Debt Ceiling Dysfunction May Spark Market Panic -- Even If U.S. Makes Bond Payments

Rep. Maxine Waters, D-Calif., speaks before the House Judiciary Committee during the nmarkup on the Violence Against Women Re
Rep. Maxine Waters, D-Calif., speaks before the House Judiciary Committee during the nmarkup on the Violence Against Women Reauthorization Act of 2012 on Capitol Hill in Washington, Tuesday, May 8, 2012. (AP Photo/Susan Walsh)

WASHINGTON -- Financial experts warned Congress Tuesday that a U.S. default may set off financial mayhem that cascades through the global economy. Even if the American government doesn't miss a bond payment, the panel emphasized, Congress would jeopardize the stability of the dollar if it fails to raise the debt ceiling by Thursday.

The event, organized by Rep. Maxine Waters (D-Calif.), is the only congressional inquiry into the potential consequences of failing to raise the debt ceiling. Treasury Secretary Jack Lew has said the government will have no legal way to pay all of its bills after Thursday unless the debt ceiling is raised.

Several Republicans have said the government can avoid missing Treasury bond payments after Oct. 17 by "prioritizing" spending -- failing to pay some bills like Social Security or government contracts, so that it can pay interest on bonds. But the experts, most representing the GOP-friendly financial industry, said this was wrong. The bond market would punish the U.S. government for failing to pay its bills, even if those bills were due to other people. It's similar to a household getting a lower credit rating for failing to pay utility bills or make car payments, even though it sends in a mortgage check, the experts said.

"Once you stop paying in one sector, where you stop that, how you have certainty that you're going to pay in other sectors, is an open question," said Rob Toomey of the Securities Industry and Financial Markets Association. "That uncertainty, again, has to be priced in."

Under an optimistic scenario, the immediate results would be higher interest rates on U.S. debt, which would mean fewer and more expensive loans for businesses and consumers. This credit squeeze would make the cost of doing business more expensive for companies, which would force layoffs and higher prices for consumers.

It's illegal, however, for the government to fail to make good on its non-debt obligations, because of laws already in effect. This creates uncertainty for financial markets about whether the bills will in fact be paid.

"What are our obligations? They are not simply the payments on the bonds," said Damon Silvers, policy director at the AFL-CIO, the largest federation of American labor unions. "They are Social Security, Medicare, payments to contractors … you start defaulting on your obligations piecemeal, everybody runs."

Financial markets that depend heavily on U.S. Treasury bonds would see significant deleterious effects, as uncertainty over the value of their bond purchases escalates.

"Everybody will worry they won't get paid," said Jim Chessen, chief economist at the American Bankers Association.

That uncertainty alone -- even without the U.S. actually missing a debt payment -- may trigger a significant exodus from money market mutual funds. Bank loans to other banks could dry up. Both of these events occurred after Lehman Brothers filed for bankruptcy in 2008, triggering a global financial panic, widespread bank failures and a deep recession. That scenario may not be repeated if Congress blows the Oct. 17 deadline, but the experts agreed it's a very real possibility. While stock market reaction to the debt ceiling standoff has been muted, other financial markets have seen significant repricing. The cost of insuring a one-year Treasury bond against default has surged from 0.06 percent of the bond in early September to 0.38 percent on Tuesday, according to data from Markit, a financial information company. This more than 700 percent increase indicates rising uncertainty over the debt ceiling.

Playing with the debt ceiling is playing with the dollar as the dominant global currency, Silvers emphasized. Most people who invest in the dollar don't hold physical cash. They purchase a Treasury bond, since it pays interest. Treasury bonds are considered "risk-free" by most financial metrics, and an actual default may force a significant reorganization of global finance with negative implications for the U.S.

Repeated demonstrations of Washington's political dysfunction for basic government obligations of paying employees and keeping it open may force the U.S. to forfeit much of its global economic influence over time, weakening Americans' standard of living.

"Argentina has amazing natural resources and they went bankrupt," Silvers said. "The reason we are risk-free is because of the confidence of the world in our political system."

The panel that appeared in Congress had many of the trappings of an official congressional hearing, but it was not. Hearings can only be called by the majority party, and Waters is a Democrat. There has been no official hearing in either the House or the Senate on the economic consequences of failing to raise the debt ceiling.



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