A failure by Congress to raise the nation's debt ceiling would cascade through the economy, increasing borrowing costs for consumers and businesses, chilling credit markets, driving down stocks and killing jobs, industry officials and economists say.
"We will set off a chain of events that will cover our entire economy and impact all Americans," Frank Keating, CEO of the American Bankers Association told the Senate Banking Committee Thursday. "These impacts would not be easily reversible. The repercussions could linger for years, providing a constant drain on our economy."
The Treasury Department has said it will run out of borrowed money on October 17 unless Congress votes to raise the nation's $16.7 trillion debt limit. Missing that deadline by even a few days likely would shave about three-tenths of a percentage point off fourth-quarter economic growth, says Mark Zandi, chief economist of Moody's Analytics.
The nation would be plunged into a severe recession if the impasse extended even a few days past Nov. 1, as the government struggles to issue Social Security checks, make payments to Treasury bond holders and meet myriad other obligations, Zandi says. Millions of jobs would be lost, he says, adding that the the nation's credit worthiness would be damaged even if the government continues to pay interest on Treasury notes while defaulting on other obligations.
The nerve-rattling chain of events would begin with investors demanding higher interest rates on Treasuries to offset the higher risk of default, Keating says. That would drive up interest rates broadly, including mortgage rates.
Meanwhile, the value of Treasuries and related securities would plummet, leaving banks, which hold $3 trillion in such assets, with far less capital to lend for everything from mortgages and car loans to business expansions.
The 2011 debt ceiling standoff in Congress - when lawmakers reached a last-minute deal to avert a crisis - cost taxpayers $20 billion in higher borrowing costs. If the U.S. government defaults this time, "the harm is likely to be measured in hundreds of billions of dollars," Keating says.
The recovering housing market would be hit especially hard. During the 2011 episode, 30-year fixed mortgage rates rose nearly 0.75%, increasing the cost of a typical monthly house payment by $100, the Center for American Progress Center said in a report.
A 1% rise in mortgage rates would reduce home sales by 350,000 to 450,000 units, Gary Thomas, president of the National Association of Realtors, told the banking committee.
"Fewer home sales mean less construction, less income from transactions, and fewer purchases of appliances, renovations and services that accompany a purchase," Thomas said. "The momentum of the housing recovery will be in serious jeopardy."
Some individuals, businesses, non-profits and state and local governments depend even more directly on Treasury interest payments or the ability to redeem a maturing note. A default would jeopardize that income, "undermining economic activity and damaging confidence," Paul Schott Stevens, head of the Investment Company Institute, a trade group, told the banking committee.
Amid the chaos, stocks markets would be hammered. During the 2011 deadlock, the S&P 500 index fell 17% as household wealth dropped by $2.4 trillion, according to the Center for American Progress and the Treasury Department. "It took six months to return to pre-crisis levels after not quite hitting the debt ceiling," the center's report says.
The combination of negative events would deal a harsh blow to consumer confidence, which already has weakened noticeably in recent days, Zandi says. That would dampen retail sales and lead to further job losses.
At the same time, the financial system would slow significantly. Banks, for instance, typically use Treasuries as collateral when they take out short-term loans, known as repurchase agreements. A default would make it more difficult to post the Treasuries as collateral, making the system far less liquid, testified Kenneth Bentsen, head of the Securities Industry and Financial Markets Association.
In turn, short-term loans that business need for basic operations could dry up, Zandi says.
If the standoff lasts through November, the Treasury Department, unable to borrow, would have to slash government spending by $130 billion, cutting economic growth by about 5%, eliminating 10 million jobs and pushing the 7.3% unemployment rate to 12%, Zandi says.
The standoff presumably would end well before that. "If we start to melt down, you would think that would push lawmakers to come to terms," he says.