7 doomsday scenarios if the US crashes through the debt ceiling
The Washington Post May 14, 2023
Federal workers furloughed. Social Security checks for seniors on hold. Soaring mortgage rates. A global financial system sent reeling.
Leaders from Congress and the White House are trying to forge an agreement to lift the federal debt ceiling, with only a few weeks before the Treasury Department may no longer be able to avert an unprecedented U.S. default. If they fail, and the government can’t meet its payment obligations, economists and financial experts predict chaos.
“It would be a lethal combination,” said Mark Zandi, chief economist at Moody’s. “You can see how this thing could really metastasize and take down the entire financial system, which would ultimately take out the economy.”
Treasury Secretary Janet L. Yellen has said the agency may only be able to sustain operations until June 1 before running out of money if the government can’t borrow more. That specific deadline — known as the “X-date” — depends on tax revenue and spending, which can fluctuate dramatically from week to week.
What happens next is also hard to predict.
The cascading impacts of default would probably compound — a pause in federal payments would hurt the economy, which would hurt the stock market, which would in turn hurt the economy even more, and so on. The interactions between collapsing home values, rising interest rates and a destabilized global financial system are hard to calculate. Some estimates suggest that more than 8 million jobs could be wiped out. Mortgage rates might soar by more than 20 percent, according to some projections, and the economy would contract by as much as it did during the 2008 Great Recession.
But what economists stress above all else is the unpredictability — particularly if the breach lasts for weeks or months. Experts stress that the worst-case scenarios are unlikely if lawmakers only narrowly miss the deadline, perhaps by hours or even a few days, but that the risks rise dramatically should the standoff persist.
“We do not know: This has never happened,” said Claudia Sahm, a liberal economist who worked at the Federal Reserve. “What makes me so concerned is I can’t sketch out, and I don’t think anyone can, is: What happens at X+1?”
Here are some outcomes that experts worry about most.
1. Stocks crash
Wall Street would probably be the first trouble spot.
So far, financial markets haven’t swung much over the debt ceiling standoff. The price to hedge against a U.S. government default has risen, as has the cost of government bonds due around the debt ceiling deadline — reflecting doubt about repayment. But those tremors are not noticeable for most households.
That is expected to change the closer the government gets to a default. The shock of a missed payment would ripple across the financial system — stocks, bonds, mutual funds, derivatives — before spilling out into the broader economy, experts say.
Stocks would likely plummet on the expectation of a wider economic downturn, as interest rates rise and investors pull funds out of the market to preserve their access to short-term cash. A banking sector already wary of making new loans could tighten up further.
The last time the U.S. government neared default, stocks took a bruising. In 2011, the X-date was less than a week away during a standoff between President Barack Obama and Republicans in Congress. Major indexes fell by roughly 20 percent.
Moody’s Analytics has estimated that stock prices could fall by roughly one-fifth, wiping out $10 trillion in household wealth and devastating the retirement accounts of millions of Americans. The White House has estimated that the decline could be closer to 45 percent.
The $46 trillion bond market would also tremble, as the values of existing Treasury bonds collapse due to higher yields on new ones. And businesses would likely halt expansion — driving stocks down even more.
2. A sudden recession
If the standoff persists, the impact would quickly spread from financial markets to the broader economy.
A drop in household wealth across the country, caused by a sell-off on Wall Street, would reduce consumer spending, which would hurt businesses, too.
And a spike in interest rates would make it harder to get a loan or start a small business. That could also crash the already cooling housing market. A recent report from Zillow projected that a default would drive mortgage rates above 8 percent and push housing sales down by a startling 23 percent. The construction industry and other sectors would feel the pain, too.
The most drastic impact might be a pause in regular federal payments to tens of millions of American families, including seniors on Medicare and Social Security and people relying on food stamps. The federal government is projected to spend roughly $6 trillion this year, which translates into roughly $16 billion per day. Not all of that goes directly to households, of course, but it’s a huge amount of money to vanish from the economy overnight.
A 2013 report by the Treasury Department found the 2011 debt ceiling standoff caused a $2.4 trillion decline in total household wealth. The broader economy, the White House Council of Economic Advisers said, could contract by as much as 6 percent, similar to the 2008 Great Recession.
