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Posted at 10:09 AM ET, 01/ 7/2011

What a debt default would mean

By Ezra Klein

PH2010121007567.jpg

The letter Treasury Secretary Tim Geithner sent to Congress on the debt ceiling is worth reading in full, as it does a nice job describing a danger that I'm not sure most people fully appreciate. My sense is that the mental model most people have of defaulting on the debt ceiling looks something like shutting down the government. But that's not it at all. It's more like shutting down the economy.

Think back to the financial crisis. The underlying cause was that various financial entities stopped believing that their loans would be repaid, and so they stopped making loans, or began demanding such high prices for making loans that credit became unaffordable. The result was economic catastrophe.

If the federal government defaults on its debt, the same thing will happen. But in this case, it will happen to the full faith and credit of the United States, not just to Wall Street.

The basic unit of borrowing in America is the debt that the Treasury sells to finance the government. Much of the rest of the debt in the country -- even when it has no direct connection to the government -- is benchmarked against Treasurys. Treasury debt normally goes for very good prices because it's considered a virtually riskless investment: Modern America has never defaulted on its debt. If that changes, then so too will the prices the market charges to loan the government money.

What happens then? As Geithner explains, "because Treasuries represent the benchmark borrowing rate for all other sectors, default would raise all borrowing costs. Interest rates for state and local government, corporate and consumer borrowing, including home mortgage interest, would all rise sharply. Equity prices and home values would decline, reducing retirement savings and hurting the economic security of all Americans, leading to reductions in spending and investment, which would cause job losses and business failures on a significant scale."

And the damage done by a debt default won't be temporary. Instead, it will permanently introduce a new variable into the market's calculation of America's risk: Right now, the market doesn't believe that our political system would ever allow a debt default. The morning after a default happens, the market will have been proven wrong, and it will have been proven wrong permanently: If it can happen once, it can happen again in 20 years. In that world, the cheap debt that America enjoys and relies on is gone forever, and our economy is likely to be permanently worse off for it.

The good news is that many political players appreciate these dangers. Speaker John Boehner is trying to demand spending cuts as part of a deal, but he's been very careful to say that "America cannot default on its debt." Charles Krauthammer has been similarly declarative. “The Republicans have to be careful here," he told Fox News. "In the end the debt limit will be raised. You can't not pass it. It is catastrophic. It means American debt is in question. It can't happen.”

But these things can take on a life of their own. A revolt among backbench members of Congress killed the first iteration of TARP, which delivered a shock to the market that many economists think intensified the severity of the financial crisis. The immigration bill that George W. Bush sought was also killed by opposition that emerged from the grass-roots and talk radio even as the leaders of the two parties were pushing for a deal.

And you could imagine the same thing happening here: Sen. Jim DeMint, who's often ahead of the curve on where the conservative movement will go next, is fighting an increase in the debt limit, and targeting his message at the GOP's freshmen class. As of yet, we really don't know how much power Boehner has over his members, nor how willing he'll be to fight for things that are necessary for the government but unpopular among his base. So I'm not ready to relax about this yet.

Photo credit: Kevin Lamarque.

By Ezra Klein  | January 7, 2011; 10:09 AM ET
Categories:  Budget  
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Comments

The Administration needs to call the Tea Partiers' bluff here. This falls into the same category as negotiating with terrorists. And does anybody really think the Republicans would negotiate in good faith?

Posted by: tl_houston | January 7, 2011 10:18 AM | Report abuse

So, *NOW* the Democrats are worried about the debt??!

Tha's pretty funny. Spend...spend...spend...don't pass a budget for the first time since 1974...spend...spend...spend.....

"Oh, Look!, we have debt! Who knew?"

Posted by: WrongfulDeath | January 7, 2011 10:25 AM | Report abuse

I certainly hope the administration has a contingency plan in place to issue an executive order to proceed with the necessary borrowing (the country is at war, after all).

