July 13, 2011 |
Photo Credit: AFP/Getty/Alex Wong
According to the conventional wisdom, the stakes around a default* are so great that after a brief game of brinksmanship, lawmakers will eventually come to their senses and raise the debt ceiling as the deadline nears.
That view, based on past precedent, will likely prove correct. But this is an exceptional moment in our political history. At this point, neither Senate Minority Leader Mitch McConnell, R-Kentucky, nor Speaker John Boehner, R-Ohio, can truly claim to speak for their caucuses. Many within the Tea Party caucus refuse to vote for a debt ceiling increase under any circumstance, and Boehner needs a good number of Dems to pass it. But the Dems have offered most of what the GOP wants, only to see them walk away from the table, insisting that all tax loopholes are sacrosanct.
Obama wants a big, grand bargain – possibly to include cuts to Medicare and Social Security – while the Democratic rank-and-file wants to run on protecting those programs next fall. So, improbable as a protracted period of default might be, with all these political divides deepening it's no longer out of the question.
Most Americans are unsure what a default actually means, and with good reason – it's virtually (but not entirely) unprecedented. So what might happen if the worst-case scenario should come to pass? We run down some possibilities below.
1. Around August 3, Some People the Federal Government Owes Money To Will Stop Getting Paid
The Treasury is now shuffling money around using a series of “extraordinary measures” to make payments. That process will be exhausted at some point between August 2 and August 12 – it's currently projected that August 2 will be the drop-dead date.
At that point, the government will be able to send out only what it collects in taxes. But the reason we have a deficit – the only reason – is that Congress authorized more spending than it's raising in taxes. According to the Bipartisan Policy Center (BPC), the federal government will take in a little more than $172 billion between the drop-date date and the end of August. But the government's commitments – to everyone from investors in U.S. bonds to the elderly, children in need of food stamps and everyone else – adds up to a bit less than $307 billion during that same period.
That means choices will have to be made. And, as the BPC notes, “Inflows and outflows do not match up well and are quite 'lumpy,'” meaning that it's not really possible to pay everyone 60 percent of what they're owed.
President Obama said he “couldn't guarantee” that Social Security checks would go out on time. $23 billion worth of checks are scheduled to be cut on August 3, but only $12 billion in tax revenues is projected to come in that day. Also scheduled for August 3 are the following:
- $1.4b defense vendors
- $1.8b Dep. of Education
- $500m Federal salaries/benefits
- $2.2b Medicare/Medicaid
- $1.4b Food/HUD/Welfare/Unemp
- $100m Veterans Affairs programs
- $100m IRS refunds to businesses
- $1.5b other spending
Looking at the entire period of August 3-31, we could pay the interest on federal bonds, Social Security, Medicare and Medicaid payments, veterans' benefits and unemployment benefits.
If we did so, we couldn't pay the salaries of military personnel and federal workers and we would have to stiff low-income people receiving housing assistance, food stamps and other benefits. We'd have to close down the federal courts and federal law enforcement agencies, stop paying for the Department of Education (think Pell grants, among other things), the Highway Administration and the EPA. Health and Human Services (the “principal agency for protecting the health of all Americans and providing essential human services, especially for those who are least able to help themselves”) would be shut down. Private contractors would be stiffed. IRS refunds would stop going out. In addition, the Department of Energy, Small Business Administration, Department of Labor and $52 billion in smaller programs would no longer be funded.
2. Real People Would be Hurt, Badly (Especially in the 'Red' States)
The idea of “limited government” is appealing in the abstract, but not in concrete terms. With the economy – the private-sector economy – in terrible shape, the New York Times notes that “close to $2 of every $10 that went into Americans’ wallets last year were payments like jobless benefits, food stamps, Social Security and disability.” That's the concrete reality, and those dollars – some of them – will disappear after August 3 if no deal is reached on the debt ceiling.
The Times broke those numbers down by state and found there was quite a bit of variation in terms of how much of their personal incomes residents of various states derive from government payments. Conservative-leaning states like West Virginia (28 percent), Mississippi (26.2 percent), Kentucky (24.8 percent) and Arkansas (24.5 percent) lead the pack; among the dozen states that depend the most on federal payments for household income, only three – Maine, Michigan and New Mexico – are considered “blue.”
3. Hurting the Economy: Demand Would Crash Further; Personal Debt Would Rise
The core problem in our economy – 70 percent of which is based on consumer spending – is a lack of demand. Businesses don't hire when they don't have customers. American households lost $14 trillion in wealth during the crash – only around half of which has since been recovered – and that has led to what economists call a “wealth effect” on demand. It simply means that when people have more assets they tend to spend more freely and when their wealth drops they pull back.
Given that about 20 percent of the money in Americans' pockets comes from the government, when those checks stop going out, households would have only two ways to respond: they could cut back on spending –further depressing demand for goods and services -- or, if they qualify for loans, they could take on new debt. There are no other options. As I've noted before, it's personal household debt, rather than public debt, that is putting a major drag on the economic recovery.
4. Hurting the Economy: Interest Rates May Skyrocket
So far, the government has been able to sell bonds (which is how it borrows money) at a low interest rate, and that tells us investors have not taken this debt ceiling brouhaha too seriously. They assume the political posturing will give way to sanity and Congress will raise the debt ceiling before long.
