What A Government Default Would Look Like
NEAL CONAN, host: This is TALK OF THE NATION. I'm Neal Conan in Washington. President Obama calls the prospect Armageddon and warns that Social Security checks and veterans' benefits could be at risk. Skeptics insist there is cash on hand and that foreign investors have nowhere else to go.
So as the clock continues to count down to the August 2nd deadline, what will happen if Congress and the White House fail to strike a deal, and the U.S. government goes into default? I'm not talking about politics here or the blame game. What happens if the government defaults for the first time in history?
We want to hear from you, if you've given any thought to what happens to you. Our phone number is 800-989-8255. Email email@example.com. You can also join the conversation on our website. Go to npr.org. Click on TALK OF THE NATION.
Later in the program on the Opinion Page, Washington Post columnist Jackson Diehl warns that we risk an Iranian takeover if all U.S. troops leave Iraq on schedule.
But first, what happens on D plus one? And we begin with Louise Story, a business reporter for the New York Times. She joins us from our bureau in New York City, and nice to have you with us today.
LOUISE STORY: Nice to be here.
CONAN: And one of the things is we don't really know because this has never happened before.
STORY: This has never happened. You can look at other countries where you've had defaults, you know, Russia and Argentina. But those economies are not really comparable to the United States economy.
What we do know is what typically happens, you know, in a big corporate bankruptcy or in a situation where something is downgraded. You've been hearing a lot about the ratings agencies and whether they'll downgrade the U.S. debt. And one thing that happens when there is a downgrade, if the U.S. debt lost its AAA rating, is that lots of insurance companies and pension funds out there are not allowed to own things that are not rated AAA. And so they would have to go sell. So not only could this affect...
CONAN: Wait a minute, the bonds that are already out there, they would be suddenly worth less?
STORY: Well, there are a lot of buyers out there, a lot of people who hold them, really pension funds and insurance companies, who cannot continue to hold things if they have a ratings downgrade. And this is a kind of forced selling that we saw during the financial crisis with mortgage bonds. When they got downgraded below AAA, there were a lot of parties that just had to sell, and that created a bit of a downward spiral.
CONAN: A bit of a downward spiral. I sort of remember the financial crisis. Calling it a bit of a downward spiral, at least on a couple of days, is an understatement.
STORY: Well, it was devastating to the economy, but in those markets, it just, it fed upon itself because there were more and more sellers.
CONAN: So as the bond ratings go down, that also means interest rates they would charge would go up. It would cost the United States more when it got back into the business of borrowing money.
STORY: Well, it's kind of like credit cards. You know, if you miss a payment to your credit card company one month, the next month, they come to you, and they say all right, you've got to pay a lot more interest - forever, or for a very long time. And that's what people are warning about for America.
You know, we pay the lowest interest of any country out there because the U.S. is considered the safest bet right now. Even with this panic about whether there'll be a default, the U.S. is still paying only about three percent on its 10-year Treasury bonds. And the thought is if there's a default, perhaps global investors will be like those credit card companies and say to the U.S. okay, from now on, you're paying more.
And you only have to look at, you know, Greece and Italy, countries where they have major fiscal problems, and look at what they're paying. Greece is paying like 20 percent interest cost.
CONAN: That's considerably more than we're paying.
STORY: Considerably more.
CONAN: And I don't think - well, who knows where it would go to. The other problem is there's literally - are the coffers empty, the government has no money to pay for, well, not just repay its debts but to pay for services, too?
STORY: The government has some leeway. You know, there is still some money actually from TARP, that program that was the federal banking bailout. They could perhaps sell equity in that. They could sell hundreds of billions of dollars the Treasury Department owns in student loans.
There are some things the government could sell, but, you know, the garage sale has to end eventually, when the garage is empty.
CONAN: The gold in Fort Knox perhaps.
STORY: Right, and so then the tradeoff would be does the government pay the bondholders, all those people who own the U.S. Treasury, their interest payment, which comes due on the 15th of every month, so it would be August 15th. Or do they stop paying people in the military? Or do they stop paying government workers or vendors to the government? There would be a really hard set of tradeoffs about what they'd do if the limit hadn't gone up.
