Published October 16, 2013
Contrary to the alarm that some politicians, traders and experts are sounding about the dire consequences if the country’s $16.7 trillion debt-ceiling isn’t raised by Oct. 17, missing the deadline will not bring an automatic default.
The fall out of not increasing the borrowing cap might not be pretty depending on Wall Street’s reaction, but experts say a default or credit rating downgrade might not have immediate consequences.
Here’s what we know will happen on Oct. 17: The amount of money Treasury has on hand drops to $30 billion from $88 billion it had at the start of the month. But here’s where it gets tricky, it’s impossible for Treasury to know its exact cash flow so it’s hard to pinpoint an exact date of a default.
"If we have insufficient cash on hand, it would be impossible for the United States of America to meet all of its obligations for the first time in our history," Treasury Secretary Jack Lew wrote in a letter to Congress on Oct.1.
It’s hard for Treasury to know precisely when it might default on any payment since its cash flows are so volatile. The department will continue to receive tax and other revenue streams past the estimated deadline, making it hard to know when it won’t have enough money to meet payments.
“Because of the inflow of tax receipts, Treasury can’t have an exact handle on its daily balance sheet,” says Charlie Smith, chief investment officer at wealth management firm Fort Pitt Capital Group. While there could be some wiggle room for exactly when Treasury would run out of money, Smith points to two “drop dead dates.” On Oct. 23, a $12 billion tab for Social Security benefits is due, and on Oct. 30, a $6 billion interest payment comes up.
The definition of default varies depending on who you ask. Some say non-payment of interest or principal of a government bond – T-bills would constitute a default, while the White House has a more expansive definition that includes any non-payment of any government bill that is legally obligated.
The Bipartisan Policy Center estimates a default could take place between Oct. 22 and Nov. 1, though this could be extended by "a couple days" if the government shutdown continues.
Wall Street has mostly shrugged off the partial government shutdown, which entered its 16th day on Wednesday, but it had been paying a little more attention to the debt-ceiling showdown as the deadline neared. On Monday, the Dow Jones Industrial Average fell 135 points as the S&P 500 dropped 12.1 points and the Nasdaq slumped 21.3 points. Wall Street reversed course on Tuesday as deal talks progressed U.S. equities rallied with the Dow closing up 200 points.
But we’ve been here before. In August 2011, an 11th-hour Congressional vote to raise the debt ceiling still led to a downgrade of the country’s credit rating, which caused the markets to sell off, sending the Standard & Poor's index down almost 20%.
On Tuesday, Fitch Ratings puts U.S. ‘AAA’ credit rating on ‘rating watch negative.’
If the government runs out of money, Treasury might be forced to prioritize payments—choosing between making payments to programs like Social Security or pay interest payments owed to our foreign debt holders.
Many experts are calling a default “a worst-case-scenario,” one that would immediately be felt in short-term money markets.
“If you leverage 20,30, 50 to 1 in investment portfolio and you might not get paid on one of your trades and you get a margin call, you have a problem,” says Smith.
The cost of insurance on the U.S. government is rising and a default could dramatically increase the cost, which could turn off foreign debt holders. “I think it’s probably a rational response, while the cost on a rates on 30-day Treasury note is still quite low, it’s up dramatically from where it used to be,” says Brad McMillan, CIO Common Wealth Financial Network. “U.S. debt is still risk free, but the definition of risk free is different than used to be.”
Anthony Hsieh, chairman and CEO of LoanDepot, says a default could send interest rates soaring 1%, which could hurt the steadily-recovering housing market. “Mortgage rates are tied in a very direct way to 10-year Treasury and a default would send those rates higher.”