What happens if the U.S. defaults on its debt?
As Washington teeters closer to a possible government shutdown at midnight Thursday, here’s why the status of the nation’s debt ceiling may ignite more worry in financial markets.
September 30 marks the end of the federal government’s fiscal year, and the deadline for Congress to pass a funding measure. The debt ceiling, which is the amount of money lawmakers authorize the Treasury Department to borrow, must be suspended or raised by mid-October, or the United States likely will default on its debt.
It’s important to note that no one knows precisely when the U.S. Treasury will run out of money to pay its bills, including bondholders, let alone what would happen next. U.S. sovereign debt generally has been considered the safest and most liquid to own in the world, and all kinds of financial markets products and processes have been pegged to the orderly functioning of the near $21 trillion Treasury market.
Still, after a couple of topsy-turvy years in which the previously unthinkable became real, some Washington and Wall Street professionals have been girding for a worst-case scenario.
“I see it as an exceedingly slim chance, although with all the theatrics, the possibility has been ramped up,” said Ben Koltun, director of research for DC-based Beacon Policy Advisors. “If it does happen, it turns a manufactured political crisis into an economic crisis. The full faith and credit of the US would no longer be full.”
The stalemate on Capitol Hill right now is over a $3.5 trillion spending package.
Will the U.S. run out of money?
In a research note published September 22, Barclays analyst Joseph Abate noted there’s additional uncertainty over the debt ceiling now because it coincides with a funding package Congress needs to pass. What’s more, changes brought by the pandemic have made it far more difficult to assess the state of the Treasury Department’s expected payouts and inflows.
Barclays’ best guess for “X date,” or when Treasury will run out of money to pay bills, is October 29, but, Abate wrote, “the confidence interval around the X date is likely to remain fairly wide.” Moody’s Analytics Chief Economist Mark Zandi has pegged the fateful day at October 20, while Beacon’s Koltun thinks markets will start to get antsy in mid-October.
Read: U.S. seen running out of cash between Oct. 15 and Nov. 4, as debt-limit drama continues
The very idea of a U.S. default remains so incongruous that the reaction in financial markets isn’t the only unknown. The current showdown in Washington also has raised big questions about the financial-systems infrastructure. It’s a bit like Y2K — no one knows how the computers will respond.
“We do not believe and the market does not believe it’s a likely scenario,” said Rob Toomey, SIFMA managing director, capital markets and associate general counsel. “But it would be a real problem scenario for the system generally and operations and settlement…