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Investors, executives and economists are preparing contingency plans as they consider the turmoil that would result from a default in the $24 trillion U.S. Treasury market.
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By Joe Rennison
The U.S. debt limit has been reached and the Treasury Department is finding ways to save cash. After it runs out of maneuvers, what once seemed unfathomable could become reality: The United States defaults.
What happens next?
The far-reaching effects are hard to fully predict: from shock waves in financial markets to bankruptcies, recession and potentially irreversible damage to the nation’s long-held role at the center of the global economy.
The probability of a default remains low, at least based on opposing lawmakers’ assurances that a deal will be done to raise or suspend the debt limit and the long odds implied by trading in certain financial markets. But as the day approaches when the United States begins to run out of cash to pay its bills — which could be as soon as June 5 — investors, executives and economists around the world are gaming out what might happen immediately before, during and after, hatching contingency plans and puzzling over largely untested rules and procedures.
“We are sailing into uncharted waters,” said Andy Sparks, head of portfolio management research at MSCI, which creates indexes that track a wide range of financial assets, including in the Treasury market.
On the cusp of default, a ‘horror scenario’ comes into view.
Some corners of the financial markets have already begun to shudder, but those ripples pale in comparison to the tidal wave that builds as a default approaches. The $24 trillion U.S. Treasury market is the primary source of financing for the government as well as the largest debt market in the world.
The Treasury market is the backbone of the financial system, integral to everything from mortgage rates to the dollar, the most widely used currency in the world. At times, Treasury debt is even treated as the equivalent of cash because of the surety of the government’s creditworthiness.
Shattering confidence in such a deeply embedded market would have effects that are hard to quantify. Most agree, however, that a default would be “catastrophic,” said Calvin Norris, a portfolio manager and interest rate strategist at Aegon Asset Management. “That would be a horror scenario.”
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A missed payment sets off a trading frenzy as markets begin to unravel.
The government pays its debts via banks that are members of a federal payments system called Fedwire. These payments then flow through the market’s plumbing, eventually ending up in the accounts of debt holders, including individual savers, pension funds, insurance companies and central banks.
If the Treasury Department wants to change the date it repays investors, it would need to notify Fedwire the day before a payment is due, so investors would know the government was about to default the night before it happened.
There is more than $1 trillion of Treasury debt maturing between May 31 and the end of June that could be refinanced to avoid default, according to analysts at TD Securities. There are also $13.6 billion in interest payments due, spread out over 11 dates; that means 11 different opportunities for the government to miss a payment over the course of next month.
Fedwire, the payment system, closes at 4:30 p.m. If a payment due is not made by this time, at the very latest, the markets would begin to unravel.
Stocks, corporate debt and the value of the dollar would probably plummet. Volatility could be extreme, not just in the United States but across the world. In 2011, around when lawmakers struck a last-minute deal to avoid breaching the debt limit, the S&P 500 fell 17 percent in just over two weeks. The reaction after a default could be more severe.
Perhaps counterintuitively, some Treasury bonds would be in high demand. Investors would likely dump any debt with a payment coming due soon — for example, some money market funds have already shifted their holdings away from Treasuries that mature in June — and buy other Treasury securities with payments due further in the future, still seeing them as a haven in a period of stress.
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A cascade of ratings downgrades creates ‘craziness’ for bondholders.
Joydeep Mukherji, the primary credit rating analyst for the United States at S&P Global Ratings, said that a missed payment would result in the government being considered in “selective default,” by which it has chosen to renege on some payments but is expected to keep paying other debts. Fitch Ratings has also said it would slash the government’s rating in a similar way. Such ratings are usually assigned to imperiled companies and government borrowers.
Moody’s, the other major rating agency, has said that if the Treasury misses one interest payment, its credit rating would be lowered by a notch, to just below its current top rating. A second missed interest payment would result in another downgrade.
A slew of government-linked issuers would also likely suffer downgrades, Moody’s noted, from the agencies that underpin the mortgage market to hospitals, government contractors, railroads, power utilities and defense companies reliant on government funds. It would also include foreign governments with guarantees on their own debt from the United States, such as Israel.
Some fund managers are particularly sensitive to ratings downgrades, and may be forced to sell their Treasury holdings to meet rules on the minimum ratings of the debt they are allowed to hold, depressing their prices.