Posted by: Jasper999 | January 7, 2011 10:30 AM | Report abuse

Pity Senator Obama wasn't more responsible back in 2006 when he voted against raising the debt ceiling then. Apparently he was channeling his inner Tea Partier.

"Gibbs was asked about Obama’s 2006 vote and statement that “the fact that we’re here today to debate raising America’s debt is a sign of leadership failure.”

The reporter said Obama had said it was wrong to vote to raise the debt ceiling because “Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren.”"

http://thehill.com/blogs/on-the-money/budget/136207-gibbs-defends-obama-2006-vote-against-raising-debt-ceiling

" The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the U.S. Government can’t pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance our Government’s reckless fiscal policies.

Over the past 5 years, our federal debt has increased by $3.5 trillion to $8.6 trillion.That is “trillion” with a “T.” That is money that we have borrowed from the Social Security trust fund, borrowed from China and Japan, borrowed from American taxpayers. And over the next 5 years, between now and 2011, the President’s budget will increase the debt by almost another $3.5 trillion.

Numbers that large are sometimes hard to understand. Some people may wonder why they matter. Here is why: This year, the Federal Government will spend $220 billion on interest. That is more money to pay interest on our national debt than we’ll spend on Medicaid and the State Children’s Health Insurance Program. That is more money to pay interest on our debt this year than we will spend on education, homeland security, transportation, and veterans benefits combined. It is more money in one year than we are likely to spend to rebuild the devastated gulf coast in a way that honors the best of America.

And the cost of our debt is one of the fastest growing expenses in the Federal budget. This rising debt is a hidden domestic enemy, robbing our cities and States of critical investments in infrastructure like bridges, ports, and levees; robbing our families and our children of critical investments in education and health care reform; robbing our seniors of the retirement and health security they have counted on.

Every dollar we pay in interest is a dollar that is not going to investment in America’s priorities.

Senator Barack Obama
Senate Floor Speech on Public Debt
March 16, 2006"

More fundamentally though you are correct about how this should have gone down: The Democrats should have cut this deal as part of the extension of the Bush Tax Cuts during the lame duck.

P.S. Any chance of getting a new interview with Rep Paul Ryan now that he's Budget Chairman? Your other ones were very informative.

Posted by: jnc4p | January 7, 2011 10:33 AM | Report abuse

--*If the federal government defaults on its debt, the same thing will happen. But in this case, it will happen to the full faith and credit of the United States*--

The politicians and all their collectivist helpers and useful idiots have been loading that camel for decades, now.

Don't say you weren't warned.

Posted by: msoja | January 7, 2011 10:39 AM | Report abuse

WrongfulDeath, does it hurt to be that intentionally ignorant, or have you dulled your senses enough that you don't feel it?

Was there not a deficit commission created by executive order because Republicans killed it in the Senate? Was one of the central goals, whether you agree with whether they achieved it or not, of the healthcare reform effort to make it deficit neutral? Did we not have 8 years or crazed Republican spending with Democrats decrying the effects on the budget?

You can think the Democrats don't do enough on the deficit, but acting like they're oblivious to it is just plain stupid. And, of course, Republican and Democratic Congresses have increased the debt ceiling because every reasonable person recognizes that it is insane not to do so.

Posted by: MosBen | January 7, 2011 10:41 AM | Report abuse

wrongful wrote:

"Oh, Look!, we have debt! Who knew?"

You obviously haven't been paying attention for the last ten years. It's not a question of whether there is federal debt. A national debt has existed since the revolutionary war. Add to that the debt levels of the other levels of governtment, state and local and it's a sizable chunk.

The question is what to do about it. No Republican seems to be advocating cuts in the military budget. Nobody in his right mind would suggest the US should default.

The answer is to try to bring current expenditure under control and to take measures to increase production. The US is unfortunately a "service economy", up to 80%. A new resteraunt or jewelry boutique or yet another yacht harbor in Florida will not improve the situation.

