The Consequences of Failing to Raise the Debt Ceiling

With every day of unproductive negotiations between the White House and congressional Republicans that passes, the prospect that the United States government will find itself unable to pay its bills becomes less unthinkable. So what happens if Congress doesn’t increase the debt ceiling?

Though we still believe that to be unlikely, the prospect is worth exploring. It’s uncharted territory. A small technical default in 1979 doesn’t compare to what would happen if the U.S. Treasury’s coffers were short, come early August. Does it mean Uncle Sam defaults the next day on principal and interest owed lenders — the foreign and domestic holders of U.S. Treasuries?

Not necessarily. President Obama would have options, but none of them are good. Odds are bondholders would be paid first, chewing up a few billion in monthly tax collections, which are sufficient to cover about three-fifths of federal spending. To pay the rest of its obligations, Treasury borrows, to the tune of $125 billion a month.

From just $107.88 $24.99 for Kiplinger Personal Finance

Become a smarter, better informed investor. Subscribe from just ~~$107.88~~ $24.99, plus get up to 4 Special Issues

CLICK FOR FREE ISSUE

https://cdn.mos.cms.futurecdn.net/flexiimages/y99mlvgqmn1763972420.png

Sign up for Kiplinger’s Free Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

On August 3, the day after Treasury Secretary Timothy Geithner says is the effective deadline for extending the debt ceiling, about $23 billion in Social Security benefits is slated to go out. The White House could choose to go ahead with that disbursement and still have enough left to pay for Medicaid, Medicare and food stamp program obligations before the coffers were empty.

Alternatively, Obama could opt to stiff the elderly and make the payroll for the country’s military and for law enforcement — ponying up what’s needed to keep the FBI, courts and prisons running. Civilian and military personnel are paid on the first and fifteenth of every month, so August 1 paychecks would presumably go out as usual. But if Uncle Sam can’t raise additional funds to roll over maturing debt and pay all of the federal government’s bills in August, August 15th paychecks will be in danger. Odds are most government employees wouldn’t get paid. It’s hard to believe that the White House would be willing to let down either Social Security beneficiaries or the men and women of the military and take the heat for paying federal file clerks. It’s more likely that a criterion similar to what has been used for furloughing government employees in the past would be invoked to determine who stays on the job and who is told to stay home.

Likely to come last on the list, in any case, are federal contractors — the businesses, small and large, that sell goods and services to Uncle Sam. Ironically, that may wind up costing taxpayers even more money in the end, because contractors who aren’t paid within the usual 30-day window after delivery are bound to sue, adding legal costs to the feds’ bottom line.

Keep in mind that it wouldn’t take default on loans to wreak havoc on the economy. Interest rates may surge even though bondholders get paid, because traders reckon that sooner or later their interest checks will be delayed. That would trigger hikes in rates for everything from car loans to farm loans, with the 30-year fixed-rate mortgage jumping perhaps as much as 1.5 percentage points.

Idaszak, now retired, worked on The Kiplinger Letter as its economics writer for 21 years. Before joining Kiplinger in 1992, he worked for 15 years with the Chicago Sun-Times, including five years as a columnist and economic correspondent in the Washington, D.C., bureau, covering five international economic summit meetings. He holds bachelor's and master's degrees in journalism from Northwestern University.