“I would fear, besides the first-order craziness, there’s second-order craziness too: Like, if you get two of the three of the major rating agencies downgrade something, then you have a bunch of financial institutions that can’t hold those securities,” Austan Goolsbee, president of the Federal Reserve Bank of Chicago, said at an event in Florida on Tuesday night.
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The financial system’s plumbing freezes up, making trading more costly and difficult.
Importantly, a default on one government bill, note or bond does not trigger a default across all of the government’s debt, known as “cross default,” according to the Securities Industry and Financial Markets Association, an industry group. This means that a majority of the government’s debt would remain current.
That should limit the effect on markets that rely on Treasury debt for collateral, such as trillions of dollars worth of derivatives contracts and short-term loans called repurchase agreements.
Still, any collateral affected by a default would need to be replaced. CME Group, a large derivatives clearing house, has said that while it has no plans to do so, it could prohibit short-dated Treasuries from being used as collateral, or apply discounts to the value of some assets used to secure transactions.
There is a risk that the financial system’s pipes simply freeze over, as investors rush to reposition their portfolios while big banks that facilitate trading step back from the market, making buying and selling just about any asset more difficult.
Amid this tumult in the days after a default, a few investors could be in for a major windfall. After a three-day grace period, some $12 billion of credit default swaps, a type of protection against a bond default, may be triggered. The decision on payouts is made by an industry committee that includes big banks and fund managers.
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The nation’s global financial reputation is permanently diminished.
As panic subsides, confidence in the nation’s fundamental role in the global economy may be permanently altered.
Foreign investors and governments hold $7.6 trillion, or 31 percent, of all Treasury debt, making them vital to the favorable financing conditions that the U.S. government has long enjoyed.
But after a default, the perceived risk of holding Treasury debt could rise, making it more costly for the government to borrow for the foreseeable future. The dollar’s central role in world trade may also be undermined.
Higher government borrowing costs would also make it more expensive for companies to issue bonds and take out loans, as well as raise interest rates for consumers taking out mortgages or using credit cards.
Economically, according to forecasts by the White House even a brief default would result in half a million lost jobs and a somewhat shallow recession. A protracted default would push those numbers to a devastating eight million lost jobs and a severe recession, with the economy shrinking by more than 6 percent.
These potential costs — unknowable in total but widely thought to be enormous — are what many believe will motivate lawmakers to reach a deal on the debt limit. “Every leader in the room understands the consequences if we fail to pay our bills,” President Biden said in a speech on Wednesday, as negotiations between Democrats and Republicans intensified. “The nation has never defaulted on its debt, and it never will,” he added.
Joe Rennison covers financial markets and trading, a beat that ranges from chronicling the vagaries of the stock market to explaining the often-inscrutable trading decisions of Wall Street insiders. @JARennison
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FAQs
What Would Happen if the U.S. Defaulted on Its Debt? ›
The government may wind up defaulting on its debt if it cannot make required payments to its bondholders. Such an outcome would be economically devastating and could plunge the world into a financial crisis.
What happens if the United States defaults on its debt? ›If the United States defaults on its debt, it would undermine faith in the federal government's ability to pay all its bills on time, affecting the government's credit rating and unleashing massive turbulence in financial markets.
Will the stock market crash if the US defaults on its debt? ›A U.S. debt default would lead to a slump in stock and bond markets, while eroding the U.S.' financial standing in the world, analysts say.
Who does the US owe debt to? ›The public holds over $24.53 trillion of the national debt, as of January 2023.1 Foreign governments hold a large portion of the public debt, while the rest is owned by U.S. banks and investors, the Federal Reserve, state and local governments, mutual funds, pensions funds, insurance companies, and holders of savings ...
What happens if the US does not raise the debt? ›If the debt ceiling binds, and the U.S. Treasury does not have the ability to pay its obligations, the negative economic effects would quickly mount and risk triggering a deep recession. The economic effects of such an unprecedented event would surely be negative.
Has the US ever been debt free? ›As a result, the U.S. actually did become debt free, for the first and only time, at the beginning of 1835 and stayed that way until 1837. It remains the only time that a major country was without debt. Jackson and his followers believed that freedom from debt was the linchpin in establishing a free republic.
Does the US ever pay off its debt? ›In modern history, the U.S. has never defaulted on its debt. The debt ceiling is the self-imposed limit on how much debt Congress allows the federal government to have. If Congress does not raise or suspend the debt ceiling, the U.S. could default on its debt, which would also impact financial markets and the economy.
