Q&A: What happens if US breaks borrowing limit?


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WASHINGTON (AP) - Negotiations in Congress to raise the nation's borrowing limit are up against a deadline of Thursday. If the limit isn't raised by then, the government will no longer have authority to borrow to pay its bills.

So what happens if Thursday comes and goes and the limit isn't raised?

The scary thing is, no one really knows. Going past the deadline would be unprecedented.

The possible consequences are complex. But none are good. The gravest threat is that the government would soon fail to make interest payments on its debt. Any missed payment would trigger a default.

Financial markets would sink. Social Security checks would be delayed. Eventually, the economy would almost surely slip into another financial crisis and recession.

Even if the government managed to make its interest payments, fears about a default could cause investors to dump Treasurys and send U.S. borrowing rates soaring.

Here are questions and answers about the government's borrowing limit:

Utah leaders cautiously optimistic debt ceiling question will be resolved
by McKenzie Romero and Richard Piatt

SALT LAKE CITY — The U.S. is drawing closer each day to hitting its head on the debt ceiling, but Utah's congressional delegation is cautiously optimistic that a solution will emerge before the Thursday deadline.

Party leaders in the Senate are in negotiations, but so far no clear plan has emerged, Sen. Mike Lee, R-Utah, said Monday.

"There are a thousand rumors circulating, and it's really difficult to know at this point which of them might be true," he said.

Lee said he doesn't believe the country will end up in default, a situation he said is prohibited by the Constitution.

However, if no solution is reached, Lee said he will support legislation instructing President Barack Obama to direct revenue as it comes in toward paying off the nation's debts as they come due.

Natalie Gochnour, an associate dean in the David Eccles School of Business at the University of Utah, called a default "unimaginable" and said the effects would be felt worldwide.

"The security of our debt and our instruments of debt are vital to countries all around the world. They look to us for stability," Gochnour said. "When our debt instruments are close to default, then all chaos breaks loose."

If the debt ceiling is breached, the U.S. would be left with roughly $30 billion to pay its bills. The full impact would be felt before Nov. 1, when $67 billion is due for Social Security payments, medicare providers and military personal for salaries and benefits.

Here in the U.S., Gochnour worries interest rates would rise because of a higher perceived risk from lenders and investors. Auto, home and business loans would be more expensive. It could be harder to get credit, and a second recession could be on the horizon, she said.

Rep. Jim Matheson, D-Utah, said it's difficult to imagine just how bad a default could be for the nation's economy and how far the ripple would reach. He said he hopes a "reasonable group of bipartisan members of Congress" will come together this week to avoid a default.

Matheson said rumors are circulating in Washington, D.C., about both the approaching debt ceiling and possible solutions to the ongoing government shutdown.

"I hope people can come to their senses and we can resolve both these issues," he said. "I think we're going down that path this week, from what the reports are now. There's been a lot of brinksmanship, as is common in politics, but at the end of the day, I'm hopeful people will come together in a constructive way."

Rep. Jason Chaffetz, R-Utah, said he hopes the impending deadline will spur lawmakers into action, calling for the White House and Senate to talk to the House.

"Everybody recognizes that going past (the Thursday deadline) is not good for the economy," Chaffetz said. "There's no reason we should be flirting with danger. Let's solve this now and get on with it."

Email: mromero@ksl.com
Email: rpiatt@ksl.com

#utah_leaders

Q. What exactly is it?

A. The borrowing limit is a cap on how much debt the government can accumulate to pay its bills. The government borrows in most years because its spending has long exceeded its revenue. The first borrowing limit was enacted in 1917. Since 1962, Congress has raised the borrowing limit 77 times. It now stands at $16.7 trillion.

Q. When will we reach the limit?

A. The national debt actually reached the limit in May. Since then, Treasury Secretary Jacob Lew has made accounting moves to continue financing the government without further borrowing. But Lew says those measures will be exhausted by Thursday. The government will then have to pay its bills from its cash on hand _ an estimated $30 billion _ and tax revenue.

Q. So what happens after Thursday?

A. The government could pay its bills for a few days. But sometime between Oct. 22 and Oct. 31, the cash on hand and tax revenue wouldn't be sufficient, according to the Congressional Budget Office. The date isn't exact because it's impossible to foresee precisely how much revenue the government will receive and when.

Q. When it runs out of cash, does the government default?

A. No, not right away. A default would occur if the government fails to make a principal or interest payment on any of its Treasurys. The first interest payment after Thursday's deadline is a $6 billion payment due Oct. 31.

Many experts think that to avoid a default, Treasury would make payments on the debt its top priority.