CONAN: And who makes that decision, the president?
STORY: The Treasury secretary usually would make it, but of course the Treasury secretary reports ultimately to the president.
CONAN: That would be a difficult decision. As I understand, we played a cut of tape, there's a big Social Security payment goes out on August 3rd.
STORY: That's right, pretty close to August 2nd.
CONAN: And at that point, does the president - is it like calling up your ATM account and realizing that there's nothing in the - there's no more money there?
STORY: Well, they just would have to make tradeoffs. They would have to say, okay, we're - they do have more money there. As I said, they have these hundreds of billions of dollars of student loans they could sell to private investors. You know, they have some resources but not enough to cover all of the bills the government has to pay.
You know, the government pays out like - they write about 80 million checks per month, is a figure I saw. So it's a lot of payments they have to make, and they would not be able to make them all if the debt limit didn't go up.
CONAN: There is also the question about future investment in the future desirability of U.S. bonds. Greece is teetering on the edge of default because it can't make payments. It's getting help from its European partners. But the United States would be teetering on the edge of default because it doesn't want to. Is there a distinction there?
STORY: Well, you know, there are different kinds of default people are talking about. Some people are talking about a technical default and saying that would be okay. That would be where the government would not pay interest to the bondholders for a short time, and they cleaned up the books and made a big deal on how to reduce our big budget problems but then came back and paid them.
And there is a big debate even up here in the financial markets among people on Wall Street. Some people are saying look, people who own Treasury bonds will be happier if the government does not raise the limit or does not raise it much but if they figure out how to get out of this debt dilemma where the revenue to the government from taxes is not enough to cover all these entitlements and costs to the government.
So some people are saying it would be better to default, and it would be better to get the books in order than to simply raise the debt limit and not solve any of our very long-term big budget problems.
CONAN: So default is preferable if it leads to a grand bargain, as the president's described it.
STORY: That's what some people on Wall Street are saying. But then you have others who say we cannot risk that. Look at how horrible it was after the Lehmann bankruptcy, for instance, in the fall of 2008, when you had all that kind of forced selling and uncertainty in the markets. They're saying the economy could not take it. The economy is still very a sick patient, and if you had a big drop in the stock market, you could really go into a double-dip recession.
CONAN: And obviously a lot of these bonds are held overseas. People are saying not just a recession - trigger a new global recession.
STORY: That's right, and, you know, China owns the very most of them, and it's interesting. You've seen China be pretty vocal with the United States, telling the U.S. they expect to be paid back on these. So this is a very delicate, global issue with China and a lot of other countries.
CONAN: We want to hear how the default, if it happens, might affect you. If you've given it any thought, give us a call, 800-989-8255. Email us, firstname.lastname@example.org. Rob's on the line, Rob calling from Ocean City in New Jersey.
ROB: Hi, how are you doing?
CONAN: Very well, thanks.
ROB: Yeah, well, you know, I've given it some thought, and I currently work for a nonprofit organization that's funded by Medicaid. So you know, there's always the prospect if, you know, they do go into default, and programs like that really get pinched that I could potentially lose my job.
That, coupled by the fact that I also am about to go back to school to get a master's in social work, this is in New Jersey, you know, it has a lot of socially funded programs, but there's always the thought of, well, if they go in default, and these programs are going to get cut or pinched or whatnot, as well as interest rates going up on my student loans, then, you know, I will - might have to rethink my plans or consider rethinking my plans.
CONAN: I wonder, Louise Story, some people say in effect, going into default, if the government wants to keep paying out, it can make the payments, but if it reduces - effectively like a big government shutdown, if it reduces expenditures by something like 40 percent.
STORY: Yeah, people are saying the government could keep paying the bondholders, all those investors who own the treasuries, but just cut off its own employees, for instance. I've got to tell you, this would not be very popular among workers here. You have to only look...
CONAN: Like Rob.
STORY: Right, I mean, and look to Greece. That's why you see all the protests in Greece, people in the streets protesting the idea of paying the bondholders but not paying the people who work there and live there and, you know, the people in Greece.