What happens if US hits debt ceiling? ›Potential repercussions of reaching the ceiling include a downgrade by credit rating agencies, increased borrowing costs for businesses and homeowners alike, and a dropoff in consumer confidence that could shock the United States' financial market and tip its economy—and the world's—into immediate recession.
What is the deadline for the debt ceiling? ›Lifting the debt ceiling.
The deal reached by President Biden and Speaker Kevin McCarthy would suspend the nation's debt limit until January 2025.
At the end of FY 2023 federal debt is “guesstimated” to amount to $32.69 trillion. Thus far, on 2023-05-25, the federal debt is $31.47 trillion. See Coronavirus Update page. Click for federal debt from 1960 to present.
What country owns the most US debt? ›
According to usafacts.org, as of January 2023, Japan owned $1.1 trillion in US Treasuries, making it the largest foreign holder of the national debt. The second-largest holder is China, which owned $859 billion of US debt.
Who owes the US the most money? ›Over the past 20 years, Japan and China have owned more US Treasuries than any other foreign nation. Between 2000 and 2022, Japan grew from owning $534 billion to just over $1 trillion, while China's ownership grew from $101 billion to $855 billion.
Which country has highest debt? ›- Sri Lanka. ...
- Portugal. Debt to GDP Ratio: 114% ...
- Cuba. Debt to GDP Ratio: 117% ...
- Bahrain. Debt to GDP Ratio: 120% ...
- Zambia. Debt to GDP Ratio: 123% ...
- Suriname. Debt to GDP Ratio: 124% ...
- Bhutan. Debt to GDP Ratio: 125% ...
- United States. Debt to GDP Ratio: 129%
It might appear impossible, but many consumers succeed in living their entire lives without any debt. People of a variety of ages and income levels have made this choice. It's not an easy feat, but if it's something you truly want, don't let naysayers talk you out of it.
Why can't the US make money to pay off debt? ›The Fed tries to influence the supply of money in the economy to promote noninflationary growth. Unless there is an increase in economic activity commensurate with the amount of money that is created, printing money to pay off the debt would make inflation worse.
Which country has no debt? ›| Characteristic | National debt in relation to GDP |
|---|---|
| Macao SAR | 0% |
| Brunei Darussalam | 2.06% |
| Kuwait | 2.92% |
| Hong Kong SAR | 4.26% |
Fewer than one quarter of American households live debt-free. Learning ways to tackle debt can help you get a handle on your finances.
Is China in debt to the US? ›China and Japan are the largest foreign investors in American government debt. Together they own $2 trillion — more than a quarter — of the $7.6 trillion in US Treasury securities held by foreign countries.
How much money does the US owe to itself? ›Nearly all of that debt – about $31.38 trillion – is subject to the statutory debt limit, leaving just $25 million in unused borrowing capacity. For several years, the nation's debt has been bigger than its gross domestic product, which was $26.13 trillion in the fourth quarter of 2022.
How can we fix US debt? ›- Avert a debt ceiling crisis and build consensus with a bipartisan commission on fiscal reform/debt reduction. ...
- Make fiscal restraint a priority. ...
- Reform Medicare/health care policy. ...
- Save Social Security. ...
- Remove budget gimmicks and pay for new initiatives. ...
- Reform tax policy.
How does the US owe so much money? ›
The federal government runs a budget deficit whenever its spending exceeds tax collections and other revenue. To make up the difference, the U.S. Treasury sells treasury bills, notes, and bonds. The national debt is the aggregate of the federal government's annual budget deficits, minus the rare surpluses.
Why does the US keep raising the debt ceiling? ›The Treasury Department must find other ways to pay expenses when the debt ceiling is reached; otherwise, there is a risk that the U.S. will default on its debt. The debt ceiling has been raised or suspended several times to avoid the risk of default.
Is the US the only country with a debt ceiling? ›The U.S. isn't the only country with a debt ceiling. So how does Denmark avoid the drama? The White House and U.S. House Speaker Kevin McCarthy have struck a tentative deal to raise the nation's borrowing limit, likely avoiding a catastrophic default just days before the deadline.
What is the current debt limit? ›Debt ceiling suspended until 2025
Every so often, US Congress must vote to raise or suspend the ceiling, so it can borrow more to pay its bills. Currently it is $31.4tn (£25tn).
