Defaulting on Debt Would Have Extreme Consequences, UT Professor Says

By Rose Cahalan in Blog on July 13, 2011 at 5:29 pm | No Comments

Talk of the debt ceiling has been consuming Washington lately, and it seems prospects for a grand deal to either raise the debt ceiling or dramatically cut spending are getting progressively dimmer. The latest sign of panic comes from Moody’s, who warns the U.S. government’s AAA credit rating could be in jeopardy if the stalemate continues.

We asked Lewis Spellman, a McCombs finance professor who also blogs on debt issues, how dire the situation is and what would happen if no deal gets done.

So what exactly is the debt ceiling?
It’s the limit on how much money the government can borrow: $14.3 trillion.  We hit the debt ceiling for the first time in history back in May, but the government found a stop-gap measure. Now we’re poised to hit it again.

When will we exceed the limit?
Soon–probably in 10 to 12 days.

What happens then?
There a few things that can happen. The government can default on its debt or it can default on its entitlements, or stop funding some branches of government, or some of each.

If we default on debt, the consequences are extreme. It would be nothing short of a financial collapse that would take down the banks and the economy. The unemployment rate would go up as well. Simply put, the government would not be able to pay its bills. Once a default happens, any future borrowing would be at much higher rates of interest. Instead of paying 3 percent interest on borrowed money, we’d be paying closer to 10 to 15 percent.

If we default on entitlements—Medicare, Medicaid, Social Security—then a lot of people are going to be upset about that. But if the government were to pay out all the entitlements it has promised to the Baby Boomer generation, it would cause a 400 percent increase in debt over the next few decades. It’s just not tenable.

What do you think will happen now?
I think the consequences of defaulting are so extreme that Congress will patch together a compromise to muddle through for now. But a default is really a question of when, not if. We may not default this year, but it’s going to happen eventually, unless there are dramatic cuts in spending.

What about the international picture?
The U.S. dollar may be in trouble, but the Euro is even closer to collapse than we are. I think that Greece’s collapse might end up saving us, actually—because it will force American politicians to realize how dire the situation really is.

Illustration by Jamie Appel

Tags: barack obama, debt ceiling, dollar, euro, john bohner