The Dow Jones Industrial Average lost nearly 570 points yesterday. The Nasdaq was down about three percent while the S&P 500 shed more than two percent of its value. While the markets have recouped some of those losses this morning, investors are clearly getting jittery.
At least some portion of the market volatility can be explained by a growing crisis in Washington. The federal government runs out of money tomorrow at midnight and U.S. Secretary of the Treasury Janet Yellen this week sent a letter to lawmakers warning that the United States will default on its debt for the first time in history if Congress does not raise or suspend the debt limit by October 18. In a hearing yesterday before the Senate Banking Committee, Yellen said that outcome “would be disastrous for the American economy, global financial markets and millions of families and workers.”
Is everyone right to be spooked? Could October, with all of its normal ghosts and goblins, be even scarier this year?
What Would Default Look Like?
Over the last week — indeed in the last 24 hours alone — several news outlets have outlined what would happen if U.S. lawmakers do not raise the debt ceiling. Here is what CNet said Americans could expect:
Spiking interest rates;
Plunging stock prices;
Stalled Social Security, Medicare, food stamp, and other benefits payments;
U.S. troops, military retirees, and U.S. federal workers going without pay and pensions; and
Declining gross domestic product and higher unemployment.
Washington, D.C.-based attorney Perry Adair told CNet default would be “a blow to our standing in the world and a boon for our adversaries such as China who are arguing to the world that the US is on the decline.”
Forbes reported that Moody’s Analytics has estimated “a U.S. default could wipe out six million jobs and $15 trillion in wealth.” The U.S. housing boom could disappear literally overnight as mortgage rates skyrocket. Of course, these predictions are all theoretical since the U.S. government has never defaulted before.
But according to MarketWatch, even getting close to default is costly. It reported, “The last two times Congress came close to not raising the debt limit, in 2011 and 2013, Moody’s Analytics found, ‘heightened uncertainty at the time reduced business investment and hiring and weighed heavily on GDP growth. If not for this uncertainty, by mid-2015, real GDP would have been $180 billion, or more than one percent, higher; there would have been 1.2 million more jobs; and the unemployment rate would have been 0.7 percentage point lower.’”
The 2013 debt ceiling standoff “cost taxpayers anywhere from $40 million to $70 million,” Moody’s estimated.
In a 2017 report, the Democratic staff of Congress’s Joint Economic Committee noted, “Over the past handful of years debt ceiling politics and threats to default on U.S. creditors did real damage to America’s reputation. In 2011, the credit rating agency Standard and Poor’s downgraded the U.S. credit rating to AA+, the first time in 70 years that the U.S. did not earn an AAA rating (the highest possible rating). S&P cited the ‘prolonged controversy over raising the statutory debt ceiling’ as a primary factor.”
Would the U.S. Be Alone? What Other Countries Have Defaulted?
Readers might remember that, in recent years, Greece defaulted on its debt. While that country is not the only one that has not been able to shoulder its financial obligations, the list of nations that have defaulted is not likely one any U.S. lawmakers wants to be on.
As The Washington Post reported a few years ago, between 1998 and 2015, “at least 16 sovereign bond issuers defaulted.” Five — Greece, Ecuador, Jamaica, Belize, and Argentina —defaulted twice. The others that defaulted were Belize, Cameroon, the Dominican Republic, Ghana, Jamaica, Moldova, Pakistan, Russia, Turkey, the Ukraine, and Uruguay. Additionally, The Post reported, “Sudan, Somalia, and Zimbabwe have been in default” to the International Monetary Fund for “several years or decades.”
More recently, Bloomberg reported, “Sovereign bond defaults have piled up at a dizzying clip in Latin America since the pandemic began. First, it was Ecuador’s turn, then came Argentina, followed by Suriname, then Belize, then Suriname again and Suriname one more time.”
Of course, none of these countries’ economies is nearly the size of the United States’, nor, unlike the dollar, are their currencies viewed as the dominant international reserve currency. Comparing a U.S. default to the experiences of these countries is therefore difficult.