3. Federal workers in limbo
The U.S. government has a process for shutting down when Congress fails to approve a new budget: Agencies whose spending hasn’t been approved prepare workers for furloughs, instructing certain “essential” staff that they will keep working without pay. There have been three shutdowns that lasted at least a full day over the past decade. Workers are all typically repaid afterward.
But hitting the debt ceiling might look nothing like that, experts say. The White House Office of Management and Budget has not yet disseminated instructions for a debt-related shutdown, which some budget analysts say would be difficult because there is no way of knowing which payments the government won’t be able to make. That could change as the deadline nears, but as of now, there is no playbook for keeping even essential federal employees on the job.
The uncertainty could affect U.S. military personnel as well as food safety inspectors, air traffic controllers and workers in other vital jobs. The federal government is the largest employer in the country, with roughly 4.2 million full-time employees, according to the Congressional Research Service. The National Association of Government Employees, which represents nearly 75,000 federal workers, sued to challenge the constitutionality of the debt limit earlier this month, citing its potential impact on federal workers.
4. Social Security and Medicare miss payments
More than 60 million people receive monthly Social Security payments, mostly seniors. A similar number depend on Medicare for their health insurance.
Some Republicans have claimed that the federal government can continue making these payments even without borrowing by redirecting incoming tax revenue. But budget experts are skeptical the Treasury Department will have the ability to send seniors these benefits on time, particularly if the breach lasts for weeks or months.
If the government can still make some payments with incoming tax revenue, the administration might have to pick between sending checks to seniors and making interest payments on the debt. But forgoing those interest payments to keep Social Security and Medicare functioning could exacerbate what would likely be an already severe financial crisis in that doomsday scenario.
5. U.S. borrowing costs soar
The federal government is able to borrow money relatively cheaply because it’s seen as a very safe credit risk - no one, in normal circumstances, expects that it might miss any payments.
The safety of U.S. government bonds has made them an essential building block in the world financial system. Serving as reserves for everything from foreign nations’ central banks to money market funds, U.S. Treasurys are widely recognized as one of the most secure and liquid investments available, backed by the full faith and credit of the U.S. government. Any financial instrument whose value is based on Treasury bonds could be thrown out of whack after a debt ceiling breach, with a sharp drop in prices leading to volatility and uncertainty worldwide.
Economists say the discount the United States has enjoyed for decades on borrowing could end. One estimate by the Brookings Institution, a D.C.-based think tank, found that breaching the debt limit could increase federal borrowing costs by $750 billion over the next decade.
6. Economic problems spread worldwide
Many nations safeguard their finances by buying large amounts of U.S. government debt, widely regarded as one of the safest assets in the world. But breaching the debt ceiling could drive the value of those bonds down, hurting reserves for many nations.
Economists fear that would dramatically increase the ranks of the countries drowning in debt, like Sri Lanka and Pakistan, with a potential rise in protests and global geopolitical instability. The Federal Reserve’s push to raise interest rates over the past year to curb inflation has already eroded the value of U.S. bond holdings for many nations. And according to the Council on Foreign Relations, more than half of the world’s foreign currency reserves are held in U.S. dollars - roughly three times as much as any other currency.
7. The dollar drops, along with U.S. prestige
A default could hurt U.S. standing on the world stage, experts say, by revealing the depth of the country’s internal political dysfunction.
Already, financial experts have been following some early signs that the world economy is beginning to shed its dependence on the dollar, with countries such as Brazil and Malaysia calling for nations to trade more frequently in other currencies. Roughly 60 percent of foreign currency exchanges still happen in dollars, but a default on U.S. debt — which could send the value of the greenback reeling — could change that.
As Yellen, in Japan on Thursday, said to reporters about a default: “It would also risk undermining U.S. global economic leadership and raise questions about our ability to defend our national security interests.”
Something more fundamental may also be at stake. Governments’ credibility is tied in part to their ability to respond to a crisis. A debt ceiling breach would cast doubt on the federal government’s capacity not only to respond to an emergency, but also to fulfill one of its most elementary functions — paying the bills. If the United States can’t do that, citizens and leaders in other countries might wonder, what else can’t it manage anymore?
“It would erode global confidence in our political system, because part of our standing in the world is based on international confidence that our political system is basically functional,” said Daniel Bergstresser, associate professor of finance at Brandeis University’s International Business School. “And this would show it isn’t.”