Will the U.S. Really Default in May if the Debt Ceiling Isn't Raised?

By Daniel Indiviglio

Of course not -- but how long can Washington afford to bicker?

590 capitol ceiling REUTERS Hyungwon Kang.jpg

Mark May 16th on your calendar. That's the day the U.S. government will hit its self-imposed debt ceiling if Congress doesn't act to raise the limit. For those keeping score at home, that's 24 days from today. Is this really a strict deadline? If the Treasury has some leeway, how much time does it have to play around with?

The Treasury Says

Earlier this month, Treasury Secretary Timothy Geithner wrote a letter to Congress, pleading that the chambers pass a bill raising the debt ceiling. In it, he explains the situation, providing the May 16th deadline. While he certainly wants a new debt limit passed by then, he also lays out a contingency plan. He says that he could take certain measures that would give him an extra eight weeks -- until July 8th.

Geithner provides a detailed explanation of the "extraordinary measures" that would be taken if a new debt ceiling isn't agreed upon by May 16th. (Sadly, neither Harrison Ford nor Brendan Fraser is mentioned.) All of the actions he could take essentially consist of internally deferring some Treasury security issuance to government entities. For example, the Civil Service Retirement and Disability Fund invests in some special-issue Treasury securities, which he could postpone. Although such measures couldn't last forever, they would give the government a little time to play with before having to take more drastic measures.

So mark July 8th on your calendar too, because according to the Treasury, that's when things would really get messy. Geithner writes:

If Congress failed to increase the debt limit, a broad range of government payments would have to be stopped, limited or delayed, including military salaries and retirement benefits, Social Security and Medicare payments, interest on the debt, unemployment benefits and tax refunds.

Of course, the U.S. would not default on its debt, so some essential programs would have to be cut or suspended, says Geithner.

Other Options?

Is the situation really as urgent as Geithner claims? "Not exactly," says Jason J. Fichtner, senior research fellow at George Mason University's Mercatus Center. The Treasury could -- and almost certainly would -- resort to less desirable, but non-catastrophic, measures to prevent default, if necessary.

Fichtner explains that there are other ways the Treasury could delay hitting the debt ceiling. The government only has to worry about paying the interest on its bonds to avoid default, which amounts to around $200 billion per year. Since the U.S. government brings in about $2.2 trillion per year, Fichtner thinks paying that interest would be quite easy.

Of course, Geithner worries about those other obligations that still require more funding, which he mentions in the block quote above. What about Social Security, Medicare, and Medicaid, for example? According to Fichtner's calculations, if you paid all three of those entitlement programs for the entire year, plus interest payments, the government would still have $400 billion left over to allocate across the rest of its budget.

To be sure, $400 billion is a lot of money. That's not the kind of cash you find lying around in the cushions of your couch. But then, you aren't Uncle Sam. As it turns out he has a very valuable sofa.

The government has some dust-collecting assets it could liquidate. It has a significant gold reserve and foreign currency holdings. The government's cash and other monetary assets add up to around $429 billion, according to the Treasury. It also has ownership stakes in a number of firms left over from the 2008 bailout. It holds some securities it acquired in connection with the financial crisis as well. All together, this would provide plenty of money to keep the government running all the way through the end of the fiscal year, September 30th, says Fichtner. So go ahead and mark your calendar one more time.

The Treasury Secretary actually mentions the potential liquidation of theses assets in his letter but quickly pushes aside the possibility. Geithner does not want to take this route for two reasons. First, he worries about the market's perception if the U.S. liquidates assets in order to make debt payments. Second, he believes taxpayers will be better served if some of these assets, like its ownership stakes in some firms, are held until the firms referenced are in a stronger position, instead of being sold at fire sale value.


So would the nation be in crisis mode after May 16th if a higher debt ceiling is not imposed? Certainly not. What about after July 8th? At that time, the situation will be more urgent, but the Treasury still has options to prolong default. If a deal isn't reached by the end of September, however, then it's time to worry. Even at that time, it's pretty unlikely that the U.S. would default, but programs would be cut and payments would be deferred, which could cause widespread anger, fear, and panic.


Image Credit: REUTERS/Hyungwon Kang

This article available online at:

http://www.theatlantic.com/business/archive/2011/04/will-the-us-really-default-in-may-if-the-debt-ceiling-isnt-raised/237719/