CB in Hamburg

Posted by: chrisbrown12 | January 7, 2011 10:44 AM | Report abuse

If the predicted chaos includes us getting out of Iraq and Afghanistan then I am hoping the GOP blocks raising the debt ceiling.

Unfortunately, this is a replay of the tax deal. Obama will submit to GOP demands and they will then raise the debt ceiling.

In essence, we will be forced to fund the wars and the war machine and everything else will be screwed.

Posted by: lauren2010 | January 7, 2011 10:47 AM | Report abuse

Ok that's what happens if we don't pay back our debt. But doesn't failing to increase the debt ceiling just mean we aren't going to borrow any more than 14.x trillion?

Posted by: MrDo64 | January 7, 2011 10:50 AM | Report abuse

Would blocking this mean we would also have to close our military bases around the world?

And stop funding Israel and other countries?

Would the fed be weakened?

If so, then I vote to block raising the debt ceiling.

Posted by: lauren2010 | January 7, 2011 11:01 AM | Report abuse

"Instead, it will permanently introduce a new variable into the market's calculation of America's risk"

About time.

Posted by: lauren2010 | January 7, 2011 11:05 AM | Report abuse


http://www.freep.com/article/20110104/NEWS05/101040378/0/news05

Detroit Public Schools will spend $49 million in federal money to push technology in the district, including distributing 40,000 new laptop computers to students in grades 6-12 for use in class, as well as more than 5,000 new desktop computers.


In 2006 USA Today reported on a study funded by the Bill & Melinda Gates Foundation. It said that several of the nation's largest school districts had less than a 50% graduation rate. Detroit Schools, the 11th largest district in the country, was dead last with an appalling 21.7%.

What a great use of stimulus money! Fuel the dropout factory.


Oh right, Detroit voted for Obama.

Posted by: krazen1211 | January 7, 2011 11:07 AM | Report abuse

Mr Doc asked:

"doesn't failing to increase the debt ceiling just mean we aren't going to borrow any more than 14.x trillion?"

No it means much more than that. For a start it would mean that the US government would default on its obligations. This would bring in its train the collapse of the dollar. The dollar's collapse would mean that oil & petrol would be more expensive than gold.

The Republicans are basically playing chicken on the edge of a steep cliff. CB

Posted by: chrisbrown12 | January 7, 2011 11:13 AM | Report abuse

This insightful take on the debt ceiling debate by a former Wall Street insider and author of the corportae thriller, MERGER is worth checking out. It is called SHAKEDOWN: http://www.sanghoee.com/blog

Posted by: gpl2105 | January 7, 2011 11:13 AM | Report abuse

The administration line should be "Every reasonable person recognizes that failing to raise the debt ceiling would be catastrophic to our economy and I call on Speaker Boehner to assume the responsibilities of governing by taking the possibility that the United States would default on its debt off the table."

Posted by: MichaelB4 | January 7, 2011 11:19 AM | Report abuse

Amen Michael, but you could leave out the quotation marks, as they are confusing. CB

Posted by: chrisbrown12 | January 7, 2011 11:24 AM | Report abuse

Dammit Ezra, stop rewriting my posts without credit. LOL

As I have pointed out before, any default would be the excuse needed to downgrade the US credit rating, so any small amount of deficit reduction would be immediately overwhelmed by the government's increased cost to borrow money.

Posted by: 54465446 | January 7, 2011 11:33 AM | Report abuse

krazen:

Have you ever seen "Escape From New York"?

Ok just substitute Detroit for New York, and move the funding to the Bureau of Prisons ledger.

Posted by: 54465446 | January 7, 2011 11:37 AM | Report abuse

lauren wrote:

"Unfortunately, this is a replay of the tax deal. Obama will submit to GOP demands and they will then raise the debt ceiling."

Actually no, not all. Obama has the whip hand on this one, he just needs to have enough nerve to use it. Any governmnet shut down would inevitably be seen as the fault of the GOP controlled House, where it would occur. Once the SS checks stop coming, even the old Tea Party people are going to forget about which side they are on.