Has The United States Defaulted Before?
“Since the day of Alexander Hamilton, the United States has never defaulted on the federal debt. That’s what we budget-watchers always say,” wrote Forbes contributor Donald Marron in 2013. “There’s just one teensy problem: it isn’t exactly true.”
According to the Bipartisan Policy Center, in 1979 Congress passed an increase “the federal debt limit with little time to spare before the federal government would have defaulted on payments for the first time in modern history.” As a result, according to Marron, that year the U.S. government defaulted on some Treasury bills. We’ve added emphasis here because that default is much, much smaller than the “catastrophe” Secretary Yellen is predicting today.
While it was a smaller event, as Marron explained, the consequences of defaulting on even some debt were pretty awful. Treasury bill interest rates spiked and stayed elevated and erratic for several months. Marron concluded, this experience “shows that even small, temporary default is a bad idea. Our leaders shouldn’t come close to risking it.”
There also have been other defaults throughout U.S. history but, again, not similar to what Secretary Yellen is warning about today. In fact, these involved U.S. states. As a 2011 CNBC story explained:
In 1841 and 1842, there nine state governments defaulted on their debts, but the federal government was not involved.
Between 1873 and 1884, 10 states defaulted. West Virginia was the worst and “was still working out its debt with creditors by 1918.” Again, the federal government was not involved.
If Congress does not pass a debt ceiling increase, or suspend it, the United States would indeed be in unprecedented territory.
In a letter to lawmakers this week, six former Treasury secretaries, including Republican Henry Paulson and Democrat Robert Rubin, said, “Failing to address the debt limit, and allowing an unprecedented default, could cause serious economic and national security harm.” According to CBS News, the former Treasury officials advised that “even a short-lived default could threaten economic growth” by roiling markets and economic confidence, cutting off vital services to Americans, and undermining the trust in the credit of the United States.
They six concluded, “This damage would be hard to repair.”
Given that: what is the likelihood lawmakers will work themselves out of this predicament?
Current State Of Debt Ceiling Play
As expected, this past Monday the U.S. Senate rejected a House-passed fiscal year 2022 funding bill that would have suspended the debt limit until December 2022. Senate Republicans, led by Minority Leader Mitch McConnell (R-Ky.), are holding fast to their objection to the inclusion of the debt limit provision in the spending bill.
As of mid-day today, Democratic leaders’ next best option is to strip the debt limit provision from the bill and bring the spending bill back to the Senate for a vote. That option keeps the government funded until early December, but it kicks the debt limit further down the road — without much time to spare.
Democrats would seemingly have only one path forward: To address the debt ceiling through the party’s proposed $3.5 trillion budget reconciliation bill. Passage of that bill requires only 50 votes, not the normal 60 required to end a filibuster in the Senate. If moderate senators like Joe Manchin (D-W.Va.) and Kyrsten Sinema (D-Ariz.) agreed, Democrats could save the United States from defaulting — and pass a major part of President Biden’s domestic agenda.
That feat won’t be easy, to say the least.
To accomplish it, both chambers of Congress would have to consider an amendment to the budget resolution they passed in August, which would take time. Additionally, federal law prohibits suspending the debt limit through the reconciliation process, so the Democrats would instead have to increase the debt limit to a specific, quantifiable level.
There is some conversation among Democratic leadership about picking a number high enough to effectively guarantee that they won’t have to deal with this issue again for several years. With the midterm elections fast approaching, however, there are some Democrats who view that path as letting Republicans off the hook if they were to win back the majority.
And then there’s this troubling development: Democratic leaders in the Senate, including Majority Leader Chuck Schumer (D-N.Y.) have increasingly rejected using budget reconciliation to address the debt limit over the last 24 hours, arguing that avoiding default should be both parties’ responsibility.
It’s unclear how – or whether – this looming crisis gets resolved.