Tipping Point Q&A: Dr. Reaser’s Response to the Debt Ceiling

Tipping Point Q&A: Dr. Reaser’s Response to the Debt Ceiling
By: Dr. Lynn Reaser

Q:  Will the U.S. government default if the debt ceiling is not raised by August 2?
A:  This is very unlikely as the government would probably pay interest and principal payments due its various creditors (U.S. and other owners of Treasury securities).  The government would, however, not be able to pay all of its other spending obligations.

Q:  Could social security payments be stopped?
A:  They could, although the government would probably temporarily halt, limit, or defer other spending obligations, such as to various federal contractors.

Q:  S&P and Moody’s are talking about downgrading the U.S. credit rating.  Will this happen and what could the consequences be?
A:  The rating agencies assess various securities according to their perception of risk to help guide investors.  They first indicated they would downgrade their rating if the debt ceiling were not raised.  Now, they indicate that the rating could be reduced if a “major” deficit reduction plan is not achieved.  Given the significant erosion in the credibility of rating agencies following the last financial crisis, it is not clear how much impact a downgrade would have.  However, there would probably be at least some adverse effects on stock prices and the dollar.

Q:  What is the worst case scenario if Congress and the President fail to forge a solution to the debt ceiling impasse?
A:  A severe financial disruption along the lines following the collapse of Lehman Brothers could ensue.  Stock prices could plunge, the dollar fall sharply, interest rates spike, and financial markets freeze up.  However, unlike the 2008 situation, where policymakers could not quickly correct the aftermath of a housing and credit bubble, the current situation does have a political solution.  A plan to reduce the deficit over time and shore up the U.S. fiscal situation can be crafted and already has blueprints drawn up by deficit reduction commissions.  Hopefully, a political solution will take place before, instead of after, financial markets force it on us.


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