Posted by: 54465446 | January 7, 2011 11:41 AM | Report abuse

@Chris Brown.

Why is not borrowing more 'defaulting on our obligations'? It seems to me more like cutting up the credit card, rather than stop paying the mortgage.

Sure it might be a terrible idea in the middle of a recession, but it seems Ezra is mixing things up (or more likely I am but I don't see why?)

Posted by: MrDo64 | January 7, 2011 11:55 AM | Report abuse

jnc4p wrote: "Pity Senator Obama wasn't more responsible back in 2006 when he voted against raising the debt ceiling then."

Why, one might think something had changed since 2006. Something like the biggest financial crisis since the Great Depression. Or one could stick one's head up one's posterior, like jnc4p, and ignore the real world.

Posted by: steveh46 | January 7, 2011 12:11 PM | Report abuse

MrDo64, I'm not an expert on this stuff, but I'm pretty sure it's not just cutting up the credit card. It's more like cutting up the card and telling AmEx, "Sorry, I don't have any money to pay off the remaining balance and interest payments." Even if we don't borrow any new money, our debt grows.

steveh56, President Obama's vote had little consequence because there was never any doubt that it would pass. Still, it was a mistake, and concerns about getting the debt under control (which are legitimate) should never lead one to threaten the economic disaster that would happen if we didn't raise the debt ceiling. Then-Senator Obama made a mistake in voting against the raising the debt ceiling.

Posted by: MosBen | January 7, 2011 12:20 PM | Report abuse

Also, we should keep in mind that this is not what people generally think of when they think of a government shutdown. The government shutdown people remember from the 90s involved Congress' inability to pass a budget that the President would sign. With no budget, there was no money to pay federal workers, so everything shut down other than essential personnel. This is saying that we won't borrow any more money than we've borrowed already, which not just leaves the government without funding to continue normal operation, it very likely leaves the government without the necessary funds to pay its debt payments.

Posted by: MosBen | January 7, 2011 12:24 PM | Report abuse

Its gratifying to hear that those on the Left agree with those of us on/in the Right - finally - that out of control spending, deficits and debt are serious problems that must be addressed.

However, the fact that their concerns arise only after Republicans have retaken the House, and after nearly $4 trillion in additional federal profligacy by Obama and the Democrats for assorted bailouts and political payoffs, all under the guise of "economic stimulus", makes their pleas for fiscal responsibility more laughable then laudable. Those who couldn't trouble themselves to pass a budget, as required by the Constitution (Sorry, Ezra!), and their sanctimonious supporters, have no business chiding others about the horrors of irresponsibility.

Posted by: Bat1 | January 7, 2011 12:30 PM | Report abuse

Here are a few questions pertaining to the origin of the debt ceiling that I hope you might answer:

1) Why do we have a debt ceiling? Is it mandated by Treasury? Who determines at what level it is at? Is this a negotiated level, or set statistically?

2) It's extremely hard to prove a counterfactual, of course, but if we had no debt ceiling would we spend as much? That is, is there any evidence, since it has been pretty routinely increased everytime we have neared it, that it poses a constraint on government spending? If not, then why have it?

Thanks!

Posted by: konokwee | January 7, 2011 12:37 PM | Report abuse

@MosBen

We could still pay the debt interest from tax revenues. We only default if we fail to increase the debt ceiling AND then don't stop spending. Maybe that's a reasonable assumption of the govt would actually do, but it isn't automatic. As other have pointed out we could pull out of Afghanistan/Iraq/Germany, close down the ag dept etc

Posted by: MrDo64 | January 7, 2011 12:43 PM | Report abuse

555

Nope. You are wrong.

The same could have been said of the tax deal.

I could have said this before the tax deal was signed: "Obama has the whip hand on this one, he just needs to have enough nerve to use it. Any new tax burdens would inevitably be seen as the fault of the GOP Senate filibuster, where it would occur. Once the tax raises start happening, even the old Tea Party people are going to forget about which side they are on."

