Wednesday, July 27, 2011

U.S. debt default would harm nation, individuals

Many Americans have dismissed the ongoing political brinkmanship over the federal debt limit as just another example of Washington partisan gridlock.

But the consequences of a U.S. default on its financial obligations are potentially breathtaking, from higher interest rates on car loans and credit cards to dramatic cuts in government agencies that affect every aspect of American life.

Experts warn a default on at least some of the government's bills is unavoidable if President Barack Obama and Congress can't come to terms on a deal to increase the debt ceiling before next Tuesday. Capitol Hill is in a race against the clock to find agreement on a solution.

The United States reached its statutory $14.3 trillion debt ceiling on May 16, and the Treasury Department since then has been taking what it calls "extraordinary measures" to stave off default. Starting next Tuesday, the emergency options are exhausted, and there soon won't be enough money to pay the nation's bills.

Although Treasury officials may be able to prioritize incoming revenue to satisfy bondholders, an estimated 40 to 45 percent of the government's other bills would still go unpaid, at least temporarily.

A July analysis by the Washington, D.C.-based Bipartisan Policy Center concluded that the Treasury Department will face an Aug. 3-31 cash deficit of about $134 billion. It will have only a projected $173.3 billion coming in to pay the month's $306.7 billion in expenses.

Because the government borrows roughly 40 cents for every dollar it spends, deep spending cuts are inevitable if the debt crashes into the ceiling and U.S. borrowing power is cut off.

Interest on Treasury securities, which would have to be paid to avoid default, damage to the U.S. credit rating and increased borrowing costs would consume $29 billion of the incoming August revenue, according to the center's analysis.

Although there is no guarantee that the Treasury Department would, or even has the legal authority to, pay the debt first, many analysts believe that it will.

If the roughly $100 billion in Social Security and Medicare/Medicaid obligations are met, tough choices will have to be made about how the remaining $44 billion or so is spent.

National defense, the Justice Department, including the FBI, and other vital government functions likely could not escape unscathed. The federal government shutdowns of 1995-96 would pale in comparison, experts say, because this time even mandatory spending would be affected.

Federal salaries, jobless benefits, Internal Revenue Service refunds and housing and nutrition assistance for low-income families could go unfunded in a worst-case scenario as could departments and agencies such as the Environmental Protection Agency, the Centers for Disease Control and Prevention and the Education Department.

"If the debt ceiling is not raised by August 2, we're not going to default on our debt, but we are going to default on about 50 percent of all of the other payments that the federal government is obligated to make," said Jay Powell, a former undersecretary of the Treasury for finance under President George H.W. Bush and a visiting Bipartisan Policy Center scholar who worked on the analysis.
"We have tried many examples of ways to cut 50 percent of spending, and you can't do it without eliminating many popular and important programs."

An archaic exercise?

What is the debt limit? It's not in the U.S. Constitution, and Congress' decision to put a cap on the national debt dates only to a liberty-bond bill passed during World War I. It covers both the publicly held debt and the debt owed because of government raids on the Social Security Trust Fund and similar accounts.

Lawmakers have raised the debt limit 10 times since 2001, according to an April report by the Congressional Research Service, Congress' nonpartisan research arm. There have been past debt standoffs, but in the end, Congress has never failed to lift the ceiling.

Many scholars and experts view the exercise as archaic; no other nation routinely must legislatively lift a debt limit to accommodate its budget spending. Increasing the debt limit is needed just to fund the government's ongoing operations and obligations and by itself does not authorize additional spending.

The federal government's debt ceiling is commonly compared to a credit card's limit. More precisely, it is akin to a situation where a credit-card holder has already spent to the hilt and can't afford to pay off the entire bill.

"It's actually not a bad analogy because you have some of the same risks with a credit card that you have with national debt," said Rep. David Schweikert, R-Ariz., who serves on the House Financial Services Committee, which oversees the Treasury.

"You're subject to the whims of the interest-rate market," he said. "Because, if all of a sudden, interest rates go up, your finance costs go up on your credit card just as they go up on the refinancing of our bonds. And often, you're using today's dollars to pay for last year's purchasing."

Spending decisions

Although there should still be more than enough cash coming to satisfy the nation's creditors - those who own Treasury bonds, bills and notes - there is disagreement about whether the Treasury Department actually has the legal authority to pick and choose how the incoming money is spent.

The department has said it doesn't, but the Government Accountability Office, Congress' nonpartisan watchdog agency, has said that it does.

On Tuesday, Schweikert and Sen. Pat Toomey, R-Pa., introduced legislation that would make sure the Treasury Department uses incoming dollars to cover expenses related to debt service, Social Security and the active-duty military.

Even the specter of a bond default could hurt interest rates for Treasury securities. Those interest rates are linked to the interest rates for home mortgages, car loans, credit cards and other financial instruments that American consumers and businesses rely on.

An actual default could have serious long-term ramifications, particularly as the United States continues to struggle with the after-effects of a painful recession.

"Interest rates in the whole economy could really go up," said Paul Posner, a professor at George Mason University in Virginia and a former GAO' director of federal budget and intergovernmental relations.

'Whipsaw effects'

Defaulting on government investors is not the only risk if the debt ceiling is not increased. Just slashing the flow of government spending by 40 to 45 percent could cause economic disruptions.
"This abrupt contraction would likely push us into a double-dip recession," Treasury Secretary Timothy Geithner warned in a May 13 letter to Sen. Michael Bennet, D-Colo.

Geithner was responding to Bennet's request for a Treasury Department assessment of the fiscal and economic ramifications of not raising the debt ceiling.

Posner predicted Americans would soon see just how deeply the federal government is involved in their daily lives, from air-traffic controllers to federal food inspectors. There will be "whipsaw effects that nobody could possibly have anticipated," he said.

"For example, you can't produce meat and have it go to market without an agricultural inspection. You're going to start seeing very weird things happening."

For his part, Schweikert has stayed optimistic and believes that an eleventh-hour deal can be struck.

"That's the nature of legislative bodies and also the nature of big corporate negotiations," Schweikert said. "You haggle and haggle down to the last moment, and that's when you're convinced that either you've gotten as much as you can get or have given away as much as you can give away. And then time closes the deal."

Other onlookers are not so confident. "The people who are responsible for this should not be sleeping," Posner said. "They are messing around with some really important stuff."

by Dan Nowicki The Arizona Republic Jul. 27, 2011 12:00 AM

U.S. debt default would harm nation, individuals

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