Democrats and even some Republicans are raising the prospect of a government “default” if Congress fails to raise the debt ceiling next month, but the risk of an actual default on the debt is small, even if the U.S. fails to act in time.
House Minority Leader Nancy Pelosi, D-Calif., warned of a default on Thursday, with just weeks to go before Congress has to act.
“With the White House, House and Senate under one party control, the American people expect and deserve a plan from Republicans to avert a catastrophic default and ensure the full faith and credit of the United States,” she said.
But there are several hurdles and fail-safes that would have to be breached before an actual default happened.
The government technically hit the debt ceiling, or its borrowing limit, in mid-March. Since then, it’s been limiting certain issuances of debt and otherwise juggling the books to stop it from exceeding the new limit, which is about $19.8 trillion.
But the Treasury Department won’t have any more tricks up its sleeve after Sept. 29 or so. If the ceiling isn’t raised by then, the government will have to find a way to spend only what it collects in revenues, as it would no longer be able to borrow to fund the rest of its regular spending.
The first major hurdle to a real default is the desire of Republicans to avoid that situation, which would not only be embarrassing but would likely cause some real panic in the markets and raise new questions about the ability of Republicans to govern. President Trump has prided himself on Wall Street’s orderly climb since he won the White House, and his treasury secretary, Steve Mnuchin, has made it clear they want a clean increase in the debt ceiling.
“This is about having a clean debt ceiling so that we can maintain the best credit, the reserve currency, and be focused on what we should be focusing on — so many other really important issues for the economy,” he said this week.
Speaker Paul Ryan and Senate Majority Leader Mitch McConnell agree and have said repeatedly the ceiling would increase on time. “America’s not going to default,” McConnell said this week.
But even if that pressure isn’t enough and Congress somehow misses the deadline, a default wouldn’t be automatic. Technically, a default is a missed payment on the principal or interest on existing debt, and close observers agree that Mnuchin would make sure those payments continue to be made, even if the government had to cut back spending elsewhere.
Mnuchin has made it clear he isn’t a fan of legislation that would prioritize which payments get made and which don’t if the debt ceiling couldn’t be raised in time. But in reality, Treasury is already widely expected to forgo some normal federal spending in the event it can’t borrow any more, in order to make sure it keeps up debt service payments, according to Romina Boccia, the Grover M. Hermann Research Fellow at Heritage Foundation.
“We can safely assume that during a debt limit impasse, Treasury would prioritize those payments … thereby avoiding what would be a sovereign debt default,” she said.
Boccia said some of the confusion is the result of how Democrats use the word “default.” Under former President Barack Obama, she said, Democrats used the word to mean any missed payment to any federal program that might occur if the government were temporarily unable to borrow more money.
But she said cutting back spending on the regular functions of government — such as Social Security payments, defense spending, tax cuts or countless other federal activities — is not the same as a default on the debt. “Late payments are not a default,” she said.
U.S. credit rating services also expect the government would prioritize debt service payments over other federal spending. Both Moody’s and Fitch Ratings said this week that they expect the government to continue servicing the debt and reduce spending elsewhere, and Moody’s even said the U.S. credit rating wouldn’t drop at all if that happened.
“Prioritization would not affect our sovereign rating,” Moody’s analyst Sarah Carlson told Bloomberg. “It’s obviously not an ideal thing, but our rating speaks to the risk of default or loss on government debt.”
Fitch said the U.S. rating could fall in this situation, but still had no expectation for an actual default on the debt.
“In Fitch’s view, the economic impact of stopping other spending to prioritize debt repayment, and potential damage to investor confidence in the full faith and credit of the U.S., which enables its ‘AAA’ rating to tolerate such high public debt, would be negative for U.S. sovereign creditworthiness,” Fitch said.
Another close observer of the situation noted a third hurdle to a default: the U.S. Constitution. This observer said the 14th Amendment to the Constitution has been read to essentially require the government to ensure U.S. debt obligations are met no matter what.
“I think the administration could be sued if they didn’t do that,” this source said.
The 14th Amendment holds:
The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.
