Guest Column: The Economic Consequences of United States Debt Default

by Peter Bluestone

Oct. 17 has been estimated as the date the United States federal government may go into default on its debt, if an agreement is not reached to raise the debt ceiling. Much has been written about what is likely to happen to financial markets if the United States does default. Some point to the financial crisis in 2008, touched off by the default of Lehman Brothers and soberly note that the holdings of the United States government are some 23 times that of Lehman Brothers. Others claim that talk of such an eminent crisis from the United States default is just fear mongering.

The reaction of the financial markets to a United States default is unknowable ahead of time. There is no precedent for such a massive government default, making comparisons to similar smaller events difficult. So if we put aside the severe risks to financial markets should the United States default, what other impacts would such a default have on the economy, when might they occur, and how would they impact ordinary Americans in and around Atlanta?

To better understand these impacts and the likelihood of them occurring, laying out a basic timeline of events surrounding the debt ceiling is useful. The Washington Post summarized this timeline well. Technically, the United States already hit the debt ceiling in May. Since then, the Treasury Department has taken many extraordinary measures to scrape together enough money to allow the country to continue to pay its bills. These extraordinary measures generally amount to the Treasury Department raiding accounts earmarked for other purposes, such as the exchange rate fund. Oct. 17 is the date that Treasury estimates that these extraordinary measures will no longer yield additional funds.

Treasury estimates that after Oct. 17, the country will have only $30 billion in cash on hand plus tax revenue coming in to pay its bills. Treasury has warned Congress that this amount would not be sufficient to cover expenditures on certain days, in which obligations needing payment can be as high as $60 billion. The Bipartisan Policy Center has estimated the largest federal payments’ due from Oct. 22 through Nov. 1. These include roughly:

• $40 billion to Social Security
• $20 billion to Medicare and Medicaid
• $15 billion in federal employee and military pay
• $6 billion in interest payments on the public debt.

Missing the $6 billion debt payment is generally considered to be the event that signals a full-fledged default to world financial markets, and could trigger a financial panic on par with that of 2008 or worse. Some claim that Treasury can mitigate this risk by prioritizing payments. For instance, withholding money from Social Security or Medicare to fund debt payment.

However, it is far from certain the federal government could prioritize payments even if it wanted to for several reasons. First, the federal bill payment system is a complex automated system involving many linked computers, processing millions of payment requests daily. It is unclear whether such a system can be successfully modified to prioritize different types of payments. Second, even if the necessary modifications could be made, it is uncertain if such prioritization would be legal.

If the debt ceiling is not raised before Oct. 17, the timeline of events afterward, is speculative, however one thing seems clear, some of the federal government's obligations will go unpaid.  Looking beyond the initial risks of financial meltdown and the hardships caused by unpaid Social Security and Medicare benefits, there are other ways that failing to raise the debt ceiling could impact ordinary Atlantans:

• Breaking the full faith and credit of the United States would have immediate and lasting effects on interest rates.
• Mortgage interest rates would rise and businesses would pay more for credit.
• For those in the areas of Atlanta hard hit by the housing bust, particularly the southern parts of the city, that would mean additional foreclosures and fewer institutional investors buying up foreclosed homes.
• The economic uncertainty brought on by the default would also likely cause firms to halt any expansion plans and stop hiring new workers, potentially sending the economy back into recession.

What happens to world financial markets on or before Oct. 17 if the debt ceiling is not raised cannot be known. However, once that threshold is crossed, many unpleasant economic events are likely to occur, including financial market meltdowns, a housing market downturn, and a return to recession.

Dr. Bluestone, a Georgia State University Urban Fellows recipient, is a Senior Research Associate with the Fiscal Research Center in the University's Andrew Young School of Policy Studies. His research has included urban economics, environmental economics and state and local fiscal policy.