Post date was nearly a year ago, but NYC Southpaw’s explanation of the debt ceiling (background, definition, issues) remains valid. Some consequences of reaching that limit, which will occur on 17 October 2013. day t, are already in progress due to the current budget stalemate and partial government shutdown.
t + 3
Hitting the debt ceiling, less than a week from now, will accelerate and intensify the consequences of government insolvency. Here’s a partial excerpt of NYC Southpaw’s original post, followed by thoughts of my own, as we approach the 17th.
The entrance to the Senate Appropriations Committee room in the US Capitol, overseen by Bellona the Roman goddess of war [formerly the Military Affairs Committee room].
Under our constitution and current law:
- Congress appropriates money to be spent on programs by passing laws, and the Treasury is required to spend it.
- Congress lays taxes by passing laws and the Treasury collects their revenue.
- To the extent that the amount spent exceeds the revenue [received], the Treasury sells bonds i.e. borrows money, to cover the difference.
- Congress sets an absolute maximum on the amount the Treasury is permitted to borrow, the Debt Ceiling…
As the national debt has grown, the Debt Ceiling has made the ominous transition from superfluous to inconsistent… public debate has arisen over how to resolve the problem:
- Increase tax revenue or decrease spending on programs. Congress has undertaken both…but all agree that…will not be sufficient. There does not appear to be political will to do more…or action may be economically inadvisable.
- Break one of the laws — either: (a) fail to make some required payments or (b) borrow money in violation of the debt ceiling … defenders of option (b) could rely upon an interpretation of the public debt clause of the 14th Amendment, which was intended to prevent Congress from reneging on Civil War debt. The White House has ruled out using it. Option (b) would more or less maintain the status quo.
Let’s focus on the more plausible path, Option A. U.S. government default on payments owed would force an immediate credit rating downgrade by credit ratings agencies Standard & Poor’s, Moody’s et. al. S&P corporate credit rating transition studies (released quarterly) assign a very low probability to downgrade from AAA- (the current rating for U.S. sovereign debt) to default. My former co-worker at S&P, Erkan Erturk, was in charge of those studies before I started working there, in 1997, and was when I left. He still is, and has not been incorrect. I do not recall whether he published a credit rating transition matrix for sovereign debt though.
t + 10? T-bills ineligible as repo mkt collateral http://t.co/GCcLcreVhI Miss an interest payment? Not-so-technical default
— Ellie K (@EllieAsksWhy)
October 7, 2013
S&P has two default ratings, D and SD. SD is selective default. If the U.S. defaulted on its debt obligations, it would probably be considered a technical default (not a credit ratings agency term). I don’t believe that world financial markets would derive much solace from the distinction. Under option A, if the government fails to make:
* salary payments to federal employees, contractors and suspends certain military veteran services: This is really bad. It is our current status now, on day t + 3
* entitlement payments or unemployment, Social Security; Medicare/ Medicaid and Health & Human Services benefits such as TANF. This is also really bad, and is in progress, though partially
* U.S. Treasury bond payments: As NYC Southpaw said, THIS will be apocalyptic. It would impact the entire financial payments system and all business transactions in the U.S.A. It would be profoundly disruptive to all commercial activity, globally. Such a scenario defines the true meaning of disruptive - there’s nothing good about it.
A U.S. Default Seen as Catastrophe Dwarfing Lehman’s http://t.co/pVuUpn7yXJ via @BloombergNews it is so risky that even DC won’t risk it
— TF Market Advisors (@TFMkts)
October 7, 2013
* active military salary and expenses; Reaction is unknowable. There would be minimal impact, if any, initially. We don’t have a draft. Military service is voluntary: They aren’t conscripts or mercenaries! Even contemplating this scenario is making me uneasy, so I’ll stop now.