It's not entirely clear what would happen if no deal is struck by the deadline, but the risks are enormous. The ratings agencies – which, despite being found utterly corrupt in the build-up of the mortgage-backed securities bubble, are highly influential – would at a minimum put the U.S. on “watch” for a downgrade. And they could in fact downgrade the federal government's debt, which is now considered among the safest investments in an uncertain world.
It's possible that defaulting for a few days would have a minimal impact if investors continued to believe the whole mess would be worked out in short order. But when investors get panicky, that would change.
There's a chance there would no longer be a market for our bonds, but a more likely scenario is that interest rates would rise, significantly, in order to entice investors. That wouldn't only impact what the government pays to borrow money, however – it would hit the entire economy. Businesses would need to pay more to borrow cash to expand their operations, which would hurt job creation. And all those American households with maxed out credit cards and big mortgages would be hit with much higher interest payments (which would also take spending money out of people's pockets).
This is, by and large, an unprecedented situation. But back in 1979, there was a very small, temporary default on payments to bondholders that arose from some technical problems following an earlier debt limit standoff. It was just a blip on the radar, quickly forgotten, and it certainly paled in comparison to the severity of a full-blown intentional default.
Yet, as the Washington Post reported, “even that brief failure to meet some obligations had expensive consequences.” The Post cited a study done by Terry Zivney, a finance professor at Ball State University, and his partner, Dick Marcus, which found that the brief glitch “resulted in a permanent increase in interest rates” of more than half a percent. The Post added that, “over time [those increased rates] translated into billions of dollars in increased interest payments on the nation’s debt, a cost shouldered by taxpayers.”
The combination of less demand for goods and services and higher costs for borrowing would in all likelihood send this fragile, painfully slow “recovery” off-track, pushing the U.S. economy – and probably the global economy – into a second, bruising recession in just a few short years.
5. It Would Increase the Deficit
Given the massive risks associated with default, it seems odd at first blush that more Americans oppose raising the debt ceiling than raising it. But it's not – many people believe that not raising the debt limit will cause the deficit to decrease. It makes intuitive sense – if the government can't borrow money, it can't run high deficits – but it's not true. In fact, failing to raise the debt limit in a timely manner would result in the opposite effect – it would increase the deficit dramatically.
The important point here is that the debt limit will be raised eventually. Everyone knows they can't simply cut payments to soldiers, vets, the elderly, government contractors and shut down a half dozen federal agencies indefinitely. What's more, the debt ceiling needs to be raised to pass any budget plan – including Paul Ryan's conservative wet dream of a budget.
So, let's say they face an impasse for more than just a few days after the limit. When they eventually lift the ceiling, the budgetary shortfall will be much larger for two reasons.
First, the interest the government will have to pay on its outstanding debt will be significantly higher, which could result in hundreds of billions of dollars in higher debt costs – in other words, it will drive up federal spending.
Second, the number one contribution to the high deficits we're running today is the recession itself – it hit tax revenues hard at every level of government. Between 2009 and this year, the federal government will have collected the lowest share of our economic output in taxes annually since 1950 (we have a revenue problem, not a spending “crisis”). Pushing the economy into another recession would hit tax revenues again. It would also increase the demand for government assistance for all those newly unemployed and relatively poorer workers.
So, at the same time that spending would be pushed higher by a default, revenues would also be pushed lower. Again, deficits are caused by only one thing: Congress choosing to spend more than it chooses to collect in taxes. If it drags on in any length, when this standoff finally comes to an end lower revenues and higher costs would result in a far bleaker fiscal picture.
Lies and Public Opinion
This is what's at stake in this bit of Beltway kabuki theater. Serious policy analysts can and do debate the precise measure of these impacts, but nobody operating within the bounds of intellectual honesty disagrees that a default would be extremely painful.
Yet, again, a plurality of Americans – especially conservatives – want to see this tragic scenario come to pass. And it's not just that they don't understand what's at stake – they're being willfully misled by their anointed leaders.
Fox did a segment asking: “Is the Fear Over Default Overblown?” Presidential candidate and Tea Party favorite Michele Bachmann blithely assured her fans that failing to raise the debt limit would simply force the government to “live within its means.” Rep. Louie Gohmert, R-Texas, a notably crazy back-bencher, said that Boehner is only listening to Obama, who is receiving bad advice from people who don't mind "lying" about the reality of the situation. "I would encourage our speaker to quit believing the president when he uses these scare tactics. There is money there regardless of what we do," he said.
Rush Limbaugh told his listeners, “we're getting the same kind of hysteria about the need to raise the debt ceiling that we got about the government shutdown.” He added that, “a genuine shutdown of the United States government isn't going to happen. It simply will not happen. Revenue would still be coming in. People are still working and paying taxes. Revenue is still coming in. The worst that would come out of it is that we would have to prioritize our spending.”
If we had an honest debate over the debt limit, and the real-world consequences of not raising it, it's hard to imagine anyone being in favor of letting the U.S. government go into default.
* “Default” is used here as a shorthand; technically, if the U.S. were to continue paying bondholders and nothing else, we wouldn't be in default on the debt per se.
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