$100 Billion: The Cost to Taxpayers of a U.S. Debt Downgrade

By Daniel Indiviglio

Prolonged deficit deal bickering will make deficit cutting even harder

600 obama boehner annoyed REUTERS Yuri Gripas.jpg

We can finally put a price tag on Washington's partisan politics. If it fails to compromise on a plan to raise the debt ceiling and cut the deficit to satisfy the rating agencies, it could cost taxpayers $100 billion. This is an estimate of how much the nation's borrowing costs will rise if its debt is downgraded. Let's consider the significance of this sum.

Where the $100 Billion Estimate Comes From

First, where did this estimate come from? It was calculated by Terry Belton, JPMorgan Chase's global head of fixed income strategy. He revealed the projection on a conference call organized by Securities Industry and Financial Markets Association on Tuesday. So this isn't political activist talking: it's Wall Street's assessment.

Belton's figure isn't the total cost of downgrade. It doesn't include the money lost by investors as Treasury prices decline. It doesn't take into account any of the other potential economic fallout either. The $100 billion is just the additional interest that taxpayers must cover in the future due to a U.S. downgrade, since Belton estimates that Treasury yields will consequently rise 60 to 70 basis points. The damage to U.S. creditworthiness would be permanent, even after the U.S. gets its AAA rating back.

And bear in mind, this downgrade cost assumes that the U.S. doesn't default. If the debate rages on for too long and the Treasury misses an interest payment, then the cost to taxpayers would be much greater.

Deficit Reduction Gone Bad

Here's the troubling paradox: Republicans and Democrats are both on board with the idea of deficit reduction. But their failure to actually put a sufficient long-term plan into place in a timely fashion while raising the debt ceiling will make their task even more difficult. A downgrade would add another $100 billion to the deficit.

And as mentioned, this is only the direct cost to taxpayers. If a downgrade cramps the already weak recovery, then incomes will rise slower than they would have, making tax revenues lower and deficits harder to close. If hiring slows, then more emergency unemployment benefits will have to be paid for longer, resulting in additional expense for the government. Again this would add more to the deficit.

One key strategy for curbing the size of deficits is actually forming a tangible plan to fix the problem. Partisan politics mean higher deficits.

Some Context

Of course, this wouldn't be the first time taxpayers have had to pay for the government's mistakes. Thanks to its ill-advised housing finance policy strategy, it was forced to bail out Fannie Mae and Freddie Mac, to which taxpayers have provided over $150 billion so far.

But that was a result of decades of bad policy and the biggest housing bubble in the nation's history. In the case of downgrade, Congress would have managed cost taxpayers $100 billion in a few months time merely through its inability to come to an effective agreement. At least in the case of Fannie and Freddie, some in the government really believed that they were promoting home ownership. A downgrade would reflect a pure failure to compromise.

Taxpayers should be absolutely outraged if the U.S. is downgraded.

Image Credit: REUTERS/Yuri Gripas

This article available online at:

http://www.theatlantic.com/business/archive/2011/07/-100-billion-the-cost-to-taxpayers-of-a-us-debt-downgrade/242638/