Posted by: lauren2010 | January 7, 2011 12:49 PM | Report abuse

Ezra Klein is not a trained economist. He merely repeats what others tell him. He is a useful idiot. Enough said. Oh by the way, if one looks around the world, one can point to all sorts of nations that have defaulted and the world still exists. Finally, there are ways around dealing with debt other than increasing the debt ceiling. Sadly, the powers that be do not want acknowledge that they exist. Sad.

Posted by: jeffreed | January 7, 2011 1:05 PM | Report abuse

Yeah, it's not clear to me why not raising the debt ceiling is synonymous with defaulting on debt. Really, we'd just have to operate deficit neutral from that moment on. Lock up the Pentagon, disband the armed forces, send an email to Afghanistan telling the forces "Thank you for your service, you are now off duty. Feel free to hitch a ride home at your leisure." Lot of social programs no longer being funded.

But the SS, Medicare, and interest payments could keep coming, the IRS would keep auditing people, and perhaps certain matching funds to states would continue (perhaps taper; not clear to what extent ending state matching could be counted as 'defaulting').

Posted by: eggnogfool | January 7, 2011 1:22 PM | Report abuse

jeffreed:

You simply don't know what you're talking about. Sorry to be so blunt, but take this time to do some reasearch.

Posted by: 54465446 | January 7, 2011 1:50 PM | Report abuse

lauren:

We simply disagree. Here's my reason. The tax cuts were inevitably known as the Bush tax cuts. Any resulting increase could hardly have been passed off on the GOP while the D's controlled everything in sight.

This is different since the Senate isn't even really involved. If the raise doesn't happen, it can be pinned primarily on the GOP.

Posted by: 54465446 | January 7, 2011 1:54 PM | Report abuse

Bat1, I don't know what rock you've been living under, but Dems have been talking about the deficit for decades. That they talk about it differently than you do, or that they have different ideas on how to approach it does not mean that they haven't been talking about it and trying to address it in the way they think is best. If you're just now hearing them talk about the deficit, then you just haven't been paying attention.

There's no contradiction between the Dems passing stimulus (or thinking that we need some more stimulus!) and thinking that the long term debt is a problem. These are short term and long term issues. We're not going to hit any debt-related crises in the next couple years, assuming the debt ceiling is raised. Our problems are long term growth, specifically in healthcare spending.

The raising of the debt ceiling is a bipartisan issue, and always has. Increasing long term debt has at various points also been a bipartisan issue, but in the last 20 years the Democratic Party, as a whole has been much more serious about deficit reduction than the Republican Party, as a whole. (Or maybe rather than the parties I should limit it to the elected members of those parties at the national level)

Posted by: MosBen | January 7, 2011 2:43 PM | Report abuse

"Was one of the central goals, whether you agree with whether they achieved it or not, of the healthcare reform effort to make it deficit neutral?" ---MosBen

Shorter MosBen:
"Republicans made us pass a piece of crap that ran up the debt by a trillion on just this one piece of legislation. We had no control!!"

Posted by: WrongfulDeath | January 7, 2011 6:12 PM | Report abuse

lauren2010 wrote:

"Would blocking this mean we would also have to close our military bases around the world? And stop funding Israel and other countries? Would the fed be weakened? If so, then I vote to block raising the debt ceiling."

That's a little like saying, "Would I get rid of my leaky faucets? And that ugly bedroom wallpaper? And those annoying phone calls? Then let the bank foreclose on the house!"

Posted by: imsa0041 | January 8, 2011 1:38 AM | Report abuse

If you are in a home and want to refinance, 2 things are absolutely key. First, you must have meaningful equity in your home. Second, you must have a good credit score. But in this economy if you do not have both of them still you could get a good rate, Search online for "123 Mortgage Refinance" they gave me the lowest rate of 3.45% my credit history is not so good.

Posted by: pamelakuo08 | January 8, 2011 4:31 AM | Report abuse

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