‘Financial Armageddon.’ What’s at stake if the debt limit isn’t raised

Lawmakers in Washington are again playing chicken with America’s creditworthiness. And the path to raising the debt ceiling is not clear.

‘Irreparable damage’

In her letter to Congress, Yellen said history shows that waiting “until the last minute” to suspend or increase the debt limit “can cause serious harm” to business and consumer confidence, raise borrowing costs for taxpayers and hurt America’s credit rating.

“A delay that calls into question the federal government’s ability to meet all its obligations would likely cause irreparable damage to the U.S. economy and global financial markets,” Yellen wrote.

A US default would undermine the bedrock of the modern global financial system.

“We pay our debt. That’s what distinguishes the United States from almost every other country on the planet,” Zandi of Moody’s said.

Market chaos

Soaring Treasury rates would set off a chain reaction in financial markets. That’s because Treasuries, viewed as risk-free investments backed by the full faith and credit of the federal government, serve as the benchmark by which virtually all other securities are measured.

Everything from stocks and bonds to exotic securities take their cues from Treasuries. A spike in Treasury rates sparked by a default would cause booming stock markets to become unglued.

“Stock prices would crater,” Zandi said. “We’d all be less wealthy, instantaneously.”

Not only would millions of Americans lose money in the stock market, but it would suddenly become more expensive for families and companies to borrow. That’s because Treasuries serve as the benchmark for mortgages, car loans, credit cards and corporate debt. A spike in borrowing costs is a huge problem for an economy that relies on access to credit.

If the debt ceiling is not lifted, then the federal government will technically default on some of its obligations. It would be forced to prioritize payments, deciding who will get paid and who won’t.

Ultimately, someone will lose out, whether it’s federal employees, veterans, Social Security recipients or defense contractors.

For all these reasons, investors are not freaking out about the debt ceiling. Wall Street expects Washington will eventually raise borrowing limit, like it always does. Failure to do so would simply be too dangerous.

‘Uniquely childish’

The precise timing of when the debt ceiling must be lifted is a bit unclear.

“Once all available measures and cash on hand are fully exhausted, the United States of America would be unable to meet its obligations for the first time in our history,” Yellen wrote.

Yellen put a finer point on it later in Wednesday’s letter, saying “based on our best and most recent information, the most likely outcome is that cash and extraordinary measures will be exhausted during the month of October.”

Of course, this debate isn’t taking place in a vacuum.

“Playing politics with the debt ceiling is always a bad idea,” said Isaac Boltansky, director of policy research at Compass Point Research & Trading, “but it is a uniquely childish notion given where we are with the virus and the economic recovery.”

In other words, a debt ceiling crisis, let alone an actual default, is the last thing the recovering economy needs right now.