Debt limit: Raise it or risk financial crisis, Treasury warns Congress

If a debt limit impasse in Congress led to a default, a Treasury report said, it could be 'catastrophic' for job creation and consumer spending. Negative effects 'could last for more than a generation.'

The Treasury Department drew a red-line regarding its capacity to meet America’s financial obligations, warning that Congress must raise the nation’s public debt limit or risk sending the economy into a severe tailspin.

The message of alarm came in a report Thursday, with only about two weeks to go before the Treasury runs up against the current borrowing cap of $16.7 trillion set by Congress.

Economists widely agree that a failure to raise the limit promptly, leaving the government unable to meet all its obligations, would have sharp negative consequences, pushing interest rates up and consumer confidence down.

The Treasury presented the scenario in particularly pessimistic terms.

If an impasse in Congress led to a government default, the report said, the effect could be “catastrophic” for job creation and consumer spending in the near term, and result in effects on interest rates and the economy that “could last for more than a generation.”

“You might get a financial crisis as bad as we saw in 2008 ... possibly worse,” a senior Treasury official told reporters on a conference call outlining the report’s conclusions. Even if the nation doesn’t default on any obligations, he added, brinkmanship that takes the nation near its fiscal edge would carry “the possibility of harming the economy.”

On the call, Treasury officials reiterated the Obama administration’s resistance to the idea that, if Congress fails to raise the cap on borrowing, the Treasury could at least avoid a technical default on its bonds by prioritizing payments of interest and principal ahead of other obligations.

They argue that all Treasury obligations, from salaries and Social Security checks to the interest on Treasury debt, are serious ones in the eye of the public as well as the government itself.

“If you start missing payments, it's default by another name,” said one of the officials, who did not wish to be quoted by name.

Currently, Washington is engulfed by the fiscal impasse over Congress’s failure to pass a measure funding the government into a new fiscal year. That has resulted in a partial shutdown of federal operations. The debt-limit deadline is a separate issue – but one that is also in play as a result of partisan wrangling over policy on taxes and spending – and over Republican opposition to Obama’s health-care reform law.

The report described the current expansion of the US economy as “weaker than expected,” and laid out the stakes of the debt-limit issue.

If lawmakers merely argue up to the deadline, and then cut a deal that avoids default, that still would have economic implications.

“Protracted debate about the debt ceiling could spark renewed financial market stress, and a fall in stock prices and wider credit [anxiety] would depress spending from the private sector,” the report says. It cited evidence from the debt-ceiling showdown in 2011, when those kinds of effects were visible.

In the late summer of 2011, credit-market stress meant that a typical home buyer who took out a loan at that time had to pay an extra $100 per month in interest costs, the report said. The reason was partly the debt-ceiling debate, and partly the ripple effects of financial turmoil in Europe at the time.

So far, financial market signals in recent days don’t reflect panic about the possibility of default. That’s because investors generally think Congress will find an 11th-hour way to raise the debt cap.

But already, the report says, “yields on Treasury bills that mature at the end of October are higher” than the yield on bills that mature earlier, which “might suggest nascent concerns about possible delays in payments on those bills.”

The officials refused to comment on how the Treasury would operate if the debt limit isn’t raised. They repeated the Obama administration’s view that there aren’t any tricks that can be pulled out of the bag – such as minting a “magic coin” of large value or arguing that the Congress-imposed debt ceiling is unconstitutional under the 14th Amendment.

The only option, they argue, is for Congress to act promptly.

President Obama has framed the issue as an obligation for lawmakers to pay the bills on spending they’ve already approved. At the same time, opinion polls find many Americans wary of raising the debt cap without combining it with reforms designed to tame the government’s borrowing habits.