Defaulting on U.S bond obligations could cause ‘mother of all financial crises’

The Treasury Department warned in a report that if the government defaults on its obligations later in October, the economic impact could be widespread and even provoke another financial crisis. Annie Lowrey of The New York Times joins Judy Woodruff to explain the debt ceiling and potential consequences.

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    And let's take a closer look now at the questions surrounding the federal debt limit and what's at stake there.

    As we have been reporting, in its report today, the Treasury Department warned that, should the government default on its debt obligations later this month, the economic impact could be widespread. It said — quote — "Credit markets could freeze. The value of the dollar could plummet. Interest rates could skyrocket. And there might be a financial crisis and recession that could echo the events of 2008 or worse."

    We will discuss what's behind those warnings in a moment. But let's start with some explanation about the debt ceiling itself.

    Annie Lowrey is a reporter for The New York Times, and she joins us now.

    Welcome back to the program.

    Remind us, what is the debt ceiling? Why is it there? Why is it needed?

  • ANNIE LOWREY, The New York Times:

    So, it's a kind of secondary check on the amount that Congress is spending. That's what it's designed to be.

    So what happens is, every year, Congress decides the amount of deficit or surpluses they're going to run by deciding how much they will spend and how much they are going to take in, in taxes, and in the event that they're running in the red, as they generally are, Treasury takes them sum and sells bonds on the bond market. So the debt limit is the cap on the total value of bonds that Treasury can sell.

    But the issue is that, if — Treasury can't raise that limit by itself. It needs Congress to do it. If they don't have enough money to pay all the bills, they need to issue those bonds. They can't right now, so it looks like they might have some kind of a cash crunch.


    So, Treasury has announced in the last few days that they expect the debt ceiling is going to be reached on October the 17th. That's just two weeks from now. What happens if that ceiling is not raised?


    So, if it isn't raised, Treasury would have cash on hand. They would have money coming in from tax receipts, but that would be it. They'd have no other way to pay the country's bills.

    So starting on that date or some time after then, they wouldn't have enough money to pay the bills everyday, and the United States would miss about 30 percent of its obligations in perpetuity until Congress raised the ceiling again.


    And so explain to us, Annie Lowrey, what's the difference between meeting obligations in terms of, say, putting — making Social Security payments, benefits, paying salaries of government workers vs. making those bonds payments that are due.


    Right. So, Treasury makes literally millions of payments a day. And so, just as you described, some of them go to Social Security recipients. Some of them go to states. Some of them go to contractors. And then some of them go to bondholders who say, hey, I bought a 10-year bond 10 years ago. I want my money back now.

    And so the issue is, it would be really bad if Treasury didn't manage to meet some of its payments to states or Social Security recipients, but they could basically say, you know what? We're going to be forced to pay you later. And that would be awful, but it probably wouldn't be catastrophic.

    The issue with the bonds is that if Treasury didn't pay its bondholders back or didn't pay the coupon payments that it's required to make on some of those bonds, they would be declared in default and it would basically throw a lot of sand into the gears of the entire financial system, and you would have had a financial crisis, and not just a small financial crisis, but like the mother of all financial crises, because treasuries are so important to the functioning of financial markets.


    So — and, in fact, that's the kind of language — what you just said is the kind of language Treasury used today when it put out a — this warning that said it that has the potential to be catastrophic. It goes back and cites what happened in 2011, when Congress flirted with not raising the debt ceiling.

    What did it say some of the consequences might be?


    So borrowing costs in some case. Consumer confidence and business confidence plunged. The stock market took a hit, which is obviously bad for businesses. It's also bad because it reduces households' wealth, so you have that kind of wealth effect, where people felt like they were a little bit poorer. They spent less.

    And there's some evidence that it actually slowed the recovery down and that the higher borrowing costs ended up costing the country billions of dollars, even though they didn't actually get into an actual cash crunch situation.


    So the people you talk to, Annie Lowrey, do they — when the Treasury uses this sort of — they paint this dire picture, saying that what could happen would be something even worse than what happened in 2008 with the financial collapse and then the recession, the people you talk to take that seriously.


    Yes, absolutely.

    So even just getting close to the limit would probably send a little waves of panic through the market. Actually getting up to the limit, to the point that Treasury couldn't pay bills, would be really bad. And the prospect that Treasury wouldn't pay bondholders is just absolutely terrifying.

    There's some idea that Treasury, if forced to, would put bondholders first in order to try and keep the financial markets calm, but it's not even clear that they have the technical ability to do that. Part of the issue here is that the United States has never actually really gone down this road. Nobody exactly knows how this all would play all, but the worst-case scenarios are really, really frightening, and even just getting close is going to send a little bit fear through the market.


    Well, there has been conversation — and you just — I think you just used the word priorities. What do we know about how the government could decide what its priorities were if something like this happened, in terms of what to pay?


    Yes, we don't know that much about it. The best information that we have comes from a Treasury inspector general report.

    And that indicates that Treasury thinks probably the best option would be delaying some payments, like we were talking about, to maybe states or other folks that it needed to pay back, and saying, you know, once the debt limit is raised again, we will get your money to you.

    But the idea that they could change their computer systems fast enough in order to make that workable is something that's — it's a real question mark. Treasury itself has said that they think that missing any payments would be just about as bad as defaults. They would think of that as being defaults. They have said that think that prioritization, putting bondholders first, wouldn't really be workable, even though a lot of market participants think that, in the case that they had to, they would do that.


    And just quickly, the White House made a point today of saying the president on his own wouldn't raise the debt ceiling. They don't believe he has the authority to do that. I gather there's not much dispute about that.



    Some folks have said that the 14th Amendment grants him the authority to go ahead and just pay the bills, even though the debt limit hasn't been raised, let Treasury start issuing new debt. The administration has just outright rejected that approach. Other administrations in the future might not, but the Obama administration is not going to do that.


    Annie Lowrey with The New York Times, thank you very much.


    Thanks for having me.