And so it's not a very palatable tradeoff, but it is true the government could choose to do that. The big wildcard is whether the rating agencies would consider that to be a default or not. They may still consider it to be a default.
CONAN: Is Rob also right that his interest rate on his student loan might go up?
STORY: So you could see if the borrowing costs for the United States go up, you could see borrowing costs for everyone who lives here go up because all of the costs we pay for mortgages and credit cards, it's all tied ultimately to what the United States as a country pays to these foreign and other private investors who own the United States' debt.
CONAN: Rob, good luck.
ROB: Thank you very much, enjoy the show.
CONAN: Thanks for the call. This is an email from Melkin(ph), or Melkon(ph), I don't know how to pronounce it, from Southfield in Michigan: I was wondering if the U.S. could simply print more money to pay its debts? I was under the impression the U.S. had this option advantage because of the independence of the dollar, unlike Greece, which is tied to the euro. The dollar would be devalued, but it could help the U.S. overcome the current political deadlock.
STORY: They cannot just print more money because of this debt limit. So that's what ties us in here. But if they increased the debt limit, the U.S. would essentially be doing that to pay off its debt. So they can do it if they raise the debt limit, but they have to raise this debt limit in Congress, and the president needs Congress to buy in on that.
CONAN: And so far, there is no agreement on that, though again, there's some talk about a technical way to extend it, to give the president the authority to raise it on his own, but the progress on that is unclear.
There was a quiet meeting at the White House on Sunday, unclear whether that made progress either on the McConnell plan, as it's known in the Senate, the sort of technical, procedural way to let the president raise the debt limit, or on potentially a deal to strike an agreement that would raise the debt limit in exchange for cuts in spending overall.
And, well, the president still insists on raising about 20 percent of that through new taxes. In any case, stay with us. Louise Story is with us, a reporter for the New York Times. We're talking about what would happen if there is no agreement and the U.S. government defaults for the first time in history.
In a moment, the head of the big U.S. investment firm PIMCO will join us to tell us why, from his perspective, a default should be avoided at all costs, even though his company might make some money in it. If you've given any thought to what happens to you in the event of a government default, our phone number is 800-989-8255. Email us, email@example.com. Stay with us. I'm Neal Conan. It's the TALK OF THE NATION from NPR News.
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CONAN: This is TALK OF THE NATION from NPR News. I'm Neal Conan. The White House says there's been some progress toward a deal to cut spending and raise the debt ceiling, but any such agreement needs Republican approval and faces a very tough vote in the House of Representatives. And the clock is ticking.
By August 2nd, the Treasury warns, the U.S. government will run out of money to pay all its bills. Again, we're not talking about the politics or the blame here, rather what happens if the government defaults for the first time in history.
We want to hear if you've given any thought to what happens to you. Give us a call, 800-989-8255. Email firstname.lastname@example.org. You can also join the conversation on our website. That's at npr.org. Click on TALK OF THE NATION.
Our guest is Louise Story, business reporter for the New York Times, and joining us now from studios at PIMCO, the large investment management firm in Newport Beach, California, is Bill Gross, the co-founder of PIMCO, who recently wrote an op-ed in the Washington Post titled "Warning To Washington: Don't Mess with the Debt Ceiling." And Bill Gross, thanks very much for your time today.
BILL GROSS: You're welcome, nice to be here, Neal.
CONAN: And you wrote that a default could actually land your firm quite a bit of money.
GROSS: Well, to the extent that we don't own many treasuries, and if the Treasury defaulted, bond prices went down and interest rates went up, it would be an opportunity to buy them at more attractive prices. So from that standpoint, we would benefit.
But we're certainly not rooting for a default on U.S. Treasury debt. I think it would be catastrophic.
CONAN: Catastrophic, you're - that's a strong word.
GROSS: Well, it is, and Ms. Story from the New York Times has done a great job, I think, in terms of outlining the particulars. You started out the program with a headline from Michele Bachmann saying that scare tactics are being applied to debt and Social Security. But those debts will be paid.
And I think that's probably the case, but the country's bills in total must be paid, and I think whenever one creditor is stiffed or goes unpaid, then bondholders view that with trepidation.
