Department’s inspector general.
But that approach would eventually cause extensive delays. On Nov. 1, nearly $60 billion in Social Security benefits, Medicare payments and military paychecks are due. With no increase in the borrowing limit, those payments could be delayed for up to two weeks.
Q. Could the president just ignore the limit?
A. Some experts say he could. The 14th Amendment to the Constitution says, "The validity of the public debt of the United States, authorized by law ... shall not be questioned." But the White House has said its own lawyers don’t think he has the authority to do so. Nor is it clear that many investors would buy bonds issued without congressional approval.
Q. Are global investors panicking yet?
A. No, not yet. The stock market surged on Thursday and Friday as Congress appeared to move closer to an agreement to raise the debt ceiling and perhaps end the partial shutdown of the government. But if prospects for an agreement were to dim early next week, stocks could sink. Investors would likely also dump Treasurys.
Interest rates on some short-term Treasurys have risen sharply in the past week. That shows that the deadline might be rattling some investors. The Bipartisan Policy Center estimates that the 2011 fight over the debt limit inflated federal borrowing costs by $1.3 billion, or about 0.5 percent, that year. Over 10 years, the estimated cost comes to nearly $19 billion.
Q. What would the economic impact of all this be?
A. Many foresee a nightmare. No longer able to borrow, the government could spend only from its tax revenue. This would force an immediate spending cut of 32 percent, the Bipartisan Policy Center estimates.
If the limit remained through November, Goldman Sachs estimates that spending would plummet by up to $175 billion. That’s equivalent to about 1 percent of the economy.
On top of that, stock markets would likely fall. Household wealth would shrink. Consumer confidence could plunge. Americans would cut back on spending. Higher rates on government debt would raise other borrowing costs, including mortgage rates.
Q. Why is it potentially catastrophic for the government to miss a payment on its debt and default?
A. The repercussions would be felt worldwide. Banks in the United States and overseas use Treasurys as collateral when they borrow from each other. If Treasurys were no longer seen as risk-free, it would disrupt borrowing and jolt credit markets. A financial crisis like the one in 2008 could follow.
Banks also hold much of their capital reserves in Treasurys. If they fell in value after a default, banks would have to cut back on lending.
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