Debt clock ticking, but default damage already unfolding

October 15, 2013 – WASHINGTON – The warnings from Wall Street are dire: A stomach-turning dive in the stock market. World economies in peril. Another recession in the United States. A replay of the 2008 financial crisis — or worse. And the date investors are worried about is fast approaching. It’s Thursday, when the United States bumps up against the $16.7 trillion limit set by Congress for the amount of money the government can borrow. Why the alarm? If Congress can’t make a deal and raise the limit, the value of United States government debt — the paper considered the safest investment on earth, the grease for the machinery of the world financial system — will be called into question. As the clock clicks toward Thursday’s deadline, signs of damage are already emerging. The Chinese, who hold more U.S. debt than any other country, have wondered aloud whether it’s time to take their money elsewhere. Consumer confidence has dropped — never a good sign with the holiday shopping season coming. And this was the warning to the Senate last week from the president of the National Association of Realtors: “It’s going to go backwards very, very fast.” He was talking about the housing market — buyers and sellers are getting nervous and canceling deals — but he might have been talking about the entire looming catastrophe if the country hits the borrowing limit. So when do things get bad? No one knows for sure, which is part of what makes Wall Street nervous. Jack Lew, the secretary of the treasury, has warned that on Thursday the government will exhaust its authority to borrow money and have only about $30 billion in cash on hand. On a busy day, the government owes as much as $60 billion in legal obligations authorized by Congress. So the government is already running on fumes. Of course, the United States Treasury isn’t a one-way account. Checks roll in every day from tax payments, including yours. The immediate problem is that the amount of money that flows into and out of the government every day swings wildly.

A lot comes in around the quarterly tax deadlines — the last was Sept. 15. A lot goes out at the first of the month for Social Security. To smooth things out, the Treasury borrows on the bond market. It accepts loans from investors, who get bonds and bills in return. That paper guarantees the holder that the government will pay the money back, plus interest. And because the United States always makes good on its bond payments — exceptions being when  the country was broke after the War of 1812 and because of a paperwork glitch in 1979 — American government debt is considered the safest investment anywhere. If the government is suddenly unable to make interest payments, the value of that debt suddenly drops. The government might be able to delay the interest payments while this gets worked out in Congress. But any delay would cause damage by itself because it would dent the creditworthiness of the U.S. government, the same way your friend would consider you less creditworthy if you “delayed” paying back the $10 he lent you for lunch. The people who determine the creditworthiness of the United States are the three big rating agencies. One of them, Standard & Poor’s, caused a shock to the financial markets in 2011, the last time Congress messed with the debt limit, by stripping the U.S. of its top-notch AAA credit rating. There’s every reason to believe further downgrades are in store if the government defaults. And some investment funds are barred from holding anything less than top-rated debt, which means they could dump U.S. debt and cause its value to plummet. The Federal Reserve cannot accept defaulted securities as collateral. And trillions of dollars of other financial contracts are built on the bedrock of Treasury bonds. It doesn’t take much of a tremor to start breaking windows. -NBC

Read More......