Congress Begins Frightening Debt Default Debate With Enormous Consequences

“We would probably be looking at something that could cause a global recession.”

WASHINGTON -- The battle over raising the nation’s debt ceiling that starts Wednesday in the House has the potential to do worldwide economic damage if Congress ultimately fails to hike Uncle Sam’s borrowing authority even for a short time, according to a range of economists.

The struggle is beginning in earnest with the advancement on the House floor Wednesday of a measure designed to soften the blow in case Congress fails to extend the limit, which stands at $18.1 trillion.

Treasury Secretary Jack Lew has warned repeatedly that the limit has already been reached and that by Nov. 3, the Treasury Department will only have about $30 billion in cash on hand -- not enough to pay all the nation’s bills on a typical day.

As a contingency, Rep. Paul Ryan’s (R-Wis.) Ways and Means Committee drew up the “Default Prevention Act,” which passed 235 to 194 Wednesday afternoon.

The bill lets the Treasury Department incur new debt only to pay for Social Security and satisfy obligations to bondholders. Other bills, such as for Medicare or defense contractors, would have to wait, even though they are for items and programs that Congress has already authorized.

Every economist HuffPost spoke to said failing to meet any obligations would count as a default and start doing immediate damage that could reach nightmare proportions, depending on how big the default is and how long it lasts.

“It’s very hard to tell where those risks turn from somewhat serious to severe to catastrophic, but there’s some scale there,” said Shai Akabas, the associate director for economic policy at the Bipartisan Policy Center. “As a policymaker making decisions, you have to be cognizant of where on that scale you are, and it’s not entirely clear that we know on an hour-by-hour, day-to-day basis.”

The lack of clarity stems from the fact that the United States has not had a major default in its history, the Treasury Department makes tens of millions of payments a month and it’s impossible to know exactly which payments would be missed.

But economists are sure that whatever the impacts, they would not be good.

Indeed, when there was a minor default caused by a technical glitch during a debt ceiling fight in the late 1970s, interest rates spiked and stayed high for a substantial period.

Even a brief default could prove catastrophic because it would start a ripple effect where the United States’ bond rating is downgraded, interest rates rise and the many institutions and other nations that rely on Treasury bonds to mitigate risk suddenly face increased risks and higher costs.

“Interest rates would increase significantly on Treasury debt, which, again, would have significant reverberations around the financial system,” said Dan White, a senior economist at Moody's Analytics who is not affiliated with Moody’s credit-rating arm. “We would probably be looking at something that could cause a global recession.”

The idea behind the Default Prevention Act is to make sure bond holders such as China are guaranteed to get paid, thereby dampening international fears.

Economists said that might help -- a little. But the impact would still be terrible. The state of Illinois offers a very small snapshot of why, said White. Illinois has been paying its bond debt, but has fallen seven or eight months in arrears on other payments, leaving its credit rating in shambles.

“It’s gone,” White said. “It’s the lowest-rated state in the United States. Their borrowing costs are much higher than the national average as a result.”

Of course, the impact of the entire nation following the same course would be much larger.

“It’s bad either way, whether you pass the Default Prevention Act or not,” said Alice Rivlin, a Brookings Institution economist who has pushed for deficit reduction for years. 

“The global economy is very fragile at the moment,” Rivlin said. “Emerging markets are in trouble, commodity prices are down, China is not growing like it was, and Europe isn’t doing terribly well. So you’re taking a strong, or relatively strong linchpin, out of total global growth -- namely us.”

Whether or not the debt limit gets raised, the current climate in Congress is already setting the rest of the world on edge.

“The longer we wait, the more folks will start to worry, especially given the political unrest in the House of Representatives right now,” said White. “The longer we wait, the more volatility, the more uncertainty there is in the market over the very near term, the worse that is for the economy.”

International investors and observers have gotten used to watching Congress push vital economic responsibilities to the brink, with a near default in 2011 and the government shutdown in 2013. But they at least believed that departing House Speaker John Boehner (R-Ohio) would ensure Congress ultimately did its job. Now observers are more worried.

“There are some folks in the Republican caucus who have explicitly said that they don’t mind going over the debt ceiling, or defaulting on the debt,” White said. “If it looks like that faction is going to gain more power, then people are going to start to be worried that maybe Congress is more than just a little crazy, more that they’re going to be detrimental to the rest of the country by taking us over the debt limit.”

In fact, some Republicans are agitating strongly to attach numerous strings to any hike in the debt limit, which Democrats would be unlikely to accept and which members of both parties in the Senate would likely reject. Boehner said Tuesday that passing a "clean" debt ceiling hike without a bunch of riders was not likely.

If Ryan replaces Boehner as Speaker, as the House is now contemplating, it would likely allay fears since Ryan is seen as responsible, even by Democrats -- even though it was his committee that advanced the Default Protection Act.

Ironically, some observers worry that the fig leaf the measure would provide could make default more likely.

“This approach is extremely dangerous,” wrote Joel Friedman in a blog post for the liberal-leaning Center on Budget and Policy Priorities. “By appearing to make a default legitimate and manageable, it would heighten the risk that one will actually occur.”

The White House has pledged to veto the bill, which is also awaiting action in the Senate.

Should the U.S. default, Rivlin said, "It would be devastating, and not just in terms of credit rating."

"We’d demonstrate that we’re not a serious country, that we renege on our promises," she continued. "It undermines any pretense we have of being world leaders of responsible countries. It would quickly be quite bad for our economy at home or abroad."

Michael McAuliff covers Congress and politics for The Huffington Post. Talk to him on Facebook.

Update: This article has been updated to reflect that the Default Prevention Act passed the House. 

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