What Default Might Look Like: A History Lesson

Reuters has an interesting analysis of what a US default might look like based on bank statements from the Treasury Department over the same period last year.

OCT. 17

The Treasury Department exhausts all available tools to stay under the cap on borrowing and can no longer add to the national debt. Treasury expects it would still have about $30 billion cash on hand to cover its bills. Among the many inflows and outflows that day, it takes in $6.75 billion in taxes but pays out $10.9 billion in Social Security retirement checks. By the end of the day, its cushion has eroded to $27.5 billion.

OCT. 18 – OCT. 29

Treasury’s cash reserve quickly dwindles. Washington only takes in about 70 cents for every dollar it spends and is now unable to issue new debt to cover the difference.

The tide turns briefly on October 22, when the government takes in $3.5 billion more than it spends.

But that temporary gain is soon erased. October 24 is an especially rough day: Treasury pays $1.8 billion to defense contractors, $2.2 billion to doctors and hospitals that treat elderly patients through the Medicare program, and $11.1 billion in Social Security, while taking in only $9.6 billion in taxes and other income.

One possible wild card: Treasury could lose the trust of the bond market.

Even though the government cannot add to the national debt at this point, it can legally roll over expiring debt. Investors have the opportunity to cash out about $100 billion worth of U.S. debt every week but choose to reinvest it. If fear of default causes investors to steer clear of new debt offerings, Treasury’s finances could unravel almost overnight.

“It’s very hard to predict,” said Brian Collins, an analyst at the Bipartisan Policy Center, which helped Reuters with this analysis. “It’s the same thing that causes (bank) runs or credit markets to freeze.”

OCT. 30

Default happens. By the end of the day, the government is $7 billion short of what it needs to pay all of its bills.

So who gets stiffed?

Everybody, according to the Obama administration.

Treasury says it doesn’t have the ability to pick and choose who gets paid. The last time the government faced this situation in 2011, they planned to wait until public coffers were full enough to pay a full day’s bills before cutting any checks, according to a Treasury Department watchdog report from 2012.

It only gets worse, according to the Reuters analysis. On October 31, a $6 billion interest payment to bondholders comes due:

A missed payment could shake that foundation. The United States currently pays some of the lowest interest rates in the world due to a strong history of repayment; those borrowing costs would almost certainly rise. Stock markets could tumble and nervous consumers could spend less of their money, further damaging the economy.

For the Treasury Department, this is where the truly tough decisions begin. Does the government pay bondholders in China or troops in Afghanistan? The Obama administration says it doesn’t have the ability to prioritize payments, but analysts are convinced it would at least try.

“Not making an interest payment on time is probably a worse way to default than not making other payments,” Collins said.

After that, tough choices:

In theory, the government could keep bondholders whole indefinitely because tax revenues are more than enough to cover interest payments, and Treasury pays creditors through a separate system than other obligations.

That would mean longer delays for everybody else. U.S. troops could fall behind on their rent payments, and seniors who rely on Social Security may have trouble buying groceries.

It’s hard to see how this scenario — or anything close to it — will come to pass. The signs will be unmistakable and unless total madness grips the capitol, it probably won’t get this bad.

But even if the scenario is partially correct, the economy will take a significant hit — perhaps enough to push us into a deeper recession. Will Congress roll the dice? If they do, snake eyes seems a definite possibility.