With most people talking about what would happen if the U.S. defaulted on its debt, the coverage of different scenarios is taking on more importance. Some conservatives are advocating that it wouldn’t be too hard on the economy, while others are predicting financial Armageddon.
NPR outlined three main groups that would be affected by the default – China, pension funds and Social Security. Here’s what it said about pension funds:
If you have a pension plan or a retirement account, there’s a very good chance you are lending money to the U.S. government.
And some big funds are taking precautions right now. PIMCO, which manages a lot of retirement money, doesn’t own any Treasuries that are supposed to pay out money between Oct. 17 (the Treasury’s deadline for raising the debt ceiling) and the beginning of December. “We’ve been avoiding them,” Tony Crescenzi, a strategist and portfolio manager at PIMCO, told me.
A lot of PIMCO’s clients can’t risk getting paid late. Some need the money to pay employees. Others need to send out pension checks. “There is de minimis risk of not getting paid on time, but it exists,” he said. “Why take the chance?”
Bloomberg Businessweek wrote a piece looking at the nuance of timing of the default, saying that how long it might last would be critical in determining what the fallout might be:
A default would without question be both harmful and stupid. But the sky would probably not fall the minute it happened. Roger Altman, chairman of New York-based investment bank Evercore Partners (EVR), told Bloomberg News’ Yalman Onaran that a default would mean “higher interest costs over some considerable period of time for the U.S. and for U.S. taxpayers.”
“If you missed an interest payment by two hours, the markets might look entirely beyond that and forgive you,” Altman added. “If you miss an interest payment by two days, four days, six days, that’s a different story. It’s very difficult to be scientific about this.”
In other words, how long it lasts is crucial. If the federal government defaults and the financial markets’ initial reaction is muted, a lot of people who made over-the-top warnings about generation-long consequences will have to change their tunes—and the public will become even more cynical. Congress will cease to take the debt ceiling seriously and it will lose its value as what House Budget Committee Chairman Paul Ryan calls a “forcing mechanism.”
This is not by any means an optimistic scenario. A soft market response may be the worst possible outcome—even worse than a swift, scary market reaction that finally galvanizes Washington into action. Here’s why: If a default doesn’t cause chaos on Day One, Congress and the White House will be tempted to prolong their game of brinkmanship into Day Two, Three, or Four, just as they have allowed the partial government shutdown to drag on for more than a week so far.
Markets and rating agencies that treat, say, an hour-long default as a forgivable glitch will lose their forgiving mood if a default drags on. Treasury debt will gradually lose its reputation as a safe harbor for investors and there could be growing dislocations in parts of finance that use Treasuries, such as repo financing and money markets. The federal government could wind up like the mythical frog that jumps to safety if put in a pot of boiling water but dies if the temperature is raised gradually.
NBC News outlined seven different outcomes ranging from a depression to a freeze in banking operations. In this section they quote Dick Bove, long-time banking analyst:
One chilling data point: American banks own $1.85 trillion in various government-backed debt, Bove calculated.
The effect, then, of a default on that debt would be devastating.
“If the Treasury and related securities were in default, one does not know what they would be worth,” Bove said. “Assume a Latin American valuation of 10 to 20 cents on the dollar and an estimated $1.28 trillion in U.S. banking equity would be wiped out.”
The potential result?
“It is my strong belief that a true default by the United States Treasury would wipe out bank equity,” he said. “All bank lending to the private sector in the United States would stop, immediately. Existing loans would not be rolled over. Immediate repayment would be demanded.”
The BBC wrote an explainer about the basic facts and what a default could mean to global markets. The Q&A had this to say about how a default could be avoided if politicians can’t agree:
US Treasury Secretary Jack Lew has warned that if a deal to increase the nation’s borrowing isn’t reached, the Treasury will exhaust the current extraordinary measures being used to pay the nation’s bills by 17 October. These bills include not just the interest on bonds but things like Social Security and veteran benefits.
Mr Lew has insisted no one really knows what will happen if and when the money runs out.
The US Treasury will still be taking in revenue in the form of tax receipts, so it could pay some bills, but possibly not all of them.
The most obvious option – to prioritise payments to bondholders so that the US would not be in default – has been ruled out by the Obama administration, and might technically be illegal, according to a study by Columbia Law professors.
Ideally, though, the Treasury would use the money from tax receipts – which would still be flowing into its coffers after the debt ceiling is breached – to pay only the interest it owes on bonds that have already been issue
While no one knows what exactly will happen in event of a default, most agree, it likely won’t be good. But the media is doing a thorough job looking at different scenarios and trying to explain them. Looks like some politicians should be paying more attention to the coverage.