The best example I have, Neal, of what happens to credit markets when creditors or any potential recipient of government bills go unpaid comes from the state of California about 18 months ago, when they started to issue IOUs to pay lots of their debt. And ever since then, the state has had interest rate expenses rise by perhaps a half to one percent relative to other states and to other treasuries.
And so this would significantly raise the interest rate bill or tab that the Treasury pays, in my opinion.
CONAN: Some people also say, all right, say we pay the Social Security bills and send out the veterans' benefits, that sort of thing, and the person who doesn't get paid is, for example, China. Where else are they going to go? Where else are they going to invest their money except the United States?
GROSS: Well, they certainly wouldn't go in the same amount to the United States. Actually, China and other reserve countries, you know, have been diversifying their treasury holdings over the past year or two. And where has that money gone? It's gone basically to the core of euro-land.
Obviously, euro-land has problems itself, with Greece and Portugal and Ireland, but Germany itself at the core, or perhaps France, you know, are viewed as safe havens and what we call cleanest dirty shirts within the environment of sovereign debt.
And so yes, China does have choices. They could go to Japan. They could go to the core of euro-land, and they could go to Canada or Australia. You know, a default in the United States would trip some wires that I don't think we want to press, not only in the case of China but in the case of holdings of U.S. treasuries by pension funds, money market funds and other entities.
CONAN: And if it's - some say also if it's two, three, four days, even a week and then they get it sorted out, no big deal, no fault, no foul.
GROSS: Well, it is a big deal. There is what is known as credit default swaps. And there are hundreds of billions of these swaps outstanding in the marketplace, and to the extent that the government doesn't pay its bills even for five, six, seven days, then the potential - not necessarily the unanimous outcome - but the potential for these CDS swaps to basically be in default and to cause a, you know, substantial turmoil in financial markets is significant.
So it's not just a five- to six-day proposition. And, you know, as Louise has indicated, money market funds and other holdings of U.S. Treasury debt, based upon either default or a downgrade by the rating services, would almost mandate a forced liquidation of those securities and set off, you know, a downward spiral that I don't think we want to encourage.
CONAN: Louise Story, do other people you talk to on this issue use words like catastrophic?
STORY: Well, certainly the ones who want the debt limit raised are using those words. But, you know, a lot of parties are preparing in case it's not lifted. I've been talking to a number of people at different banks who have developed contingency plans, shifting their own Treasury holdings in case the government does not lift the limit because although a lot of people think they will, you know, it's not that long ago that no one thought that Lehmann would be allowed to go bankrupt.
So people, as it gets closer, are starting to say what can we do to be prepared, what can we do to shift our holdings. I bet PIMCO has done some kind of contingency planning because it's getting so close.
CONAN: Bill Gross?
GROSS: Well, we are, Neal, and certainly contingency planning from the standpoint of currency. We haven't talked about that, but not only U.S. Treasury bond prices but the valuation of the dollar within the context of the global market is at risk.
We don't know exactly how much the dollar might decline, but it's fair to say that because the dollar is the reserve currency, because it's the currency through which a majority of global transactions take place, that the faith in the dollar itself and therefore the continued global commerce on a day-to-day basis would be at risk. And so we sort of think a three- to five-percent decline in the dollar might result from a technical default in terms of U.S. Treasury debt, and that's a contingency that I think many investors are taking into account.
CONAN: Let's get another caller in on the conversation. Let's go to Elliot(ph), Elliot on the line from Moses Lake in Washington.
ELLIOT (Caller): Hi, I'm actually a farmer here in central Washington, and I am a Tea Party supporter and a Republican. But I think that there should be no question that the debt limit needs to be raised because I think there's all kinds of unintended consequences, which we're not prepared to deal with, one of which being a fluctuation in commodities.
As the gentleman from PIMCO mentioned, you know, the dollar, the fluctuations that could occur there could have real and lasting effects on the price we pay for everything from corn to oil to whatever it is we may buy. So I think that this is not something that should be toyed with but should be passed without question.
CONAN: Even if that means passing just a clean bill, just raise the debt limit, we'll talk about the debt and the deficit some other time?
