ICYMI: Washington Post (Opinion): "What would U.S. default actually look like? 'Financial Armageddon.'"

Yesterday, Washington Post columnist Catherine Rampell laid out the extreme ramifications of House Republicans toying with defaulting on the national debt, including: rising interest rates and a plummeting stock market.

She also highlighted that this would just be the beginning, that "the United States might permanently lose its privileged economic and standing and ability to influence global affairs as we now do."

This is why President Biden's position is exactly right: Congress needs to take action to prevent default, without hostage-taking or political brinksmanship, just as they did three times under the last President.

Read the full piece below:

Washington Post: Opinion: What would U.S. default actually look like? 'Financial Armageddon.
[Catherine Rampell, 5/4/23]

For months you've heard warnings about the Very Bad Things that could happen if Congress fails to raise the debt ceiling. U.S. government default! Market crash! Global financial crisis!

That probably feels abstract, maybe even hyperbolic. Worldwide financial meltdown? Really?

I spent recent days talking to financial market experts and former government officials about the potential fallout. I wanted to better understand the channels through which panic and losses could spread and precipitate "financial Armageddon," as one former Federal Reserve official dubbed it. (Other phrases that came up in interviews: "nightmare scenario," "bankruptcies that rival those in the Great Depression," and "we might have to go back to trading beads.")

To be clear: There are many unknowns. Be skeptical of ultraprecise forecasts that quantify down to a tenth of a percentage point how much, say, unemployment would rise. Consequences will also vary depending on what markets think will happen. A 24-hour default during which a debt-limit deal appears imminent is different from one in which everyone believes lawmakers may have repudiated some debt forever.

One useful lens for thinking through possible consequences was suggested by Richard Berner, a senior Treasury official during the 2011 debt-limit crisis: The global financial system is like an upside-down pyramid, and the tip of that pyramid is the U.S. Treasury market. "Everything else rests upon it," he told me.

With these disclaimers, here's a summary of what market experts relayed. Our scenario assumes the U.S. government fails to pay for not only key services such as Social Security checks and military salaries but also principal or interest on at least some U.S. Treasury securities. (It's unclear whether the government has technical capacity to effectively prioritize payments, anyway, or if ratings agencies would care.) On to the consequences, in seven terrifying steps:

1) Treasurys get downgraded — as does virtually every other asset on earth.

U.S. Treasury debt has long been considered risk-free, with the relative riskiness of other assets benchmarked against it. So the sudden realization that Treasurys are unsafe cascades through other assets, including bonds of U.S. corporations. These bonds would be downgraded, making it more expensive for companies to borrow.

2) Interest rates rise for U.S. consumers, businesses and the government. It becomes more expensive to buy a house or invest in new equipment. Our federal debt problems — the concern supposedly motivating default threats in Congress — also worsen as debt-service costs rise. (Merely flirting with default in 2011 increased government borrowing costs by $1.3 billion that year.)

3) Global investors likely would sell U.S. dollar-denominated assets as confidence in them evaporates; the dollar might lose value in foreign-exchange markets.

4) Stock markets plummet. Investments that are even slightly risky become less attractive to hold amid so much uncertainty.

5) Companies holding Treasurys suffer hits to both revenue and balance sheets.
Companies reliant on interest payments for revenue might now have a cash-flow problem. They'll try to borrow more to cover costs — but banks will want to hoard cash, not give out more loans, during a crisis. So these companies may have trouble paying payroll, rent and other expenses.

This could have knock-on effects for anyone expecting payments from these cash-strapped companies.

6) There might be a scramble to close out trades that people would otherwise hold.
Spurred by post-financial crisis regulations, Treasurys are increasingly used as collateral when people engage in other kinds of transactions — for example, to back borrowing when purchasing bonds or mortgages. If that once-rock-solid collateral suddenly drops in value, more collateral might be demanded right away — or the transaction might have to be "closed out" immediately; i.e., the loan would have to be repaid in full or the full purchase amount for the asset delivered — ASAP.

This is known as a margin call.

Now, imagine hordes of people being told to close out at once because everyone's collateral has lost value. This leads to a huge sell-off across other markets because everyone is racing to get the funds their broker or lender demands in time. ("It would be like a global margin call," Berner said.)

7) If No. 6, happens, and everyone attempts to close out their trades at once, some of the infrastructure underpinning large parts of the financial system (called "central counterparty clearinghouses") could essentially get overwhelmed and go down. Backup plans meant to kick in may not work, as they're not really meant for a systemic shock of this kind.

These clearinghouses are tightly interconnected with each other and other institutions and markets; most people I interviewed said they are the fastest and scariest source of contagion to the rest of the world economy.

That's just the early-stage damage. Longer term, the United States might permanently lose its privileged economic and standing and ability to influence global affairs as we now do.

If you're not afraid yet, you should be.