13 Ways a Debt-Ceiling Breach Would Destroy the Economy

Poisonous partisan politics will affect all Americans if the nation loses its AAA credit rating

Until recently, the idea of a U.S. downgrade was inconceivable. But with each day that passes without Congress striking a debt ceiling deal, this possibility becomes more real. While Washington's poisonous politics doesn't always affect most Americans, a U.S. default would have catastrophic effects from Wall Street to Main Street. Either directly or indirectly, many corners of the U.S. economy rely on the nation's creditworthiness. In what ways might a U.S. downgrade affect you?

The most obvious consequence of a downgrade is the harm it would inflict on U.S. Treasury securities. Some investors will worry about the will of the nation to live up to its obligations. Other investors, however, might be forced to sell their Treasuries if their portfolio criteria require AAA-rated securities. As a flood of Treasuries hit the market, they will begin to lose value.

When the U.S. begins to issue more bonds, it will also face higher debt costs. Demand for Treasuries will weaken and investors will want to be paid more for the greater political risk the securities will be perceived to pose. Even if the U.S. manages to quickly get its act together and raise the debt ceiling after a short period of default, the damage will already be done. The market will punish the U.S. for some time, as the consequences of the nation's political risk will linger in investors' minds.

But the decline of Treasuries is just the beginning. The nation's credit also provides support for other markets. One market now explicitly guaranteed by the U.S. is that for agency mortgage-backed securities, issued by Fannie Mae and Freddie Mac. Trillions of dollars of this debt is in the market and all could be subject to downgrade if the U.S.'s sovereign debt rating drops below AAA.

The market for municipal debt would also be affected indirectly by a U.S. downgrade. Some states and localities are able to achieve AAA ratings on their debt due to the implicit support of the U.S. government. The rating agencies assume that the federal government would not allow a state to go bankrupt. If the nation loses some credibility through a downgrade, so will some states and localities.

The financial industry will be gravely affected by a U.S. downgrade, well beyond its mere holdings of U.S. Treasuries. Remember those "too big to fail" banks that were bailed out in 2008? Many of them are still assumed to be implicitly guaranteed by the U.S. government. Their ratings benefit accordingly. Moody's said last week that some of these big banks would be downgraded if the U.S. loses it's AAA-rating.

In the broader financial industry, other firms might be affected as well. The rating agencies have also said some large insurance companies enjoy AAA ratings due in part to implicit government support and could be downgraded. Clearing houses, responsible for ensuring that the derivatives market runs smoothly, could also suffer a downgrade.

These all might sound like vague, intangible problems to most Americans, but they aren't. They will have real effects on Main Street businesses, retirement portfolios, and the U.S. economy broadly. If Congress doesn't raise the debt ceiling this week all of these consequences become clear dangers that the nation will face. Click through the gallery above to see 13 ways in which a U.S. downgrade will affect all Americans.

Image Credit: REUTERS/Kevin Lamarque