"We believe the government would continue to pay interest and principal on its debt even in the event that the debt limit is not raised, leaving its creditworthiness intact," says Moody's Investors Service, a credit rating agency.

But that is the subject of intense dispute in Washington. The House has approved a bill to require such "prioritization." The Senate hasn't passed it, though. And President Barack Obama has threatened to veto it.

Without an increase in the borrowing limit, the government couldn't pay other obligations on time, such as Social Security benefits, bills from government contractors and Medicare reimbursements. Those payments are also legal obligations, Lew argues, and failure to pay them would essentially be equivalent to a default.

In any case, making some payments and not others is harder than it might sound. Treasury makes roughly 100 million payments a month. Nearly all are automated. Lew says the Treasury's computer systems aren't equipped to choose some and not others among all those outgoing checks.

And without cash in reserve, any minor glitch could cause Treasury to miss a debt payment _ and default.

"Treasury would do everything in their power to not miss a debt payment," says Donald Marron, an economist at the Urban Institute and a former economic adviser to President George W. Bush. "But when you're in untested waters under a great deal of stress, bad things happen."

Q. What other problems might be raised by prioritization?

A. Consider the legal and political obstacles. The government is legally obligated to pay its contractors. If not, the contractors could sue for non-payment. And how long would members of Congress stand by as Treasury holders in China and other nations were paid interest, while payments to U.S. veterans and Social Security recipients were delayed?

Q. How would investors react if the government made its interest payments but fell behind on other obligations?

A. Badly, most economists say. If the government couldn't pay veterans' benefits, federal employee salaries or other bills, investors would almost certainly demand higher interest rates at future Treasury auctions. That would drive up the cost to taxpayers of servicing the government's debt.

A failure to pay any obligation "would severely damage perceptions of our creditworthiness," says David Kelly, chief global strategist at JPMorgan Funds.

Each week, the government issues new short-term debt and uses the proceeds to pay off maturing debt. This step doesn't increase total debt. So it would still be allowed even if the borrowing limit wasn't raised. But it's possible that not enough investors would want to buy the new debt. That would leave the government short of cash to pay off its maturing debt. The result: a default.

Q. What else could Treasury do?

A. It could make its interest payments first _ then delay all other payments until it collects enough tax revenue to make a full day's payments. That would avoid choosing among competing obligations. Treasury officials favored this approach during the last borrowing-limit fight in 2011, according the Treasury Department's inspector general.

But that approach would eventually cause extensive delays. On Nov. 1, nearly $60 billion in Social Security benefits, Medicare payments and military paychecks are due. With no increase in the borrowing limit, those payments could be delayed for up to two weeks.

Q. Could the president just ignore the limit?

A. Some experts say he could. The 14th Amendment to the Constitution says, "The validity of the public debt of the United States, authorized by law ... shall not be questioned." But the White House has said its own lawyers don't think he has the authority to do so. Nor is it clear that many investors would buy bonds issued without congressional approval.

Q. Are global investors panicking yet?

A. No, not yet. The stock market surged on Thursday and Friday as Congress appeared to move closer to an agreement to raise the debt ceiling and perhaps end the partial shutdown of the government. But if prospects for an agreement were to dim early next week, stocks could sink. Investors would likely also dump Treasurys.

Interest rates on some short-term Treasurys have risen sharply in the past week. That shows that the deadline might be rattling some investors. The Bipartisan Policy Center estimates that the 2011 fight over the debt limit inflated federal borrowing costs by $1.3 billion, or about 0.5 percent, that year. Over 10 years, the estimated cost comes to nearly $19 billion.

Q. What would the economic impact of all this be?

A. Many foresee a nightmare. No longer able to borrow, the government could spend only from its tax revenue. This would force an immediate spending cut of 32 percent, the Bipartisan Policy Center estimates.

If the limit remained through November, Goldman Sachs estimates that spending would plummet by up to $175 billion. That's equivalent to about 1 percent of the economy.

On top of that, stock markets would likely fall. Household wealth would shrink. Consumer confidence could plunge. Americans would cut back on spending. Higher rates on government debt would raise other borrowing costs, including mortgage rates.

Q. Why is it potentially catastrophic for the government to miss a payment on its debt and default?

A. The repercussions would be felt worldwide. Banks in the United States and overseas use Treasurys as collateral when they borrow from each other. If Treasurys were no longer seen as risk-free, it would disrupt borrowing and jolt credit markets. A financial crisis like the one in 2008 could follow.

Banks also hold much of their capital reserves in Treasurys. If they fell in value after a default, banks would have to cut back on lending.

(Copyright 2013 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.)

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