What Would Happen if the U.S. Government Defaulted on its Debt?

Question: I’ve heard the comment that if the U.S. government were to default on its debt, “everything goes down” — presumably banks, credit unions, etc. Would a default necessarily result in runs on retail banks and credit unions and insufficient funds to cover deposits?

Paul Solman: It sure would be ugly. Maybe a global show stopper. The U.S. government owes almost $9 trillion to creditors. (It owes another $4.5 trillion to itself: the Social Security and Medicare trust funds, mostly.)

$9 trillion is a lot of debt to default on. By way of comparison, Lehman Brothers was reported to be only $600 billion in debt when it folded and look what THAT did to the world economy.

So every bank or company or individual or foreign central bank that owned U.S. treasuries (i.e., U.S. debt) would suddenly be asking — and asked — the question of anyone holding a bad loan: How much is it really worth? That in turn depends on the terms of the default. But for the U.S. government to default on its debt would be a financial event of unimaginable magnitude in today’s interdependent global economy.

That said, there’s “default” and a “default event,” which is the language used in credit default swaps. If Congress doesn’t raise the debt ceiling before our national debt rises above it, is that “default”? What if we get into a major political conflict with China and default on obligations held by the Chinese, but not by others?