ELLIOT: Yeah, like I said, I'm a strong Tea Party supporter, and I'm all for small government and getting them out of my business. But this is not the fight that we need to be fighting. The consequences of not getting this done I think are too dire for this country for people to take political stances that are unreasonable at this point.
CONAN: Elliot, thanks very much for the call.
ELLIOT: No problem.
CONAN: Let's see if we can go next to - this is Ken(ph), and Ken's on the line from Cleveland.
KEN (Caller): Yeah, hi. The previous caller kind of said the same thing I was going to say in one point and, well, ask, really is - I would think that one thing that's going to happen is that the price of pretty much everything is going to go up because there's going to be like a trickle effect.
I don't know, I can't really articulate it, but I just know that a lot of companies, they have departments which do investing of the cash that they have on hand. They just don't have a big savings account or big checking account, they invest what they're not going to need immediately, and it's going to have an adverse effect on that.
And the other thing I was wondering about is, I mean, not paying the debt, if we use the previous analogy of a credit card, I mean, it's not going to lower the expenses of the United States. It's not going to lower our cost. It's just in effect saying hey, we're not going to pay our bills.
CONAN: Louise Story, I've heard that indeed the default could cost a lot of money.
STORY: It could absolutely cost a lot of money because if the United States ends up paying a lot higher interest rates, that means every year - we already spend hundreds of billions of dollars a year in interest. It could be more. Some people say if interest rates for the U.S. went up just one percent that it could be $100 billion of additional interest each year.
And that's, you know, like the Department of Education and Department of Energy's budget right there. And so that's all money that would not be available to pay out for education or, you know, energy causes or medical causes or anything that you need in the United States. It would just be going in interest to these investors.
So that's what people are warning about and saying it would be good to avoid having these interest rates for the United States go up perhaps permanently.
CONAN: Thanks very much, Ken.
KEN: Well, how about this - the other point where it's really not going to - I mean, maybe some, you know, park rangers are going to get laid off, and, you know, as a budget matter, well, we won't have to pay those expenses, although we'll probably have to pay something in - states will have to pay in unemployment, but I mean, this isn't going to lower anything that the government has to pay for. It's not going to make government smaller in any way, is it?
CONAN: Well, it's going to force the government to be spending a lot less money, 40 percent, one way or the other.
KEN: But we're going to have to pay it back eventually. I mean, we've already incurred the costs by passing the legislation saying we're going to do this, and we're going to do this. And just refusing to pay isn't going to change that, is it?
CONAN: No, it's not. It's - these bills will all eventually have to be paid.
KEN: So it's not going to make government any smaller.
CONAN: Well, for the short term, but the contraction is going to cost a lot of money. It's an odd situation. They had that situation in Minnesota with the government shutdown. It turned out that shutting down the government because of a budget dispute, very similar to the one in Washington, is - it costs a lot of money. So, anyway, Ken, thanks very much for the call.
KEN: Thank you.
CONAN: There's an email. This from Charles in Sacramento: The effect of failing to increase the borrowing limit - I'm a federal employee, 35 years, and a military retiree. I'm stalling on paying bills as I expect to not receive a paycheck as well as some more of my retiree checks after that. Once things return to normal, pay off debts as quickly possible as the interest rates will explode. So will federal employees get furloughed, Louise Story?
STORY: Well, that is so interesting that he is already not paying some of his bills in anticipation, because this is what economists feared. Economists are saying if you don't pay government employees, if you put them on furlough, they're not going to be out shopping. They're not going to be out spending. And that will be a real hit to the economy. So it's interesting he's preemptively doing that. I don't know how many people are preemptively doing it, but it could be many more.
CONAN: Well, Bill Gross, contingency plans, you're doing that on a sort of corporate level.
GROSS: Well, we are. You know, we're speaking to currency, and we're speaking to diversifying our assets into other countries. And the previous caller, Ken, you know, speaking to - or I guess it was your caller from Sacramento...
