Doug Elmendorf is the Director of the Congressional Budget Office. Today’s entry in the Director’s Blog is sobering:
Even a slight increase in the perceived risk of U.S. government securities would probably raise interest payments by a lot for years to come. If Treasury rates were pushed up by just one-tenth of a percentage point, the government would pay $130 billion more in interest over the next decade . . . If, instead, Treasury rates rose by four-tenths of a percentage point, the government would pay more than half-a-trillion dollars in additional interest over the next decade.
. . . public statements by many financial-market participants and experts have made clear that default by the federal government on obligations to debt holders would be a significant shock to the global financial system and economy. That shock could trigger large swings in stock prices, private interest rates, and the value of the dollar relative to other currencies; it might also generate massive disruptions and damage to the payments system and the flow of credit; and it would probably weaken the economy and reduce output and employment relative to what they would otherwise be. Indeed, the lack of a plan for increasing the debt ceiling may already be hurting household and business confidence, and default would reduce confidence further and increase uncertainty about future government policies, which would lower spending even apart from the effects of changes in asset prices and interest rates.
It is also unclear what would happen if the federal government were to default on obligations other than Treasury debt . . . debt holders might be unconcerned because the payments due to them would not be directly affected; however, debt holders might conclude instead that if the government is willing to default on some obligations, it could default on its obligation to them next. In any event, the individuals, businesses, and state governments that are owed money under current law and are counting on receiving it would clearly need to deal with sudden and unexpected shortfalls in their own finances.
The budget is on an unsustainable path. Debt held by the public is already higher relative to GDP than it has been in more than half-a-century, and CBO projects that it will exceed its all-time high in about a dozen years under current policies.
[...] Following the intensive public discussions of the past few months, a failure to agree on credible, specific policy changes would increase doubts about the ability of the government to manage its budget. That could, in turn, raise the perceived risk of U.S. government securities, which would lead to higher Treasury interest rates, higher government interest costs, and the possibility of dislocations in financial markets.
Moreover, and with a larger immediate impact on most Americans, the economy remains mired in a severe slump. Three-and-a-half years after the recession started, roughly 10 million fewer Americans have jobs than if employment had continued to expand at its pre-recession pace. Total output of the economy this year will be about $700 billion less than would occur with high use of our labor and capital resources. In addition, 44 percent of the workers who were unemployed in the first half of this year had been out of work for more than 26 weeks—an unprecedented share in the period since World War II. CBO expects that the lingering difficulties of the long-term unemployed in finding jobs, as well as the loss in business investment during the slump, will weigh on the nation’s output for years to come.
[...] With the federal budget and the economy both facing such serious problems, the additional problems that would probably be caused by a default on the federal government’s obligations could be especially damaging. We are on the brink of harming the budget and the economy, possibly undermining the international financial system, and doing significant damage to the credibility of legal commitments made by the U.S. government.
Gulp.
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Congressional Budget Office Analyses
- Of the revised Boehner proposal
- Of the Reid proposal
- Comparison of the two proposals
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Wall Street bankers, from senior executives to traders, are complaining that the Federal Reserve is refusing to engage in planning for any downgrade or default by the US. With only days to go to the US Treasury’s August 2 deadline to raise the debt ceiling, bankers say they are not getting a response to efforts to discuss the market impact of a failure to reach a deal in Washington or if credit rating agencies cut the US triple A standing.
The Treasury has so far refused to make public any contingency plans for the event that there is no rise in the debt ceiling. Unless the Treasury indicates, for example, whether it would prioritise interest payments, it is hard for the Fed to discuss the implications with banks.
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Presenting, courtesy of Bloomberg, le chart du jour — an eye opening inversion of the US credit default swap curve:
That means, as Bloomberg eloquently put it, that it costs more to insure US Treasuries for one year than it does for five years, for the first time ever.
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