You might have noticed the negotiations between President Barack Obama and House Republicans to raise the federal debt ceiling have not been going so well. Despite a very public awkward side-hug between Speaker John Boehner and Majority Leader Eric Cantor--the latter wants the former's job--and talking-points discipline from both sides Thursday that the latest talks were "cordial," the possibility that Congress will blow the deadline is real. Rank-and-file Republicans don't like Senate Majority Leader Mitch McConnell's Plan B, which would require a two-thirds majority to disapprove of Obama's request to raise the debt limit. And the White House is insisting on some ways to raise revenue by closing loopholes or raising taxes on the rich and corporations, which Tea Party-backed lawmakers hate. So what happens if Washington can't get it done by August 2? Bad things.
From Aug. 3-31, the government would have to reduce spending by $134 billion. That is to say, it would pull $134 billion out of the economy in just 29 days--more than 10 percent of monthly GDP.The economic effects at a time of 9 percent unemployment would be catastrophic, even if the bond market did not demand higher interest rates on Treasury debt--which it very likely would.
Let's say Obama paid Social Security, unemployment, and veteran's benefits, met the military payroll, and kept the courts and the FBI running. Those programs alone would take up about $70 billion, leaving only $73 billion to run the rest of government.With those remaining funds, Washington would have to make some exceedingly unpleasant choices: It could pay doctors, hospitals, nursing homes, and home health agencies what it owed for Medicare and Medicaid services, but that would cost $50 billion and leave just $23 billion to pay all other bills--everybody from defense contractors to senior day care center operators to disaster relief.
In that case, the United States would lose its triple-A rating. That, in turn, could unhinge the global economic system, said influential bond investor Mohamed El-Erian...The U.S. triple-A rating holds together many parts of the global system El-Erian told CNNMoney's Poppy Harlow. "We simply do not know how the global system will operate without the triple A. We'll see a lot of realignments that can be very costly. We'll be in the land of the unpredictable."
If foreigners began curtailing their investment in Treasuries as a result of a default, Treasury rates, and thus Treasury's borrowing costs, would undoubtedly rise. A sustained 50 basis point increase in Treasury rates would eventually cost U.S. taxpayers an additional $75 billion each year.
Third, the financial crisis ... could trigger a run on money market funds, as was the case in September 2008 after the Lehman failure. In the event of a Treasury default, I think it is likely that at least one fund would be forced to halt redemptions or conceivably "break the buck." Since money fund investors are primarily focused on overnight liquidity, even a single fund halting redemptions would likely cause a broader run on money funds. Such a run would spark a severe crisis, disrupting markets and ultimately necessitating the same kind of backstops that Treasury and the Federal Reserve initiated in the aftermath of the 2008 crisis.
A literal interpretation would be that Mr. Obama loses the White House, either to a Republican or (less likely) to an independent candidate. But the Republican Party loses its majority in the House. Maybe quite a few Democratic incumbents in Congress also lose.More broadly, it would mean that any victories achieved in 2012 would be superficial and Pyrrhic. The public would not trust either side to carry out its agenda. The next several election cycles would be extremely volatile. Prospects for independent candidates for president and for third parties, whether emerging from the center of American politics or from the wings, would improve significantly. And within the major parties, power would tend to transfer away from those who hold it.