When the government spends more than it earns, it has a budget deficit and must issue debt in the form of Treasury securities. The U.S. has run a deficit for the last 20 years, substantially increasing the national debt. In fact, according to the Department of the Treasury, the current debt is $31.4 trillion.
How much do we owe China? ›| Rank | Country | U.S. Treasury Holdings |
|---|---|---|
| 1 | 🇯🇵 Japan | $1,076B |
| 2 | 🇨🇳 China | $867B |
| 3 | 🇬🇧 United Kingdom | $655B |
| 4 | 🇧🇪 Belgium | $354B |
Total US federal government debt breached $30 trillion mark for the first time in history in February 2022. As of February 2023, total federal debt was $31.5 trillion; $24.6 trillion held by the public and $6.9 trillion in intragovernmental debt.
When did the US have the most debt? ›The United States public debt as a percentage of GDP reached its highest level during Harry Truman's first presidential term, during and after World War II. Public debt as a percentage of GDP fell rapidly in the post-World War II period, and reached a low in 1973 under President Richard Nixon.
How Much Is America worth? ›United States - Federal Government; Net Worth (IMA), Level was -20997153.00000 Mil. of $ in July of 2022, according to the United States Federal Reserve.
Is China in a debt crisis? ›China's debt is nearly 44% of its GDP and its local governments owe nearly $5.14 trillion. With the economic slowdown and collapse of land sales revenue, provinces and local governments in China are facing an embarrassing situation.
Do countries still owe the US money from ww2? ›
The case of debts arising from World War II is somewhat less complicated. At this time only four countries, discussed below, owe the U.S. government debts of any size arising from World War II programs to aid our allies. Other countries have paid their debts in full.
Does China have more debt than the US? ›The United States, holding the highest national debt globally, has a total of $31.68 trillion, representing a YoY increase of $1.3 trillion or 4.28%, reaching $30.38 trillion. Therefore, China's national debt has surged almost three times that of the United States in the past 12 months.
Does Britain still owe America money? ›The debt was to be paid off in 50 annual repayments commencing in 1950. Some of these loans were only paid off in the early 21st century. On 31 December 2006, Britain made a final payment of about $83m (£45.5m) and thereby discharged the last of its war loans from the US.
Why does China buy U.S. debt? ›Key Takeaways. China invests heavily in U.S. Treasury bonds to keep its export prices lower. China focuses on export-led growth to help generate jobs. To keep its export prices low, China must keep its currency—the renminbi (RMB)—low compared to the U.S. dollar.
What happens if a country refuses to pay its debt? ›Today, a government that defaults may be widely excluded from further credit; some of its overseas assets may be seized; and it may face political pressure from its own domestic bondholders to pay back its debt. Therefore, governments rarely default on the entire value of their debt.
What country has the lowest debt? ›On the other end of the spectrum, Brunei has the lowest debt to GDP ratio at 1.90%, followed by the Cayman Islands at 4.50%, Kuwait at 7.10%, and Afghanistan at 7.40%. There are regional trends when it comes to debt to GDP ratios.
Does China have debt? ›China's debt overhang far exceeds the burdens facing the United States. As recently as 2020, total debt in the United States relative to GDP exceeded China's. But as of mid-2022, China's relative debt burden stood 40 percent higher than America's.
At what age should you be debt free? ›The Standard Route. The Standard Route is what credit companies and lenders recommend. If this is the graduate's choice, he or she will be debt free around the age of 58.
Are you debt free if you have a mortgage? ›Being debt-free means you don't owe any outstanding debt. However, carrying no debt other than your mortgage payment or a credit card you pay in full each month could make sense.
What percent of Americans are in debt? ›Even though household net worth is on the rise in America (at $141 trillion in the summer of 2021)—so is debt. The total personal debt in the U.S. is at an all-time high of $14.96 trillion. The average American debt (per U.S. adult) is $58,604 and 77% of American households have at least some type of debt.
What would happen if the stock market completely collapsed? ›
Stock market crashes wipe out equity-investment values and are most harmful to those who rely on investment returns for retirement. Although the collapse of equity prices can occur over a day or a year, crashes are often followed by a recession or depression.
Does debt affect market value? ›Debt is often cheaper than equity, and interest payments are tax-deductible. So, as the level of debt increases, returns to equity owners also increase — enhancing the company's value. If risk weren't a factor, then the more debt a business has, the greater its value would be.