GROSS: ...speaking to, you know, basically curtailing his own expenses. It is an excellent example of the entire system not shutting down but slowing down with a cautionary type of emphasis. This may be a one-to-two-week thing if in fact the debt ceiling is raised but nonetheless it slows the economy in the short run and it simply points out that the situation and the resolve should have taken place months ago as opposed to here in the last hour.
CONAN: We're talking about what happens if there's no political agreement between Congress and the White House and we do go into default on August 2nd. You're listening to TALK OF THE NATION from NPR News. Our guests, you just heard Bill Gross, founder of PIMCO, a global investment management firm. He's in Newport Beach, California, at his company's headquarters. And Louise Story is with us at our bureau in New York City. She's a reporter for The New York Times. Let's go next to Darryl(ph). Darryl with us from Deerfield in Florida.
DARRYL (Caller): Hi.
CONAN: Hi, Darryl. Go ahead, please.
DARRYL: Hi. Well, I was just explaining to the other nice gentleman that I'm an educator, and I got hurt on the job. There was a big fight and I got beat up. So I had to retire on disability and Social Security disability. And with that, I'm making less than half what I was making. So I'm losing my home, and I tried some modification, and I've been denied twice. And if I don't get my money, who's going to take care of me? I mean, I'm really concerned about that. I paid all my student loans back and I did the right thing. So now, what happens to me and other people like me?
CONAN: Well, Louise Story, you said earlier it's likely, given the political pain if it doesn't happen, that the government will find a way to send out the Social Security checks and veterans benefits, that sort of thing.
STORY: Well, it's very hard to know what they would do. What I said was it would be very unpopular for the government if they started not paying out bills that the citizens expect, but it's very hard to know what they would do. They do have money available that they could do - they could still pay those things for a little while but not for good. And now, this is really the reason we have the debt limit. It was introduced in 1917 so that when you hit it, Congress and the public would have a sort of debate, like we're having now, about what are the spending priorities, should the budget be bigger, should it be smaller, what should we cut?
And so to a certain degree, the debate it's stirring here about what are the priorities of the country is an important one. And so if you raise the debt limit, that will not solve the problem. Ultimately, this debate on the priorities of the country will have to be resolved.
CONAN: Darryl, we wish you the best of luck. Thanks very much for the call.
DARRYL: Thank you very much.
CONAN: And here's an email from - this from Kevin in Baltimore: I'm a recent college graduate who benefited greatly from federal funding and grants while attending a university that would otherwise have been far beyond my means. With two younger siblings still in college in similar situations, I worry they will not find such resources available to them. Will federal funding for higher education be a target for nonpayment if the spending limit is not increased? And I would have to think, Louise Story, that it would be.
STORY: Yeah. Everything seems to be on the table, and, you know, it's a really tough time for young people going to school and coming out of school because it's very difficult for them to get jobs as well. So it's kind of a double whammy.
CONAN: Bill Gross, we just have a minute left, but I want to ask you a question about the impression that business leaders and indeed world leaders would have of a Washington, D.C. that is not able to seemingly make decisions if the United States goes into default.
GROSS: Well, yes. I think what this debt crisis demonstrates more than anything, Neal, is the dysfunctionality of the American political system and what it bodes for future years. I mean, in Canada or the U.K., they have a parliamentary system which can produce a rather immediate thumbs-up or thumbs-down on fiscal direction, such as we're talking about today. But in the U.S., we've got a divided Congress. We're in perpetual election mode, which leads to inaction.
And I'm not suggesting - I don't think Ms. Story is either - that we just do something ,because we should have a debate; the right policies are important, but we're kicking the can down the road as a nation. And I think that affects economic growth, and it affects the prestige of the United States on a global basis.
CONAN: Bill Gross co-founded the investment management firm PIMCO, and he joined us from Newport Beach, California. Thanks very much for your time today.
GROSS: Thank you.
CONAN: And Louise Story is a business reporter for The New York Times. She joined us from our bureau in New York City. Thanks to you as well.
STORY: Thank you.
CONAN: Coming up on The Opinion Page, the risks of pulling U.S. troops out of Iraq by the end of the year and the risks of staying longer. I'm Neal Conan. Stay with us. It's the TALK OF THE NATION from NPR News.
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