Here's Everything That Could Happen If the U.S. Breaches the Debt Ceiling


The United States, like the House Lannister, always pays its debts.

The U.S. is on the path to reach its debt ceiling on October 17. Whatever comes on October 17 we will be in uncharted waters. No one can know for sure what will happen then, but we can all at least be informed about the current dynamics and the possible outcomes. Here's some things you need to know.

While the shutdown is the reason to talk about furloughs and government employees, as the debt ceiling approaches all eyes will now be on the U.S. Treasury market. Many economists and investors view the debt ceiling as a much more significant issue for the economy than government shutdown. Failure to raise the debt ceiling might result in the inconceivable: the U.S. failing to pay its debts.

Wall Street, complacent up until a few days ago and perhaps mistakenly counting on the common sense to prevail in D.C., is becoming increasingly nervous. Morgan Stanley economists put the economy at level 3 Econ DEFCON, citing worsening condition in Washington D.C.

U.S. Treasuries theoretically could suffer a big rout, but all signs in the Treasury markets point that the exact opposite will happen. The benchmark 10-year Treasury bond shows no signs of panic and in fact its yield has declined over the past month.

Here's Felix Salmon on why this is happening:

"One reason why is that Treasury bills are unique in many ways, including the weirdest way of all: as worries about the creditworthiness of the U.S. government increase, the price of Treasury securities tends to go up, rather than down. Even if the U.S. hits the debt ceiling, that won't hurt the price of U.S. debt; instead, general nervousness will only cause investors to flow into Treasuries and out of riskier assets. Which is to say, out of everything else."

There are certain ways out of the impasse, but none of those have been tried before. There's the talk of evoking the 14th Amendment that states that U.S. shall pay all its debts, theoretically enabling the president to do just that; he could order the Treasury Department to mint a trillion-dollar coin and deposit it at the Fed. These solutions have been widely discussed and mostly discarded during our last debt ceiling stand-off back in 2011. A more interesting and more feasible solution that has been making rounds in the financial blogosphere (a bit wonkish but a great read) this time is the issuing of "Obama bonds"; bonds issued at a premium, say $275, that will pay par ($100) at maturity. The beauty of such bonds is that they would enable the U.S. government to raise $275 for every $100 increase in its debt.

There are a few other nuances to keep in mind. While the debt ceiling will be reached on October 17, a $12 billion Social Security payment will not be due until October 23 and the $6 billion Treasury bonds interest payments are not due until October 30. There's a chance that during that brief window, public and investment community outcry will reach s fever pitch and enough GOP Congressmen will be swayed to end this artificial, self-created crisis with or without face-saving maneuver. At some point, saving face would become the least of the GOP's concerns. That point will, hopefully, come next week.

If it doesn't, the Treasury will have to find a way to pay its debts. Contrary to some commentators, Treasury can't prioritize its payments. In other words, it can't choose to pay interest on its debt at the expense of Social Security checks. Frankly, Treasury Secretary Jack Lew should be prepared to break some laws to uphold the Constitution. I'd pay to see Republicans' arguments if they dare to bring a case to the Supreme Court accusing the Obama administration for such violations. Think about the logical pretzel they will have to contort themselves into: they'd have to demonstrate that default is preferable to breaking some obscure Treasury Department procedure.

Meanwhile, in the GOP land there are signs of some retreat: they are lowering their ransom demands. While not a reason to breathe with relief just yet, it's a welcoming and telling development. Because they now want out of that self-imposed political cul-de-sac, perhaps they came to a realization that the strategy of keeping the country hostage every six months over the debt ceiling, while brilliant at first glance, is damaging to the Republican brand. Thus, even if we were to default this time, it's safe to assume the House GOP will think twice before trying such tactic again.

There can be no half-measures when the full faith and credit of the United States is on the line. In 2011 Obama chose a half-measure, when he should have gone all the way. He'll never make that mistake again. The U.S. always pays its debts. Even if the Treasury has to break some laws to do it. Obama realized that a few weeks ago. Ryan, Cantor and Boehner are beginning to realize that now.