Debt-ceiling crisis: The U.S. won't "default" after Aug. 2. Something much weirder will happen.

Commentary about business and finance.
July 27 2011 5:10 PM

It's Not "Default"

The U.S. will not default after Aug. 2. Something much weirder and more chaotic will happen.

US President Barack Obama. Click image to expand.
President Barack Obama

Here's the good news: The United States is not going to default. "But wait!" you might say. Look at all those news reports saying we're going to default after Aug. 2! Hasn't Slate been warning about the dire consequences if Congress does not authorize Treasury to borrow more money for months now as well?

Yes, something awful and weird will happen in early August, but it isn't going to be default. The Treasury will need to issue more bonds to make promised payments to the country's creditors, senior citizens, federal employees, and so on. Without that extra cash, the federal government will need to miss 40 to 45 percent of its payments, according to calculations by the Bipartisan Policy Center. But that is not default. Default is too tidy a term for it. The chaos that might hit after Aug. 2 has no precedent, and therefore no name.

Still, let's try to be specific. On Aug. 2 or soon after, Treasury will "exhaust its borrowing authority." That does not mean that we "hit the debt ceiling." We hit the ceiling back in May, and since then the country has not been able to issue new debt, only to roll over maturing bonds. "Exhaust its borrowing authority" means that Treasury will no longer be able to fudge the country's finances enough to keep all payments going out on time.

The country could default, meaning it would stop paying interest or principal to its bondholders. But the likelihood of that happening is nil. Doing so could trigger panic in the financial markets and force higher borrowing costs throughout the global economy. "Default with a downgrade is a game changer," warns Tim Ryan, the head of the Securities Industry and Financial Markets Association, "with dire consequences for money funds, capital markets and banking systems broadly. It will be a systemic event in its own right." The Treasury Department will not admit outright that bondholders will get prioritized over, say, Social Security recipients. But they will.

That means it will be soldiers, doctors, federal employees, and government contractors who will see their payments delayed. There is no real term of art for this scenario, at least not yet. But the wonks have taken to calling it "selective default," "payments prioritization," or "delinquency."

It will be something like a government shutdown. But during a shutdown, mandatory spending payments—such as Social Security checks and Medicare reimbursements—keep going out. That will not necessarily happen in the event of "selective default," or "delinquency," or "debtpocalypse," or what have you. And though shutdowns always come with a degree of uncertainty, they are hardly unprecedented in Washington. The White House and Treasury have a tested playbook for a shutdown. They do not have one for the debtpocalypse.

"Payments prioritization" is probably the best term, if a dry one, since it conveys the real sticky heart of the matter. Treasury is going to need to decide who gets paid and who doesn't—making temple-rubbing, flinty-faced, increasingly bedraggled Timothy Geithner the most economically powerful person in the country until Congress resolves this.

The choices would be difficult. In August, the United States could use its cash receipts to make its interest payments ($29 billion) and pay Social Security benefits ($49.2 billion), Medicare and Medicaid ($50 billion), defense contractors ($31.7 billion), and unemployment insurance ($12.8 billion)—all considered of vital importance.

But that would leave about half of the bills unpaid. Federal employees, from the zookeepers to the prosecutors to the prison guards, would have to make do without their salaries. There would be no transfers for food stamps, housing programs, the IRS, the EPA, or the troops either. The Bipartisan Policy Center notes that "the reality would be chaotic." The results would be unfair. Treasury would be picking "winners and losers."

During that time, the country would also suffer from any number of knock-on effects. The major ratings agencies would downgrade U.S. sovereign debt, possibly raising the country's borrowing costs permanently. (Politico reports that's what the White House is really worried about.) Some money-market and mutual funds would not be able to hold Treasuries without an AAA rating, meaning the specter of plummeting bond values and a credit crunch. Even if the bond market stayed relatively calm, investors might dump U.S. stocks and other investments, hoarding cash instead. Nobody really knows what would happen.

So we might not have a great term for what we have inaccurately termed the big "default" after Aug. 2. But we know its risk: a recession. And we know how we got here: idiots.

Annie Lowrey is a contributing editor for New York magazine. She can be reached at annie.lowrey@gmail.com.

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