Economic outlook grim if no debt deal reached

[July 16, 2011]  WASHINGTON (AP) -- Horror stories are flying about the damage that might be wreaked should Congress and President Barack Obama fail to cut a deal by the Aug. 2 deadline to increase America's borrowing limit. Nearly every American is in harm's way, either directly or indirectly.

Absent a deal by then, the government would find itself tight on cash and unable to borrow -- and have to start deciding which of the 80 million bills due in August it should pay and which it should put off.

Tough decisions would come immediately: On Aug. 3, some $23 billion in Social Security benefit payments are due to be processed. On Aug. 4, the Treasury Department must pay $87 billion to investors to redeem maturing Treasury securities. On Aug. 15, more than $30 billion in interest payments come due.

In addition to those costs, the government normally pays $5 billion to $10 billion daily to defense contractors, Medicare providers, federal employees and others.

Obama has said he can't guarantee Social Security checks and payments to veterans and the disabled will go out on schedule in the absence of a deal: "There may simply not be the money in the coffers to do it." He could be challenged on that, however, because some legal and congressional budget experts question whether he can unilaterally decline to pay Social Security benefits if there are still assets in the program's trust fund.

Regardless of how that issue is resolved, there's no question that government services, programs and benefits could take an enormous hit.

No one knows exactly what choices Obama and his top officials would make if the crisis comes. The White House Office of Budget and Management is the agency charged with reviewing possible cuts in benefits and payments while the Treasury Department handles cash flow. All have been mum about their crisis plans, apparently to avoid market speculation or panic.

But Treasury Secretary Timothy Geithner has insisted the deadline is real. "There is no credible way to give Congress more time," he said recently.

One analysis, by the Bipartisan Policy Center, suggests that once the government runs out of cash and lacks the power to further borrow, it would need to slash spending at once by as much as a whopping 44 percent. The U.S. now borrows more than 40 cents for every dollar it spends.

So long as the Treasury has tax revenues coming in, it can still make interest payments to technically avoid default. Some analysts think it would lean that way at first, so as to do less harm to the country's long-term credit rating. Default would be a "major crisis" that would radiate "shockwaves" through the financial system, Federal Reserve Chairman Ben Bernanke told Congress recently.

But putting a priority on paying interest on maturing debt to avoid a default would simply force spending cuts instead -- some of them more likely to hit ordinary people.

Parks and monuments can be temporarily shut. That's been done before.

But is it worth taxpayers' money to pay the costs of pursuing a second trial against former baseball star Roger Clemens if the judge who declared a mistrial in his perjury case this week clears the way? And what about clinical trials on new drugs or other scientific research projects? Or completing half-finished highway construction projects?

The government is even weighing the prospect of selling off some of its assets -- gold in Fort Knox, buildings, property, even some national parklands -- to make ends meet, if absolutely necessary.

Government contractors are likely to be among the early victims, says Paul Light, professor of public policy at New York University. "No new contracts. Delayed payments. Stop work orders. I can't imagine that Obama would ever touch soldiers' pay. But you'd get closing of parks, as we've seen in Minnesota, the national monuments, freezes on discretionary spending including Medicaid."

He suggested other early austerity steps would likely include halting of highway projects and research grants, and orders to stop clinical trials of new drugs and cancer research.

The state government shutdown in Minnesota may indeed offer a preview of what lies ahead on a larger scale. State parks were closed. Driver's licenses weren't issued. Beer giant MillerCoors was told it couldn't sell beer in the state because its licenses hadn't been renewed.

Some conservative congressional Republicans have questioned whether there would really be a crisis if the Aug. 2 deadline were missed. They note that the government could cut programs instead and still make interest payments at least for a while. But Congress' top two Republicans, House Speaker John Boehner and Senate Minority Leader Mitch McConnell have agreed that failure to raise the limit could provoke an epic economic catastrophe.

And major rating agencies such as Moody's and Standard and Poor's have already signaled they're poised to lower the nation's coveted Triple-A credit ratings if no agreement is reached. They also hinted that the ratings might be lowered even if the U.S. continues to make interest payments on its debt.

"Global investors will start asking themselves, how long will they get paid if Social Security recipients don't?" said Mark Zandi, chief economist at Moody's Analytics. "There would be long-lasting economic damage. The economy would be back in recession. Tax revenues would be falling again and the deficit increasing."

The U.S. has gone through short government shutdowns before -- most recently in late 1995 and early 1996 -- because of political standoffs.

But now the stakes are far higher because the dispute may capsize the entire U.S. economy, not just shut down government agencies and delay benefit checks.

Any unprecedented default on the U.S. debt would send the price of Treasury bonds -- long viewed as the world's safe-haven investment -- tumbling and interest rates soaring. And the higher rates wouldn't just be on Treasury bills and bonds but also on a wide variety of consumer and business loans pegged to Treasury rates, from mortgages to credit cards, car loans and student debt.

A U.S. default, or near-default, could also cause financial panic around the globe as international investors flee Treasury bonds and bills and other dollar-denominated investments. The value of the U.S. dollar against other major currencies could tank.

Given the nation's already high unemployment rate and shaky housing markets, it would likely send the economy quickly back into recession.

"There's a huge amount of misunderstanding about the seriousness of this among the American people," said Robert Reischauer, former head of the Congressional Budget Office and now director of the Urban Institute. "One reason is that, while experts have been apoplectic about this for the better part of four months, there is no tangible evidence of any of these consequences coming to pass," because the stock market has still been going up and interest rates have remained low.

"Most people spend their lives worrying about the things that affect them immediately and the things they have some control over. And this is not one of them," Reischauer said. "But it will be very soon."

The Dow Jones Industrial Average lost 778 points on one day in October 2008 when the House voted down the bank bailout bill, known as the Troubled Asset Relief Program -- a vote that was quickly reversed.

Economists can easily see a 1,000-point or larger plunge in the Dow if the negotiations to raise the debt ceiling fail -- dealing a savage blow to already fragile 401(k) plans and similar retirement investments.

How hard and fast really is the Aug. 2 date? The national debt, the legacy of years of accumulated deficit spending by presidents and legislators of both parties, now stands at $14.34 trillion. The government blew past the legal debt limit on May 16. Treasury has kept paying bills with accounting footwork ever since but is nearing the end of that, officials say.

Now, said Geithner recently, "We're left running on fumes."

[Associated Press; By TOM RAUM]

AP Economics Writer Martin Crutsinger contributed to this report.

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