A number of diaries here, and a very large number of print news, internet, radio and television reports have pondered the question: What would happen if the US were to default on its Treasury debt. I'm kind of shocked by how understated most of these reports are. I keep reading that interest rates will spike and that therefore the US would have to pay more on its accumulated debt.
It seems to me that these explanations are kind of ridiculous. This is not the worst that would happen. What would happen is that whatever money in the bank you might be lucky enough to have in this Great Recession would essentially disappear, at least for a while. You would not be able to cash a pay check if, miraculously, you held onto a job. That's unlikely because the commercial paper market which has recovered somewhat from 2008 would evaporate again, and companies use commercial paper to meet payroll. ATMs will cease to function; grocery stores will not be able to restock; truck drivers will pull over to the sides of highways leaving goods undelivered; ships carrying food, raw materials, cargo containers, coal and oil will head to the nearest port and dock indefinitely; farmers will stop planting crops; and we will be living in a kind of post nuclear hell. Think: Argentina in the period when the working and middle classes were reduced to scavenging municipal garbage dumps in order to eat as a result of their financial meltdown.
How do I know this? Because this experiment has already been done. It happened in 2008, except through a lot of luck and some very risky investments, the Fed and Treasury and Bank of England and Bank of Japan pulled us back from the brink. (Sorry, Bernanke haters, you're just plain wrong.) In 2008, hundreds of billions of dollars worth of triple A rated mortgage backed securities ("AAA MBS") defaulted or seemed on the verge of default, leading to a freezing of interbank lending and transfers. Well, Treasuries are used for a lot of the same banking purposes as AAA MBS were used for -- only they're much, much more vital to the system and there are trillions of dollars more of them. So, let me repeat: This experiment has been done before, so I'm not speculating. We know what will happen. Why it will happen is a more complicated story.
The overwhelming majority of people on the left and the right underestimate what exactly happened in 2008 and how close we came to complete financial armageddon. Among other things that happened in 2008, there was a run on the money market that was estimated to be building to $4-$5 trillion in a few hours if the money market and commercial paper market hadn't simply been shut down. Letters of credit, a form of interbank lending required for shipping, disappeared and ships basically went to port and waited. Some truckers, many of whom relied on a specialized system of credit that evaporated, pulled over to the side of the road. Financing for the planting of the winter wheat crop, which was supposed to be planted around that time and constitutes the majority of wheat used in the US, dried up. The system of financing credit cards (credit card receivable asset backed securities) collapsed, and credit card issuers began notifying cardholders that their limits were reduced to their balances or even lower. Student loan asset backed securities dropped to zero, and if the Obama administration and Fed hadn't stepped in, millions of students would have had to drop out of college, and the car loan backed securities market also dried up, leading to the collapse of the automakers' markets because few could get car loans even if they wanted to buy a car. The idiosyncratic local "factoring" financial sectors used by grocery stores and other retailers collapsed. Trains were stacked up in train yards and in rarely used side rails because there was no financing for interstate rail shipping. Worst of all, the "system of payments," the system by which banks honor each other's checks (like paychecks) and ATM withdrawals froze, and as Dean Baker said on DemocracyNow at the time about the necessity of a TARP bailout (and I can't forgive him for changing his tune and becoming a critic AFTER TARP was enacted and saved the world):
I mean, there is a point. The system of payments stopped working last week. If that happened, we would have to, like, go to buy our groceries with gold. We had a serious situation.
I wrote about this in these two diaries, here and and here
There are strong parallels between the financial crisis of 2008 with its default or potential default of AAA MBS, and potential scenarios for what would happen if there was a US default on Treasuries. That's because banks and other financial institutions use these securities for many reasons, some of them not well known to the general public. Financial institutions generally do not hold cash. They want their money always to be working for them (ie earning interest), so almost every dollar's worth of value is invested in something. For basic safe parking of cash, that's triple A, "investment grade" securities, which include Treasuries and used to include AAA MBS.
These securities are (were) called "cash equivalents." Treasuries still are cash equivalents. Defaulting on cash equivalents is like telling the banks, pension funds, central banks of other countries, state and municipal treasuries, and other financial institutions, that their cash is worthless. It's like saying to us normal folks, those ones, fives, tens and twenties in your pocket and those numbers on your checking or savings account are today worthless.
This is one of the peculiarities of the debt market, or bond market, or fixed income market as its variously known. For regular folks, if you lend a friend money and it's a day late (and a dollar short) you figure, OK, Joe owed me $20 for payment Wednesday, and I got $19 on Thursday, it's no biggy, I'll get the last $1 on Friday, Joe's payday.
But the bond market considers a bond that has defaulted, even for an hour, let alone for some indeterminate time into the future until when Republicans will become sane again, as basically worthless. That's because that's the essence of a bond or Treasury. It pays exactly on time. Other transactions can be timed around it. The interest is certain so the holder can schedule payouts to its creditors with certainty. This is why stocks and bonds are completely different markets.
Also, bank regulations generally don't want banks to fudge about whether their assets are good or bad. If an asset looks bad (eg if its payment is going to be delayed until Eric Cantor gets over his hissy fit) then the bank needs to write it down -- mark to market -- rather than mess around with trying to make its balance sheet look better than it actually is.
So if the US defaults on its debt, some $14 trillion in US debt would become worthless for many purposes. It wouldn't be worthless obviously, but it probably wouldn't be investment grade. Much of that $14 trillion is intra governmental debt (eg, Treasuries held by the social security trust fund) so let's be generous and say $10 trillion in value held by various public and corporate and financial institutions is rendered untrustworthy and no longer investment grade.
Many banks, insurance companies, finance companies, pension funds and governments world wide would instantly become insolvent. Period. A default means instant insolvency for innumerable corporations, banks, financial institutions, pension funds and other holders of US debt. The FDIC would have to seize hundreds if not thousands of banks and resolve them-- except ooops! the FDIC would have no money to resolve and reopen these banks because the federal government would have no money, and no ability to borrow, in order to resolve these banks. This means unlike in 2008, the banks get shut, but not consolidated with other banks, and without the insurance that makes every bank account whole.
It would be like what has happened in Latin America from time to time, when the financial authorities in times of crisis have simply shuttered the banks and frozen all accounts for long periods of time, such as up to a year.
You would not be able to get whatever few dollars you have in the bank, of course.
But then again, there wouldn't be much to buy.
Just as you wouldn't be able to get your money or cash your check, neither would the local electric company or the coal or gas company it buys fuel from, or the railroad it relies on to ship those fuels.
Back in 2008, there was an estimate that if something wasn't done to restore the credit system, if there wasn't some way to get the trains and trucks running, to get the local grocery credit factors going, the cities had only a few days of food left on the shelves, which would soon be gone, and would probably be gone sooner as panic set in (when people realized that their bank accounts were frozen and the grocery store shelves were emptying). Well, this would be much, much worse.
This is the scenario that these Republican buffoons, these criminals, these traitors, these amoral monsters, these idiots, are fooling around with as they play their meaningless political games.
The political leaders don't want to panic you, so they're not telling you this. The Democrats want you to be scared, but not too scared. But as I said up front, this is not "uncharted territory," because we saw hundreds of billions in triple A securities disappear in 2008 and we know what happened, and we know what almost happened, but for TARP and the Fed's massive injections of liquidity into the system. Now we're talking about disappearing $10 trillion of the absolutely safest investment in the world.
If this happens, you'd better get directions to the nearest municipal garbage dump because there might be some old rotten half eaten Big Macs that the rats and sea gulls haven't gotten to yet.